Signing up for survival

The road to net zero carbon emissions is littered with broken promises and half-truths, if the practices of major multinationals are anything to go by.

A report released in February by two European non-governmental organisations (NGOs), New Climate Institute and Carbon Market Watch, found 25 of the world’s biggest companies plan to reduce their absolute carbon emissions by just 40% on average, not the 100% the ‘net zero’ goal demands.

‘We’re fooled into believing that these companies are taking sufficient action, when the reality is far from it,’ said Gilles Dufrasne of Carbon Market Watch, one of the report’s authors. ‘Without more regulation this will continue. We need governments and regulatory bodies to step up and put an end to this green-washing trend.’

As trusted business advisers, lawyers must be ‘at the forefront’ of taking climate action and ‘need to step up to the plate and help our clients navigate their net zero transitions as well as transform our own businesses to do the same’, says the Law Society.

‘The legal profession needs to start taking account of climate change risks and their consequences in every transaction and agreement,’ says the Society. ‘Many businesses are at the start of their net zero journey, and are looking for help in making that transition – that translates [in]to billable hours to advise in a way that doesn’t harm the planet.’

One way is to persuade clients of all sizes and in all sectors to use environmentally friendly clauses in their contracts.

Maria Connolly, head of clean energy and real estate and an executive board member responsible for sustainability at TLT, says this can be an effective approach to tackling climate change. ‘While it can take years for climate legislation to take effect, contract clauses are a quick and straightforward way for businesses to work with suppliers on reducing the environmental impact of their operations. It helps to reduce their Scope 3 emissions [greenhouse gases emitted throughout their supply chain] and shows that they are taking steps towards achieving their net zero and other sustainability commitments.’

Connolly adds that ‘contract clauses can also be quickly amended if there’s a change in the law or the company’s ambitions’.

‘Contractual terms that encourage the reduction of Scope 3 emissions provide a solution that can be inserted into contracts immediately,’ says Ben Metz, executive director of The Chancery Lane Project (TCLP). The project was set up to create open-source contract clauses to help organisations address climate risks and impacts and achieve net zero.

'Contract clauses are a quick and straightforward way for businesses to work with suppliers on reducing their environmental impact'

 Maria Connolly, head of clean energy and real estate, TLT

‘As the clauses specify legally enforceable procedures and quantifiable metrics to track climate pledges, their inclusion in supply contracts is a powerful way to take decisive action on reducing emissions and meeting climate targets,’ he says.

Lawyers report increased awareness and adoption by clients of ‘green’ clauses.

Sinéad Oryszczuk, special counsel and vice-chair of Covington’s global environmental, social and governance (ESG) team, says: ‘There’s been a sea-change in terms of recognition and perception of climate and environmental imperatives generally, and of how green or sustainability clauses can and do work across sectors and agreements.’

‘Green’ clauses have been around for a long time. But during the past 18 months their adoption has accelerated as part of an ‘exponential growth’ of contractual terms that are designed to build a ‘wider’ socially responsible business ecosystem covering ESG issues, says Oryszczuk. Most corporate clients are now considering how best to incorporate ESG provisions, particularly in supply contracts, she notes.

‘COP26 probably had a lot to do with the more sudden shift and proliferation; it felt as if COP was a moment of baton-changing when the private sector took over the lead from governments,’ Oryszczuk argues.

Contractual greening is best understood ‘within the context of the full range of the UN Sustainable Development Goals (SDGs) rather than just the environment or climate’, says Adrian Walker, global head of Hogan Lovells’ ESG practice. ‘The SDG lens is increasingly used by public- and private-sector clients to frame their objectives in relation to people and the planet.’

‘Corporate clients are pretty much all thinking about what the climate and ESG agenda means for them as a business and their purpose,’ says Walker. ‘They have to think about the whole business and how that translates into sales, products and services, supply chain and finance, and the associated governance and contractual arrangements.’

