Climate-change risks for company leaders

Introduction

Climate change is making it more risky to serve as a director or officer of some energy companies.

The fund set up to pay victims of California wildfires is suing 22 former executives and board members of PG&E Corporation, the parent company of the electric and gas utility that serves northern California, for their failure to take actions that could have prevented the wildfires. The suit had been on hold while PG&E was in bankruptcy, but resumed moving forward in late February.

Lawsuits are proliferating after a cold snap in Texas in February left millions without electricity and water and caused a number of deaths.

Companies buy directors and officers insurance, and corporate articles and by-laws typically contain indemnification provisions. But these protections are not bullet-proof.

Directors and officers have a fiduciary duty to the company to exercise adequate oversight of company affairs.

They also have a duty of loyalty to the company.

If directors or officers breach these fiduciary duties, they can be sued for the resulting losses by the company. However, in practice, it is more common that the company itself does not sue and that instead a shareholder seeks to sue derivatively on the company's behalf, particularly where a company suffers heavy losses.

Of course, claims for damages are not the only sort of liability company leaders may face for misconduct. For example, two executives of a South Carolina utility company pled guilty to criminal charges in 2020 for their roles in misleading investors about the status of a nuclear power plant that was facing major cost overruns and construction delays. (For more details, see “Charges against corporate officers” in the April 2020 NewsWire.)

California

The lawsuit against 22 former PG&E directors and executives claims they breached their fiduciary duties to PG&E and should be held liable for subjecting it to billions of dollars of damages and loss of market capitalization resulting from the 2017 North Bay Fires and the 2018 Camp Fire. The suit was originally filed as a shareholder derivative suit in 2018, but was put on hold by the courts to allow time to sort out conflicting creditor claims after the company filed for bankruptcy.

As part of the bankruptcy plan approved last year, PG&E assigned its claims against the former board members and officers to the Fire Victim Trust, the entity created to administer and distribute funds set aside to pay fire victims on their claims against PG&E. The bankruptcy stay has been lifted and the trustee, who has taken over as the plaintiff, filed an amended complaint and is proceeding with the action.

The core theory in the lawsuit is that the former directors and officers prioritized short-term profits (and lining their own pockets with lavish compensation and bonuses) over incurring the costs of safety and regulatory compliance. The complaint provides a detailed account of PG&E's repeated risk-management failures and safety violations that the complaint claims led to the 2017 North Bay Fires and the 2018 Camp Fire.

The California Public Utilities Commission found that the 2018 Camp Fire was caused when a 100-year-old, outdated and worn "C-hook" broke, causing a pole, wires and other equipment to fall to the ground and ignite the fire. PG&E was found to have violated 12 public utility regulations and codes, pled guilty to multiple felonies, and was fined more than $2 billion.

The lawsuit against the directors and officers claims they breached a duty to exercise reasonable care by failing to ensure inspection and maintenance of PG&E's equipment such as the aged C hook. The suit also says that PG&E knew that one of its transmission lines involved in sparking the fire was a hazard and had determined that the line needed maintenance. However, PG&E cancelled maintenance on the line in 2014 and there were no subsequent climbing inspections of the line.

As to the 2017 North Bay Fires, the suit claims the officers and directors failed to ensure that PG&E complied with California Public Utilities Commission regulations for keeping power lines cleared of vegetation. They allegedly compounded that failure by failing to ensure that PG&E installed a power shut-off system for use during high-wind periods. Such power shut-off systems are critical during high winds because of the risk that trees will make contact with power lines and start fires. The complaint alleges that PG&E should have installed a power shut-off system in 2017 because it was six years behind at the time on its vegetation management program.

PG&E's directors and officers also allegedly failed to ensure that the company took other critical risk-management measures, such as reprogramming circuit breakers so that they would not automatically re-energize power lines in order to avoid fires caused when trees or limbs contact power lines and cause outages. The complaint claims that the directors and officers knew these conditions posed an unacceptable risk and that a de-energization program was needed during extreme fire danger conditions, but failed to ensure implementation of the necessary programs in compliance with applicable regulations and standard.

The suit charges that this was all a product of the directors' and officers' fostering an environment in which safety and regulatory compliance were sacrificed to improve corporate profitability (and their own incomes), resulting in corporate liabilities that exceeded the entire market capitalization of the company by billions of dollars.

Texas

The recent events in Texas, where blackouts left millions of customers without power for days amid bitterly cold temperatures, have not yet given rise to similar actions against directors and officers. But they have already spawned a raft of other lawsuits and investigations and, by all accounts, there will be many more.

To date, the actions filed include wrongful death claims and class actions filed against the Electric Reliability Council of Texas and against a number of power companies alleging failure to prepare properly, despite prior warnings, for cold weather.

