Reducing wildfire-related D&O liability risk

This article is co-authored by Marsh and Norton Rose Fulbright

Recent catastrophic wildfires in California and Hawaii have intensified public scrutiny of utilities and other companies that operate in areas susceptible to wildfires. These tragic events led to substantial regulatory penalties and damage awards to affected property owners and resulted in multiple shareholder lawsuits against individual directors and officers of public utilities for alleged securities disclosure violations and breaches of fiduciary duty.

While some of these director and officer (D&O) suits have been dismissed or remain pending, others have resulted in substantial eight- and nine-figure settlements. In light of these potential liabilities, D&O insurance underwriters have increased their scrutiny of environmental-related risks — including wildfires — when designing and pricing D&O insurance policies.

Considering the elevated scrutiny, companies operating in areas affected by wildfires would be prudent to maintain robust disclosure and governance practices in addition to taking responsible steps to reduce their wildfire-related risks. The line between an early dismissal and a substantial monetary settlement can be a fine one, underscoring the importance that companies exercise additional caution in preparing and reviewing their public disclosures with respect to wildfire-related risks. Boards should also take steps to ensure appropriate director-level oversight of wildfire and other environmental risks.

Recent wildfire-related shareholder litigation

Wildfire-related D&O cases are a subset of the event-driven shareholder suits that have proliferated in recent years. Event-driven suits are D&O claims that arise from adverse environmental, safety or other high-profile incidents that create unfavorable publicity and negatively impact the value of the enterprise.

Plaintiffs in event-driven securities class actions typically argue that the company’s prior disclosures underplayed the risks leading to the adverse event. Derivative plaintiffs and bankruptcy litigation trustees may also claim that directors and officers breached their fiduciary duties by exercising inadequate oversight of the risks in question.

Similar to the approach taken in other event-driven actions, counsel for plaintiffs in wildfire-related D&O suits will typically scour a company’s public statements in the years preceding the wildfire to identify statements that arguably underplay the risk of wildfires or exaggerate the company’s preparedness. Any public statements by a public company in any public forum may be subject to scrutiny by securities plaintiffs. In addition to SEC filings, earnings call transcripts and other traditional investor-focused communications, plaintiffs may scrutinize public statements in other forums, such as media interviews, filings with utilities regulators, public testimony, website disclosures and any other public forums where wildfire-related issues are discussed.

Types of statements that may be challenged as misleading

There are multiple types of statements that plaintiffs may allege to be misleading. These include:

Maintenance-related statements

Plaintiffs will look for public statements that arguably overstate the consistency and effectiveness of the company’s wildfire-related maintenance practices. For example, plaintiffs may attack a utility’s pre-wildfire representations about how often equipment is inspected or upgraded and question whether the utility’s actual practices are consistent with the representations.

Statements regarding vegetation management

Plaintiffs will also scour for statements that allegedly overstate the extensiveness and effectiveness of vegetation management practices. Companies should exercise care to make sure such statements are factually supported and do not overstate the company’s actual efforts in reducing risk from overgrown vegetation.

Statements regarding consultants, monitors and remedial measures

Securities fraud plaintiffs may also attack public disclosures regarding the retention of consultants or monitors — or the development of plans for enhanced wildfire risk mitigation measures after prior wildfires — through allegations that the company failed to implement the recommendations or enhancements. Announcements of measures intended to mitigate wildfire risks may also come under increased scrutiny, especially if plaintiffs argue that the company failed to implement promised plans.

Risk disclosures

Plaintiffs may also assert that wildfire-related risk disclosures are misleading because they suggest the risks are based on future occurrences rather than existing maintenance or safety deficiencies. In addition, plaintiffs may question whether risk disclosures about the impacts of climate change and extreme weather on wildfire risk are misleading for allegedly deflecting blame from the company’s own safety practices.

Litigation disclosures

Plaintiffs may also attack wildfire-related litigation contingency disclosures on the grounds that they falsely convey that a company’s liability exposure is uncertain when this is already known.

Strategies for reducing wildfire-related D&O risks

Public companies that operate in areas susceptible to wildfires should exercise vigilance in their disclosure and governance practices to reduce D&O liability risk and maximize the prospects for early dismissal. In addition to taking responsible steps to reduce the underlying wildfire risks, companies should consider the following disclosure and governance steps to mitigate D&O liability risks.

• It is crucial that public disclosures not overstate what is actually happening on the ground regarding equipment maintenance, vegetation management and other wildfire-related safety issues. Companies should ensure there are robust communication channels between the persons responsible for public disclosures (including senior management) and those knowledgeable about the company’s maintenance and safety efforts.
• Companies should be candid about existing wildfire-related compliance and safety shortcomings when drafting risk disclosures and in making other wildfire-related disclosures. It is prudent to steer away from boilerplate risk disclosures and avoid conveying the impression that compliance or safety deficiencies are merely hypothetical future possibilities if there are significant existing shortcomings.
• Companies should carefully review SEC filings and other public disclosures to ensure that stale disclosures about wildfire mitigation are not repeated if they are no longer supportable.
• Companies should consider forming a disclosure committee and/or centralizing management oversight of public disclosures to ensure the company is speaking consistently and truthfully about wildfire risks and mitigation efforts in all public communications. Companies should also consider having disclosure counsel involved in reviewing all public wildfire-related disclosures and not simply the SEC disclosures.
• Crisis planning for wildfire events should incorporate strategies for making disclosures in the immediate aftermath of a wildfire. This is particularly importance since companies often face intense pressure to provide information to the public in the days and weeks following a crisis event, which can increase the risk of misstatements unless the company is sufficiently prepared.
• Directors of companies operating in wildfire-prone areas should ensure robust board-level oversight of management’s plans for mitigating wildfire risk, including appropriate documentation in board minutes and materials to confirm these issues are considered on a regular basis. There is a growing trend of plaintiffs in shareholder derivative suites using books and records demands to obtain board records in advance of litigation, underscoring the importance of robust board-level records to maximize the prospects for dismissal.
• Companies should engage an experienced insurance advisor or broker to help them prepare ahead of meetings with D&O insurance underwriters to discuss the company’s strategy for minimizing wildfire-related D&O risk. D&O underwriters may ask specific questions on wildfire risk, including casualty limits purchased, wildfire safety protocols and corporate governance around public statements on this issue.

As wildfires continue to threaten residents in California and other states, organizations operating in those areas will face additional pressure to minimize D&O risks arising from wildfire-related disclosure and governance practices. As with other risk areas, a robust D&O insurance program can help protect your directors and officers from the liability risks posed by the growing frequency and severity of wildfires.