Climate-related disputes: Adaptation and innovation

As scientific consensus over the evidence of climate change and humanity’s causal impact continues to mount, the scrutiny of state and corporate action (or inaction) as contributors to climate risk is intensifying. For companies operating in the energy sector, climate change manifests as a complex myriad of legal, financial and reputational risk. The number of climate-related cases commenced to date is well over 1,100, and that number continues to rise. Most cases fall beneath the radar (low key skirmishes over statutory permissions or breaches) but in recent years a number of high stakes claims have been fought very publicly before the highest courts and regularly in the courts of public opinion. Regardless of success, such claims inspire imitative cases all over the globe. Put plainly, climate-related disputes risk is now part of corporate reality.

Whilst most legal challenges to date have been brought before national courts, there is a role for arbitration as a forum for resolution of climate-related disputes. Indeed, arbitration has the potential to become a key mechanism for the enforcement of environmental law and policy.

Climate-related disputes and legal risk

The range of climate-related disputes brought to date is vast – it is a global phenomenon, where legal issues traverse multiple fields of law and various causes of action, and involve a wide range of claimants and defendants from multiple sectors. Climate-related disputes risk is not just an energy sector issue, though for obvious reasons that sector has become a primary target.

The risk profile is not only complex but in a state of flux. This is partly due to innovative claims being brought by claimants as they seek to get around the legal hurdles frequently faced by such claims (standing, justiciability, causation, to name a few). It is also due to the ongoing evolution of climate related regulation, on the national and international stage, as states grapple with how to address climate change and who should shoulder the fiscal burden.

Climate-related disputes can be roughly divided into two categories: (1) cases brought to either mandate or change climate related policy or conduct; and (2) cases brought to seek financial redress for damages associated with climate change.

Legal action as an instrument to drive change

The first category includes cases pursued by NGOs, pressure groups (often crowd-funded) and even governmental authorities against governments to enforce existing climate policies or accelerate policy change. The Urgenda case is a notable example. The Urgenda Foundation successfully sued the Netherlands and obtained a court order compelling the government to implement more stringent climate change policies (the case is under appeal). Urgenda spawned numerous copycat proceedings across the globe, with mixed rates of success. In addition, there have been regulatory investigations of corporates over disclosures of material climate-related risk, and significant levels of investor activism, including investor claims. These also fall within this category as the intention is still to drive policy change, albeit corporate change or behavior. Unsurprisingly, we are also seeing claims (largely by industry actors) aimed at driving policy change in the other direction.

For this type of dispute (at least for the time being), national courts will continue to be the fora of choice, and arbitration will play a more limited role.

A big part of the attractiveness of litigation is the public nature of proceedings – public relations and reputational pressure is brought to bear on defendants, and claimants also seek to raise the profile of and galvanise public support for what is often a political or public interest cause. Pressure groups readily admit that publicity is often a significant win, even if the case is lost on legal merits. In contrast, arbitration has an inherently private nature. Of course, not all arbitrations are confidential (though many are), but almost all arbitrations are private – in that only parties can participate in proceedings, access pleadings and evidence, attend hearings, and see the final awards. To the extent that awards or arbitrationrelated judgments are published, these are often anonymized.

More fundamentally, as arbitration is a contractual process, public interest groups often will not have legal standing to pursue arbitration. Likewise, there can be problems with arbitrability.

Legal action as a means of seeking financial redress

In the second category are claims against corporates where the main purpose is to seek damages for direct or indirect effects of climate change on the claimant’s property or investments (often in conjunction with other relief). A number of such claims have been brought by individuals and pressure groups (again often crowd funded). One example is Lliuya v RWE AG. In that case, Germany’s largest electricity producer, RWE, is being sued by Saúl Luciano Lliuya, a Peruvian farmer, for a financial contribution towards costs of putting in place flood protections in his village in Peru. This claim is notable for its fact profile – Lliuya is suing RWE before the German courts for emissions released in Germany which Lliuya alleges contributed to climate change and ultimately the melting of a Peruvian glacial lake above his village thereby necessitating the flood defences. It shows the truly global nature of climate change disputes risk. The case survived an initial challenge, with the court of appeal finding that a polluter can be liable for impacts of climate change in principle. The case is ongoing.

