ESG Risks for Cannabis Companies Will Impact Directors and Officers

Corporations are increasingly responding to environmental, social and corporate governance (ESG) concerns, driven by evolving public sentiment and investor demands. This has taken the form of corporate pledges of action on ESG issues, sometimes from the directors and officers (D&Os). Cannabis companies have been trailblazers on social equity, inclusion and environmental issues, highlighting their importance long before ESG gained traction in the wider corporate world. Despite its well-intentioned words and actions, however, the cannabis industry is not free from potential ESG-related exposures that may lead to additional risks for cannabis executives in the years to come.

The Impact of ESG

The growing importance of ESG is reflected by the emergence of shareholder resolutions around environmental and social issues. There was a record number of these shareholder demands in 2021, nearly doubling the prior record set a year earlier. This included proposals on environmental and climate change matters such as setting reduction targets for greenhouse gas emissions, as well as proposals on diversity at all corporate levels.[1] The Securities and Exchange Commission has echoed these concerns, reflected in proposed rules that were announced in 2021 on corporate disclosures related to board diversity, climate change, governance and cybersecurity risk management.[2]

There is increasing competition between companies to attract capital by making and following through on ESG goals. As noted by the Global Sustainable Investment Alliance, ESG investments grew to more than $30 trillion in 2018,[3] and these assets were poised to reach $41 trillion by the end of 2021.[4] ESG pledges have become an important mechanism for D&Os to raise capital and increase profits. Even a company’s ability to purchase insurance is now impacted, with certain carriers providing favorable pricing, policy retentions and limits if the company is advancing ESG initiatives. [5] Although the cannabis industry has recently benefitted from multiple new insurance products for D&O and other management liability, it remains a hard market with risks that are difficult to adequately insure.

Cannabis and ESG

Cannabis companies have made their own ESG pledges, such as HEXO Corps pledge to be carbon neutral, which was achieved in September 2021.[6] Cannabis giant Trulieve announced in November 2021 the publication of its first ESG Report, highlighting the company’s ESG achievements to date and establishing targets on environmental and diversity, equity and inclusion (DEI) initiatives.[7] Similar ESG pledges from cannabis companies soon will be commonplace and even expected.

Although ESG messaging and disclosures can be good for business, they come with significant disclosure-based risks. Some examples of ESG claims that already have impacted the corporate world include (1) environmental claims involving pledges on climate change and net water positivity, (2) social claims such as #MeToo and failure to meet DEI goals, and (3) corporate governance issues such as action around cybersecurity risks. Cannabis companies have been subject to management liability arising from these same issues. One may reasonably expect more ESG-related risk to cannabis D&Os going forward based on the combined impact of the cannabis industry’s rapid growth and increasing ESG pressures on all companies.

Environmental Claims

D&Os of cannabis companies already have been subject to traditional securities litigations over alleged false and misleading statements, such as that in Ortiz v. Canopy Growth Corp. et al.[8]; In re: Cronos Group Inc. Securities Litigation[9]; and Kasilingam v. Tilray Inc. et al.[10] As the publics emphasis on environmental issues intensifies, there should be a greater concern for litigation over environmental-related corporate goals and statements. The cannabis industry is well aware of the dangers of public backlash on sensitive issues involving land and water use, pesticides and run-off, sustainable packaging and the high energy requirements of cultivation lighting.

To date, environmental claims made against cannabis companies have been connected with traditional securities class actions arising from alleged misstatements, such as that alleged in Acerra v. Trulieve Cannabis Corp., 2021 U.S. Dist. LEXIS 247894, at 2 (N.D. Fla. Dec. 30, 2021). That proposed class action against Trulieve, its CEO and former CFO was partially based on claims about the quality of Trulieves marijuana-growing facilities. Although the court ultimately dismissed the complaint, it found the companys description of climate controlled involving an outdoor facility in Florida with no heat or air-conditioning does not measure up and was a sufficient allegation of a material misstatement.

