Diversity and inclusion considerations for boards: Focusing on the 's' in ESG

ESG issues are regularly in the news and are a key consideration of boards – particularly in the West. Social issues are by their very nature complex and can provoke strong opposing views among a company’s stakeholders – including shareholders, regulators, employees, and customers. Any position on a social issue becomes even more multifaceted and complex for companies that operate across jurisdictions due to differing and sometimes opposing cultural norms and legislation. We have seen many social issues advocated for or against by government regulation, on social media, via shareholder activism, and with consumers voting with their feet or calling for boycotts of certain brands.

Two recent examples from the United States demonstrate the risks companies and boards face when litigation arises borne out of opposition to its position on a social issue.

Case 1: Gender identity and sexual orientation

In 2022, a major US entertainment company faced criticism for not taking a stand on the expansion of Florida’s controversial Parental Rights in Education Act, termed the ‘Don’t Say Gay Bill’ (“the Bill”), which limits discussion of sexuality and gender identity in schools. The company’s silence was met with disappointment and frustration by creative partners and employees, some of whom staged walkouts, while others decried the silence on the issue as “weak” and “unacceptable”. Subsequently, the company’s board held a special meeting and issued a statement against the Bill. However, when they did take a stand, the board faced a counter-backlash, with Florida's State legislature voting to dissolve the company’s special tax district.

A shareholder then made a books and records request relating to the company’s public opposition to the Bill. The shareholder alleged that in taking their stance, the directors breached their fiduciary duties as they “either put their own beliefs ahead of their obligations to stockholders or flouted the risk of losing rights associated with the special district” – referring to the loss of special tax status. In response, the company argued there was no entitlement to the books and records as there had been no mismanagement by the board, although it did produce certain documents.

In June 2023, the Delaware Court denied the shareholder’s (“the plaintiff”) books and records request. The judge in the case determined that simply disagreeing with the board’s stance on a social or political issue was “not evidence of wrongdoing” and that the plaintiff did not have a proper purpose in seeking to inspect the books and records of the company. The judge held that directors are vested “with significant discretion to guide corporate strategy – including on social and political issues” and there was no “evidence that the directors were grossly negligent or acted in bad faith”. The judge further noted that directors had the power to consider issues where its stakeholders, not just its shareholders, had strong views and then take rational decisions in the best interest of the company.

Case 2: Workforce diversity

A US beverage company has long been very open about how it links diversity goals to executive pay, including its hiring targets for indigenous people and people of colour. However, the company’s stance on diversity made it an attractive target for conservative activists seeking to challenge such policies as illegal discrimination against white job seekers.

In 2022, a minority shareholder (“the plaintiff”) – holding just $6,000 in shares – brought a legal claim against the company alleging that its hiring goals for people of colour and contract awards to diverse suppliers required [the company] discriminate based on race. The plaintiff alleged that the directors were in breach of various laws, invited employment discrimination lawsuits, and endangered the interests of the company.

Prior to bringing the case, the plaintiff had sent a demand letter to the company raising these allegations, ostensibly on behalf of the shareholders. At that time, the company thoroughly investigated the claims and responded that its diversity, equity, and inclusion policies were in the company’s best interests.

The court ultimately dismissed the plaintiff’s claim. In an August 2023 judgment, it held that the plaintiff did not have the company’s best interests at heart in bringing the case and was instead politically motivated to take action against what it perceived as “woke” corporate America. The judge commented that if the plaintiff did not want to be invested in “woke” corporate America, it could simply sell its shares and shop elsewhere, rather than wasting the court’s time. The claim was forcefully dismissed, the plaintiff was denied the right to appeal and, unusually, the company was allowed to seek its legal fees from the plaintiff.

What these two cases means for boards

These two cases show that US courts are reluctant to interfere in issues within the discretion of a board provided their decisions are rational, justifiable, and can be shown to have been taken in the company’s best interests.

It could sensibly be assumed that a similar approach would be taken in English courts, as directors have a statutory duty to “promote the success of the company”, but in doing so must have regard for the interests of employees, relationships with customers and the community, and the environment, whose interests may not always be aligned.

Boards should consider the following:

The judge in the second case was particularly swayed by the fact that, upon receiving the demand letter from the plaintiff, the board of directors thoroughly investigated the allegations, including instructing experts and legal counsel to evaluate whether the allegations had merit. Properly minuting board discussions and decisions can provide clear evidence of the decision-making process, which may need to be relied on in court.
Both companies were able to argue that their progressive social policies were in keeping with their brand and benefited their business. Early engagement with stakeholders, especially shareholders and employees, could help ensure that everyone understands the reasons behind social policies and lessen the chance of disputes and shareholder activism.

Taking professional advice and carefully considering these complex issues will benefit the board when it comes to defending attacks.

How your D&O policies could respond

Although these claims were unsuccessful, it’s likely that social issue activists will continue to look for targets. Some will be emboldened by the 29 June 2023 US Supreme Court ruling that race-conscious university admissions policies violated the Equal Protection Clause in the US Constitution.

Defence costs arising from this type of litigation can be very significant. Responding to social issue claims is time consuming for managers and boards and involves a significant outlay of expert and professional fees, including potentially public relations (PR) representation. In the US, unless otherwise granted as in the case above, legal defence costs are usually irrecoverable from the other side even if the defence is ultimately successful.

Companies should ensure their directors and officers liability (D&O) protection is wide enough to capture social issue litigation and has sufficient limits, including PR sub-limits. Not all D&O policies provide cover for the costs associated with responding to books and records requests, for example – which formed the basis of the litigation against the entertainment company – and is pertinent for US-based companies where such requests are common. The costs associated with responding to shareholder activism are also not generally covered by traditional D&O policies.

Speak to your Marsh adviser if you have any questions or concerns about any of the issues raised in this article.

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Diversity and inclusion considerations for boards: Focusing on the 's' in ESG