Navigating ESG challenges with ADR: Forging a sustainable future - Part II

By Ajla Serdarevic

Student

Geneva LL.M. in International Dispute Settlement (MIDS)

A. Serdarevic - Navigating ESG Challenges with ADR Forging a Sustainable Future (Part 2).p

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Abstract: This article examines the importance of Environmental, Social, and Governance (ESG) principles in the context of arbitration and sustainable development. It consists of two parts that explore the rise of ESG, highlighting its evolution from soft law instruments to binding obligations. Topics covered include the challenges of implementing ESG practices, with a focus on the adoption of ESG standards and emphasizing their role in fostering long-term stability and global sustainability.

Keywords: ESG (Environmental, Social, and Governance), Arbitration, Sustainability, Corporate Responsibility

The environmental and social factor of the term ESG is, to a degree, vague and encompasses different claims related to the environmental and social aspect of the term. The first factor, which is E is the most understood at the moment due to the concerns of environment protection, security of natural resources, and minimizing the damage done by infrastructure. After the Paris Agreement, a great international recognition of commitment to achieve net zero was established, with many different actors passing laws and internal management to stay committed to this goal. This shows how the E factor is connected to governance but also that with growing laws regarding the environment, an increased chance of environment-related claims is possible to occur. The London School of Economics’ Grantham Institute for Climate Change study found 2,671 climate change laws and policies and 1,982 litigation cases related to climate change globally as of 2022, and the figures are rapidly changing day by day. [1] This same probability is present in social factors regarding laws and policies that aim to have companies achieve positive impacts on a larger scale. The UN Principles for Responsible Investment (hereinafter PRI) is an international organization launched in 2006 that promotes ESG. PRI's mission and goals are founded in its six core principles, which signatories to PRI must stay committed to.

The six principles[2] are:

Principle 1: Incorporation of ESG issues into investment analysis and decision-making processes;

Principle 2: Becoming active owners and incorporate ESG issues into ownership policies and practices;

Principle 3: Seeking appropriate disclosure on ESG issues by the entities in which we invest;

Principle 4: Promoting acceptance and implementation of the Principles within the investment industry;

Principle 5: Working together to enhance our effectiveness in implementing the Principles;

Principle 6: Reporting activities and progress towards implementing the Principles.

The PRI recognizes the growing relevance of ESG in investment practices and assesses the risks in accordance with ESG standards. The PRI offers its signatories with exemplary actions for each individual principle. Even the International Chamber of Commerce Task Force on Resolving Climate Change Related Disputes through Arbitration and ADR stated the information regarding PRI signatories reporting their climate change risks from 2020. [3] Sustainable funding and activities aligned with upkeeping the ESG standards, once clearly established, should be encouraged around the world. Environment and health regulation, a subset of the right to regulate, has been the subject of intense scrutiny because it impacts citizens’ rights and their quality of life.[4] The concerns states are dealing with that are in relation to environmental protection results in work on the international investment agreements (hereinafter IIA). This evolution of IIAs is connected to ESG since there is a balance to be achieved between the protections offered to investors, sustainable development, and human rights. This is also where the governance factor plays an important role since states have the extensive right to regulate and use their police powers. This tussle has played out in numerous investor-state dispute settlement cases where tribunals have held the host state liable for violations of the obligations despite the state attempting to raise arguments that the measure falls within its regulatory space and exists in pursuance of legitimate public interest concerns.[5] An example is the SAUR International v Argentina, where under ICSID Arbitration Rules and applying the Argentina France BIT, the Tribunal decided in favor of the investor. The dispute arose regarding the water and sewer service concession agreement. Claims arising out of the alleged failure of the government of the Argentine province of Mendoza to implement service tariff increases under an agreement between Saur's subsidiary and the federal government, in the wake of the State's 2001-2002 economic crisis. [6] The fundamental right to water and the right of the investor to benefit from the protection offered by the APRI operate on different levels: in its sovereignty, the public administration has special powers to guarantee the enjoyment of the fundamental right to water, but the exercise of these powers is not absolute and must, on the contrary be combined with respect for the rights and guarantees granted to the foreign investor under the APRI.[7] The Tribunal found as such that IIA has been breached by the state by violating the fair and equitable treatment and indirect expropriation of the investment. This shows an example of the protections investors have and, on the other side, the regulatory power of states. In this case, the protection of investors was favored, but tribunals also looked into the aspect of the state pursuing public policy. Another example is Urbaser SA & Ors v Argentina where claims were brought under the Spain-Argentina BIT and the state counterclaimed that the investors had breached international human rights more specifically the right to water. The tribunal in the Urbaser case accepted its jurisdiction over the Argentina’s counterclaim based on human rights and confirmed that the “right to water” was a human right under international law.[8] There are three key points to be taken away from the Urbaser case, first is that a broad jurisdictional clause was the reason why the counterclaim was accepted. Second, it is, on the one hand, remarkable that the tribunal, by citing international human rights instruments, found that human rights obligations such as the right to water can be imposed directly on international corporations.[9] This also shows the changes that are happening with human rights obligations being imposed on corporations and investors, connecting it back to the S factor within the ESG.

