How can your contracts help you further your ESG objectives?

If environmental, social and governance (ESG) commitments are central to your model of business, have you considered whether your supply chain contracts are supporting this strategy? Perhaps you have already felt important customers flex their muscles in this way and tighten up their requirements via their contracts, as they work towards enhancing sustainability of operations, social practices and ethical business conduct between parties. If so, should you be including specific clauses in your contracts to help achieve your common objectives?

We are seeing a shift from companies using ESG considerations in their operations to actually incorporating ESG clauses within contracts. The driving factor for this shift is a combination of rising expectations from investors and customers, alongside the need to protect reputational risk and gain marketplace edge.

What do ESG clauses generally cover?

Just because ESG clauses include environmental, social and governance elements, it does not mean you need to include clauses for each and every aspect. Commercially, contracts will be tighter if there is focus on the most important elements that matter to your business.

For example, if your business is focused on producing sustainable products or relies on green certifications such as ‘B Corporation’, you might consider adding in contract clauses that commit your suppliers or manufacturers to using greener fuel sources or getting certified to certain third-party standards. This could benefit your business in the following ways:

• the clauses increase the evidence you can provide to customers and future investors; and
• such clauses could give you more credibility in the industry or marketplace, thereby giving you a competitive advantage.

Alternatively, if your business employs staff in other countries, the ‘social’ part of the ESG clauses may help you commercially and in furthering your ESG objectives and goals. If investors or customers support or have confidence in knowing you are committing to fairer pay practices or safer working conditions, are serious about protecting human rights, or committed to diversity inclusion, this can give you further confidence to push the benchmarks further.

The last element of ESG contracting you may wish to consider relates to governance and compliance. These focus on anti-corruption practices and ethical business conduct. This element has actually become partially commonplace in most contracts nowadays through the inclusion of modern slavery and anti-bribery clauses. Governance clauses clearly present your business to be reliable, in compliance and committed to operating ethically.

Can ESG clauses be legally binding and enforceable?

Once incorporated into a contract ESG clauses would operate like any other clause, legally binding the parties to the warranties made. A failure to comply would result in a breach of contract, potentially giving rise to remedies such as termination of contract, damages or other agreed remedies.

However, it is important to note that the enforceability of ESG clauses very much depends on how they have been drafted. Drafting the clauses in a way that is not vague, and that has clear measures against which one can assess if there has been a breach, would strengthen the ability to enforce such clauses. A degree of proportionality must also be present in the wording. For example, setting unrealistic timelines or thresholds (say for reducing greenhouse emissions) or including burdensome penalties as a remedy, or drafting the clauses to be obviously in favour of one party, could all mean a court of law may be reluctant to enforce such clauses.

While language such as ‘reasonable endeavours’ or ‘must act sustainably’ are examples of how not to draft ESG clauses because of their uncertainty, it is vital to seek professional legal advice so that parties are clear what is expected of them.

Parties can also agree on areas that must be contractually binding and those that are intended to be more guiding principles. Balancing the risk appetite of both parties together with commercial practicality is important, and our team of expert lawyers can help you address these questions and more:

• What must be done and by whom?
• When is performance required and for how long?
• How compliance will be assessed and by whom?
• How should remediation work?
• Are there to be reporting requirements?
• Will parties have audit rights and obligations?
• What about performance being impacted by parties further down the supply chain or subcontractors?
• Which legislations apply? Note ESG contracting is not the same across countries – this will be particularly important where the obligations trickle down to the wider supply chains, which may include partners abroad.

Good practice tips

As well as advising you on the above, we can also guide you when putting in place practical protocols to ensure the ESG clauses benefit your business the way they are intended to, while also reducing the risk of issues with breaches and enforceability.

For example, we would work with you to:

• cross check the responsibilities within the ESG clauses against your internal policies and capabilities;
• check resources are in place for auditing, check compliance and advise on how to handle administration resulting from the clauses being implemented; and
• cross check the ‘trickle down’ effect to ensure ESG clauses in one contract do not adversely affect contracts in other parts of the supply or manufacturing chain so as to ensure there is consistency.

How we can help

As ESG considerations move from policy to practice to contractual commitments, our team of solicitors can help you navigate this shift. Whether it is for a service agreement, supply chain contract, manufacturing contract, investment or acquisition transaction, we have the expertise to ensure ESG clauses propel your business rather than hinder it.

For further information, please contact Ian Barnard or Richard Wrightson in our company and commercial team.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.