ESG issues are front and centre in many sectors and many boardrooms. The UK real estate sector is no exception. Unsurprisingly, the principal focus has been on the "E", with the environmental aspects of developing and operating buildings in the United Kingdom being the most prominent. That is not to suggest that companies and investors are unconcerned by social or governance issues in the sector, but there has been much more written on the environmental impacts of the built environment. However, litigation risks, often resulting from the gap between publicly announced aspirations and actual achievements, are as relevant to the UK real estate sector as in many other sectors, such as fossil fuels or chemicals, which tend to attract more attention.
This White Paper explores recent legal challenges to companies based on gaps between aspirations and achievements and applies them to the UK real estate sector. It also considers environmental and other ESG risks (and opportunities) in the UK real estate sector. As companies formulate their own aspirations and plans for the future, they should keep these issues in mind.
FERTILE GROUND FOR LITIGATION: THE GAP BETWEEN ASPIRATION AND EXECUTION
The lessons of broader climate change litigation are evident. Whether based on alleged damage to the environment or claims of "greenwashing", novel legal theories have been deployed to pressurise, challenge and seek redress from governments and, more recently, businesses. First to be targeted were entities from the oil and gas sector, but now we are seeing claims being brought against companies in various sectors such as pension funds, banks, automotive groups, consumer groups and chemical groups. The UK real estate sector is not immune and may well be next.
Where is the greatest risk for those involved in the UK real estate sector? It is probably not in the direct climate change claims faced by fossil fuel businesses elsewhere. But it may well emerge as a result of the often well-intentioned, and wellpublicised, aims, aspirations or promises made by the real estate sector around sustainability.
There is a clear and, for many, long-overdue focus on sustainability within the wider economy and in the real estate sector. It is not as if environmental considerations are new to the real estate world—environmental impact assessments have been a feature of new developments in the United Kingdom since the late 1980s, for example, and, before that, building regulations have included limits on thermal energy performance since the 1960s. However, there is now an unprecedented level of attention on sustainability. Whether from regulators, third-party investors, consumers, tenants, shareholders or from within boardrooms, the emphasis on sustainability is everywhere. But with ESG litigation growing in many other jurisdictions, it is most definitely a case of "mind the gap"—any delta between words and deeds presents risk for those involved in the UK real estate sector.
So why does it matter if a company does not adhere to its own public ESG commitments? For companies listed in the United Kingdom, a good demonstration of this risk is the recent case of Autonomy and others v Lynch and another [2022] EWHC 1178. This involved a claim against two former executives indirectly made under section 90A of the United Kingdom's Financial Services and Markets Act 2000 ("FSMA"). This provision provides that, in certain situations, an issuer of securities is liable to pay compensation to an investor if they relied on published information containing untrue or misleading statements. There is no exclusion for ESG statements. The case was the first time the English High Court had considered this type of claim at a full trial. Whilst the case was not a direct ESG claim by shareholders (it was a post-closing M&A dispute brought by the relevant company itself), it illustrates the mechanism that shareholders could potentially use to seek redress for inaccurate ESG disclosures. Section 90 of the same Act, the sister provision to section 90A which applies to listing particulars, may also be used by such claimants to bring a cause of action. A detailed discussion on the requirements of FSMA is beyond the scope of this White Paper, but listed companies should take note. ESG litigation is not, though, restricted to just listed entities in the United Kingdom, as we explore further below.
The Gap Used as a Challenge to the Board
There have been two recent, and notable, ESG cases seeking to challenge boardrooms in the United Kingdom. In the event, neither was granted permission to proceed (though one case may still be appealed). Both serve as examples of the types of claims that may be brought against a board, and of the significant challenges claimants (or groups of claimants) will have to overcome in the United Kingdom to successfully make them.
The first case, filed in 2021, is McGaughey and Others v Universities Superannuation Scheme Limited (USS) and Others, in which a group of individuals sought permission from the court to bring an action against the board of a pension scheme for, amongst other allegations, a failure on the part of the directors to create a credible plan for disinvestment from fossil fuel-related asset classes.
In a judgement handed down on 24 May 2022, the High Court refused permission for the claim against USS to proceed on the basis that the claimants had not demonstrated (as an evidential matter) that USS has suffered any immediate financial loss as a result of the alleged failure to adopt an adequate plan for long-term divestment of investment in fossil fuels. The Court believed there was also a failure to show that the claimants themselves had suffered loss (a further evidential point). The Court further found that USS's adopted ambition of net zero by 2050, with policies for working with the companies in which it invests in the meantime, was "well within the discretion of the Company in exercising its powers of investment". The decision to dismiss the application for permission to continue this claim as a derivative action was upheld by the Court of Appeal on 21 July 2023 (McGaughey & Ors v Universities Superannuation Scheme Limited [2023] EWCA Civ 873).
The second case, filed in 2023, was ClientEarth v Shell Plc and others, in which an environmental charity with shares in Shell sought the permission of the English court to bring a derivative action against the Shell board of directors for breach of directors' duties, claiming that the board were fundamentally mismanaging the physical and transitional impacts of climate change. In judgments handed down on 12 May and 24 July 2023, the High Court refused permission for the claim against Shell to proceed. The Court found that ClientEarth had not demonstrated a prima facie case against Shell's directors. The subjective nature of directors' duties was stressed; it was for the directors themselves (acting in good faith) to decide how best to promote the success of the company for the benefit of its members, and to decide how much weight to give to the factors they are required by statute to consider. It was further found that the directors did not have a duty necessarily implied to have a plan in place to meet specific climate targets. ClientEarth have indicated that they intend to seek permission to appeal this decision.
While the claims against both USS and Shell were refused permission to advance, both the USS claim and the ClientEarth action are examples of the types of actions activist (or concerned) shareholders may seek to bring against a company's board. ClientEarth, in particular, has been vocal and open as to their legal strategy. Others may seek to follow it.