Such an example is the focus on new IIAs as well as drafting it clearly in the Bilateral Investment Treaties (hereinafter BITs). Some of the examples of model treaties and BITs include provisions indicating the inclusion of ESG standards and obligations, such as in the South African Development Community Model Bilateral Investment Treaty Template, from 2012 Dutch Model Investment Agreement from 2019 and Morocco–Nigeria BIT from 2016. The Morocco-Nigeria BIT contains some innovative provisions that attempt to strike a balance between the power of the host State to regulate its economy and the need to protect the rights of foreign investors in the host State.[10] This is an important step since environment and health, as well as other human rights, have not always been explicitly regulated in IIAs, which is a trend that has been changing rapidly in recent years. The 2011 OECD survey Environmental Concerns in International Investment Agreements studied 1,623 IIAs pertaining to 49 States. [11] The survey was conducted in order to analyze the extent, type and frequency of environmental language used in IIAs. The findings from this survey show relevant insights into the pre-2018 era and how far environment language has come compared to survey findings. The findings also show that states, even pre-2018, had different approaches when it comes to the inclusion of environment language in IIAs, including in regard to health. The UNCTAD’s Investment Policy Framework for Sustainable Development paper from 2015 also suggests several points for lawmakers to consider when drafting and negotiating IIAs. This includes incorporating concrete commitments to promote and facilitate investment for sustainable development, balancing state commitments with investor obligations, and ensuring an appropriate balance between protection commitments and regulatory space for development.[12] Looking at pre-2018 approaches to environmental and health language inclusion as well as states' commitments to sustainable development, the standards have been raised even higher nowadays in IIAs. The great paradigm shift that states have made is also connected to ESG to facilitate these changes to gain financial stability as well as create long-term sustainability.

Environmental protection is prioritized, and as such, environment-related disputes naturally arise, such as claims related to the use and phase-out of certain natural resources. Over recent decades, around 50% of arbitration awards concerning environmental claims related to contractual guarantees were established during the sale and purchase of either companies or contaminated industrial sites.[13] The environmental-related claims are more present in litigation. It is yet to be seen how ESG claims are to be resolved in arbitration. Both investment and commercial arbitration have been the forum for ESG disputes, which is expected to increase further. As stated earlier, ESG is industry-specific, and as such, disputes often arise from the energy sector. Baker McKenzie’s The Year Ahead report for 2022, based on the collated data from 600 in-house lawyers from large companies around the world, findings that in some industry sectors, such as Energy, Mining and Infrastructure, and Healthcare and Life Sciences, concerns over ESG disputes now surpass those for cybersecurity and data.[14] According to the report, corporations are currently more concerned with governance disputes (Image 1) that will arise from ESG than environmental-related disputes. This is also related to corporations aiming to maintain their reputations and positions in the markets in which they operate.

Image 1: What types of disputes present a risk to your organization in 2023?

