What are climate change and sustainability disputes?

Introduction

It is impossible to ignore that climate change and sustainability issues are scorching hot topics (pardon the pun). On a daily basis, these issues are debated in the news, at industry roundtables and dinner tables, as well as on the floor of parliaments around the globe. Inevitably, these issues have also become part of the legal landscape and are being argued before courts and tribunals. The range of climate change and sustainability legal disputes 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. The disputes risk profile for companies is not only complex but in a state of flux as claimants and defendants present ever novel arguments, and as legislators, regulators, courts and tribunals grapple with how to address these complex issues and who should bear the significant legal and fiscal burdens. For many in-house counsel, the sheer breadth of these issues is nightmare-inducing and makes it difficult to assess the likely legal and regulatory risks and to formulate strategies to mitigate those risks. In this two part series, using examples from recent cases referred to arbitration, we seek to offer a simple introduction to the types of climate change and sustainability disputes that are being brought in international arbitration and to explore related trends. This first article explores climate change and sustainability related arbitrations arising out of contracts.

What are climate change and sustainability disputes?

There is no single definition of what constitutes a climate change related dispute. One helpful description was offered in the recent ICC Commission Report ‘Resolving Climate Change Related Disputes through Arbitration and ADR’ (ICC Taskforce Report) which took a broad view of such disputes as including “any dispute arising out of or in relation to the effect of climate change and climate change policy, the United Nations Framework Convention on Climate Change (“UNFCCC”) and the Paris Agreement”.  

We largely adopt that broad approach, save to add ‘sustainability’ to our definition. This is in recognition of the fact that these disputes often encompass other distinct issues which fall within the broader sustainability sphere. For example, human rights and other fundamental rights have traditionally been viewed as a distinct category but these are inherently related to and impacted by climate change. Commentators tracking climate change dispute trends have for years been predicting (accurately) that there will be an increase in claims that are essentially climate change related disputes but formulated as fundamental rights arguments. This is a trend that will increase in coming years, not least because such arguments have already enjoyed some success. Other examples are biodiversity and land degradation issues which are impacted by climate change (and in turn compound the impacts of climate change) but which are also impacted by many other factors. Put simply, the term “climate change” on its own is now unhelpfully narrow. 

Admittedly, even this definition is flawed. ‘Sustainability’ also notoriously suffers from being too subjective and lacking in clearly defined parameters. However, rather than getting wrapped up in linguistic niceties and wrestling with a strict definition, it is perhaps easiest to follow the approach famously taken by U.S. Supreme Court Justice Potter Stewart to describe his threshold test for obscenity: “you know it when you see it”. To that end, this two part series offers a number case examples to bring to life the variety of climate change and sustainability related disputes ending up in arbitration.

At the risk of re-complicating matters, it can also be useful to roughly divide climate change and sustainability disputes by certain practical identifying features. For example, it can be helpful to use the following categories (again somewhat similar to the approach taken by the ICC Taskforce) when talking about such disputes: 

1. cases brought to either mandate or change climate-related policy or conduct; 
2. cases brought to seek financial redress for damages associated with the effects of climate change; 
3. contractual disputes arising out of the industry transitions which the energy sector and all major industries are currently undergoing; 
4. contractual disputes resulting from climate-related weather events; 
5. related disputes between foreign investors and host states; and 
6. related disputes between states, and between other transnational actors. 

A key reason for selecting these categories is that the potential role for arbitration varies significantly depending on the category of dispute, with arbitration having a greater role (in practice and in potential) in categories 3 to 6. This is largely because claims that fall within categories 1 and 2 tend to be based on statute or constitutional or administrative law rather than contract. Those disputes necessarily tend to end up before national courts (if not deferred to political fora). More fundamentally, as arbitration is a contractual process, public interest groups often will not have legal standing in arbitration (though it is important to note that it is not so cut and dry as, in some instances, non-parties to the arbitration agreement may be able to participate such as by applying to intervene as amicus curiae in investment arbitration, or with joinder of third parties the consent of the parties in commercial arbitration). There can also be problems with arbitrability of certain disputes falling within these first two categories. 

