ESG disputes in international arbitration

Introduction

Environmental, Social and Governance, or ESG, is an umbrella term for issues relevant to an organisation’s assessment of its impact on society and the environment. As the importance of ESG in corporate policies and investment decisions increases, so too will the number of disputes arising out of ESG-related issues. We are already seeing that those issues are broad-ranging, with a huge variety of ESG-related claims already being brought across a variety of judicial and quasi-judicial forums, but there are two categories of claims that are especially appropriate for resolution by arbitration: (1) commercial contract claims; and, (2) treaty-based claims. In this article, we look at recent ESG-related developments and how they are likely to affect international arbitration in the near future.

Commercial contract claims

Appropriate management of commercial contracts is one of the ways that companies are able to tackle ESG risks. Exceptional supply chain disruption following the Covid-19 pandemic has presented an opportunity for companies to review their existing supply chains and seek to incorporate ESG principles into their contract portfolio. These ESG principles may derive from a company’s own ESG goals and policies, or from applicable laws. ESG contractual provisions will be particularly key where there are different standards, laws or regulations, and levels of transparency, between various countries along the supply chain. Jurisdiction-based differences can be addressed via contractual provisions requiring all counterparties to comply with stipulated ESG-related obligations.

Examples of ESG-related provisions include:

• Climate change/net zero goals, for example, the Chancery Lane Project, which is a collaborative effort between UK lawyers to develop contractual provisions that support the fight against climate change.
• Responsible business commitments, for example the code of conduct of the Responsible Business Alliance, which is used by companies to develop contractual provisions covering various ESG issues.
• Renewable energy and/or sustainability commitments.
• Human rights and/or anti-discrimination commitments, for example the American Bar Association’s model contract clauses, which were updated in 2021 to expand the scope of ESG obligations to include human rights obligations for buyers in international supply chains.
• Indemnity provisions covering environmental incidents.

Most of these types of provisions are new, innovative and accordingly untested. They are also likely to contain broad obligations that may be difficult for companies to comply with or demonstrate compliance with in practice. Inevitably, this will lead to disputes between counterparties, concerning both novel questions of interpretation, enforceability and measurement of compliance with ESG-related provisions, as well as more typical breach of contract claims for non-performance of ESG-related obligations or overstated ESG-related representations or warranties.

As many of the companies now including ESG-related provisions in their contracts operate globally, we can expect that international arbitration will commonly be the chosen forum for the resolution of ESG-related disputes.

Treaty-based claims

ESG-related protections are also increasingly being included in international trade and investment treaties. This could give rise to a new and novel claims and defences in investor state dispute settlement, with more claims being brought by rather than against states, for example, being entitled to bring claims (or counterclaims) against investors for ESG failures and/or the dilution of investor protection where that protection conflicts with a state’s ESG objectives. Usually, the forum for dispute resolution will be investment treaty arbitration under ICSID.

Some notable examples of new ESG-related treaty provisions include:

1. The Energy Charter Treaty: Tentative agreement in principle on a modernised treaty was reached by the contracting parties in June 2022. Although we will not know full details of the modernised text until late 2022 at the earliest, and it will still require ratification by every contracting state before it could come into force, a number of the proposed changes would radically limit the protection of traditional fossil fuel investments and promote investment in the renewable forms of energy and related technology. See our May 2022 article, ECT modernisation article.
2. EU-Angola Sustainable Investment Facilitation Agreement: The EU Commission began negotiating its first bilateral investment agreement in June 2021 with Angola. The intention of the agreement is to achieve “good governance and cooperation”, with goals including “facilitating investment by enhancing the transparency and predictability of investment measures” and “promoting sustainable development and responsible investment”.
3. Singapore/Australia – Green Economy Agreement: Negotiations between Singapore and Australia for a bilateral “green” trade agreement have also begun. The purpose of the Green Economy Agreement is to help the countries achieve their common target of net zero emissions by accelerating the adoption of low-carbon and green technologies, low-carbon and renewable energy, and decarbonised production processes. There is also a broader aspiration for the Green Economy Agreement “to serve as a pathfinder that contributes to multilateral and regional policy development by establishing policies, standards and initiatives that will not only create good jobs in green growth sectors, but also strengthen environmental governance and global capacity to address environmental issues, in particular climate change.”

In part, this modernisation of international investment treaties is being driven by the wave of treaty claims in recent years arising out of changes to domestic energy regulation. For example, numerous claims have been brought against Spain, Italy and the Czech Republic since feed-in tariff regimes to support renewables investment were withdrawn in the early 2010s, and two energy companies commenced ICSID arbitrations against the Netherlands under the Energy Charter Treaty following its announcement that coal power plants would be phased out by 2030. Many of these cases actually concern the withdrawal of policy aimed at promoting clean energy, as opposed the imposition of such policy on investors in traditional energy sectors. In any event, states are looking for greater freedom to regulate in the area of ESG without exposing themselves to claims from investors, whilst also trying to remain attractive to foreign investment.

There additionally seems to be a developing trend of including ESG-related obligations for investors in treaties. For example, the Netherlands 2019 Model BIT provides that investors can be held responsible for a failure to comply with the UN Guiding Principles on Business and Human Rights and the OECD guidelines for multinationals. As the purpose of BITs has historically been to provide protections and a means of recourse for investors against foreign states, not the other way round, this marks a definite shift in priorities and emphasises the increased importance of ESG-related issues in foreign investment. It remains to be seen whether and how states might enforce these types of obligations against investors, but there have been instances in the past where corporates have been held directly accountable under BITs. One high profile example is the ICSID case of Urbaser v Argentina ICSID Case No. ARB/07/26, where the tribunal found in favour of Argentina’s counterclaim based on the allegation that Urbaser’s failure to provide the relevant investment violated the human right of access to water.

There is also the possibility for treaties to include a mechanism where damages are reduced to account for harm caused to the environment or local community, such as that included in the India Model BIT. If this type of mechanism starts appearing in more treaties, investors may see tribunals decrease the damages that they are awarded in treaty-based arbitrations as a result of ESG-related issues.

Conclusion

Whilst courts have been the forum for most ESG disputes to date, with the rise in ESG-related contract clauses and the inclusion of ESG provisions in international investment treaties, commercial and investor state arbitration is expected to play a much greater role in ESG dispute resolution in the future.