Anthony Collins senior associate Natalie Barbosa says that for her clients in the local government and housing sectors ‘what is new is the call to engage in environmental matters in a more consistent fashion, considering climate, biodiversity and wider environmental concerns across all of the activities of an organisation, rather than only in specific contracts or projects’.

Early phases

So how far is this enhanced commitment to the environment actually being integrated into contracts? Although most clients have been open to the idea of introducing climate-related clauses, ‘the process is in its early phases and the concept remains novel. Many clients remain wary of trying to introduce, let alone impose, such terms on counterparties who are perhaps not as far down the road with their journey to net zero’, says Clyde & Co partner Richard Power.

Heavy industry, which includes steel, aluminium, fertiliser and electricity production, is the sector furthest ahead in implementing climate change clauses, says Dr Oleksiy Feliv, managing partner of Ukraine’s Integrites. In no small part, this is because they are facing a new EU levy: the carbon border adjustment mechanism.

‘Agriculture, transport and logistics, I would say are behind,’ he says.

Renewable energy is also leading the way, according to Anna-Marie Slot, global ESG and sustainability partner at Ashurst. But companies in all industries, including the built environment, energy and transport ‘are starting to think about how climate change is reflected in their documents’, she adds. For example, a number of companies in the telecoms sector are adding contractual clauses developed by TCLP into their preferred documentation.

According to Slot, ESG-related clauses are entering documents ranging from sustainability-linked loans to bonds, where companies are setting key performance indicators relating to ESG aspects, to supply contracts where counterparties are required to share ‘scope and related data’.

Power says the clauses that are attracting the most interest are those which encourage counterparties to align to ‘net zero goals, or at least to allow one party to obtain information about, and even audit, the other’s greenhouse gas emissions and ESG policies.

‘This is particularly the case in supply chain contracts, especially involving transport and logistics,’ Power says. ‘However, my impression is that the emphasis on green investment coming out of COP26 will spur on the introduction of similar clauses – and perhaps warranties and even termination clauses – in finance agreements, as investors become more and more aware of the need to invest in environmentally sustainable projects.’

Companies are increasingly making green pledges and public commitments, but these need to be truthful and not misleading right along the supply chain, as they are being scrutinised ever more closely by authorities, NGOs, competitors and consumers. Hence, according to Oryszczuk: ‘Due diligence and information sharing clauses have become much more common, along with commitments to meet and adopt certain standards and practices.’

TCLP has developed more than 100 freely available climate clauses for law firm precedents and commercial agreements that cover multiple practice areas and sectors – from commercial and corporate to real estate and dispute resolution.

Simone Potter, TCLP’s director of knowledge, says that ‘building & land’ climate clauses, including property, construction, environment and planning, ‘are particularly popular’, but commercial and supply chain clauses are also attracting interest ‘as they are widely applicable, adaptable and easy to use across a range of industries’.

Meanwhile, TCLP’s ‘net zero best in class’ clauses (which align with the Paris Agreement’s goals) have seen renewed interest since COP26, Potter notes.

Driving adoption

So what specific legal requirements are driving the adoption of green clauses?

‘The Task Force on Climate-related Financial Disclosures,’ which was launched by global regulators in 2017, ‘is urging companies to make disclosures within their mainstream annual financial filings regarding their assessment, management and mitigation of climate-related risks and opportunities,’ says Power.

A similar requirement applies to UK company reports from 6 April 2022 via the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022. This is focusing companies’ attention on climate-related risks, and that in turn means taking steps to tackle Scope 3 emissions across supply chains and engaging with contractual counterparties, Power explains. The MilieuDefensie et al v Royal Dutch Shell decision has also ‘focused corporate minds on potential exposure to environmental claims’, he adds. Following a claim by seven Dutch NGOs, in 2021, the Hague District Court ordered Shell to reduce carbon dioxide emissions by 45% by 2030 relative to 2019 levels.