Such shareholder actions are not irrelevant to real estate operators. They are based, in part, on the codified duties of directors as set out in the Companies Act 2006, which applies to English real estate companies (special purposes vehicles or otherwise) just as much as they do to companies like Shell. Those duties include an obligation, in the context of the duty to promote the success of the company, to have regard to "the likely consequences of any decision in the long term" and "the impact of the company's operations on the community and the environment". With the permission of the court, shareholders are entitled to bring a claim on behalf of the company against a board of directors that breaches its duties. A director of a real estate company should consider the outcome of these judicial challenges with particular interest. The court's treatment of them is likely to be relevant to those operating in the real estate sector too.
The Risk for UK Real Estate Companies Is Not Just in the United Kingdom
The ESG disclosure landscape is changing rapidly, both in the European Union and in the United Kingdom. That creates group-wide risk for businesses of a kind which crosses borders. The EU Sustainable Finance Disclosure Regulation ("SFDR") which, amongst other things, determines how funds are classified in mandated disclosures, came into effect (in part) in March 2021. Whilst the SFDR has not been adopted into UK law post-Brexit, there are a number of ways in which it could be relevant to UK firms, either as a requirement (for example, where funds are marketed into the European Union under national private placement regimes) or for practical reasons (such as investor pressure to comply). There is also further regulation on the horizon in the United Kingdom, such as the Sustainability Disclosure Requirements the UK Government is presently considering.
Reporting aligned to the recommendation of the Task Force on Climate Related Financial Disclosures ("TCFD") adds to the burden of ESG reporting requirements and opens up new risks associated with accuracy of disclosures and the mitigation of physical and climate risks to corporate operations, including real estate. In the United Kingdom, TCFD has gained traction as the UK government has committed to fully aligning climaterelated reporting obligations with the TCFD regime. Therefore, it is expected that the UK regulators will, over time, require a combination of TCFD and the reporting requirements ultimately produced by the International Sustainability Standards Board. Currently, companies listed on the main market of the London Stock Exchange have been required to make TCFDaligned reporting since January 2022 on a "comply or explain" basis. The TCFD disclosure requirement is being extended to additional companies (as well as large asset managers) over time. In addition, the outputs of the Transition Plan Taskforce, expected later in 2023, are likely to lead to more specific requirements for climate transition plans in the private sector, again increasing accountability for organisations to back up disclosures with action.
UK companies subject to reporting requirements in the United States will have additional, and sometimes varying, reporting obligations from the UK requirements. In March 2022, the U.S. Securities and Exchange Commission ("SEC") proposed rules that, if adopted as proposed, would require covered companies to provide specific climate-related information in their registration statements and periodic reports filed with or furnished to the SEC, including disclosures regarding direct (Scope 1), indirect (Scope 2) and, for certain companies (i.e., if material or if the company has set a related goal or target), up-and-downstream value chain (Scope 3) emissions. The SEC's proposed rules would depart from the SEC's historical regulation of SEC-reporting foreign private issuers (or "FPIs"), which has largely deferred to applicable home country rules and provided significant phase-in periods for FPIs, instead imposing specific disclosure obligations on foreign companies reporting in the United States.
Scope 3 emissions disclosure requirements under the SEC's proposed rules raise a number of issues for UK companies subject to reporting in the United States, including because: (i) such companies would be required to make a judgment call as to "materiality" under U.S. law that may not conform to other jurisdictions' legal frameworks; (ii) other frameworks and regulators may apply different, and potentially contradictory, emissions measurement and reporting standards; and (iii) UK companies are likely to face practical difficulties associated with accurately collecting information regarding their supply chain in accordance with the SEC proposed rules, since their third-party providers and other members of their value chain are less likely to be subject to U.S. securities laws and may not collect or report their own Scope 1 and 2 emissions data, necessary to calculate Scope 3 emissions.
Whilst not all underlying companies are subject to these regulations and requirements, they can create a waterfall effect, where a fund will look to the underlying companies and their assets (wherever based) in which it invests to help it meet the required characteristics. More directly, for companies with operations in the European Union, even if the corporate HQ is located elsewhere, new requirements are firmly on the horizon as part of the European Union's "Green Deal" package. These primarily take the form of the Corporate Sustainability Reporting Directive, or CSRD, set to phase in over the next several years (expanding the preexisting Non-Financial Reporting Directive to a materially greater number of large companies doing business in the European Union) and the Corporate Sustainability Due Diligence Directive ("CSD3D"), which will require in-scope companies to take certain steps, such as adopting a plan ensure that their business strategy is compatible with limiting global warming to 1.5°C in line with the Paris Agreement, adopting due diligence policies and taking more disruptive action such as ending contractual relationships where adverse impacts on the environment cannot be stopped or mitigated.
There is also a feedback loop for companies subject to both the EU and the SEC proposed rules, for example for a UK company with substantial continental European operations that also has listed securities or is a registered company in the United States. Upon being required to "adopt a plan" to align with the Paris Agreement under the CSD3D, such company would also in its U.S. filings (pursuant to the SEC's proposed rules) be required to provide significant disclosure regarding its plan, including the relevant metrics and targets used to identify and manage physical and transition risks.
These additional regulatory requirements will likely put increasing pressure on UK-based businesses to set out clearly their ESG policies and disclosures even if not caught directly. The CSD3D, for example, will (when in force) compel EU companies to seek contractual assurances from companies in their "value chain" (even if based outside of the European Union) that they will comply with the EU companies' code of conduct and due diligence policies. Walking the walk, though, is different from talking the talk, and UK companies putting in place policies without appropriate oversight (or action) may create their own pitfalls.
Click here to continue reading . . .
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
