Environmental, social and governance (“ESG”) concerns are driving businesses globally to re‐calibrate their mergers and acquisitions (M&A). In a new article, I contend that, despite a growing ESG backlash in the United States, ESG issues will continue to be salient for many businesses undertaking acquisitions.

In a 2023 industry survey of senior executives, “96% expect ESG scrutiny in deals to increase over the next three years, including 48% who expect it to increase significantly.” The expected rise in ESG scrutiny in deals is not surprising. Over the last decade, numerous people and institutions, including investors, stakeholders, governments, international and transnational organizations, and academics have pressed companies to address ESG issues in their business decisions. Accordingly, there are multiple factors for ESG’s prominence in M&A. They include regulatory changes, financing and contractual pressures on buyers in deals, investor and other stakeholder demands, and companies’ own internal policies, practices, and procedures. In addition to affecting the business rationale for some deals, these factors give the parties involved an incentive to enhance ESG due diligence and transaction planning.

ESG’s impact has been most acutely felt in the due diligence process. Due diligence is an integral part of dealmaking, influencing every aspect of a transaction from deal structure, pricing, and documentation to whether a deal closes. Risk assessment, including with respect to non-financial factors, has long been an important focus of M&A due diligence. The emphasis on ESG has broadened and modified both the scope and reporting of risk assessment in due diligence, adding complexity to an already complex process. For example, with companies increasingly exposed to risks from climate change, it is crucial to evaluate any real estate holdings for such risks. Similarly, a target’s supply chain may be severely disrupted by extreme climate events. Additionally, M&A due diligence regularly encompasses diligence on sexual harassment or misconduct issues at target companies. Buyers are also often advised to conduct diligence on workplace culture and workforce composition at a target company. As experts note, ignoring the “S” part of ESG can have significant negative ramifications – including lawsuits, investigations, and negative media attention – for a buyer after a deal closes.

Enhanced ESG due diligence will likely also expand the reporting and analysis of due diligence generally in M&A deals. It may require amendments to information request lists, additional questions in the due diligence question and answer process, new areas of focus at expert sessions, and wider research in public sources. Moreover, enhanced ESG due diligence will likely involve multiple advisers and advisory firms. The expanded need for expertise may also lead to more documents prepared during the due diligence process and higher transaction costs.

Despite these uncertainties and costs, enhanced due diligence may prove valuable to buyers in the long run. It may not only enable better integration management, but also allow buyers to avoid substantial post-closing liabilities. For example, the U.S. Department of Justice’s M&A Safe Harbor policy, announced in October 2023, provides incentives for companies to invest in strong compliance programs, to conduct due diligence, and to timely disclose misconduct by the acquired entity.

Yet, the complexities of ESG due diligence are significant. My article’s case study of human rights due diligence in M&A illustrates some of the challenges. Legislation mandating human rights due diligence has proliferated around the globe, especially in the European Union. Furthermore, even before laws mandating human rights due diligence, leading organizations, including the United Nations Global Compact and the International Bar Association, issued guidance for businesses to follow when conducting human rights due diligence in M&A deals. Such due diligence would involve “the process of assessing a target’s human rights risks and impacts, as well as its compliance with applicable laws and international standards related to human rights,” including anti-human trafficking and slavery policies, non-discrimination policies, and anti-harassment policies.

Nonetheless, even proponents of human rights due diligence in M&A recognize its challenges. Those challenges are particularly salient in the human rights context, where the broad and global nature of human rights due diligence laws and many companies’ reliance on complex global supply chains may require a human rights expert to analyze norms, standards, laws, and risks implicated by a target’s business while facing the fast pace of a typical M&A deal. Human right due diligence may also affect the confidentiality of a deal and be difficult to conduct in the M&A context, where confidentiality is of utmost importance. And dealmakers may resist a diligence process that may result in significant costs and delays. There are also questions about whether M&A diligence teams possess sufficient human rights or local expertise in the dealmaking process. For M&A lawyers to appropriately assess the human rights risks of a deal, there may need to be additional interdisciplinary training for lawyers.

ESG factors have also begun to affect transaction planning in M&A. Many ESG issues overlap with and are captured by the broad representations and warranties traditionally included in M&A transaction documents, while others present opportunities for additional risk allocation through refinement of representation and warranties. An ESG-focus in deal-making has also expanded to other deal planning mechanisms such as closing conditions, indemnifications, and purchase price adjustments. However, to date there is little data on whether there are any established provisions or deal technologies that address ESG issues through the acquisition agreement. Future research should empirically explore the extent to which M&A contracts have shifted to address ESG risks.

This post comes to us from Afra Afsharipour, the Martin Luther King, Jr. Professor of Law at UC Davis School of Law. It is based on her article, “ESG Dealmaking,” available here and written for the 2023 Symposium on the “Future of ESG” hosted by the University of Pennsylvania Journal of Business Law and the Institute for Law and Economic Policy to honor the scholarship and influence of Professor Jill E. Fisch. A version of this post appeared on the Oxford Business Law Blog.