International Arbitration in 2022
The rising significance of ESG and the role of international arbitration
Environmental, social, and governance (ESG) issues continued to dominate legal, political and business agendas in 2021.
Some of the most notable developments that will affect how companies address ESG issues in 2022 and beyond include:
- The groundbreaking Shell decision by the Hague District Court, which represents the first time a court has imposed a legal obligation on a company to reduce its CO2 emissions.
- The European Commission’s much-awaited “Fit for 55%” legislative package, which aims to achieve a 55% reduction in carbon emissions by 2030 and net zero by 2050, along with the expected publication in early 2022 of its proposed Supply Chain Directive, which will impose human rights due diligence obligations on companies operating in the EU.
- COP26, which made significant progress in achieving the goals of the Paris Agreement, including by establishing the Glasgow Financial Alliance for Net Zero, a forum for leading financial institutions to accelerate the energy transition, and a new International Sustainability Standards Board to develop ESG disclosure standards for companies.
These developments make it clear that courts, governments and investors expect companies to facilitate the energy transition and safeguard workers’ human rights, two ESG pillars seen as central to building back better in the wake of the COVID-19 pandemic. Companies will need to rethink the ways they do business to respond to these changes, which, in turn, will result in ESG-related disputes. Given that international arbitration is the preferred dispute resolution mechanism of many companies for cross-border disputes, its role in resolving ESG-related disputes will only increase.
Legal and commercial pressures on companies to move to net zero and protect workers’ human rights have created additional risks, which require overhauling not only internal policies and practices, but contractual relationships as well. As a result, ESG clauses are increasingly finding their way into commercial contracts.
A company subject to supply chain regulation, for example, would be well advised to take all possible steps to protect itself from the risks that arise from its suppliers’ businesses, and indeed those of its suppliers’ suppliers. It should ensure that contracts with suppliers contain appropriate protections, for example, in the form of representations, warranties and indemnities. Similarly, any potential purchaser of, investor in, or lender to the company should take steps to protect itself from the same risks using similar contractual mechanisms. The risks arising from supply chain regulation can be far-reaching and need to be managed not only by the company targeted by the regulation, but by the entities that interact with it as well.
ESG clauses are novel, complex, and largely untested, factors that are likely to give rise to disputes about how they should be interpreted and applied. To the extent a dispute does arise and the underlying contract contains an arbitration clause, the dispute will be determined by arbitration.
Several features of arbitration make it particularly well suited for use in exactly these cases. Arbitration allows the parties to choose specialist arbitrators who have the requisite knowledge and experience. These may be lawyers with expertise in human rights law in cases concerning supply chain regulation, or they may be engineers or other experts who understand the technology at issue in cases concerning the energy transition. Arbitration also provides a neutral forum and flexible procedures, so the parties can design a dispute resolution process that accommodates their needs and the nature of the dispute. For example, expert evidence may be given prominence and be tested more thoroughly by other experts. Finally, the almost universal enforceability of awards through the New York Convention provides peace of mind that the dispute will be resolved fully and finally through an enforceable award, thus providing commercial certainty.
That arbitration is essentially a private dispute resolution mechanism does pose challenges in cases where questions of public interest are concerned, such as those involving the environment and human rights. However, these concerns can be addressed by adding features to arbitration such as allowing the publication of awards and permitting third-party interventions. Such steps can ensure that arbitration remains an effective way to resolve commercial disputes going forward, including in the ESG context.
Two trends we noted in our 2019 and 2020 top trends reports developed further in 2021. First, investment arbitration cases continue to arise as a result of domestic ESG regulation enacted primarily in response to the energy transition. Some investors are arguing that regulations, and the manner in which they have been introduced, have significantly impaired the value of their assets and are claiming compensation. The high-profile cases relating to the phase-out of coal in the Netherlands and the ongoing wave of cases concerning the rollback of renewable energy subsidies in Spain and Italy fall into this category.
Second, States are continuing to include ESG provisions in trade and investment treaties and are using these treaties as tools to advance their sustainability objectives. Indeed, 2021 saw the birth of a new breed of investment agreement – the sustainable investment agreement – putting ESG issues at the heart of trade and investment policy.
The European Commission kicked off negotiations for a Sustainable Investment Facilitation Agreement with Angola, which will focus on promoting sustainable development and responsible investment, improving economic diversification and resilience, and supporting the energy transition. The agreement is expected to be the first in a series of sustainable investment agreements between the EU and African nations. In a similar vein, Singapore and Australia commenced negotiations for a Green Economy Agreement, which is intended to be a world-first agreement that combines trade, economic and environmental objectives.
Also interesting is the model Sustainable Investment Facilitation and Cooperation Agreement developed for The Gambia to assist in its treaty negotiations with other nations. The model agreement draws heavily on the UN Guiding Principles on Business and Human Rights and includes a number of innovative elements, in particular relating to investment arbitration. Not only does it expressly allow the host State to bring counterclaims, but it also permits third-party natural persons to bring claims against investors relating to human rights matters arising out of the investment. The model agreement also requires investor conduct to be considered in determining any compensation, requires the investor to pay the necessary deposits, and allows use of the Hague Rules on Business and Human Rights Arbitration as an alternative to the ICSID Rules.
This new form of investment agreement illustrates that while States continue to see trade and investment treaties as essential to achieving their economic objectives, they are increasingly looking to them to achieve their ESG objectives as well. Although the exact form of these treaties and the dispute resolution mechanisms they will contain remains to be seen, it appears likely that the legal regimes relating to trade and investment, the environment and human rights will continue to converge. Companies wishing to invest abroad should keep abreast of these developments to ensure that they can take advantage of the opportunities these treaties provide and protect themselves against relevant risks.
The Covid-19 pandemic has brought ESG issues into sharp focus for companies. The environment, human rights, health and safety, taxation, data protection and corruption are likely to be some of the major ESG themes in coming years. ESG issues are already familiar in the investment arbitration context, where disputes concerning the energy transition and human rights frequently arise. ESG-related disputes will also increasingly arise in the commercial arbitration context, as companies adapt their businesses to comply with new laws and regulations, and to respond to commercial pressures.