ESG due diligence: a new phenomenon on the rise

Back to Corporate and M&A Law Committee publications

Martin Brodey
DORDA Rechtsanwälte, Vienna

Clemens Semelmayer
DORDA Rechtsanwälte, Vienna



On 14 January 2020, the $7tn investment fund Blackrock published the annual letter by its CEO, Larry Fink, which had previously been sent to the CEOs of all the investment companies in Blackrock's portfolio.

In this letter, Fink, on behalf of Blackrock and the investors behind it, acknowledged the importance of more sustainable investments in ‘green’ companies by focusing on transparency in the portfolio companies and the associated monitoring and reporting obligations of the respective management with regard to sustainability issues:

‘Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.’[1]

Additionally, Fink announced that Blackrock would amend its strategy and increasingly withdraw from, or not invest in, those companies that did not meet the required high standards in terms of sustainability, such as social or ecological responsibility, in the future.

Since this statement by one of the most important people in the private equity scene, sustainability has emerged from the shadow of being a marginal topic for M&A. Since increasingly investors care about a potential target's environmental, social and governance (ESG) performance, we as M&A lawyers have to adjust to our clients' demands.

ESG due diligence

Economists worldwide attribute to ESG criteria an increasingly important role in the evaluation of a potential target company.[2] As a result, lawyers are now increasingly expected to deal with these issues in legal due diligence and the drafting of purchase agreements.

Within the framework of ESG due diligence, the focus should be placed more on sustainability issues. The risks and violations uncovered can then either be presented in a separate ESG due diligence report (this tends to be the case with very large companies) or (more frequently) as a separate item in the legal due diligence report.

The British investment management company LaSalle captured the importance of this relatively new way of examining a target company for investors in a global study in 2019. Thirty-seven per cent of the interviewed managers from a wide range of major investment firms expressed that ESG issues play a leading role when deciding on a potential investment. However, global regional differences apply: whereas about 45 per cent of investors from Europe, Africa and the Middle East considered ESG issues to be important for an investment, the same case applies for just about 32 per cent of investors from Asia-Pacific and only about 25 per cent of investors from North and South America.[3]

While environmental aspects, such as the examination of the target’s real estate for possible contamination, have long been an important part of traditional due diligence, a large number of new topics are now appearing on the radar of M&A lawyers because of the developments outlined above in the context of ESG due diligence. The main difference is that the examination of environmental aspects (such as the above-mentioned possible contamination) has not been carried out from a sustainability point of view. Investors generally only wanted to check whether there were significant financial risks in this area relating to the target company, which had to be taken into account in the calculation of the purchase price or through corresponding warranty commitments/ indemnities.

It would be wrong to say that the new ESG risks are not also checked for financial reasons; however, these cannot be provided with a price tag as easily since they are ‘soft skills’ that emphasise ESG-focused companies compared to non-sustainably positioned companies and therefore make them more valuable.

Environmental: the Fridays for Future development

For large parts of the population, climate protection is a significant point of interest and, following the extensive global protest movement ‘Fridays for Future’ in 2019, it is no longer possible to imagine politics and business without the protection of the climate as a major factor. As mentioned in the introduction, unconditional commitments from the corporate world to support the fight for climate protection are still a comparatively new phenomenon. However, the past few years have caused a change in how investors and business leaders think.

Although ‘environmental due diligence’ is already a common element of traditional due diligence, additional questions now arise in the area of ESG due diligence. In the past, one would almost exclusively focus on potential environmental pollution (contamination) caused by the target company or for which it was responsible from the perspective of liability risks or the threat of business interruptions, whereas today the (additional) question is raised as to what a company is proactively doing to protect the climate. In particular, the use of renewable energy (eg, photovoltaic systems), the conscientious use of resources such as water and electricity or the support of a CO2-neutral way of working should be considered. The reason here on the one hand is that customers are paying more attention to how ‘sustainable’ the products or services they purchase are; on the other hand, both private and institutional investors are increasingly looking to invest in companies that promote climate protection (eg, by subscribing to ‘green bonds’).

Depending on the sector of the target company, the supply chain should also be examined to determine whether any cost-neutral or even cost-reducing measures have been taken or are planned to reduce the company's CO2 footprint. If a company has already implemented a plan to take steps towards or even achieve climate neutrality, this will have a positive effect on the ESG assessment. In that respect, however, it must be ascertained whether this plan is actually implemented conscientiously or it is merely intended to convey a ‘green’ image to the outside world.

Social: diversity and harmony in the workplace

The ‘social’ part of ESG due diligence goes further in depth: the auditor looks at the more distant past (which, from an economic point of view, is only a risk to a limited extent due to statutes of limitation) in order to uncover potential problematic behaviour in the workplace.

The issue of sexual harassment in the workplace is regularly in the spotlight. If there have been repeated complaints or even legal disputes in the past, an investment in this company – in addition to penalties for disregarding labour law provisions – can mean immense reputational damage not only for the company itself but also for the investor. Especially in recent years, the media have increasingly taken up this issue and accused the management of such companies of inactivity or a lack of preventive measures.