In the built environment minimum energy efficiency standards are to increase from the current E rating to C in 2027 and then to B in 2030, which has made landlords focus on how they can improve their properties, says Connolly. ‘However, EPC ratings don’t tell the whole story,’ she says. ‘How you use the property is key to driving the journey to net zero.’

For Oryszczuk, it is difficult to pinpoint the specific legal drivers that are accelerating the adoption of green clauses. ‘It’s more a change in mindset and a recognition that environmental protection, climate change impacts and sustainability are everyone’s problem and responsibility,’ she says.

Rush of new law

That said, she draws attention to ‘a deluge of legal and policy initiatives’ in the UK and the EU, such as the Environment Act 2021 and the European Green Deal (to make Europe climate-neutral by 2050). There is also a proposal for a new EU directive on ‘corporate sustainability due diligence’ to protect human rights and the environment across supply chains (published by the European Commission on 23 February) that will see ‘fundamental rewrites of most, if not all, environmental and wider ESG rules and policies’.

This year, the European Commission is also implementing legislation on a taxonomy for sustainable finance, and the US Securities and Exchange Commission is planning to mandate ESG-related disclosure.

'While some of the legislative measures are still at the proposal or policy stage, early and careful adoption of green clauses may position a corporate well with government'

Sinéad Oryszczuk, Covington

‘There is a tsunami of new legislation globally,’ Walker says. ‘Many clients have global operations, either on the supply chain or on the reporting side, so they are concerned with the laws globally and that makes things very complex as the position is not harmonised.’

To some extent, the TCLP initiative will allow companies to get ahead of this complex and changing future of rules and regulations.

‘Most clients include statutes and regulations in their contractual obligations,’ but where ‘the clauses produced by the TCLP are interesting is in those areas that are not currently regulated or regulations are evolving,’ Slot observes.

Oryszczuk says: ‘At present, while some of the legislative measures are still at the proposal or policy stage, early and careful adoption [of green clauses] may position a corporate well with government, and potentially enables them to help setting the legislative environments.’ She adds: ‘That can be a very important advantage for multinationals in particular which are facing a raft of differential standards and requirements.’

So how best to embed green clauses into contracts? Connolly says: ‘The best time to start considering this is right at the outset, at the heads of terms stage, as there’s an argument that it becomes too complicated to negotiate down the line.’

She adds: ‘That said, if organisations and their suppliers are both serious about sustainability, then adding green clauses to their contracts at the renewal or renegotiation stage is an ideal way of achieving their respective goals.’

Connolly observes that clients can be ‘daunted by the magnitude of the task’ involved in adopting net zero clauses. But she advises that the ‘key is to start somewhere, as doing something is always going to be better than doing nothing’. In a real estate context, for example, landlords could consider simple things such as not requiring all alterations made by a tenant to be removed at the end of their term. This will reduce the embedded carbon in the property.

Obstacles

Organisations lacking a legal department to ‘ensure such clauses are adopted uniformly throughout the organisation’, or for those that do have legal teams, a ‘lack of capacity to carry out the exercise’ are the main barriers to the uptake of green clauses, says Barbosa.

‘Many organisations don’t realise they can positively contribute to addressing the climate and biodiversity crisis through… their contracting,’ Barbosa notes.

‘It’s always difficult to change the status quo,’ says Slot, and that’s relevant to everything that a business does, including drafting contracts. This is ‘compounded by the lack of universal standards or agreed metrics’.

The TCLP initiative seeks to address this issue. As Becky Annison, director of engagement at TCLP, puts it: ‘The idea of doing something that is not currently market standard is often intimidating and can feel risky. TCLP’s rigorous peer review process and case studies that demonstrate the use and implementation of clauses should allow potential users to have confidence in our clauses.’

