Fiona McKerrell: How ESG credentials are gaining relevance in business restructuring

Fiona McKerrell: How ESG credentials are gaining relevance in business restructuring

Fiona McKerrell

Environmental, social and governance (ESG) considerations have taken on an increased significance in recent years, and the pace of change is accelerating. ESG performance is becoming an additional standard by which businesses are being judged by consumers, investors and other stakeholders. With increased reporting requirements and a growing number of companies committing to ambitious environmental targets, the importance of ESG metrics throughout supply chains is going to intensify dramatically.

When planning and implementing a restructuring of a distressed business, time is generally of the essence. The stakes are high and a keen understanding of the issues that need to be addressed is critical.

While ESG considerations may not be the predominant focus in the restructuring of a distressed business, they can still have an important part to play in the restructuring strategy, irrespective of the sector in which that organisation operates. This article looks at a number of ways these considerations may arise. Here are some of the key areas of ESG focus in corporate restructurings.

Stakeholder support

Any successful restructuring will require support from relevant stakeholders. That may include investors, lenders, suppliers, customers, employees and regulators, who will have their own ESG propositions and values. A restructuring strategy that incorporates ESG elements which resonate positively with stakeholders may increase the prospects of obtaining the necessary stakeholder support – provided the rest of the restructuring proposition stacks up, of course!

Access to funding

Financial institutions, such as lenders, are themselves subject to increased scrutiny and reporting requirements. They are adopting their own comprehensive ESG strategies and recognising that markets, shareholders and customers are paying attention.

At the moment, it is not uncommon to see lenders requiring the corporate governance of an organisation to be strengthened as a condition of ongoing support, e.g. by requiring the appointment of an independent director. Our expectation is that ESG metrics will become an increasingly important factor in lending decisions. Poor performance against ESG metrics may limit a business’ access to funding from mainstream finance providers.

The increased focus on ESG is also leading to new sustainable finance lending products, which reward, via favourable debt pricing, those businesses which perform well on ESG metrics. The ability of a business to access such financing options will depend on the strength and measurability of its ESG proposition.

Value enhancement

A strong ESG proposition can also provide significant opportunities to enhance value. For instance, it can assist in attracting and retaining customers. It may also lead to cost reductions (e.g. through lower energy consumption or reducing waste) and can encourage employee engagement and motivation, which is particularly important when trying to implement a successful restructuring. It can also help attract and retain talent and investment.

Timelines and decision-making

ESG elements are also an increasing area of focus for potential investors in, or purchasers of, a business when conducting their due diligence. Environmental issues of concern may include the organisation’s carbon footprint and emissions, and the energy efficiency of its premises, to name but a few. Social issues of focus may include employee rights and safety, the impact (positive or negative) of the business and its supply chain on the communities in which it operates, product safety, and diversity and inclusion. Governance issues may include analysis of the organisation’s decision-making processes, its policies and procedures, and its adherence to legislative, regulatory and reporting requirements.

Where a restructuring strategy will involve third party due diligence, understanding the areas of likely focus, addressing issues ahead of time, where possible, and facilitating access to the relevant information and documentation for relevant parties will help expedite what is often a time-critical process. When time is of the essence, a quick informed decision is better than a slow one, even if the decision is not the one you are hoping for.

Understanding supply chains

With ESG-related reporting requirements only set to increase, as illustrated by the UK Government’s consultation on mandatory climate-related disclosures, and with a growing number of organisations expressing ambitious commitments to ESG-related targets, particularly in relation to reducing greenhouse gas emissions, we can expect to see pressure pushed down through supply chains. The ESG credentials of a supplier will become an area of increased focus in procurement and those that cannot meet expectations will lose out. The next few years will be critical.

Risk Mitigation

Litigation risk

Breaches or perceived breaches of ESG provisions can result in legal action, whether that is by regulators, stakeholders or activist groups. Such litigation can be very costly and take up a significant amount of management time, distracting focus from the core business. A proactive approach to ESG issues, risk mapping and obtaining expert advice can assist in mitigating the risk of such action being taken.

Risk to directors personally

Where a company enters an insolvency process, the insolvency practitioner appointed is required to investigate the directors’ conduct and can take action for any breach of their duties. Where a company is in financial distress, directors therefore need to be mindful of their duties and the potential for them to incur personal liability.

Irrespective of whether or not a company is facing financial challenges, directors need to consider the risks to them personally in connection with ESG-related obligations when discharging their duties. For example, while not widely relied upon in bringing actions against directors to date, section 172 of the Companies Act 2006 requires a director to promote the success of the company for the benefit of its members and, in so doing, have regard to factors including the impact of the company’s operations on the environment. A director is required to exercise reasonable care, skill and diligence in performing their duties and it is not difficult to see how appropriate consideration of ESG factors should form part of meeting the relevant standard expected.

An example of the consequences of getting it wrong

Failing to give sufficient consideration to ESG factors in the context of a restructuring can have serious repercussions. One need look no further to find a case in point than the actions of P&O Ferries in March this year, when it sacked nearly 800 employees via Zoom with immediate effect, without warning or consultation. This restructuring decision, which was taken to hire a cheaper agency workforce based outside the UK in an attempt to address the financial pressures faced by the business, resulted in a public backlash, parliamentary scrutiny, admissions of having knowingly broken the law, civil and criminal investigations, and the potential of personal liability for directors. It’s an extreme example that highlights the issues well. Even if the recent restructuring decisions taken by P&O secure the company’s survival, they are likely to have tarnished the reputation of P&O and its board for many years to come.

ESG affects every business

ESG covers a vast and complex area of interwoven concepts. It is of relevance to all businesses. A corporate restructuring may present an opportunity to embed ESG into future strategy for business optimisation. In any event, relevant ESG considerations, even if they are not at the heart of what are often very difficult decisions, should not be disregarded.

Fiona McKerrell is a partner at Shepherd and Wedderburn
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