(Breakdown of ESG risk)[15]

There is an overlap between the governance and social disputes regarding the ethical practices of companies and issues related to discrimination. Governance is connected to broad duties a company has to stay committed. The focus is also on having parent corporations responsible for the subsidiaries as well as organizations accountable for supplier activities. Since governance is in focus and states as well as international institutions are enacting legislation, companies and organizations are taking steps to follow such trends, for example, improving due diligence in the audit of supply chains. Environmental disputes remain a matter of concern, especially in issues related to climate change. However, external factors influence the balance that states seek to reach between staying committed to environmental protection obligations and respecting investors' rights. Certain external factors, such as the Russian invasion of Ukraine, consequences of the invasion, etc., are affecting the industries, and it's showing that European countries cannot make a swift transition to renewable sources. Due to the dependency on fossil fuels, states have to remain connected to the investors. However, it also brings a degree of scrutiny from environmental activists. It is important to mention that disputes are no longer restricted to specific events or projects, as claimants seek to bring about behavioral change by challenging organizations’ commitment to ESG standards and the accuracy of their claims on implementation.[16] Different legal mechanisms can be used to bring ESG claims. In addition to mechanisms that are connected to good governance, companies, and organizations are looking into efficient forums for revolving ESG disputes.  The risk of an ESG dispute is not only arising from what the companies, organizations and even states are accountable for but also what they do not say or hide in plain sight. Arbitration is not only important for the future of ESG in terms of a dispute resolution mechanism but also as a manner of establishing governance. Investor-state arbitral tribunals, through writing of the awards as well as giving public remarks, define specific principles and set standards for states. In addition, decisions made ex-post by tribunals with regard to the balance between investor protection and other important public purposes may influence what later tribunals will do and may influence ex-ante the behavior of States and investors.[17] Another important risk management tool is incorporating ESG clauses in contractual agreements. The type and implementation of ESG clauses can vary considerably from one contract to another depending on several factors, including a company’s size, geographical location, and the nature of the transaction.[18] ESG clauses are the step towards staying committed to complying with the ESG requirements in relation to the contractual agreement. It can also be formulated as ESG reporting as a way for suppliers to report on the progress. For example, various organizations have compiled guidance on ESG-related contract clauses which, if adopted, allow for parties to bring a claim in the event another contracting party fails to comply with its particular ESG commitments.[19] ESG accountability will continue to be a demand in the future, especially with the concerns of organizations having governance risks.

In commercial arbitration, environmental-related claims were brought before PCA, SCC, and HKIAC to solve environmental disputes, especially after the adoption of The Kyoto Protocol. Limited information is available on these cases due to the confidential nature of arbitration, but they range from a commercial contract dispute involving a hydroelectric company from Asia and a European company to a dispute on the units needed to offset emissions against carbon credits.[20] Another innovative step was after the Hague Rules, better facilitation of social-related claims can be resolved in arbitration. The Hague Rules, as well as institutions such as UNCITRAL, are tackling the issue of transparency in arbitration. Since ESG requires a degree of transparency, the confidentiality of arbitration could present itself as a limit compared to litigation. Still since it’s recognized that ESG-related disputes are sensitive, and industry related it is yet to be seen how a balance will be achieved between confidentiality and transparency.

In conclusion, ESG is not a new concept; however, the term is constantly expanding, and it is yet to be seen how, in resolving ESG disputes, tribunals will approach it when looking at the circumstances of the case and wording of ESG clauses. For all actors, ESG has become an important tool for a sustainable future. The first step is to have good governance, especially since companies and organizations are concerned with governance-related disputes that might arise. Arbitration is an attractive forum for resolving ESG disputes due to its general advantages over litigation as well as using it to tailor the approach of resolving such disputes, including arbitrators that have specialized knowledge regarding ESG. It is also beneficial for parties to opt for arbitration in case of non-compliance with established ESG obligations. Arbitration will not only be used as a forum and mechanism to resolve ESG disputes but awards and remarks by arbitrators will vastly improve the defining and use of ESG by states, companies, and organizations in their activities. Environmental and social-related topics have become a central concern for states as well as companies, and ESG plays a vital role in establishing sustainability on a larger scale.

[1] Climate Change Laws of the World, Grantham Research Institute on Climate Change and the Environment (8 Jun. 2022), https://climate-laws.org.

