Climate Change: Directors’ and officers’ risk ahead?

For years, environmental issues, including issues arising from global warming, have hovered on the periphery of concerns affecting directors’ and officers’ liability exposure. But an April 2, 2007, decision by the U.S. Supreme Court, together with a confluence of other causes and concerns, may mean that corporate officials and their insurers may no longer have the luxury of treating global climate change as a peripheral concern.

A short time ago, I would have had very little patience with an article like the one that follows. I cannot abide alarmists who try to convert peripheral concerns into major crises. But the developments described below persuade me that these issues are no longer peripheral and must be confronted.

The most important factor in this revised view is the U.S. Supreme Court’s ruling in Massachusetts v. EPA. The Court held that the U.S. Environmental Protection Agency had violated the Clean Air Act by declining to regulate new-vehicle emissions. The Court’s actual holding is narrow; the Court did not direct the EPA to issue regulations, but rather said only that the EPA “must ground its reasons for action or inaction in the statute.”

While the Court’s holding is narrow, two aspects of the decision are very important. The first is the Court’s conclusion that Massachusetts’ interest in global climate change was sufficiently particularized to permit the state to have “standing” to bring its claim. The second is the Court’s holding that greenhouse gas emissions are “pollutants” under the Clean Air Act. These elements, taken in their full political, cultural and economic context, mean that the decision could represent a turning point in the climate change debate in this country.

In the past, litigants who sought to assert global warming claims based on allegations of generalized harm have failed because their claimed injuries have been held insufficiently particularized to support a justifiable controversy. The Supreme Court’s holding that the alleged harm to Massachusetts from global climate change was not too diffuse but will influence future courts’ ruling on the criteria that must be established for litigants to bring climate change claims.

The Court’s holding that greenhouse gas emissions are indeed “pollutants” is broadly applicable to a wide variety of industries. Most immediately, this holding will impact a host of lower court cases that had been stayed pending the outcome of Massachusetts v. EPA. It will also put pressure on the EPA to introduce some form of greenhouse gas emissions regulation, or cede control of the issue to a newly reconstituted Congress that has already made clear that climate change is a top legislative issue. Barring that, the states, which are already racing ahead of Washington on these issues, may set the standard.

At the same time, the press has been full of reports underscoring the increasing political and social pressures that are accumulating around this issue. For example, on April 6, 2007, the Intergovernmental Panel on Climate Change released its latest report on climate change impacts, raising even more alarming concerns regarding global warming. In addition, recent debates before the U.N. Security Council addressed political, security and military threats that may arise from global climate change. While there may be a continuing scientific debate on the question of whether or to what extent global temperature changes are caused by human activity, events may have already overtaken the scientific debate. Indeed, a coalition of American businesses, in recognition that governmental action in this area is now inevitable, recently took steps to try to get ahead of the political debate and proposed their own regulatory approach to greenhouse gas emissions.

The bottom line is that greenhouse gas emission regulation is coming. Where this issue becomes a D&O risk for publicly traded companies is through their continuing disclosure obligations. Under Item 101 of Securities Exchange Commission Regulation S-K, publicly traded companies must disclose current and anticipated material effects from compliance with environmental regulations. Under Item 303 of Regulation S-K, companies must disclose “any known trends or uncertainties” that could have a material impact on their business or operations.

Because of those disclosure obligations, many public companies will face the increasing challenge of articulating the impact of greenhouse gas emission regulation, legislation and litigation on their business and operations. While that challenge most obviously affects companies in the automobile manufacturing and utilities industries, other affected industries could include transport, mining, energy, insurance and shipping, as well as any other business whose operations involve or are impacted by greenhouse gas emissions.

The disclosure obligations create a context within which it is prudent to assume that D&O claims will arise, for example, for failure to disclose adverse regulatory impacts or costs.

D&O policies typically contain a pollution exclusion, often described as an “absolute” pollution exclusion. Although it is an interesting question whether the standard pollution exclusion would actually preclude coverage for a claim arising out of greenhouse gas emissions, most pollution exclusions these days also include a coverage carve-back for derivative and shareholder lawsuits. In addition, some Side A difference in conditions (DIC) forms have narrower pollution exclusions or omit the exclusion altogether, which would allow the Side A DIC policy to provide drop down coverage under certain circumstances. The fact that this insurance coverage program must anticipate claims of a type that may not have arisen previously underscores the importance of enlisting the assistance of skilled D&O insurance professionals in the D&O insurance transaction.

The bottom line is that this once peripheral issue may be moving to the center in the months ahead. The time for D&O insurers and policyholders to prepare to address these issues is now.

Kevin M. LaCroix is an attorney and a director of the OakBridge Insurance Services, Beachwood, Ohio, office. An earlier version of this article appeared on LaCroix’s Internet Web blog, the D&O Diary. http://dandodiary.blogspot.com. E-mail: klacroix@oakbridgeins.com. Phone: 216-378-7817.