Article
ESG, private enforcement and strategic litigation in times of war
What to consider in the context of proper business management?
(article also available in German)
ESG (Environmental, Social and Governance) describes the fundamental principles of sustainable business. Stakeholders have increasingly high expectations of a company’s ESG performance. While recently, due to the climate crisis, ecological sustainable management was the most prominent of the three ESG criteria, Russia’s war in Ukraine confronts domestic companies with new fundamental questions in the area of ethical corporate governance and integrity. How should existing business relations with Russia be handled? Is doing business with and in Russia still socially acceptable? Is my company still able to act in an ESG-compliant manner?
Current developments primarily
Military goods embargoes, sector and goods/services-related restrictions as well as the restriction of the EU capital and financial market and payment transactions have already considerably limited the economic cooperation of many domestic companies with Russia. Meanwhile, more than 400 private sector leaders have joined the state sanctions and left Russia as a business location[1]. The list is long: well-known listed examples (among many others) are VW Group, Nestle, British American Tobacco, Unilever and Deutsche, but also US giants such as McDonald’s, Starbucks and Coca-Cola. Visa, Mastercard and American Express have also suspended their business with Russia.[2]
Their decisions to terminate contracts with Russian entities or in Russia are a strong social signal – but from a purely economic point of view controversial: Mastercard and Visa reportedly carried out around three-quarters of all debit and credit card payment transactions in 2020 in Russia.[3] McDonald’s, with three Russian subsidiaries[4], recently had over 900 locations in Russia and Ukraine, which together are reported to have contributed 2% to group sales and 3% to total operating profit[5] .
Is that good business judgement?
Members of the Executive Board shall exercise the diligence of a prudent and conscientious business manager with respect to the management of the company. This is the case if the Executive Board member is not guided by extraneous interests when making a business decision and may assume, on the basis of appropriate information, that he or she is acting in the best interests of the company (“business judgement rule“).
Does a board that leaves a functioning market for societal reasons act for the good of society? How can such a drastic business decision be presented within the framework of the obligation towards profit-oriented shareholders?
With ESG performance having a significant impact on the market capitalisation, cost of capital and investment activity of many large corporations, the key term may be social responsibility: many corporations and companies have made extensive commitments to act ethically and with integrity in addition to aiming at climate goals as part of ESG. The response to Russia’s war now puts such declarations into public consideration and shows whether companies are living up to their stated purpose and social values. In the EU, tighter legislation is to be expected: The Commission’s proposal for a new directive on comprehensive due diligence in relation to sustainability and human rights was adopted on 23 February this year[6].
Corporate governance and ESG values under scrutiny?
By way of example: The US oil company Exxon Mobil has committed itself to the highest level of integrity by means of corporate governance in a Code of Ethics[7], even where the law allows otherwise. Now, Exxon Mobil is actually one of those corporations that is more or less completely withdrawing from the Russian oil and gas business[8]. The fact that Exxon Mobil is fulfilling its promise to act ethically despite a promising project in Russia and is announcing its withdrawal for reasons of ethical and social responsibility isunderstandable in the light of the company’s experience with ESG litigation: due to environmental, i.e. climate protection issues, the oil company has already had to struggle with ESG law enforcement. In the USA, a civil lawsuit was filed by way of private enforcement in which a village in Alaska sought damages from Exxon Mobil, BP and other companies active in the energy sector for negative impacts of climate change[9]. Although the lawsuit was ultimately unsuccessful, the negative media effect was undeniable. This is one of the goals of strategic litigation. The aim is to raise awareness of ESG issues in society as a whole, above and beyond the individual case, in order to exert pressure on political decision-makers and market participants to take action. Most recently, Exxon Mobil was in the focus of stock market reporting in connection with ESG shareholder activism: because the management did not sufficiently adapt the business strategy to global efforts to combat climate change, small hedge funds succeeded in removing two Board members in May 2021[10].
In the same vein, shareholder activist ClientEarth recently informed Shell’s Board of a possible lawsuit for inadequate preparation of the company to transition to net-zero production and manage climate risks. ClientEarth believes this raises serious questions about the long-term value of the company. ClientEarth is urging institutional investors to join or support the lawsuit ahead of Shell’s Annual General Meeting.
The power of public criticism in connection with business in Russia is demonstrated by the case of Coca-Cola. While the company was recently criticised for not withdrawing from Russia, their strategy changed within a very short time when the hashtag #BoycottCocaCola briefly became one of the most used on Twitter. After a few days, the world’s largest beverage producer gave in to the pressure and announced that it would withdraw from Russia for the time being.[11]
“Bad” Business – should I stay or should I go?