As such this two part series focuses on categories 3 to 6, presenting a selection of cross-industry examples of each. Categories 3 and 4 – contractual disputes – will be covered in this first article. Disputes between investors and states, and disputes between states, will be covered in part two. 

Disputes arising out of contracts relating to transition, adaptation or mitigation, or resilience activities

The IPCC Special Report on the impacts of global warming of 1.5°C predicted the need for “rapid, far-reaching and unprecedented changes in all aspects of society”, which includes in particular “rapid and far-reaching transitions in land, energy, industry, buildings, transport and cities”. Transitions in these key sectors, individually and collectively, will impact every private, commercial and public endeavour. One hundred years ago, transitions in energy, industry and transport led to fundamental societal change. The advent of the automobile, for example, enabled speedier and safer travel over larger distances, transformed industry and trade, and reshaped our cities as well as our private lives. Modern transitions to limit and adapt to the changing climate (not least, the energy transition) call for an equally radical reorganisation of the way our societies, cities, industries and lives are configured and run. The difference is that these transitions are occurring at a pace that has never been attempted nor achieved in the history of humanity. 

It is trite to say that significant financial investment will be required to fund these transitions. According to a recent report by the IEA, to reach net zero emissions by 2050, the cost of annual clean energy investment worldwide will need to more than triple by 2030 to approximately USD $4 trillion. It also requires massive deployment of all available clean energy technologies (such as renewables, electric vehicles, and energy efficient building retrofits) and huge investment in research and development for new technologies between now and 2030. That is just the cost of the energy transition – the transitions occurring in other major industries will also require significant levels of investment. In addition, according to the 2020 UNEP Adaptation Gap Report, the costs of adaptation (i.e. measures to reduce countries’ and communities’ vulnerability to climate change by increasing their ability to absorb or withstand the impacts) are estimated at USD $70 billion annually in developing countries. This figure is expected to reach USD $140-300 billion in 2030 and USD $280-500 billion in 2050. 

This presents enormous opportunities for industry and businesses. It will, however, also result in an increased risk of disputes. This is in part due to a simple increase in the number of transactions, a percentage of which will invariably result in some form of dispute. In addition, there is also an increased risk of disputes given the particular characteristics of these transactions. Many investments and projects will be peppered with novel aspects, such as new innovations (technologies, products or processes), new infrastructure and systems, new collaborations (including between non-traditional partners such as energy and technology companies), new suppliers and manufacturers, new markets and customers, and new competitors. These are also occurring in the context of a rapidly changing regulatory environment as new regulatory regimes are introduced or old regimes adapted to be fit for purpose. As is the case with clean energy technology, project partners will find themselves navigating a heavily regulated industry, perhaps for the first time. Last, but certainly not least, the pace at which these transitions are occurring will have a significant impact on the risk profile – mistakes are bound to happen in the course of rapid, large scale disruption.  

International arbitration is frequently the dispute resolution mechanism of choice for many of the sectors undergoing these transitions, in particular, energy, natural resources, infrastructure, and transport. Statistics provided by the major arbitral institutions evidence that consistently a high proportion of disputes administered by those institutions involve these sectors. It is also the 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, natural resources and infrastructure sectors). Parties also favour arbitration where confidentiality and privacy is important to disputant parties (as is often the case with contracts involving technology and innovation). Many climate change and sustainability disputes are also technical in nature, and therefore arbitration again offers an edge over litigation because parties can select arbitrators with relevant expertise to adjudicate the dispute. This is borne out by a recent 2019 SCC Report on ‘Green Technology Disputes in Stockholm’ (SCC Report) which concluded that more green technology companies are resorting to arbitration to resolve their disputes. Therefore, a significant number of the disputes arising out of industry transitions and other adaptation and resilience activities have, and will continue to, end up in international arbitration proceedings. 

Arbitration examples 

The SCC Report cited a number of cases involving renewable energy facilities (from wind farm to biogas installations) noting that over 60% of its green technology disputes involved renewables. It stated that typical issues raised involved whether the facility satisfied the contractual standards, for example production of the agreed amount of power, or preventing environmental risks. (Read also our article in this issue on Renewable Energy Project disputes).

