Environmental, Social and Governance (ESG) is a concept that is taking on more and more significance in commercial contracts as well as within the wider business community. It is important that businesses understand how ESG clauses can take shape in their commercial contracts and that they recognise some common issues that should be considered when incorporating, negotiating and reviewing such clauses.
What are ESG clauses?
ESG clauses are wide-ranging, and some are already relatively common to see in commercial contracts meaning you might already have them without realising it.
- Environmental clauses could include provisions aimed at promoting biodiversity, net zero targets and the prevention of land contamination
- Social clauses cover issues such as human rights, health and safety and equal pay
- Governance clauses include anti-bribery and corruption and anti-money laundering.
What to consider when drafting ESG clauses
There is no one-size-fits-all approach to reviewing and drafting ESG clauses. It will, of course, depend on a number of contextual factors including the business of the parties, the nature of the contract and the aim of the clause(s). However, some of the standard issues you should consider are as follows:
- Legislation – what is the applicable legislation? There are numerous international regulations on ESG issues, and any clauses should be compliant with all applicable legislation. For instance, the Climate Change Act 2008 made the UK’s commitment to net zero by 2050 legally binding. However, not all ESG clauses will have specific legislation underpinning them. This may have an impact on a parties’ legal obligations to include ESG clauses in their contract.
- Drafting – as with any clause, clarity and certainty is vital. Parties will need to ensure that an ESG clause does not leave room for interpretation and makes the requirements clear. The same applies to any penalties for failing to comply with the ESG requirements that either party wishes to impose.
- Long-term thinking – ESG regulation has increased in recent years and businesses would do wise to keep abreast of likely future developments. If parties know that there are obligations which will soon become law, they will need to consider whether they wish to be bound by these obligations in the contract.
- Standard market practice – naturally, the standard practice will depend on the relevant industries of the parties. Market norms may be difficult to analyse as they are not fixed in place, but it may be prudent to consider if there are particular ESG clauses or standards that are normal, or even expected, in a relevant sector.
- Commerciality – it is important than any ESG clauses included are not contrary to the purpose of the contract and are commercially consistent with the wider provisions. They must be achievable otherwise a party could be in breach of contract before they even start.
- Practicalities – ESG clauses, which are more detailed or complex, may impose obligations which are burdensome, particularly if one party has significantly fewer resources than the other(s). The parties should consider the logistics and costs that may be incurred as a result of detailed or complex ESG clauses.
- Transparency – as ESG clauses become more commonplace and their importance garners greater public support and recognition, so does the potential for negative PR and reputational issues to arise if a party is publicly named for not adhering to them. These clauses need to be given proper consideration and procedures put in place to monitor performance and evidence compliance.
As ESG becomes more prevalent in contracts, businesses would do well to consider the above factors when drafting or agreeing to ESG clauses in their contracts.