DEI and Sexual Harassment

Litigation with cannabis companies also has resulted from equity and diversity concerns and sexual harassment claims. For example, in Lanora Vasquez v. Blubird World LLC, dba MindRite Dispensary, allegations were made involving various acts of sexual harassment by the male employees of MindRite, including causing sexual content to be on the workplace computer, sexualizing female customers, making comments about the bodies of female customers and coworkers, and trying to get female coworkers to engage in sex whenever a work event included alcohol.[11] Another litigation, EEOC v. AMMA Investment Group, involved claims of sexual harassment by a general manager of a retail distributor of medical cannabis products.[12]

On the diversity side, the cannabis industry, lawmakers and regulators have struggled in most jurisdictions to find the right formula for promoting social equity. Allegations of rigged lotteries and unfair points-based scoring systems for cannabis licenses abound, while many cities and states cant seem to strike a fair balance between protecting social equity applicants from predatory operating agreements and recognizing the legitimate interest of the minority investor shareholders.

These issues have resulted in an explosion of litigation across the nation. Notable actions include MediGrow LLC v. Natalie M. Laprade Medical Cannabis Commission, involving a claim against the state of Maryland for failing to promote diversity in the cannabis industry,[13] and Sozo Illinois, Inc. v. Pritzker et al., challenging the priority given to social equity applicants.[14] Although these complaints did not name any D&Os as defendants, they show that the cannabis industry is not immune from social concerns around diversity and discrimination.

Data Privacy and Cybersecurity

Cannabis companies also have been subject to litigation for cyber breaches. In Warshawsky et al. v. cbdMD, Inc et al., a class action was brought by customers who purchased CBD products from cbdMD Inc and had their personal information compromised when cbdMD suffered two cyber-attacks on its e-commerce platform in the spring of 2020.[15] As alleged in the complaint, the breaches occurred as a result of cbdMDs failure to implement reasonable security procedures and practices appropriate to the nature of the information they collected from customers. This case was settled in March 2021.

Other cyber breaches have impacted the cannabis industry, such as the data breach involving Sunniva, a cannabis company in Canada,[16] and the unsecured database belonging to THSuite, a point of sale software platform used by many cannabis businesses.[17] While these actions did not name the D&Os, there have been a number of data breach lawsuits where D&Os have been named, including recent ones in 2021 involving T-Mobile,[18] Ubiquiti[19] and 360 DigiTech.[20]

Adopting an ESG Mindset

Companies should never adopt a mindset that ESG is simply an annoying distraction or passing fad, and instead embrace ESG as an important cornerstone to the company’s future risk management planning. ESG should be seen as a process for identifying and mitigating a spectrum of evolving risks from cybersecurity and workforce-of-the-future issues to protecting the brand from business decisions that may harm the climate or alienate customers and investors. From this viewpoint, cannabis companies are uniquely situated to leverage their experience navigating strict regulations that already incorporate ESG policies involving sustainability, social equity and consumer protection.

Many cannabis companies have exceeded what is required in the regulations by voluntarily adopting DEI and environmental best practices. Although this head-start hopefully will result in decreased ESG-related claims and litigation against cannabis companies compared with other market sectors, cannabis D&Os should remain vigilant.

Companies that wish to begin embracing ESG principles may consider appointing an officer or director who is responsible for gathering information across departments that is needed for an initial ESG assessment. Changes to the company’s corporate governance should be made with input by legal counsel and approval by the board. When announcing ESG-related goals or making public statements that involve those issues, the company should be scrupulous in ensuring that proper disclosures are made. These public statements can readily become the basis of D&O litigation.

As the cannabis industry continues to mature, the concerns facing their D&Os will continue to mimic those of other companies. The growing focus on ESG initiatives will continue within the cannabis industry, and it is likely that cannabis companies will be held accountable for pledges made. Litigation involving environmental claims, diversity and inclusion, sexual harassment, cyber breaches and other governance issues are now being brought against cannabis companies, and future actions may name their executives as well. D&Os of cannabis-related entities must understand their organizations risks and opportunities related to ESG and have their disclosure and reporting match those issues.

There are financial incentives for cannabis companies to be ESG-conscious, but the landmines explode when actions do not match promises.