Despite sanctions and partly because of negative publicity, some companies are currently making a conscious decision not to leave the Russian market[12]. Outside the scope of the currently existing export sanctions[13] this is permissible so long as the criteria of the Business Judgement Rule are taken into account, i.e. the decision is taken ex ante for the benefit of the Company.
Nevertheless, even in the supposed safe haven, caution is advised: ESG is often a useful tool for activists to push agendas regardless of true goals and intentions. Although it is (still) unclear whether stakeholders are willing to resort to private enforcement or shareholder activism inthe context of humanitarian issues such as the Ukraine-Russia war, it is likely. Many financially motivated activists are keen to use ESG issues to gain support from institutional investors. As the number and size of ESG-focused funds continues to grow, so will the opportunities for other activists in order to maximise the impact of corporate attacks for their own purposes.[14] It is likely that the war in Ukraine and the ethical viability of corporate strategy in this context will also be such a connecting point for activists.
We are leaving: how does the withdrawal work?
If the fundamental decision to withdraw is made, further steps must not be taken rashly. If Austrian law is applicable in the relationship with the Russian contractual partner, each contract must be analysed and processed separately. In the absence of special regulations that entitle the termination of the contract, such a termination of business relations could be presented for the following reasons:
- Force majeure: Force majeure is an external, unavoidable event for which the parties are not responsible and which was not foreseeable at the time the contract was concluded (OGH 1 Ob 93/00h). This typically includes natural disasters, (particularly recently) pandemics, but also war.
- Omission of the basis of business: The basis for the transaction is the typical underlying circumstances that are assumed by the contracting parties to exist. With respect to the Ukraine war, for example, the basis of the transaction could be the conduct of the Russian state in accordance with international law, whereby further criteria such as unforeseeability, unreasonableness of the continuation of the contract and alienation of spheres (RKO0000034) must also be present.
- Loss of trust: A contract can be terminated without granting a period of grace if the contractual partner has acted in breach of trust or the contract, which has led to a loss of trust that makes the continuation of the contractual relationship appear unreasonable (RS 0111147; OGH 5 Ob 120/21i). It should be noted that in this case the contractual partner must always have been the cause of the loss of trust, which in the case of the war in Ukraine would require a particularly precise examination.
Conclusion
When considering whether further business with Russia as a business location is in the best interests of the company, the Executive Board must also consider from an ESG perspective whether business with partners in countries that violate international law should be maintained. It must be accountable to shareholders and the Supervisory Board for decisions in this regard. The reasons for and against maintaining contracts vary from sector to sector and must be examined on a case-by-case basis.
Whether the decision is in favour of or against withdrawal from Russia, the management will have to address questions on this issue at upcoming general and shareholders´ meetings. This is especially relevant in the light of the EU’s legislative plans in this regard. If trust is withdrawn, there is the threat of dismissal and, in the case of default, claims for damages under the Act on Stock Corporations (Aktiengesetz) or the Austrian Limited Liability Act (GmbHgesetz).
[1] Over 400 Companies Have Withdrawn from Russia-But Some Remain | Yale School of Management
[2] Consequences of the war of aggression: These companies are leaving Russia | tagesschau.de.
[3] Consequences of the war of aggression: These companies are leaving Russia | tagesschau.de.
[4] 2020 Annual Report.pdf (mcdonalds.com).
[5] McDonald’s: Strong Russian commitment hits the share price – DER AKTIONÄR (deraktionaer.de)
[6] ANNEX to the proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937.
[7] Code of ethics | ExxonMobil.
[8] ExxonMobil to discontinue operations at Sakhalin-1, make no new investments in Russia.
[9] Native Village of Kivalina v. ExxonMobil Corporation et al, 696 F.3 d 849 (9th Cir. 2012), Weller/Tran, Climate Change Lawsuits in legal comparison Law – Private Enforcement as a Global Trend?
[10] Exxon loses board seats to activist hedge fund in landmark climate vote | Reuters.
[11] Coca-Cola: Withdrawal from Russia – Share under pressure – DER AKTIONÄR (deraktionaer.de).
[12] Over 400 Companies Have Withdrawn from Russia-But Some Remain | Yale School of Management.
[13] Current status of sanctions against Russia and in relation to Ukraine – WKO.at