Such claims are not limited to individuals or pressure groups but are also being brought by sub-national governmental authorities. For example, the various high profile lawsuits commenced by US cities and communities against carbon majors, before both federal and state US courts.

Arguably also within this category are claims by foreign investors against states, which seek to apportion liability for the impact of climate-related state conduct (e.g. change in policy or law) on their investments.

In at least the short term, arbitration will have a greater role in this category than in the first.

An enhanced role for arbitration?

There is scope for arbitration to play a more prominent role in resolving climate-related disputes. In broad terms there are three key areas where this may prove likely:

Commercial arbitration

Climate change will affect the energy sector in multiple ways – manifesting as physical risk, transitional risk and/or legal or regulatory risk. As such, there are multiple ways that climate-related issues might result in commercial disputes. An obvious example is force majeure claims. Where new risks manifest, parties invariably seek to mitigate and allocate such risks as between them contractually. Unsurprisingly, many contracts now include obligations to comply with and/or warrant compliance with environmental, human rights or sustainability obligations, and commitments to put in place back-to back arrangements with counterparties further down the line. Disputes over those provisions will eventually arise.

International arbitration is frequently the dispute resolution mechanism of choice for cross-border transactions, particularly where a party is a state or state-owned entity or an emerging market is involved, as is often the case in the energy sector. The confidential nature of commercial arbitration means that it is difficult to track the extent to which climate-related issues are already being raised. But given the scope of climate risk, it is clear that more disputes with climate-related elements will be decided by commercial arbitration.

Investor-state arbitration

Significant investment will be needed to fund global climate goals. In 2017, the OECD estimated that $6.3 trillion of investment is needed annually until 2030, of which only a small proportion will be met by states. The gap will be filled by private investment, including foreign direct investment (FDI). Reports are already showing a significant rise in FDI in low carbon initiatives and climate financing. With any increase in new FDI, there will be an increase in disputes between investors and host states.

Disputes will also likely arise in the context of pre-existing investments. Over the last ten years, legal, regulatory and other changes in response to environmental issues have been implemented at an unprecedented rate, at both international and national levels. These will increase as states introduce measures to meet the Paris Agreement commitments and seek to allocate the financial costs of dealing with climate change. Changes to the investment environment often also leads to disputes between investors and host states. Bilateral or multilateral treaties (BITs or MLTs) offer foreign investors a further layer of protection against host state conduct. In particular, they generally afford investors the direct right to bring proceedings against host states, usually in investor-state arbitration (ISDS). A prime example is the significant number of claims (40 at last count) brought against Spain under the Energy Charter Treaty (ECT) following reforms to Spain’s renewable energy policies. Climate-related claims in investor-state arbitration are likely to increase.

Anti-ISDS proponents warn of the “chilling effect” of ISDS on public interest regulatory action. That chilling effect is often wrongly blamed on ISDS as a system, and is often misstated or overstated. Any chilling effect would not be the result of arbitration as a process, rather the result of the substantive terms agreed in the BITs. Generally BITs preserve states’ rights to pursue legitimate policy objectives, such as the protection of public order, security, morality and health, and taxation, amongst others. Newer BITs, such as the Netherlands’ draft model BIT, expressly reference states’ rights to regulate to deal with environmental and human rights issues. Moreover, there is little evidence to support the claim that companies are abusing ISDS – of the 767 known ISDS arbitrations, only 32 awards dealt with state measures to protect the environment and public health (statistics reported in Annette Magnusson, “New Arbitration Frontiers: Climate Change” in Evolution and Adaptation: The Future of International Arbitration, ICCA Congress Series no. 20, Kluwer forthcoming). If older treaties do not provide such exceptions or the terms are unsatisfactory and in fact being abused, then there is a case for renegotiation of those terms. Likewise, concerns over transparency of public interest ISDS can be dealt with by states signing up to initiatives such as the Mauritius Convention on Transparency in Treaty- Based Investor-State Arbitration. These criticisms are not, however, valid reasons for discarding the ISDS system.