In this context, M&A practitioners can check, for example, whether mandatory training for employees took place or whether information documents and options for confidential complaints have been made available/are available. In the US, the phenomenon of ‘Weinstein clauses’ has recently been observed. With the help of specific warranties in company purchase agreements, purchasers can be assured that there has been no sexual harassment in the target company (often to the knowledge of the directors – ‘to the best of my knowledge’ – and/or limited to a certain period of time).

In addition, discrimination against employees based on gender, age or other criteria can have serious legal and reputational consequences for the target company and the investor. In the case of global transactions, other serious misconduct in the area of labour law should be taken into account. Violations of human rights or the use of child labour will therefore probably lead to ‘no deal’ scenarios in most cases.

Under the heading of ‘social’ due diligence, the efforts of the target company to comply with ‘social responsibility’ are also examined. In other words, the social commitment is being assessed in this step. Is there a workplace kindergarten to take care of the employees’ children? Does the company management react to traumatic events outside the workplace, eg, by offering anonymous psychotherapeutic care after a terrorist attack? In an overall assessment, it should be determined what the target company offers to support its employees and their environment apart from monetary compensation.

Comprehensive ESG due diligence in the area of ‘social’ does not only display serious ‘findings’, such as the co-operation of the target company with a company that is associated with child labour, but also provides a significant added value for the potential buyer. By carefully analysing the relations between employer and employees, but also between the employees themselves, the working climate and conflict potential in the target company is revealed to the potential buyer who would normally not gain such insights in a regular due diligence exercise. This kind of corporate culture (which is difficult to quantify in financial terms) plays an important role nowadays, as younger employees in particular are not only looking for financial incentives but also for a good working environment when choosing their employer.

Governance: trust is good, supervision is better

Over the course of the past decade, ESG governance has increasingly joined corporate governance. Investors want to be updated by their fund managers on how sustainable their investments really are. To meet those demands, most investment managers have already developed their own ESG policies with corresponding monitoring and reporting systems.

The two most effective methods of collecting ESG information from target companies, according to respondents of the LaSalle's 2019 Global ESG Survey,[4] are annual management questionnaires (used by 78 per cent of institutions) and face-to-face interviews with company officers (used by 52 per cent of respondents). In addition to their own monitoring systems, investors also rely on ‘ESG scores’ from external rating agencies.

The new governance also includes the ever-growing anti-money laundering (AML) guidelines, which require so-called know-your-customer (KYC) checks. Such checks can identify where certain money flows come from. This process is used to minimise the risk of illegally obtained money being laundered (ie, the illegal origin being concealed) through the purchase of services and the acquisition of companies. Investors, regardless of whether they invest with equity or debt capital, must also comply with these new, constantly tightened rules.

In the area of governance in ESG due diligence, it will also be critical whether an ESG policy has already been implemented at the target company and how compliance with the voluntary goals and requirements is monitored and documented in the company. In Austria, for example, this can be verified by examining the mandatory sustainability report. For the potential buyer it could be of great interest to harmonise the general ESG policy of the target company with the group’s internal policy, as well as to adapt any ESG governance regime already in place at the target company or, in the absence of such, to implement a new regime for reporting in this area. Such standardisation measures enable institutional investors (such as pension funds) to present a consistent image to their own investors. In addition, a consistent (ESG) governance regime for all investment companies is more efficient and easier to control internally. Depending on the quality of the control and reporting in the area of sustainability in the past, investors’ risk assessments can be corrected upwards or downwards, which in turn can have an influence on the company's purchase price.


Sustainability has had a fixed place in the M&A business for quite some time. Particularly when examining target companies in the course of due diligence, M&A lawyers look into risks that are found in the area of sustainability. However, the global movement, fuelled by statements from large investment companies such as Blackrock, has raised the awareness of investors, business managers and thus also lawyers so that today an increasing number of ‘standard’ due diligences also include social and environmental issues.

Even if the drafting of a separate ESG due diligence report will probably remain an exception in Austria for some time (this is also due to the small average size of M&A deals there when compared internationally), the lawyers involved should be sensitised to the potential consequences of ESG failures, which are then included in the legal due diligence report.

The phenomenon of sustainability and M&A, which Blackrock has brought not only to the playing field but finally to the centre of the investment market, will continue to gain importance in the coming years. The evaluation of ESG factors during a due diligence exercise will become a regular part of our work.

[1] Laurence D Fink, letter to clients, see www.blackrock.com/corporate/investor-relations/blackrock-client-letter, accessed 23 April 2021.

[2] Andrew R Brownstein, Steven A Rosenblum, David M Silk, Mark F Veblen, Sabastian V Niles and Carmen X W Lu, ‘The Coming Impact of ESG on M&A’ (Harvard Law School Forum on Corporate Governance, 20 February 2020) see https://corpgov.law.harvard.edu/2020/02/20/the-coming-impact-of-esg-on-ma/.

[3] ‘PERE ESG Investor Survey 2019’, (LaSalle Investment Management), see www.lasalle.com/images/uploads/PERE_ESG_Investor_Survey_2019.pdf, accessed 23 April 2021.

[4] ibid.