While Federal Requirements Become More Uncertain, State and Local Sustainability Disclosure Rules Remain Relevant
The Supreme Court has created significant uncertainty regarding the power of federal regulatory bodies to mandate sustainability reporting. However, regardless of sustainability-related reporting requirements imposed at the federal level by the Securities and Exchange Commission ("SEC") and other federal regulatory bodies, companies can expect, and may already have, disclosure obligations under the laws of various states and cities in the US in which they operate.?
For example, under the California Transparency Supply Chains Act of 2010[1], which went into effect on January 1, 2012, every retail seller and manufacturer doing business in California and having annual worldwide gross receipts that exceed $100 million is required to disclose its efforts to eradicate slavery and human trafficking from its direct supply chain for tangible goods offered for sale.? The disclosures must be posted on the retail seller's or manufacturer's website with a conspicuous and easily understood link to the required information placed on the business' homepage. In the event the retail seller or manufacturer does not have a website, consumers must be provided the written disclosure within 30 days of receiving a written request for the disclosure from a consumer.? At a minimum, the disclosures should disclose to what extent, if any, that the retail seller or manufacturer does each of the following:
The exclusive remedy for a violation of the disclosure obligations is an action brought by the California Attorney General for injunctive relief.
As of early 2024, over twenty states had acted independently of the federal government to adopt their own state climate policies including specific GHG reduction targets to address climate change and supporting initiatives relating to carbon pricing, emission limits, renewable portfolio standards, and promotion of cleaner transportation.[2]? It can be expected that implementation of these policies will include rulemaking on businesses operating in those states, although the same legal challenges marshalled against the SEC’s disclosure rules can be expected.? The first test case will likely come from California, where two new laws went into effect in October 2023 that require public and large private companies that do business in California to disclose their GHG emissions (“SB 253”) and their climate-related financial risks (“SB 261”).[3]? As background, the California Global Warming Solutions Act of 2006 requires California’s State Air Resources Board (“SARB”) to adopt regulations to require the reporting and verification of statewide GHG emissions and to monitor and enforce compliance with the act, and requires the SARB to make available, and update at least annually, on its internet website the emissions of GHGs, criteria pollutants, and toxic air contaminants for each facility that reports to the SARB.?
SB 253[4], referred to as the “Climate Corporate Data Accountability Act”, requires the SARB, on or before January 1, 2025, to develop and adopt regulations requiring specified partnerships, corporations, limited liability companies, and other business entities with total annual revenues in excess of $1 billion and that do business in California, defined as “reporting entities,” to publicly disclose to the emissions reporting organization, and obtain an assurance engagement on, starting in 2026 on a date to be determined by the SARB, and annually thereafter, their scope 1 and scope 2 greenhouse gas emissions and, starting in 2027 and annually thereafter, their scope 3 greenhouse gas emissions from the reporting entity’s prior fiscal year.? SB 253 requires the SARB to review during 2029, and update as necessary on or before January 1, 2030, these deadlines to evaluate trends in scope 3 emissions reporting and to consider changes to the deadlines.? SB 261[5] requires, on or before January 1, 2026, and biennially thereafter, a covered entity (generally entities with total annual revenues over $500 million) to prepare a climate-related financial risk report disclosing the entity’s climate-related financial risk and measures adopted to reduce and adapt to climate-related financial risk and make a copy of the report available to the public on its own internet website.? These reporting requirements are set to take effect in 2026.
The new California laws are limited to disclosures and do not prescribe the actions that companies should take relating to their GHG emission or other practices relating to climate change; however, business groups filed a complaint in the Central District of California on January 30, 2024 seeking declaratory and injunctive relief against the two laws, arguing that the laws violated the First Amendment, principles of federalism, and the dormant Commerce Clause doctrine, each of which have also been suggested as grounds for objecting to the SEC’s proposed climate-related disclosure rules.[6]? Other states are watching development in California closely and New York is already actively considering legislation similar to what has gone onto the books in California.[7]
California is also one of a number of US jurisdictions that have adopted provisions “allowing corporations to opt in to a legal structure that expressly expands the purpose of the corporation beyond advancing the pecuniary interests of its shareholders” and “allow or require directors to consider environmental, societal, or other impacts of corporate activity, even at the expense of shareholder value”.[8]? Corporations adopting these provisions are generally known as “benefit corporations” in the US and from the beginning proponents of these types of entities acknowledged that the performance of a benefit corporation in creating general or specific public benefit would not be readily apparent from financing statements and it was necessary and appropriate to require that benefit corporations prepare and distribute an annual benefit report to permit an evaluation of the entity’s performance so that the shareholders could judge how the directors have discharged their responsibility to manage the corporation and thus whether the directors should be retained in office or the shareholders should take other action to change the way the corporation is managed.[9]
Section 14630(a) of the California General Corporation Law (“CGCL”) requires that a California benefit corporation must deliver to each shareholder an annual benefit report including all the following:
(1) A narrative description of all of the following: (A) the process and rationale for selecting the third-party standard used to prepare the benefit report; (B) the ways in which the benefit corporation pursued a general public benefit during the applicable year and the extent to which that general public benefit was created; (C) the ways in which the benefit corporation pursued any specific public benefit that the articles state it is the purpose of the benefit corporation to create and the extent to which that specific public benefit was created; and (D) any circumstances that have hindered the creation by the benefit corporation of a general or specific public benefit.
