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Thursday, May 30, 2013

Managing Lender Liability in Equator Principles Implementation - Regulatory Offences

The Equator Principles III ("EP III") states that: "As financiers and advisors, we work in partnership with our clients to identify, assess, and manage environmental and social risks and impacts in a structured way, on an ongoing basis." It is well known that lender liability for environmental and social matters may arise from operational or managerial control by a lender over a project, or where a lender aids and abets regulatory offences of their borrowers. This article considers the risks associated with regulatory prosecutions of an Equator Principles Financial Institution (EPFI), acting as auditors and possibly co-managers of environmental and social risk management of their borrowers. We also consider management strategies, including the role of legal professional privilege. This article is part three of a three part look at managing lender liability in EP implementation.  The first article looked at post-loan legacy liabilities, and the second at third party beneficiary rights in the EP context.

Most EPFI have little experience being the subject of regulatory investigations in environmental, health and safety or labour standards conexts, particularly outside of the financial industry. However, in the implementation of the EP, EPFI may increasingly find themselves exposed to the environmental and social regulatory risks of their borrowers. This creates a whole host of risk management issues that EPFI must be alert to in EP implementation.

Most legal regimes impose primary liability for environmental, health and safety and labour standards on those persons or organizations with operational or managerial control, possibly including lenders where lenders are seen to be in a managerial role in relation to a project. In the US this arises under environmental legislation like CERCLA and similar principles are applied in other jurisdictions like Canada or Australia. Every jurisdiction will be different in how liability is imposed for environmental and social offences.

In addition to corporate liability, there may also be personal liability for managers and directors where environmental or social liabilities arise. Moreover, there can be liability for third parties who are found to be "aiding" or "abetting" regulatory violations, meaning that a person (including possibly a lender) knew or ought to have known about a regulatory violation but did nothing to prevent it.

While this type of liability is very well known generally, what may not be so well known is how it applies in the EP implementation context, to affect lender liability.  The reality is, wherever EPFI are auditing and assessing legal and regulatory compliance of their borrowers and even suggesting management approaches through the Action Plan and monitoring and review processes as "partners" with their borrowers, there will exist the possibility that an EPFI could be accused of a regulatory offence, along with their borrowers. That means that both the EPFI as corporations, as well as individual employees, officers or directors, could find themselves the subject of a regulatory prosecution in relation to an EP project.

Avoiding Liability as a Co-Manager of Environmental and Social Risks

To the extent that a managerial relationship with a project proponent were found by a regulator and a project became the subject of a regulatory prosecution for environmental and social issues, it is conceivable that an EPFI holding itself out as working "in partnership with our manage environmental and social risks" could be sucked into the resulting litigation. This could potentially include the risk of personal liability for employees, directors and officers of EPFI.

To avoid this particular risk, EPFI should avoid the mantle of "co-manager" of a project and not exercise operational control over the project to the extent possible. This may be quite challenging since the EP itself is worded as a process involving EPFI as partners in management of environmental and social risk. What will be more important than wording, however, will be the actual role of the EPFI in the operational decision making of the project. In practice, the EP were not designed to create operational control of projects by lenders, but rather to act as a private governance framework for the project administered through contractual relationships. If implemented as a management system however regulatory liability of the lender for the borrower's offences may be result.

Avoiding Aiding and Abetting Regulatory Offences

Avoidance of managerial control would not, on its own, alleviate the risks associated with aiding and abetting regulatory offences. Aiding and abetting can occur where an EPFI knows or ought to have known about a regulatory offence and does not take adequate steps to address it.  This could occur, as noted above, wherever legal and regulatory compliance assessments are conducted, which do occur during EP Assessments, Action Plan and Environmental and Social Management System development, Independent Reviews and Monitoring and reporting. If regulatory compliance failures are not identified, or are identified and ignored, this could create risks for an EPFI in relation to any future regulatory prosecutions.

To manage this area of risk, another important step in EP implementation will be to ensure that assessments of compliance, including legal and regulatory compliance of the project, are as accurate as possible. This would mean having properly qualified advisors involved in making assessments about compliance (which is primarily legal and regulatory compliance in accordance with Principle 3 of the EP) on the project.

The independent review process would be a critical time to ensure this is done - ensuring that EP implementation has been reviewed by a qualified legal expert. Perhaps surprisingly, this is often not done by EPFI and legal and regulatory assessments, plans and compliance reviews are often not developed or even reviewed by qualified lawyers in practice. Such practices should be changed in response to EP III which makes legal and regulatory compliance the "first instance" consideration in implementing the EP (see Principle 3).

Aside from the obvious benefit of having properly trained persons making the required compliance assessments, there is also the issue of professional indemnity insurance which typically does not cover advice that falls outside of the competency of the professional giving the advice. This could affect the ability of the EPFI to recover for negligent advice that affects their own legal situation. By having qualified legal practitioners giving legal and regulatory compliance advice, EPFI will ensure they are protected from professional negligence.

The Role of Legal Professional Privilege

In order to avoid complete disclosure of all internal documentation regarding legal compliance assessments (which could be held against the borrower or EPFI in a regulatory prosecution) to investigating regulatory authorities, legal professional privilege should be attached to internal analyses to the extent possible. This necessitates that the document originate in the provision of legal advice from a qualified legal practitioner when the document is created, in the provision of legal advice.

Action plans, Assessments and independent monitoring and review reports created in the implementation of the EP, opining on the legal and regulatory compliance of the project, could reasonably be considered as legal opinions deserving of legal professional privilege, so long as they are created by qualified legal professionals.

Legal professional privilege plays a critical role in managing the context and disclosure of information to regulators scrutinizing an EPFI or borrower's conduct in relation to a possible regulatory offence. Taking steps to create and retain legal professional privilege over documents can therefore have a significant effect on how regulatory prosecutions can be defended and proper planning must take place long before the prosecution occurs.

Legacy Liabilities

While there may be time limitations for government regulators to take action for regulatory violations, but it is possible that such limitations could expire well beyond the life of a loan.

As such, there is the possibility that an EPFI could become embroiled in litigation as a legacy to a loan which had already been repaid. This creates a clear legacy liability that reamins on an EPFI's books and must be managed to the extetn possible. I have published a more detailed discussion of this issue in an earlier post.

One important legacy consideration is the retention of documents.  In light of the fact that an EPFI could face regulatory prosecution for offences that relate to a project arising during the life of the loan, documents relating to such offences will need to be retained in accordance with the applicable retention period. This period should be identified in cooperation with legal advisors.


In light of the foregoing, EPFI must be alive to the increasing environmental and social regulatory risks they face in implementing the EP.  Characterizing the EP as a "credit-risk" or "risk management" framework will not alleviate these issues in any way. Wilful blindness is no defence and there can be no substitute to prudent planning.

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