ESG-related Arbitrations: A New Kid On The Block

• Published date: 09 February 2023
• Subject Matter: Corporate/Commercial Law, Environment, Litigation, Mediation & Arbitration, Corporate and Company Law, Contracts and Commercial Law, Environmental Law, Arbitration & Dispute Resolution
• Law Firm: Schoenherr Attorneys at Law
• Author: Ms Nata'a Lalatović and Dragana Nikoli&#263

Companies are no longer only assessed on their financial performance. Increasingly they are being asked to demonstrate that their business activities are socially responsible, environmentally sensitive and contributory to sustainable development.

This is because ESG (Environmental, Social and Governance) factors have substantially gained in importance. While ESG reporting and regulatory requirements are on the rise, rating agencies are factoring in ESG compliance when assessing creditworthiness. Incentives to showcase ESG compliance are also coming from investors, shareholders, suppliers, employees, customers, local communities and other stakeholders.

Companies are thus increasingly making ESG a part of their decision-making process. They keep looking for legal mechanisms that would allow them to secure ESG compliance. When they fail, their responsibility is often assessed in international arbitration.

Commercial contracts

One way of securing ESG compliance is by including ESG clauses in business agreements (e.g. commercial, sales and supply agreements, construction project agreements, loan facilities, even M&A contracts), usually as representations, indemnities or warranties. For example, buyers and suppliers often agree to conduct human rights due diligence, or a developer warrants to comply with environmental and health policies.

ESG clauses should be used as a driver for positive change. However, they may easily become a burden because they are still new and untested. Yet, they create binding contractual obligations, liability and exposure for the parties. In other words, ESG clauses should not be taken lightly.

To encompass a wide variety of often imprecise and complex standards and metrics, ESG clauses are typically drafted too broadly. While "catch all" terms and concepts in ESG clauses have their advantages, it is hard to expect that they are consistently applied across different industries and sectors. The main environmental concerns and responsibilities are likely to be perceived differently by, for example, an energy company and an investment fund. Likewise, labour standards in the supply chain of a large production facility inevitably differ from those applicable to an online service provider. Accordingly, misinterpretation or misapplication of ESG clauses may easily lead to a new type of dispute: ESG disputes.

Cross-border ESG disputes may be decided in commercial arbitrations if the underlying business agreements contain arbitration clauses...