Meet The Authors

Jonathan Meer focuses his practice on insurance coverage, including monitoring and coverage determinations, with a concentration on directors and officers (D&O), professional errors and omissions (E&O), lawyers (LPL), employment practices and cyber liability programs. Jonathan represents the interests of primary and excess insurers based in the United States, China, London and Bermuda in high-exposure claims against directors and officers of public and private companies, nonprofit boards, financial institutions and insurance companies. He has addressed claims related to shareholder class actions seeking multimillion-dollar damages against public companies and their directors and officers, as well as other high-profile fraud cases involving a variety of issues.

 

Ian Stewart is the Regional Managing Partner of Wilson Elser’s Los Angeles office. He is founder and co-chair of the firms Cannabis and Hemp Law practice, where he leads a national multi-disciplinary team of lawyers who serve all aspects of the cannabis and hemp industries, as well as financial institutions and insurance companies that service those industries. Ian has been named to the prestigious Chambers USA 2020 and 2021 guide in Cannabis Law.  He is a member of the Advisory Board of the International Cannabis Bar Association (INCBA) and participates on the Policy Council of the National Cannabis Industry Association (NCIA). Ian also sits on the Executive Committee of the Los Angeles County Bar Associations Cannabis Section and is chair emeritus of NCIAs Risk Management and Insurance Committee. He is one of MG Magazines 30 Powerful Cannabis Attorneys You Should Know and is listed within Cannabis Reports 10 Powerful Marijuana Lawyers in California. Ian has also been named by National Law Review as Go-To Thought Leader in 2018 and 2021 for his publications on cannabis law and policy.

 

---

[1] Investors Press for Progress on ESG Matters, Harvard Law School Forum on Corporate Governance, February 9, 2022.

[2] Id.

[3] https://www.cnbc.com/2019/12/14/your-complete-guide-to-socially-responsible-investing.html

[4] https://www.bloomberg.com/news/articles/2022-02-03/esg-by-the-numbers-sustainable-investing-set-records-in-2021

[5] ESG considerations increasingly factor into D&O underwriting, Business Insurance, February 2022.

[6] https://www.yahoo.com/now/hexo-achieves-carbon-neutrality-103000632.html

[7] https://investors.trulieve.com/news-releases/news-release-details/trulieve-cannabis-corp-issues-inaugural-environmental-social-and

[8] Ortiz v. Canopy Growth Corp. et al., 19-cv-20543, U.S. District Court, District of New Jersey.

[9] In re: Cronos Group Inc. Securities Litigation, 20-cv-01310, U.S. District Court, Eastern District of New York.

[10] Kasilingam v. Tilray Inc. et al., 20-cv-03459, U.S. District Court, Southern District of New York.

[11] Lanora Vasquez v. Blubird World LLC, dba MindRite Dispensary, No. 18CV41572, Oregon Circuit Court, Multnomah County.

[12] EEOC v. AMMA Investment Group, LLC and Maryland Health Management, LLC, t/a, Natures Medicines, 20-cv-02786-DKC, U.S. District Court, District of Maryland.

[13] MediGrow LLC v. Natalie M. Laprade Medical Cannabis Commission, 487 F. Supp. 3d 364, 371 (D. Md. 2020).

[14] Sozo Illinois Inc. v. Pritzker et al., 21-cv-03809, U.S. District Court, Northern District of Illinois.

[15] Warshawsky et al. v. cbdMD Inc. et al., 20-cv-00562, U.S. District Court, Western District of North Carolina.

[16] https://www.bloomberg.com/press-releases/2019-09-09/sunniva-reports-filing-of-parallel-class-action-lawsuit-regarding-previously-announced-privacy-breach-at-natural-health-service-k0cjrn4q

[17] https://news.bloomberglaw.com/privacy-and-data-security/insight-mitigating-data-breach-risks-facing-marijuana-businesses

[18] In re: T-Mobile Customer Data Security Breach Litigation, Multidistrict Litigation Judicial Panel, MDL No. 3019.

[19] Molder v. Ubiquiti Inc., et al., 21-cv-4520, U.S. District Court, Southern District of New York.

[20] Balderas, et al. v. 360 DigiTech, Inc, et al., 21-cv-6013, U.S. District Court, Southern District of New York.