Another electricity provider accused of price gouging was hit with both a class action seeking over $1 billion in damages and a suit by the Texas attorney general. The largest power cooperative in Texas filed for bankruptcy protection. Prosecutors have announced criminal investigations into the power outages.

If the companies involved suffer significant losses as a result of the fallout from the blackouts, derivative suits alleging oversight failures against directors and officers, particularly of public companies, appear likely to follow.

D&O insurance

D&O insurance policies generally cover damages and legal fees if the director or officer is sued personally for alleged wrongful acts related to their company roles. The policies also usually also provide coverage to the company itself.

Policies also cover both current and former directors and officers. D&O policies are usually "claims made" policies, which means they provide coverage only if the claim is made while the policy (including any extended coverage period the company purchases) is in effect.

While D&O policies are not uniform, there are important limitations on coverage that may affect whether or to what extent a policy covers any particular claim.

First, depending on the size of the claims and the number of persons sued, the policy's dollar limits may or may not be adequate to cover all of the liability and defense costs. This is particularly apt to be an issue where the losses are catastrophic and the lawsuit targets a large number of directors and officers.

Second, there are typically coverage exclusions that may eliminate coverage, depending on the specific policy language and the precise claim.

For example, policies generally exclude coverage for intentional, willful or deliberate misconduct or criminal acts. This might eliminate coverage, for example, for intentionally implementing a program of regulatory non-compliance. This exclusion may be subject to a "final adjudication" requirement, so that it is not triggered until there is a final court decision finding such misconduct, and the insurer has to fund defense costs until there is such a determination. However, if there is ultimately a final adjudication of such misconduct, then the insurer may be entitled to recover amounts it paid to defend the director or officer.

The policy may also exclude coverage for claims by one insured against another insured; unless there is an appropriate exception to the exclusion, it could eliminate coverage for shareholder derivative actions.

Further, the policy could exclude bodily injury and death which, depending on the specific language, could eliminate coverage where the company losses at issue arose from wrongful death or bodily injury claims.

Third, an insurer may be able to restrict or eliminate coverage where information about the activities and risks was known before the policy was purchased, but was not disclosed to the insurer during the insurance application process.

Fourth, the insurance may not include coverage for punitive damages and, depending on the state, may be prohibited from offering such coverage.

Applying these and other coverage exclusions and limitations will depend heavily on the exact language of the D&O policy and the factual details of the claim.

Corporate indemnification

Directors and officers may also be protected by corporate articles and by-laws indemnifying them against claims concerning their corporate roles, or, for directors, exculpating them from liability. But these provisions also have significant limitations.

State corporation laws typically authorize, but do not require, corporations to indemnify directors and officers for damages and legal expenses related to claims concerning their corporate roles.

However, state law generally bars indemnifying intentional misconduct. For example, Delaware's statutes permit indemnification only if the director or officer acted in good faith, reasonably believed his or her actions were not opposed to the best interests of the company and had no reasonable cause to believe his or her conduct was unlawful. Further, corporate indemnification may be of little value if the corporation is bankrupt, leaving the directors and officers with unsecured claims against the bankrupt estate.

State laws generally permit exculpation — the elimination of monetary liability — of directors, but not officers, for breaches of their fiduciary duty of care (for example, for simple negligence).

The advantages of this over indemnification are that it potentially permits a motion to dismiss such claims at an early stage, before expensive discovery, and that it is unaffected by the corporation's bankruptcy since it is not a claim for payment by the corporation. But states typically bar exculpating directors for breaches of the duty of loyalty, bad faith, intentional misconduct, violations of law or transactions in which the director derived an improper personal benefit.

Board members

Anyone who serves or is asked to serve on the board of a company that could be charged with contributing to climate-related disasters should take steps to insulate himself or herself from liability for fiduciary-duty claims.

Most importantly, he or she should closely examine the pertinent company policies and programs — including regulatory-compliance policies and programs for identifying and addressing climate-related operational risks — and the company's implementation of those policies and programs.

Directors should actively engage with management to assure that risks are minimized and that compliance programs are real, robust and effective. It may be appropriate to increase the frequency of meetings where these issues are addressed. Further, directors should assure that their oversight activities, including discussions, analyses and plans, are appropriately documented.

Further, directors and officers should make sure that the D&O coverage that the company has in place is adequate, both as to the amount of coverage and as to the policy's terms. They may consult with the company's internal insurance professionals or its broker to understand the relevant terms of coverage and assess whether more favorable terms are available in the market and at what cost.

Finally, directors and officers should also examine the corporation's indemnification and exculpation provisions. To the extent those provisions do not afford the maximum protection permitted by state law, they may want shareholder approval for amended provisions that do so.

These steps may not guarantee immunity to future fiduciary-duty claims, but they will aid in defending against any such claims and in maximizing the protection afforded by D&O insurance and corporate indemnification and exculpation provisions.