[This article has been authored by Aditya Joby and Nankee Arora, final and third-year law students at JGLS.]
Keywords: ESG Clauses, Investment Arbitration, International Commercial Arbitration, ESG Implementation
Environment, social and governance (“ESG”) issues have become a dominant factor in commercial decision-making and investments. The rise of the Covid-19 pandemic has brought into focus the crises plaguing the climate and communities across the world. With this renewed focus comes pressure on international corporations and investment agencies to recalibrate their operations to assist in the alleviation of ESG issues. An increase in ESG clauses, that is, clauses in contractual agreements featuring human-rights benchmarks, compliance to global ESG targets and obligations to report non-compliance with standards, is one such corporate recalibration. While commercial actors have given in to public and governmental pressure, it is yet to be seen whether they can successfully uphold and implement their ESG commitments in the real world. Attempts to implement these goals will undoubtedly bring forth disputes between parties and thus, this piece seeks to evaluate whether the existing frameworks of International Commercial Arbitration and Investor-State Arbitration are suitable forums to implement and uphold ESG norms.
International Commercial Arbitration And ESG
International commercial disputes are predominantly resolved through arbitration and therefore the increasing inclusion of ESG clauses in business agreements is bound to be reflected in arbitration matters arising therefrom. ESG clauses are novel and innovative mechanisms to meet Sustainable Development Goals and are thus undoubtedly likely to bring about problems such as interpretation, measurability of impact and conflicts in legal jurisdictions that may give rise to the regulation and proliferation of arbitral awards. Additionally, while privacy and confidentiality of arbitration proceedings are touted as one of its key advantages, in the case of ESG clauses it could result in the exclusion of third parties who are at risk of injury if the commercial parties fail to comply with the standards entrenched in said clauses.
While some aspects of the nature of arbitration are less than ideal for implementing ESG clauses, other aspects remedy these weaknesses. Arbitration disputes are flexible in nature and the process adopted to resolve the dispute may be customised to fit the nature of the dispute in question, thus providing scope to include relevant stakeholders in the arbitration. It has also been recommended that parties could publish the awards granted in such disputes in the public domain for third-party perusal. However, in the event of a third party being dissatisfied with the award, the cost for them to seek an amendment to the award without being a party to the dispute, especially in the absence of established regulations enabling them to do so, would be patently unjust, thus, an inclusive dispute-resolution process is likely to be the most effective resolution.
It has also been suggested that the ability of parties to appoint specialist arbitrators who may be better suited to interpret and enforce ESG clauses is another significant feature of arbitration that is fitting to resolve such cases. However, a possible issue that it may bring up in India, for example, is that in cases of International Commercial Arbitration, when the parties determine an even number of arbitrators in their agreement, a sole arbitrator is appointed by the Supreme Court under Section 10 of the Arbitration and Conciliation Act, 1996 (“A&C Act”). The prerequisites of being appointed as an arbitrator under Section 11 of the A&C Act provide no mention of specialised skills that would be more qualified to resolve ESG-related contentions. These factors present the risk of an insufficient number of arbitrators or unqualified arbitrators if parties do not proactively determine the quantity and or quality of the Arbitral Tribunal in jurisdictions such as India. It suggests that the parties must actively engage in using the available legal tools and procedural flexibility to ensure that the ESG clause is being interpreted accurately and inclusively, so as to satisfy the purpose for which it was included. While the Arbitration framework for resolving ESG disputes in various countries such as India is still in the process of development. It is perhaps more effective for parties of International Commercial Arbitration to take their disputes to International Arbitration forums such as the Permanent Court of Arbitration (‘PCA’) or the International Chamber of Commerce (‘ICC’) that have more sophisticated frameworks such as the Report of the ICC Task Force on Arbitration in Climate Change Related Disputes, the PCA Optional Rules for Arbitration of Disputes Relating to the Environment and/or Natural Resources, and The Hague Rules on Business and Human Rights Arbitration.
Investor-State Arbitration And ESG
The use of investment treaties has become prevalent, considering the significant economic growth that accompanies it. However, since the agreement is primarily between States, actual stakeholders – the affected foreign investors, citizens, and institutions affected by the terms of the treaty are not allowed to participate in these proceedings except in an observational capacity. However, there has been the proposal of using an amicus curiae, who would be able to provide an informed opinion on the subject of the arbitration and the arbitration process, while also shortening the proceeding. It would also provide a voice to the “public”, who are affected by the outcome of the arbitration but may not be able to express the same. However, this proposal is still under scrutiny, since they would be afforded similar rights as parties, breaching the confidentiality inherent to an arbitration. Thus, the creation of Investor-State Arbitration to rectify disputes arising from the breach of such treaties is imperative. Investment Treaty Arbitration covers this, with the creation of the ICSID, which in turn created the Investor-State Dispute Redressal System (“ISDS”), which is an integral part of Investor-State Arbitration.
Although this system has been criticised for being used to misuse investor rights, there have been recent changes that indicate that the ISDS is reforming to include Business Sustainability, and holding corporations accountable for their Corporate Social Responsibility. An example of this change, is a State being awarded compensation for the actions of an investor, that could be prosecuted under its domestic law, which is seen in Burlington v. Republic of Ecuador, wherein the tribunal exercised its jurisdiction to award compensation for a violation of Ecuadorian law.
The majority of investment protection treaties have arbitration clauses which provide for Investor-State Arbitration. Thus, the incorporation of ESG clauses within treaties is better placed, since it allows investors to hold States accountable for breaches in treaties regarding ESG norms. Examples of such inclusion could be seen in the Energy Charter Treaty, which includes protection for fossil fuels, and promotes investment in renewable energy technology, and the implementation of ESG norms in BITs, as seen in the BIT between Morocco and Nigeria, wherein there is a mandate for completion of impact assessments, and certification based on a pre-determined environmental standard.
The implementation of Investor-State Arbitration to effect change at a governmental level has also been demonstrated in the case of Urbaser v. Argentina, wherein it was found that the failure to provide the investment amount was tantamount to the violation of a human right to water. This is a violation of the UN Guiding Principles on Business and Human Rights and the OECD guidelines for Multinationals, which holds corporations accountable for the violation of a treaty obligation as per the 2019 Model Bilateral Investment Treaty.
However, there are still contentions that Investor-State Arbitration is not the best method for the implementation of ESG norms, as there are difficulties in ascertaining soft rules within a community that are malleable, and dependent on changing social circumstances. Furthermore, due to the private nature of arbitration, enforcing arbitral awards against third parties that have also caused damage would not be possible, and would require the creation of a framework like the Bangladesh Accord, which binds companies to create a safer work environment for factories producing Ready-Made Garments.
While international commercial arbitration has the beneficial characteristics of procedural flexibility and the scope for the intervention of experts, the discretion of the parties in actively enforcing these benefits to ensure the implementation of ESG norms, presents the threat of ESG clauses being mere greenwashing tools for commercial organisations.
Thus, the likelihood of the implementation of an ESG clause need not be evaluated merely on the standards it sets for the commercial parties but on the effectiveness and inclusivity of the process it prescribes to resolve the disputes emerging from such a dispute. Investor-State Arbitration still seems to be a viable option for the implementation of ESG Norms, as it provides a more transparent and objective analysis of a dispute, while also apportioning responsibility on States and Corporations alike, as a part of treaty obligations that have wide-ranging repercussions on all stakeholders of a treaty.