'Many organisations don’t realise they can positively contribute to addressing the climate and biodiversity crisis through their contracting'

Natalie Barbosa, Anthony Collins

Possibly the biggest barrier is cost. As Power says: ‘There is a consciousness that as the world emerges from the debilitating effects of the Covid-19 pandemic, businesses might not be in the most robust of health, and it might not be the best time to cause commercial disruption by requesting contract renegotiations, or to be imposing onerous terms via standard contracts.’

TLT’s latest survey of the UK’s top 100 retailers found that the majority see sustainability as a cost centre rather than a cost saver, despite the many examples of sustainability initiatives actually saving money and there being long-term benefits to being seen as a sustainable business by customers, suppliers and employees, Connolly points out.

‘Cost is a barrier, especially for SMEs and industries with traditionally low profit margins, such as construction’ says Annison. ‘The hard reality is that de-carbonising is going to cost someone something. The TCLP clauses do provide a means of ensuring that cost is crystallised, specified and accounted for in the negotiation of contracts. If something is a contractual obligation, it will be priced,’ she says, adding that TCLP’s clauses ‘shed daylight on these costs and start powerful and necessary conversations about who is best placed to bear that cost’.

Time is money, and another major hurdle to overcome is the perceived delay that including net zero drafting could involve.

‘This is why it’s so crucial to discuss sustainability and net zero issues at the heads of terms stage. This enables the parties to agree who is going to be responsible for what – including any costs – and the implications of non-compliance,’ says Connolly. ‘If this isn’t agreed by the time the deal gets to the lawyers, those discussions have to be had further down the line, when the parties just want to get the deal done.

To that end, Annison says: ‘Our workshops are excellent networking opportunities to discuss and hear from peers on how they have overcome obstacles, anonymising and re-sharing as much of that learning as possible.’

They are also designed to tackle unfamiliarity with green drafting. ‘These events encourage people using the clauses to partner with suppliers, tenants and anyone who may receive a contract with a TCLP clause in it, to explain why the clause is in there and the effect it has,’ says Annison.

Proponents maintain the benefits of green contracts are manifold. Dr Feliv says: ‘Many green initiatives prove to be financially favourable over the long term’.

Green contracts are designed to help clients achieve their stated ‘net zero’ goals, as well as their reporting obligations, by requiring counterparties to provide information for emissions reporting purposes; to align counterparties with the client’s pathway to ‘net zero’; and even to terminate a contract if a counterparty will not perform its obligations in an environmentally sound way.

Power explains: ‘Legally binding and enforceable climate-conscious clauses also signal that a client is serious about their net zero commitment, which, combined with science-based targets and transparency about progress and where more needs to be done, is one of the readily available means of mitigating a risk of green-washing allegations.’

For Barbosa, reasons include preparedness for the ‘inevitable’ increase in legislation, reporting demands and reduction targets on organisations; the ability to bid for work requiring environmental commitments and proactive policies; and meeting public and consumer expectations for organisations to play their part in the global effort.

According Oryszczuk, there are both immediate and long-term positive outcomes – from good PR, competitive differentiation and first-mover advantage, to fulfilment of market and consumer expectations, lending criteria and procurement terms.

Environmental clauses also give ‘credibility to environmental and green initiatives which in turn have reputational and even recruitment benefits’, Oryszczuk says.

Walker’s advice to businesses is to look beyond legal compliance and to consider environmental and other clauses as a way to enhance growth. ‘Most companies are thinking of ESG and the climate space as a highly brand relevant competitive sport and key to their shareholder and market perception,’ he says. Hence the need for them to use contracts ‘to drive best performance, not just compliance’, he adds. Examples include finance contracts where across debt and capital markets green requirements, linking the cost of debt to improving carbon performance or other forms of SDGs, are becoming increasingly common.

Power concludes that above all climate-conscious clauses in contracts ‘will help tackle climate change and combat global warming, which benefits not only clients’ businesses but the world at large, and generations to come’.

 

Marialuisa Taddia is a freelance journalist