(2) An assessment of the overall social and environmental performance of the benefit corporation, prepared in accordance with a third-party standard applied consistently with any application of that standard in prior benefit reports or accompanied by an explanation of the reasons for any inconsistent application.[10] The assessment does not need to be audited or certified by a third party.
(3) The name of each person that owns 5 percent or more of the outstanding shares of the benefit corporation, either beneficially, to the extent known to the benefit corporation without independent investigation, or of record.
(4) The statement required by CGCL § 14621 (i.e., the statement of the board of director whether, in the opinion of the board, the benefit corporation failed to pursue its general, and any specific, public benefit purpose in all material respects during the period covered by the report).
(5) A statement of any connection between the entity that established the third-party standard, or its directors, officers, or material owners, and the benefit corporation, or its directors, officers, and material owners, including any financial or governance relationship that might materially affect the credibility of the objective assessment of the third-party standard.[11]
When Delaware, the recognized leader in statutory and case law innovations in corporate law, passed its statute in 2013 recognizing “public benefit corporations”, the Governor made the following observations[12]:
“Delaware public benefit corporations will function like and enjoy all the same benefits as traditional Delaware corporations, and they will have three unique features that make them potential game changers. These three features concern corporate purpose, accountability, and transparency.
Corporate Purpose: Delaware public benefit corporations will have a corporate purpose ‘to operate in a responsible and sustainable manner’. In addition, to provide directors, stockholders, and ultimately the courts, some direction, they are also required to identify in their certificate of incorporation a specific public benefit purpose the corporation is obligated to pursue. The overarching language helps ensure that a public benefit corporation serves the best long-term interests of society while it creates value for its stockholders. The requirement to identify a specific public benefit purpose gives managers, directors, stockholders, and the courts, important guidance to ensure accountability, while preserving flexibility for business leaders and their investors to choose the specific public benefit purpose they feel will drive the greatest total value creation.
Accountability: Unlike in traditional corporations, whose directors have the sole fiduciary duty to maximize stockholder value, directors of public benefit corporations are required to meet a tri-partite balancing requirement consistent with its public benefit purpose. Directors are required to balance ‘the pecuniary interest of stockholders, the best interests of those materially affected by the corporation’s conduct, and the identified specific public benefit purpose.’
Transparency: Delaware public benefit corporations are required to report on their overall social and environmental performance, giving stockholders important information that, particularly when reported against a third-party standard, can mitigate risk and reduce transaction costs. Given the trend in public equity markets toward integrated ESG (Environmental, Social and Governance) reporting and the growing private equity market for direct impact investing, this increased transparency can help investors to aggregate capital more easily as they are able to communicate more effectively the impact, and not just the return, of their investments.”
Delaware General Corporation Law (“DGCL”) § 366(b) requires that each Delaware public benefit corporation must no less than biennially provide its stockholders with a statement as to the corporation's promotion of the public benefit or public benefits identified in the certificate of incorporation and of the best interests of those materially affected by the corporation's conduct.? The statement must include the objectives the board of directors has established to promote such public benefit or public benefits and interests; the standards the board of directors has adopted to measure the corporation's progress in promoting such public benefit or public benefits and interests; objective information based on those standards regarding the corporation's success in meeting the objectives for promoting such public benefit or public benefits and interests; and an assessment of the corporation's success in meeting the objectives and promoting such public benefit or public benefits and interests.? DGCL § 366(c) provides that the certificate of incorporation or bylaws of a public benefit corporation may require that the corporation: (1)?provide the statement described in DGCL § 366(b) more frequently than biennially; (2)?make such statement available to the public; and/or (3)?use a third-party standard in connection with and/or attain a periodic third-party certification addressing the corporation's promotion of the public benefit or public benefits identified in the certificate of incorporation and/or the best interests of those materially affected by the corporation's conduct.
Delaware also took another notable step in this area by adopting the Delaware Certification of Adoption of Sustainability and Transparency Standards Act (the “Act”), which went into effect on October 1, 2018 and reflected the intent of Delaware lawmakers to support business entities formed and organized under Delaware law (i.e., corporations, limited liability companies etc.) in their global sustainability efforts by providing them with a new method for signaling their commitment to global sustainability by, among other things, preparing and publicly disseminating reports containing certain information relating to their sustainability commitments and activities.[13]? The Act allows the Delaware Secretary of State to issue a certificate of adoption of transparency and sustainability standards to any Delaware entity that executes, acknowledges and delivers to the Secretary of State a “standards statement” and complies with certain other requirements includes payment of fees and maintenance of good standing.[14]?