A criticism perhaps worth closer consideration is whether, as a matter of policy, individual arbitrators appointed on an ad hoc basis have sufficient legitimacy to decide the validity of state conduct where it touches on areas of public interest. But this criticism ignores the need that ISDS addresses as well as the fact that there is currently no viable alternative. ISDS came into existence because host states wished to encourage FDI, and foreign investors needed certainty as to how their investments would be treated and some effective avenue for recourse in the face of host state misconduct. National courts or state-state diplomacy (or hostility) had proved largely ineffective or unsatisfactory in resolving disputes. Tearing down the ISDS system (without any effective replacement) will only lead to greater risk for investors, greater nationalism, and “tit for tat” state-state measures.

Also often overlooked is the potential for BITs and ISDS to facilitate and enforce sustainable development and “climate-positive” policies. BITs can, for example, impose obligations on states to promote sustainable development, climate-positive trade or sharing of environmental technologies. The Netherlands’ draft model BIT is again a good example – states must ensure “high levels of environment and labor protection” and “reaffirm their commitment” to international human rights and environmental treaties, including the Paris Agreement. It also allows tribunals to take into account investors’ conduct where they have not complied with the UN Guiding Principles on Businesses and Human Rights, and the OECD Guidelines for Multinational Enterprises. ISDS tribunals have already shown a willingness to engage on such issues. In Urbaser SA & Ors v Argentina, in the context of investor claims under the Spain-Argentina BIT, Argentina counterclaimed that the investors had breached international human rights obligations (the right to water). The tribunal held that it had jurisdiction over the counterclaim and that consideration of international human rights obligations was within its competence. Ultimately Argentina failed to establish any breach of obligations owed by the claimants, but the tribunal’s willingness to accept jurisdiction was itself a significant development.

There is little doubt that arbitration has a role to play in resolving climate-related investor-state disputes. The scope and breadth of that role is still to be seen and will no doubt fluctuate over time along with political, economic and public perception changes.

State-state arbitration

Arbitration already plays a role in resolving state-to-state disputes, under both BITs and MLTs. One well-touted example in the environmental context is the Indus Waters Kishenganga arbitration (Pakistan v India, PCA 2011-01) commenced under the Indus Waters Treaty. There is obvious scope for arbitration to play a similar role in respect of climate-related state-state disputes.

There are two key climate treaties – the Paris Agreement, aimed at enabling states to combat climate change and adapt to its effects, and its parent framework, the UN Framework Convention on Climate Change (UNFCCC). These mark a significant leap forward in global climate change policy. Currently, however, there is a lacuna in respect of enforcement. The Paris Agreement contains optional provisions for state-state arbitration, to be conducted in accordance with yet-to-be agreed arbitral procedure. It also incorporates the dispute settlement provisions of the UNFCCC (with minor necessary alterations). But to date the majority of state parties (with the exception of the Netherlands, Tuvalu and the Solomon Islands) have chosen not to opt-in to these procedures. The difficulty is that there is little impetus (but significant disincentive) for states to open themselves up to claims from other states, particularly given the potentially catastrophic impact of climate change which some states already claim threatens their very existence.

It will likely take substantial public and political pressure, at international and national levels, before the majority of states agree some form of dispute resolution provisions for climate-related disputes. In parts of the globe, the trend towards nationalism and hostility towards international treaties (and international arbitration as a process) may make this difficult to achieve any time soon.

However, if and when such consensus is reached, arbitration is well-placed to fill the breach, not least because it is a neutral, impartial forum.

Conclusion

Climate change is leading to new economic realities and new legal frameworks to which all state and corporate entities must adapt. Climaterelated litigation and legal risk is the new corporate reality. To date, many test cases are unsuccessful but activists across the globe are finding innovative ways to bring legal challenges. Frequently, the battleground is the court of public opinion, and damage is done regardless of whether the claim is successful. Regulation is increasing in this area, as states grapple with how to resolve these issues and, importantly, who should pay – this too brings legal risk and ultimately disputes. As a neutral forum, arbitration is arguably well placed to play a leading role as an arena for resolving many of these climate change disputes. Furthermore, it has the potential to fill an existing lacuna and become a key mechanism for the enforcement of international environmental policy.

With special thanks to Christopher Aird, trainee, for his contribution to this article.

A version of this article will also be published in Global Arbitration Review.