ESG disputes in international arbitration

April 2023  |  FEATURE | LITIGATION & DISPUTE RESOLUTION

Financier Worldwide Magazine

April 2023 Issue

Businesses are increasingly aware that dubious environmental, social and governance (ESG) practices can have significant financial and reputational consequences. Recent years have seen growing calls for companies to embed meaningful ESG strategies within their overall operations. Countries are introducing regulatory measures such as mandatory ESG disclosures. Failing to comply, or engaging in ‘greenwashing’, may see companies subjected to regulatory investigations, criminal and civil proceedings, and hefty fines.

But beyond the risk of regulatory enforcement, there is also the looming threat of general ESG disputes.

A recent report by the London School of Economic and Political Science concluded that the cumulative number of climate change-related cases globally has more than doubled since 2015, bringing the total number of cases to over 2000. Around a quarter of these were filed between 2020 and 2022.

Over the last 12 months, further legal cases have been brought against fossil fuel companies, especially outside the US. All sectors are theoretically at risk of facing climate-related disputes, but those increasingly targeted include food and agriculture, transport, manufacturing, plastics, and banking and financial services.

Companies, investors and asset managers now find themselves in legal jeopardy from several directions, making it hard to come up with a definitive plan or strategy around ESG disputes.

With companies under both regulatory and commercial pressure to transition to net zero and uphold human rights across their operations, managing those risks requires overhauling not only internal policies and practices, but external contractual relationships as well. As a result, ESG clauses are finding their way into commercial agreements with third parties. Today, companies demand more from the organisations they partner, contract or work with, binding them to certain commitments and specific standards.

While courts have been the forum for most ESG disputes to date, the inclusion of ESG provisions in commercial contracts and investment treaties is expected to shift at least some of the focus toward arbitration.

ESG-related claims

ESG-related claims can take various forms. According to Norton Rose Fulbright’s ‘Climate change and sustainability disputes: International arbitration perspectives’, such disputes can be roughly divided into the following categories: (i) cases brought to either mandate or change climate-related policy or conduct; (ii) cases brought to seek financial redress for damages associated with climate change; (iii) contractual disputes arising out of the extensive transitions which the energy sector – and indeed all major industries – are currently undergoing; (iv) contractual disputes resulting from climate-related events; (v) disputes between foreign investors and host states; and (vi) disputes between states, and between other transnational actors.

According to a 2017 Organisation for Economic Co-operation and Development (OECD) report, to fund and achieve global climate goals, an estimated $6.3 trillion of investment will be needed annually until 2030, of which only a small proportion will be met by governments. The gap will be filled by private investment, including foreign direct investment (FDI). As a result of the significant investment required, disputes between investors and host states will be inevitable. Arbitration is well placed to take a prominent role in resolving investor-state disputes with climate change and sustainability elements.

Issues such as misselling, greenwashing, parent company liability, directors’ liability, environmental protection, sustainability, bribery and corruption, local community impact, and human rights can all impact companies. Many ESG-related challenges are linked to climate change or supply chains. Given the scale and severity of these issues, ESG clauses are increasingly common in commercial contracts. To the extent a dispute does arise and the underlying contract contains an arbitration clause, the dispute will be determined by arbitration.

Suitability of arbitration

Several aspects of arbitration make it particularly well suited for these types of disputes. Notably, arbitration allows the parties to choose specialist arbitrators who have the requisite knowledge and experience of technical issues to understand the complex details in question. Future ESG disputes will be novel, complex and largely untested, which affects how they will be interpreted and applied.

Arbitration also provides a neutral forum and flexible procedures, so the parties can design a process that accommodates their needs and adapts to the nature of the dispute.

The international aspect of ESG disputes also lends itself to arbitration thanks to the New York Convention, which allows an award to be enforced in virtually any jurisdiction more easily than a court judgment. Referring more ESG disputes to arbitration would avoid overloading court systems while maintaining a high standard of procedural redress.

There are, however, potential drawbacks and concerns with respect to arbitration’s suitability for resolving ESG disputes. There is, for instance, a potential imbalance of resources between multinational organisations and governments that might find themselves in dispute. According to statistics from Global Justice Now compiled in 2017, 157 of the top 200 economic entities by revenue were corporations, not national governments. Further, the top 10 corporate revenues exceeded $3 trillion.

Questions have also been raised around the lack of transparency in commercial arbitration proceedings. Such questions persist, despite recent efforts by some arbitral institutions to establish presumptions in favour of publishing information on the composition of arbitral tribunals and arbitral awards.

Appropriate provisions

Going forward, ESG issues will continue to be championed by customers, investors and regulators. Companies need to understand their impact and obligations across different jurisdictions, and adapt accordingly.

The evolution of ESG concerns on the international stage is leading to new economic realities and legal frameworks which corporate entities need to address. In the event they find themselves embroiled in an ESG dispute, arbitration offers parties a suitable method to resolve it. From the outset of any commercial venture, companies should consider their ESG risks and make appropriate provisions in their governing documents.

© Financier Worldwide

BY

Richard Summerfield