Any entity seeking a certificate of adoption of transparency and sustainability standards from the Delaware Secretary of State does so to secure authorization and permission under the Act to disclose, publicly or privately, that it is a reporting entity; however, a key requirement is the preparation of a report with respect to each reporting period[15] that contains the following[16]:
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Entities interested in taking advantage of the statute will obviously be concerned about the risk associated with making public declarations regarding matters that are often difficult to measure objectively and which often are subject to circumstances that are beyond the reasonable control of the entities.? Importantly, the Act makes it clear that neither the failure by an entity to satisfy any of its standards, nor the selection of specific assessment measures, nor any other action taken by or on behalf of the entity pursuant to the Act or any omission to take any action required by the Act to seek, obtain or maintain status as a reporting entity, shall, in and of itself, create any right of action on the part of any person or entity or otherwise give rise to any claim for breach of any fiduciary or similar duty owed to any person or entity.[17]? However, entities would be subject to civil or criminal penalties if they misrepresent their activities while purporting to comply with the requirements of the Act.
While the Act is an interesting and innovative development with respect to the convergence of sustainability and corporate governance, compliance will hardly be a simple matter and Delaware entities will need to consider what standards and assessment measures are most appropriate for their businesses and stakeholders; invest time and efforts in conducting a rigorous review of the entity’s performance vis-à-vis the selected standards, presumably with the input of an experienced outside provider; prepare a detailed report covering at least the matters prescribed by the Act; develop and implement plans for remediating any failure to meet the standards applicable to the entity; and continuously develop strategies and plans for each reporting period to ensure that the standards are met.? Responsibility for all of this will fall on the members of the governing body of the entity, particularly those members of any committees created by the governing body to focus on sustainability and reporting issues.
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Notes
[1] California Civil Code § 1714.43.
[3] A third bill, AB 1305 , also went into effect and would require a business entity that is marketing or selling voluntary carbon offsets within California to disclose on the business entity’s internet website specified information about the applicable carbon offset project and details regarding accountability measures if a project is not completed or does not meet the projected emissions reductions or removal benefits, as provided. AB 1305 would also require an entity that purchases or uses voluntary carbon offsets that makes claims regarding the achievement of net zero emissions or other, similar claims, to disclose on the entity’s internet website specified information. AB 1305 would require an entity that makes these claims to disclose on the entity’s internet website all information documenting how, if at all, a claim was determined to be accurate or accomplished, how interim progress toward that goal is being measured, and whether there is independent third-party verification of the company data and claims listed.
[4] SB 253 .
[5] SB 261 .
[6] For further discussion of the new California climate disclosure laws, see A. Husselbee, The Implementation and Legal Risks of California’s New Climate Disclosure Laws (December 20, 2023) .
[9] For further discussion of benefit corporations, see A. Gutterman, Certifications and Rating Systems for Assessing Social and Environmental Impact (Oakland CA: Sustainable Entrepreneurship Project, 2023) .
[10] The term "third-party standard" is defined in the statute as a standard for defining, reporting, and assessing overall corporate social and environmental performance to which each of the requirements of CGCL § 14601(g)(1)-(4) apply including the requirement that the standard has been developed by an entity that does both of the following: (A) accesses necessary and appropriate expertise to assess overall corporate social and environmental performance; and (B) uses a balanced multi-stakeholder approach.
[11] For discussion of additional requirements of the California law relating to benefit corporations, see A. Gutterman, Certifications and Rating Systems for Assessing Social and Environmental Impact (Oakland CA: Sustainable Entrepreneurship Project, 2023) .
[12] J. Markell, “A New Kind of Corporation to Harness the Power of Private Enterprise for Public Benefit”, Huffington Post (July 22, 2013) .? For discussion of additional requirements of the Delaware law relating to public benefit corporations, see A. Gutterman, Certifications and Rating Systems for Assessing Social and Environmental Impact (Oakland CA: Sustainable Entrepreneurship Project, 2023) .? For a comprehensive guide to Delaware’s public benefit corporation statute, see F. Alexander, The Public Benefit Corporation Guidebook: Understanding and Optimizing Delaware’s Benefit Corporation Governance Model (Morris Nichols Arscht & Tunnell, 2016) .
[13] 6 Del. C. § 5000E.? For additional discussion of the requirements of the Delaware Certification of Sustainability and Transparency Standards Act, see A. Gutterman, Certifications and Rating Systems for Assessing Social and Environmental Impact (Oakland CA: Sustainable Entrepreneurship Project, 2023) .
[14] 6 Del. C. § 5002E.? For the requirements of the “standards statement”, see 6 Del. C. § 5003E.
[15]? "Reporting period'' means a period of 1 year, the initial such period to begin not more than 1 year following the filing of the standards statement, and subsequent reporting periods to begin on the day following the last date of the prior reporting period, unless a governing body elects to shorten the duration of a reporting period that has not begun in order to change the start date for subsequent reporting periods.
[16] 6 Del. C. § 5001E(11).
[17] 6 Del. C. § 5006E. The Act includes procedures for annual renewal of reporting entity status and restoration of reporting entity status in the event an entity that has previously been reporting fails to file a renewal statement in a timely manner.? 6 Del. C. §§ 5004E-5005E.