Construction issues always prove fertile ground for disputes, with usual disputes relating to quality, liability for additional costs, work and delay (including liquidated damages claims). A high profile example is that of the disputes brought in the wake of a disaster during the construction of the multibillion Hidroituango hydroelectric dam in Colombia which collapsed causing a major flood. A Colombian public utility is seeking USD $1.6 billion from a Spanish insurer following the collapse, and another billion dollar dispute with the consortiums behind the project has also been referred to arbitration. A less extreme example, cited in the SCC Report, is a dispute concerning construction of a biogas facility in which it was alleged that the work performed suffered errors so significant that the facility could not be used. There are many other examples of construction disputes related to renewable energy or resilience and adaptation projects or infrastructure being referred to arbitration. 

In addition to these common issues, recent upheavals at both global and regional levels have led in some instances to companies struggling to find financing for projects which has led to delays at best, termination of contracts at worst, and ultimately arbitration. 

There will also be disputes related to financing, whether that be financing of climate change or sustainability-related projects, failure to meet technical specifications to achieve green or sustainability-linked financing, or the appropriate use of sustainable finance or climate-related funding. Similarly, disputes will arise under carbon credits or emissions trading schemes. As an example, a Danish engineering company won a USD $150 million SCC award against two Russian state-owned entities in an arbitration arising from a contract to undertake works to reduce carbon emissions at gas pipelines. Under that contract, the engineering company was to receive carbon credits for its work which it could trade on international markets under the Kyoto Protocol. However, the Russian entities failed to get the project registered by a certain time. In response, the claimant sought to enforce a contractual mechanism to claw back its investment and an agreed rate of return. In turn, the defendants (unsuccessfully) alleged in the arbitration that the contract was procured by corruption and related criminal complaints in Russia were also instigated. 

Supply and delivery disputes related to climate change or sustainability-related contacts are also commonplace, involving performance, delivery, quality and quantity issues. Commodities are an important area to watch – on the one hand fluctuations in commodity prices will impact climate change and sustainability-related contracts, and on the other hand, commodity prices and contracts (whether related to or unrelated to climate change and transition activities) will be impacted by the effects of climate change and the transitions. For example, commodities may be harder to source or transport due to more extreme weather conditions, and there will be fluctuations in demand and prices, for example, due to technological advances, or changes in policy, law or consumer sentiment, and in some instances certain commodities may no longer commercially viable as a result. Given the fluctuations to commodity prices that have been seen in recent years, and the further anticipated fluctuations in global markets, price review disputes, as well as disputes over performance and termination, with some connection to climate change and sustainability are predicted to rise. Gas price review arbitrations of course spring immediately to mind when thinking about price review disputes, and these cases offer real insight to what could come given most were driven largely by external events such as changes to markets and economic crises, and as a group they resulted in some of the highest-value disputes in the world. But to offer another example, a dispute between a German manufacturer and supplier and a Taiwanese photovoltaic (PV) company related to performance of a long-term supply agreement for silicon wafers (an essential component of cells used to generate solar electricity) was referred to arbitration after the PV company refused to continue to perform the contract following a rapid plunge in the cost of silicon and wafers.

The SCC Report also cited contract-based arbitrations involving unpaid delivery of wind energy converters, claims for payment for consultancy services in connection with share issuance for an organic food producer, and disputes arising from distribution agreements (such as where breach of an exclusive distribution agreement in respect of bioenergy products was alleged). Other commercial disputes such as under licencing, joint venture and partnership agreements related to climate change and sustainability projects should also be expected.

As governments invest in new projects and infrastructure related to the energy and other industries’ transitions or to mitigate the effects of climate change, it is inevitable that contractual disputes involving states and state owned entities will arise. As an example, a German renewables company successfully pursued ad hoc arbitration against the African state of Lesotho after the state refused to perform on a contract to purchase solar energy equipment. Subsequent court proceedings to enforce the €50 million award have also been pursued in the US, UK, South Africa and Mauritius. Nigeria is also reportedly facing an ICC claim worth USD $400 million after allegedly breaching a settlement intended to resolve a prior arbitration over the construction and operation of a major hydropower project. The underlying dispute involved allegations that the main contractor had been excluded from the project. Similarly, a dispute has been reported to have arisen in relation to a wind energy complex in a remote area of the Dominican Republic. The claimant company alleged that it had completed a comprehensive, multi-year study of the wind patterns in the contracted area, leased the property for the complex and obtained all the required licences – only for the state-owned energy company to refuse to formalise a power purchase agreement (PPA) and awarded the PPAs to other companies.

