Climate Change and D & O Risk
Let me acknowledge at the outset that a short time ago I would probably have had little patience with an article like this one. I cannot abide alarmists who try to turn peripheral concerns into major crises (see, for example, my prior post, here, decrying specious efforts to convert avian flu into a generalized corporate priority). But the Supreme Court’s recent opinion, together with a confluence of other causes and concerns, persuades me that many companies no longer have the luxury of treating global warming as a peripheral concern.
The most important (but by no means the sole) factor in my revised view of this topic is the recent U.S. Supreme Court ruling in Massachusetts v EPA. The Court held that the EPA had violated the Clean Air Act by improperly declining to regulate new-vehicle emissions standards to control carbon dioxide emissions that contribute to global warming. In and of itself, the Court’s ruling is somewhat narrow. Indeed, the Court declined to reach the question whether or not the EPA must reach “an endangerment finding” requiring regulation of carbon dioxide emissions in new vehicles. The Court held only that the EPA had “offered no reasoned explanation for its refusal to decide whether greenhouse gases cause or contribute to climate change.” The court remanded the matter to the lower court (and from there, to the EPA) with the direction that the EPA “must ground its reasons for action or inaction in the statute.”
While the Court's holding is narrow, there are two components of the Supreme Court's decision that are, however, very important. The first is the Court’s holding that the injury of which Massachusetts complained in bringing the suit was sufficiently particularized for Massachusetts to have "standing" to bring its claim. The second is that greenhouse gas emissions are "pollutants" under the Clean Air Act. These elements, taken in the case’s full political, economic and legal context, could mean that the decision will, in the words of the April 3, 2007 Washington Post article discussing the case (here), “serve as a turning point.”
Among the most important reasons the decision may serve as a turning point is the plethora of lower court cases that had been held in abeyance pending the outcome of Massachusetts v. EPA. The most important of these other cases is the Mass v. EPA companion case in the D.C. Circuit, Coke Oven Environmental Task Force v. EPA, No. 06-1322 (D.C. Cir., filed April 27, 2006) (refer here). Just as the Mass v. EPA case challenged the EPA’s inaction on new mobile source (i.e., automobiles) greenhouse gas emissions, the Coke Oven case challenges the EPA’s inaction on new stationary sources (i.e., utilities) greenhouse gas emissions. The Supreme Court’s holding in the Mass v EPA case that greenhouse gases are indeed pollutants under the Clean Air Act is broadly applicable to both mobile and stationary sources. In other words, the EPA’s regulatory response necessarily must carry implications for a broad range of industries. In addition to the Coke Oven case, other lower court cases on these and related issues were also held in abeyance, and will now go forward in light of the Supreme Court’s ruling in Mass v EPA.
In addition, a variety of state and federal cases either filed in the past or now pending have directly attacked the sources of greenhouse gas emissions (particularly automobile manufacturers and electric utilities) in several tort-based lawsuits, usually on public nuisance theories. The courts have largely dodged these cases in the past, invoking the principle that the claimants’ allegations of generalized harm are insufficiently particularized to support a justiciable controversy. The Supreme Court’s holding that Massachusetts had adequate standing to present a justiciable controversy could have a very significant impact on future courts’ rulings on jurisdictional standing and justiciability criteria that must be satisfied for litigants to bring climate change-based cases. (An interesting commentary on the Supreme Court's standing holding can be found here.)
The Supreme Court’s decision is only one of several important recent developments affecting these issues. The November 2006 election also dramatically changed the political landscape, and the Democratic majority in both houses of Congress has brought climate change to the top of the legislative agenda. Bills have already been introduced in both chambers to address climate change directly. While a congressional consensus on these issues may prove elusive, the states are in the meantime moving forward. California’s landmark Global Warming Solutions Act of 2006 is only one of several states' legislative initiatives in this area. A decision by the EPA to decline the Supreme Court's invitation to reconsider its decision not to regulate greenhouse gases could be the worst possible outcome for business, because it will spur Congress to action, and even barring that, invite action from the states, who are racing ahead of Washington on these issues. The Economist magazine has a good summary (here, subscription required) of the confluence of the legistaltive and regulatory forces on the issue of greenhouse gas emissions.
None of this has been lost on the business community. For example, on January 22, 2007, a coalition of ten companies joined several environmental groups to propose (refer here) a cap-and-trade program regarding greenhouse gas emissions.
All of these forces are likely to gain momentum in light of continuing developments, such as the Intergovernmental Panel on Climate Change’s April 6, 2007 release of its latest report (here) on climate change impacts, raising even more alarming concerns regarding global climate change (about which, refer here).
