Agency ESG Litigation Under Loper Bright

A Department of Labor (DOL) rule allowing fiduciaries to consider environmental, social, and governance (ESG) factors in investment decisions could be an early indicator of how courts will adjudicate challenges to agency rules without Chevron deference.  DOL’s 2020 Investment Duties Rule permits DOL fiduciaries to consider ESG factors in retirement plan investments when there is a “tie” between investment options, such that the fiduciaries cannot decide between investments “on the basis of pecuniary factors alone.”  In response to public comments, DOL modified this rule in 2022 to require fiduciaries to make investment decisions “based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis,” which may include ESG factors when there is a “tie” between the financial benefits of different investment options.

Private parties and 26 states challenged the 2022 Rule as violating the Employee Retirement Income Security Act of 1974 (ERISA) and the Administrative Procedure Act (APA).  ERISA dictates that a fiduciary must “discharge his duties with respect to a plan solely in the interests of the participants and beneficiaries” and “for the exclusive purpose of providing benefits to participants and their beneficiaries.”  The plaintiffs argued that the plain text of ERISA precludes consideration of non-pecuniary factors, even as tiebreakers. 

In a move that surprised many observers, Judge Matthew Kacsmaryk—the Northern District of Texas judge who made headlines when he struck down the FDA’s approval of mifepristone and nixed the Biden Administration’s attempt to rescind the Trump Administration’s “Remain in Mexico” policy—ruled in favor of DOL.  The court first stated that ERISA does not specify how agencies should respond when there is a “tie” between investment options, clearing the first step of Chevron deference.  The court next found that ERISA requires employers to seek purely financial ends in investment plans, and that DOL’s interpretation that ESG factors may contribute to these financial ends was reasonable, and therefore warranted Chevron deference.

But the district court expressly acknowledged that its decision might not withstand the test of time.  In a footnote, the court explained that “[p]laintiffs aver that Chevron ‘should be limited or overruled.’ Plaintiffs’ objections to Chevron are well taken. But the Court will apply Chevron in appropriate circumstances ‘until and unless it is overruled by our highest Court.’”

And overruled it was.  Just days before the scheduled oral argument in the plaintiffs’ Fifth Circuit appeal, the Supreme Court overruled the 40-year-old Chevron deference doctrine in Loper Bright Enterprises v. Raimondo.  Instead of deferring to an agency’s reasonable interpretation of an ambiguous statute, federal courts must determine the “best” interpretation of ambiguous statutes themselves. 

Rather than rescheduling the case, however, the Fifth Circuit pressed on, holding argument as planned.  The demise of Chevron was a key theme, with both sides arguing they should prevail in the Fifth Circuit because their reading of the statute was the best.  Indeed, even before Loper Bright, DOL—perhaps seeing the writing on the wall—argued in its Fifth Circuit briefing that “the tiebreaker standard is valid even aside from the Chevron framework, because it is not just a reasonable construction but the best construction of ERISA.”  Regulated entities and regulators alike from all industries were watching closely to see how the Fifth Circuit would approach that issue, post-Loper Bright. 

Unfortunately, the wait will continue.  Over the parties’ objection, the Fifth Circuit declined to answer that question, and instead sent the case back to the lower court to decide this issue in the first instance.  The Fifth Circuit justified this approach as both time-honored and “relatively [u]ncontroversial.”  Harkening back to language from Loper Bright itself, the court also described its decision as “modest” and “hum[ble],” as it permits the court of appeals to “benefit of the considered judgment of [its] esteemed colleagues on the district courts. 

But the Fifth Circuit panel also added an important—and unusual—caveat:  Because it was already familiar with the parties’ arguments, the judges explained that they would hear the case again when it inevitably comes back to the Fifth Circuit on appeal, thereby providing the parties with an unusual degree of advance notice of their appellate panel.  Typically, litigants have to wait until well after filing their opening briefs to learn the identity of the judges that will hear their case—in the Fifth Circuit, that information is released about one week prior to argument.

The case will now return to the district court to determine the very question it declined to decide last September: whether DOL’s ESG rule represents the best reading of the statute—or not. 

The Future of ESG Post-Loper Bright

The DOL litigation will provide an important test case to see how courts approach ESG-based issues post-Loper Bright, now that the ball is fully in their court.  The plaintiffs argue that nonpecuniary factors, like ESG considerations, are inherently not “benefits” within the plain meaning of that term.  Because the fiduciary must act exclusively for the purpose of providing “benefits” to participants and beneficiaries, ESG-factors are off limits, full stop.  DOL contends that the tiebreaker rule only comes into play when an investment choice cannot be resolved merely by looking to pecuniary factors alone; the fiduciary must break that tie somehow, and in that narrow situation, considering ESG factors is therefore appropriate.  The court will have to resolve which of these presents the best interpretation of the statute.

This case could also provide an important test scenario for the role of Skidmore deference post-Loper Bright.  Skidmore is a lesser form of deference that allows courts to defer to agency interpretations that “have the power to persuade.”  Loper Bright was clear that this doctrine remains in play.  With Chevron off the table, perhaps courts that previously deferred to the agency under Chevron step two will now look to Skidmore deference to justify putting a thumb on the scale in favor of the agency.  That could be particularly useful in situations like this, where policy considerations were a key driver for the rule.

Similar issues have arisen in litigation involving private parties.  In another Northern District of Texas case, a group of American Airlines 401(k) investors sued American Airlines, alleging the company breached its fiduciary duties of prudence and loyalty and its duty to monitor fiduciaries by utilizing investment funds and managers that consider ESG factors.  This suit does not involve the DOL rule or any other agency action.  Instead, it is a breach of fiduciary duty claim in which the court conducted a bench trial after denying defendants’ motion for summary judgment.  The trial concluded on June 27, 2024, and a decision is pending.  Although Loper Bright does not apply to this action between private entities, this case will provide another data point for how courts will assess the interaction between ESG factors and fiduciary duties.

Hogan Lovells is here to help.  With the decision in Loper Bright, agency rules governing ESG-related issues may be on the chopping block as courts are asked to determine whether a fiduciary can properly consider ESG factors.  Other litigation has brought similar questions to the forefront in the context of private actors.  Now that courts have more power to modify agency interpretations of federal statutes, venue shopping in circuits like the historically-conservative 5th Circuit or the historically-liberal 9th Circuit may become even more important.  Hogan Lovells has deep experience in this area, having successfully litigated ESG and agency cases across the country.

Please contact David Foster and Danielle Desaulniers Stempel (U.S.) to learn more.

The District Court’s decision in the DOL rule litigation is Utah v. Walsh, No. 2:23-CV-016-Z, 2023 WL 6205926 (N.D. Tex. Sept. 21, 2023).  The Fifth Circuit’s decision is Utah v. Su, No. 23-11097, 2024 WL 3451820 (5th Cir. July 18, 2024).  The District Court’s decision in the American Airlines litigation is Spence v. Am. Airlines, No. 4:23-cv-00552-O, 2024 WL 3092453 (N.D. Tex. June 20, 2024).

Authored by David M. Foster, and Danielle Desaulniers Stempel.