Disputes involving infrastructure arrangements are also likely to increase given that in many instances infrastructure for transition-related projects may be limited or need to be introduced specifically for these projects. As an example, a dispute under a partnership agreement to build a wind farm was referred to arbitration after the claimant alleged that, because the grid connection was no longer available for the wind farm, an event of default under the agreement had occurred and it therefore had the right to transfer its shares in the project back to the respondent. In a similar vein, a Chinese-owned entity has reportedly threatened a Pakistani state entity with arbitration over a USD $2.2 billion electricity transmission project that is part of China’s Belt and Road Initiative over alleged delays in commissioning work which also involved counter-allegations over the impact on the local grid.

Contracts affected by climate change and sustainability issues

The effects of climate change are already impacting commercial enterprises. A quick review of reports by insurance companies shows significant increases in losses due to extreme weather-related events – the increasingly frequency and severity of which many attribute to climate change. These impacts are predicted to further worsen in the coming years. Its worth noting that the effects could go beyond the physical; they could also be transitional (such as loss of an existing market or new competitors), or legal or regulatory (such as inability to renew permits or greater restrictions on doing business that impact profitability). 

There is a myriad of ways that weather-related issues might negatively affect contracts and result in commercial disputes. Obvious examples are claims of force majeure, frustration or termination due to the impact of weather-related events. Disputes relating to insurance arrangements will also arise. The recent COVID-19 pandemic offered insight into the potential scale of global disruption that climate change could have, and highlighted in particular the vulnerability of supply chains. (Also read our article in this issue on Supply Chain disputes).

More broadly, however, changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent, leading to contractual defaults or distressed or stranded assets. 

In addition, where new risks manifest, parties will 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 these provisions will invariably arise. 

Again, commercial arbitration will be the dispute resolution mechanism of choice for many of these contracts, and there will be an accordant increase in disputes being brought in arbitration as the effects of climate change continue to manifest around the globe. 

Arbitration examples

A number of disputes have arisen out of the recent severe storms in Texas in early 2021 which caused widespread power blackouts across Texas, shut down oil and gas wells, froze pipelines, and led to the price of natural gas skyrocketing. Other countries that are reliant on natural gas imports from the US were also impacted, including Mexico which also suffered widespread blackouts. Reportedly, a US investment bank  commenced international arbitration against Mexico’s state electric utility to recover USD $400 million in debt that allegedly arose under a gas purchase agreement as a result in massive surges in the daily price rate as compared to the monthly rate. The utility has refused to pay the increase which it said was caused by an unforeseen event (as well as now alleging other discrepancies in the deal). 

Disputes have also been referred to arbitration and litigation in relation to important infrastructure such as ports and railway lines which suffered devastating damage from flooding, after which the impacted transport companies and the state were unable to agree who should be liable for the costs of repairs and whether the flooding constituted an event of force majeure. 

Conclusion

Climate change is leading to new economic realities and legal frameworks to which all state and corporate entities must adapt. Climate change and sustainability disputes are the new corporate reality. There is no cause for alarm – no transaction is without risk. However, parties are well advised to consider dispute resolution mitigation and resolution strategies at the outset of every transaction. A well-drafted arbitration agreement is a key contractual risk allocation mechanism. As a neutral forum, offering access to expert adjudicators, arbitration is arguably well placed to play a leading role as an arena for resolving many climate change and sustainability disputes arising out of contractual relationships. Other important mechanisms include conducting climate change and sustainability disputes risk audits of the company’s global and regional operations, and establishing protocols for dealing with disputes immediately as they arise. If done well, these can save significant time, costs, reputation and preserve relationships with counterparties. The latter is a critical point in climate change and sustainability contractual disputes given many such contracts will be long-term arrangements involving significant levels of investment both at the outset and ongoing. Considering disputes risk at the outset of such transactions is the best way to avoid a climate change disputes disaster.