[2] PRI. (2017). What are the Principles for Responsible Investment? [online] Available at: https://www.unpri.org/about-us/what-are-the-principles-for-responsible-investment [Accessed 19 Jul. 2023].

[3] Resolving Climate Change Related Disputes through Arbitration and ADR, ICC Commission Report (2 Nov. 2022), https://iccwbo.org/content/uploads/sites/3/2019/11/icc-arbitration-adr- commission-report-on-resolving

[4] Crina Baltag, Riddhi Joshi, Kabir Duggal, Recent Trends in Investment Arbitration on the Right to Regulate, Environment, Health and Corporate Social Responsibility: Too Much or Too Little?, ICSID Review, Vol.00, No.00 (2023), p. 3.

[5] Ibid.p.2

[6] Unctad.org. (2023). SAUR v. Argentina | Investment Dispute Settlement Navigator | UNCTAD Investment Policy Hub. [online] Available at: https://investmentpolicy.unctad.org/investment-dispute-settlement/cases/174/saur-v-argentina [Accessed 20 Jul. 2023].

[7] SAUR International SA v Republic of Argentina, ICSID Case No ARB/04/4, Decision on Jurisdiction and Liability (6 June 2012) para 331

[8] Iisd.org. (2018). Urbaser v. Argentina – Investment Treaty News. [online] Available at: https://www.iisd.org/itn/en/2018/10/18/urbaser-v-argentina/ [Accessed 20 Jul. 2023].‌

[9] Iisd.org. (2018). Urbaser v. Argentina – Investment Treaty News. [online] Available at: https://www.iisd.org/itn/en/2018/10/18/urbaser-v-argentina/ [Accessed 20 Jul. 2023].‌

[10] Kluwer Arbitration Blog. (2017). BIT between Morocco and Nigeria – A Bold Step in the Right Direction? - Kluwer Arbitration Blog. [online] Available at: https://arbitrationblog.kluwerarbitration.com/2017/06/22/bit-morocco-nigeria-bold-step-right-direction/ [Accessed 22 Jul. 2023].‌

[11] Kathryn Gordon and Joachim Pohl, ‘Environmental Concerns in International Investment Agreements: A Survey’

(2011) OECD Working Papers on International Investment 2011/01.

[12] UNCTAD, ‘Investment Policy Framework for Sustainable Development’ (2015) <https://unctad.org/system/fles/offcial-document/diaepcb2015d5_en.pdf> [Accessed 22 Jul. 2023].

[13] Jacob Grierson et al., Is Arbitration Helping or Hindering the Protection of the

Environment and Public Health?, 38 J. Int’l Arb. 327, 329 (2021).

[14] The Year Ahead Global Disputes Forecast 2023. (n.d.). Available at: https://www.bakermckenzie.com/-/media/files/insight/publications/2023/theyearaheadreport2023.pdf.‌

[15] The Year Ahead Global Disputes Forecast 2023. (n.d.). Available at: https://www.bakermckenzie.com/-/media/files/insight/publications/2023/theyearaheadreport2023.pdf.

[16] The Year Ahead Global Disputes Forecast 2022. (n.d.). Available at: https://www.bakermckenzie.com/-/media/files/insight/publications/2023/theyearaheadreport2022.pdf.‌

[17] Benedict Kingsbury, Stephan Schill, Investor-State Arbitration as Governance: Fair and Equitable Treatment, Proportionality and the Emerging Global Administrative Law, IILJ Working Paper 2009/6 (Global Administrative Law Series)

[18] Cms.law. (2023). ESG contractual clauses – ensuring compliance within your supply chain. [online] Available at: https://cms.law/en/gbr/publication/healthy-horizons/esg-contractual-clauses-ensuring-compliance-within-your-supply-chains [Accessed 24 Jul. 2023].

[19] Gauthier Vannieuwenhuyse,'Exploring the Suitability of Arbitration for Settling ESG and Human Rights Disputes', in Maxi Scherer (ed), Journal of International Arbitration, (© Kluwer Law International; Kluwer Law International 2023, Volume 40 Issue 1)

[20]Ibid.