Around the world, environmental, social, and governance (ESG) considerations continue to have an increasing presence in M&A transactions. ESG considerations are relevant from the early stages when a transaction is merely being contemplated and remain relevant through the due diligence process, negotiation of the definitive agreement, and up to and post-closing.

In our recent webinar, “The impact of ESG on M&A transactions,” a multi-jurisdictional panel of Dentons lawyers comprising Jason Saltzman (Canada), Helen Bowdren (United Kingdom), Matthew Clark (United States), Daniela Jaimes (Latin America), and moderated by Kelli Patel (Canada), examined the emerging influence of ESG throughout the lifecycle of an M&A transaction in the United States, Canada, Europe, and Latin America. 

Stage 1: Before the deal – how do ESG considerations impact the willingness to transact?

ESG considerations are increasingly becoming relevant in business decision-making by investors when considering M&A transactions. These considerations impact investors’ decisions to divest certain assets, while others may opt not to engage with a target company with a weak ESG track record. A January 2022 Forbes article lists ESG criteria as one of the relevant factors to be considered at the negotiating table in Latin American countries. ESG is particularly relevant for cross-border transactions impacting a country like Brazil, where the federal government’s policies on the Amazon have raised concerns about the environmental and social policies of many Brazilian companies.

In the US and Canada, acquirers are beginning to evaluate the ESG risks and opportunities in the target’s business against their ESG policies to compare the level of alignment with their ESG strategy. As a result, it is becoming increasingly common, even for private companies, to be mindful of their ESG practices generally and to prepare ESG information at the early stages of a deal, as potential suitors are likely to evaluate the target’s ESG practices.

In the UK, it is common to see ESG issues being actively considered in large cross-border M&A deals. Clients treat ESG-related risk factors as being a higher priority compared to previous years. As a direct consequence, companies that have a positive ESG story are better able to attract capital - for example, renewable energy companies.

Stage 2: Letter of intent (LOI) and due diligence phase – how do ESG considerations impact the assessment and valuation of the target?

ESG considerations can play an important part in the due diligence and LOI phase. While there are no unified metrics to make an accurate assessment of the materiality of ESG factors (which will often depend on the relevant industry and the profile of the potential buyer), there are some considerations that acquirers should keep in mind. In preparing ESG diligence materials, the first step is to examine whether ESG data exists and assess the accuracy of the data. From there, risks should be identified, including regulatory, shareholder activism, reputational, and litigation risks. Litigation risks are most frequently observed in relation to climate risk and human rights litigation. Depending on the industry, location, and nature of the deal, environmental risks could be significant, and environmental due diligence should be a priority. For instance, in Venezuela, a company could face potential civil and criminal liability based on its treatment of the environment.

Increasingly, when acquirers are considering whether to pursue a transaction, a target’s activities are assessed, and even if their activities are legal, acquirers are interested in whether the target’s current business practices will be regarded favourably by stakeholders (principally investors and customers) – particularly in relation to supply chain, emissions, and modern-day slavery. Other considerations include whether the target complies with the ‘soft law’ or industry standards expected for their sector, whether the target has made climate-related claims that can be validated, and if such claims cannot be validated, what risks do the acquirers face regarding greenwashing claims. Acquirers will also want to question whether the target has completed its due diligence as it relates to suppliers and other third parties. They will also want to review underlying contracts to assess whether appropriate clauses and warranties are included in supplier/third-party contracts.

Stage 3: Negotiating the definitive agreement – how do ESG considerations impact the transaction documents?

In the US, it is still rare to see ESG clauses expressly included in M&A agreements. However, in light of the #MeToo movement, there has been some use of the so-called “Weinstein Clause,” which is a representation that, to the knowledge of the company, no claims of sexual harassment have been made against any current or former executive officer. It is likely that as investors continue to focus on ESG performance, we may start to see more ESG-specific clauses in agreements. These could include specific representations and warranties, changes to Material Adverse Effect clauses, closing conditions, and potentially ESG-specific indemnities.

In Europe and North America, although not expressly identified as ESG representations, environmental and labor, anti-bribery and corruption, and anti-money laundering representations have always been present in big transactions and will continue to be important, although they may not adequately cover specific ESG risks. Warranties and indemnity insurance may provide coverage for such risks in the future, although insurers seem unwilling to provide such coverage at the current market premiums.

Specific ESG contractual provisions are uncommon in Latin America, although the usual representations on compliance with environmental and labour laws are usually present.

Stage 4: Signing, announcing, closing, and post-closing – are ESG considerations relevant after the deal is concluded?

Much of the advice that emerges from ESG due diligence focuses on actions to be taken after closing. These are not usually actions taken to ensure or satisfy the completion of an acquisition; rather, they would be considered part of the 100-day or 12-month plan after the acquisition. Ultimately, the goal of ESG due diligence in M&A deals is to look at what the target company will look like in the future, and that vision should be clear in the agreements that are signed. Parties should also consider what specific ESG metrics, if any, go into the deal announcement.

To learn more about the impact of ESG on M&A transactions, watch the webinar here.