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A growing number of sustainability and ESG-related disputes will be resolved through arbitration

Contrary to expectations, the 2020 Covid-19 tragedy has accelerated trends that prioritise sustainability and focus on Environmental, Social and Governance (ESG) issues. Many States have announced that low-carbon investment will be at the core of economic recovery packages, while carbon-intensive energy production will be phased out in the coming years. States have also asserted that, by tackling inequality and strengthening protections for labour rights, they will build back their economies better than they were before. Many in the private sector have also set carbon reduction targets and committed to conducting due diligence on ESG impacts. 

International Arbitration Review

These radical changes in public and private sector priorities and ways of doing business will inevitably generate disputes, many of which will be resolved through international arbitration.   

Resolving ESG disputes through commercial arbitration

Pressure is mounting on businesses in many sectors and jurisdictions to include ESG-related clauses in their commercial contracts and to make them both binding, and enforceable.  This pressure is coming from regulators, litigants, investors and other stakeholders who seek to hold businesses to their ESG-related voluntary commitments, and accountable for their and their business partners’ adverse impacts. 

The pressure has prompted initiatives to devise ESG-related contract clauses, including the Chancery Lane Project (which produced a “Climate Contract Playbook” in February 2020), and a Working Group of the American Bar Association’s business law section (which finalised “Model Contract Clauses to Protect Workers in International Supply Chains” in January 2021).  Several industry-specific projects to draft model contract terms are also underway.  Some companies that are already members of ESG-related risk management initiatives (such as the Equator Principles Initiative) or already impose ESG-related codes of conduct on their suppliers (such as companies in the technology, fashion or fast-moving consumer goods sectors) are reviewing their contracts to replace hortatory language with mandatory language and ensure that ESG terms are enforceable, while taking care not to assume responsibility for the failings of their counterparties. 

Arbitration clauses are already included in many of the contracts between parties in the sectors that will be most affected by the increase in public and private interest in ESG.  Arbitration clauses are included in many contracts governing the energy, natural resources, infrastructure and construction sectors, for example, the sectors that are the most likely to be involved in climate change related disputes.  Such disputes fall into three broad categories: (a) disputes arising from specific transition, adaptation or mitigation contracts entered into in order to meet specific climate change goals or commitments; (b) disputes arising from contracts more generally where, for example, contractual performance has been affected by the parties’ responses to changes in national laws and regulations; or the environmental impacts of climate change itself; and (c) disputes which the parties have agreed to submit to arbitration after the dispute has arisen.

International commercial arbitration, already the preferred method of cross-border dispute resolution for many in these sectors, is well-suited to resolve climate change and other ESG-related disputes.  Companies tend to prefer arbitration where they anticipate that disputes may have adverse reputational effects, as it is generally confidential, and they value being able to choose their adjudicators where they anticipate that disputes may require special expertise.  For these and other reasons, arbitration provides an appropriate forum in which to resolve business-to-business climate change-related disputes (as acknowledged by the ICC Task Force on the Arbitration of Climate Change Related Disputes), environmental disputes (as suggested by the drafters of the PCA’s Optional Rules for Arbitration of Disputes Relating to the Environment and/or Natural Resources) and human rights-related disputes (as suggested by the drafters of the Hague Rules on Business and Human Rights Arbitration).

Given that they are generally confidential, it is difficult to assess how many international commercial arbitrations raise ESG issues.  However, companies are being assessed for their ESG performance at a time when there is no official consensus about the standards that should be applied for that purpose in many sectors.  For that reason alone, ESG-related disputes are sure to come before arbitral tribunals in 2021 and beyond. 

Resolving ESG-related disputes through investor-State arbitration

Many States are encouraging the private sector to make huge investments to combat and adapt to climate change, and to help develop resilient economies that respond to the sustainable needs of communities.  Such States realise that, if they are to meet the commitments they have made under climate change, environmental and human rights treaties, and achieve the Sustainable Development Goals by 2030, they will need assistance and cooperation from the private sector, including foreign investors.   

Last year, several States turned to trade and investment treaties as a means to prevent other States from competing to attract foreign direct investment by relaxing labour and environmental standards, or their nationally determined commitments under the Paris Agreement.  The USCMA, for example, requires each of the States Parties to fulfil their obligations under environmental treaties, and includes a mechanism to hear complaints if Mexican factories deny workers the freedom to organize and collectively bargain.  The text also creates presumptions that any labour or environmental violation affects trade and investment.  Another example from 2020 is the EU–UK Trade and Cooperation Agreement, which requires the parties to respect the Paris Agreement.

States have also been turning to investment treaties as a means to require investors to uphold human rights and environmental standards.  For example, the 2019 Netherlands Model bilateral investment treaty (BIT) provides that “[i]nvestors and their investments shall comply with domestic laws and regulations of the host state, including laws and regulations on human rights”.  The India Model BIT directs tribunals to reduce damages to reflect “mitigating factors” which can include “any unremedied harm or damage that the investor has caused to the environment or local community or other relevant considerations regarding the need to balance public interest and the interests of the investor”.  At the next OECD Investment Treaty Conference (currently postponed from March 2020 due to the Covid-19 crisis), States will discuss options for further integrating policies relating to business responsibilities into trade and investment treaties.

Investment treaty arbitration is another arena in which States are beginning to challenge ESG-related misconduct of foreign investors.  For instance, in the 2017 case of Urbaser v. Argentina and the 2018 case of Aven v. Costa Rica, tribunals accepted that corporations have responsibilities under international law and asserted jurisdiction over the States’ counterclaims.  Argentina’s counterclaim was that Urbaser failed to provide the necessary level of investment to ensure respect for the internationally recognised human right to water, while Costa Rica’s counterclaim was that Aven had failed to comply with the applicable treaty’s requirement of compliance with environmental measures taken by the host State.  Other tribunals have been willing to limit the damages recoverable by investors due to failures in relation to environmental or human rights standards (in Bear Creek Mining Corporation v. Peru, for example); or find that they lack jurisdiction to hear the case on the basis that the investor procured the investment through corruption (in World Duty Free v. Kenya, for example).

With the new focus on ESG, the conduct of investors is likely to come under increasing scrutiny, potentially affecting their ability to rely upon investment treaty protections and exposing them to counterclaims by States.  Likewise, States’ compliance with climate change, environmental and human rights treaties, and the interplay between their obligations under those treaties and investment treaties, are likely to be central issues in many investor-State arbitrations in the years to come. 

This article is part of the International Arbitration Review.

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