ESG and Due Diligence – An Overview

Kiran Malik

22 Mar, 2023

Environmental, Social, and Governance (ESG) factors have become increasingly important for companies operating in high-risk markets or industries. Due to the potential risks associated with these markets, such as corruption, human rights abuses, and environmental damage, companies have a legal responsibility to conduct thorough due diligence to mitigate these risks. Failure to do so can result in legal liabilities, reputational damage, and financial losses. In this blog, we will explore the legal risks and responsibilities that companies face in high-risk markets or industries, and the importance of prioritizing ESG and due diligence to fulfill these responsibilities.

ESG Factors and Due Diligence

ESG factors are a critical consideration for companies conducting due diligence in high-risk markets or industries. Environmental factors, such as pollution and deforestation, can result in legal liabilities for companies that fail to mitigate these risks. Social factors, such as human rights^[1] abuses and labor violations, can also lead to legal consequences for companies that do not take adequate measures to prevent or address these issues. Governance factors, such as corruption and lack of transparency, can result in criminal liabilities for companies.

ESG factors can affect legal risks in several ways. Firstly, companies that do not take adequate steps to prevent or mitigate ESG risks may be in breach of local laws and regulations. Secondly, failure to address ESG risks can lead to harm caused to people and the environment, resulting in legal liabilities for companies. Finally, corruption and bribery can result in criminal liability for companies, particularly in jurisdictions with strict anti-corruption laws.

In order to avoid these legal risks, companies must prioritize ESG factors in their due diligence processes and develop effective risk management procedures to address these risks. By doing so, companies can fulfill their legal responsibilities and avoid the potential legal, financial, and reputational consequences of failing to address ESG risks.

Legal Risks and Responsibilities for Companies

Legal risks and responsibilities for companies operating in high-risk markets or industries can be broken down into several specific areas:

1. Compliance with local laws and regulations:

• Companies must comply with local laws and regulations to avoid potential legal liabilities, fines, and penalties.
• Failure to comply with these laws can result in legal consequences, including loss of business licenses, civil or criminal penalties, and reputational damage.

2. Liability for harm caused to people and the environment:

• Companies can be held liable for harm caused to people and the environment, including pollution, deforestation, human rights abuses, and labor violations.
• Companies can be held responsible for the actions of their suppliers or contractors, adding to their potential liability.
• Failure to address these risks can result in legal liabilities, financial losses, and reputational damage.

3. Criminal liability for corruption and bribery:

• Companies can face criminal liability for corruption and bribery, particularly in jurisdictions with strict anti-corruption laws.
• Companies that fail to implement adequate anti-corruption measures, such as conducting due diligence on business partners or implementing compliance policies and training programs, can face significant legal consequences, including fines and imprisonment.
• Bribery can also result in reputational damage and loss of business opportunities.

4. Importance of implementing effective due diligence procedures:

• Effective due diligence procedures can help companies identify and mitigate potential ESG risks.
• Companies should conduct thorough due diligence on business partners, suppliers, and contractors to ensure compliance with local laws and regulations, and to prevent harm to people and the environment.
• Due diligence can also help companies identify potential corruption and bribery risks, and implement measures to prevent these risks.

Case Studies of ESG and Due Diligence

Here are two case studies of ESG and due diligence:

1. Union Carbide Bhopal Gas Tragedy:
   • In 1984, Union Carbide’s pesticide plant in Bhopal, India, leaked toxic gas, resulting in the deaths of over 3,500 people and causing long-term health effects for thousands more.
   • Union Carbide faced legal action for negligence and violation of environmental regulations, and eventually settled for $470 million with the Indian government.
   • The tragedy highlighted the importance of effective due diligence procedures for companies operating in high-risk industries, and led to increased scrutiny of environmental and safety regulations in India.
   • Lessons learned: Companies must prioritize environmental and safety risks, conduct thorough due diligence on potential risks, and implement effective risk management procedures to avoid potential legal and reputational consequences.
2. Coca-Cola Groundwater Depletion:
   • In 2003, Coca-Cola faced allegations of groundwater depletion and pollution in Kerala, India.
   • The company faced legal action and protests from local communities for violating environmental regulations and causing harm to the health and livelihoods of local communities.
   • Coca-Cola eventually agreed to implement measures to address the allegations, including reducing water usage and increasing community engagement.
   • Lessons learned: Companies must prioritize social and environmental factors in their operations, engage with local communities, and implement effective due diligence procedures to identify and address potential ESG risks.

These case studies highlight the importance of effective due diligence procedures for companies operating in India. Companies must prioritize ESG factors, comply with local laws and regulations, and implement effective risk management procedures to avoid potential legal, financial, and reputational consequences.

Conclusion

Companies operating in high-risk markets or industries must prioritize ESG and due diligence to mitigate legal risks and fulfill their responsibilities. Effective ESG due diligence involves identifying high-risk markets or industries, conducting thorough due diligence, implementing effective risk management procedures, developing a comprehensive ESG policy, and training employees on ESG and due diligence. By prioritizing ESG and due diligence, companies can not only mitigate legal risks but also improve their reputation, attract investors, and contribute to sustainable development. Therefore, it is essential for companies to take ESG and due diligence seriously and integrate them into their business operations to ensure long-term success.

Also Read:
Legal Due Diligence – Everything You Need to Know
ESG and Sustainable Development: How are they Related?
Future of Environmental, Social, and Governance (ESG): Emerging Trends and Opportunities for Investors