The point here is not merely some generalized concern about the changing cultural, political, regulatory, legislative and litigation context. The point is that all of these changes represent particularized concerns for many public companies, affecting their disclosure obligations under Regulation S-K. Two provisions of Reg. S-K are particularly applicable here, Item 101 and Item 303.
Item 101(c)(1)(xii) requires companies to disclose current and anticipated “material effects” of compliance with environmental regulations:
Appropriate disclosure also shall be made as to the material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries. The registrant shall disclose any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem material.As new EPA regulations and state mandates regarding greenhouse gas emissions accumulate, many companies may find themselves for the first time obliged to provide Item 101 environmental regulation impact disclosure, and other companies will be compelled to provide more extensive Item 101 disclosure than may have been the case in the past.
Item 303 requires companies to “describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenue or income from continuing operations.” There are an increasingly large number of increasingly important trends and uncertainties surrounding global climate change that will affect an increasingly greater number of companies, requiring these companies to adapt their Item 303 disclosure accordingly.
The type and range of financial consequences that might arise from global warming is a topic far beyond the scope of the blog format. A good summary of these topics can be found in the Association of British Insurers June 2005 report entitled "Financial Risks of Climate Change" (here). There is, in brief, no limit to the number of potential "risks, trends and uncertainties."
Because of these disclosure obligations, many public companies will face the increasing challenge of articulating the impact of global climate change regulation, legislation and litigation on their business and operations. Because of the extent of the impact (both probable and possible) and the prospect for developments that could have dramatically negative consequences for at least some companies, future shareholder litigation surrounding these disclosures necessarily must be anticipated. The various political, regulatory and litigation trends identified above will obviously affect companies in the automotive and energy generation businesses (and supporting industries), but emphatically not these companies alone. Other industries that seem likely to be affected include insurance, transportation, manufacturing, shipping, and other businesses whose operations have (or which could sustain) a substantial environmental impact, even if it is entirely localized. There are certainly other industries that are beyond my imaginative capacity to anticipate here.
In short, the public company disclosure obligations create a context within which it is prudent to assume that D & O claims may arise. To the extent claims do arise, the wording of applicable D & O policies could have an enormous impact on the availability of D & O insurance to defend and indemnify companies and their directors and officers.
D & O policies typically contain a pollution exclusion. I was surprised to observe, upon careful reading of several typical pollution exclusions for purposes of writing this post, that it is not obvious that the standard pollution exclusions were intended to pertain to greenhouse gas emissions or consequences arising therefrom. The term “pollutant” as used in many policies’ exclusions simply may not encompass greenhouse gas emissions. Indeed, there may be several arguments on which to contend that the standard pollution exclusion wording has no relation to greenhouse gas emissions or their environmental consequences. (Of course, whether or not such contentions would be persuasive to a court is a matter of pure conjecture, on which I do not opine.)
Nevertheless, assuming the exclusion would otherwise preclude coverage for claims pertaining to greenhouse gas emissions, the pollution exclusion in most D & O policies these days carves back coverage for derivative suits and shareholder claims. In light of the possible course of future litigation in this area, the wording of the pollution exclusion, and in particular the wording of the carve back for shareholder claims and derivative lawsuits, will be absolutely critical. The fact that this policy language must anticipate cases and claims of kind that may not have previously arisen underscores the importance of enlisting the assistance of skilled D & O insurance professionals in the D & O insurance transaction.
A good resource in this area is the article by J. Wylie Donald and Loly Garcia Tor of the McCarter & English law firm entitled “Climate Change and The D & O Pollution Exclusion” (here).
A good round up of blog commentary on the Massachusetts v. EPA case can be found here. A round up of press coverage about the case can be found here.
Connecticut Law School Conference: On Thursday April 12, 2007, I will be participating on a panel at a conference at the University of Connecticut Law School. The conference is entitled “D & O Insurance: Shareholder’s Friend or Foe?” and the panel on which I am participating is entitled “Can Insurers Reduce Securities Litigation Risk?” Further information about the conference can be found here. Prior D & O Diary posts on the topic of D & O insurance and corporate governance can be found here and here.
Weather Central: If the rest of the world must learn to adapt to extreme weather as a result of climate change, they may want to spend a little time here in Cleveland. For the first time in recent memory we missed a White Christmas last year, but by God we are going to "enjoy" a White Easter this April. The rest of the country has no absolutely no idea how chilling is the phrase "The lake effect snow machine is engaged and stalled over the lakeshore." The old story about the Eskimos having dozens of words for "snow" undoubtedly is true, but kindred spirits here understand that almost all of the "snow words" would be unsuitable for a family-oriented blog.