chevron-down Created with Sketch Beta.

Dispute Resolution Magazine

Magazine Archives

Arbitration of ESG-Related Disputes: Prospects and Prerequisites

Patrick Thieffry

Summary

  • Human rights and environmental considerations play a role in current international arbitral practice.
  • A rising question is whether arbitration is an appropriate forum for resolving ESG-related corporate governance disputes, compared to other disputes involving strong public interests.
  • Arbitration is an optional mode of dispute resolution and parties should only consent if they feel comfortable with the process and if it is socially acceptable to stakeholders.
  • The application of legal ESG-related rules depends on the type of policy instrument considered, the nature of the specific behavior, and the ecological risks to the affected environment.
Arbitration of ESG-Related Disputes: Prospects and Prerequisites
FanPro via Getty Images

Jump to:

The idea of considering environmental, social, and corporate governance (ESG) criteria in corporate decision-making is not a soft-law concept irrelevant to arbitration. The private sector is increasingly bound to consider ESG factors when making decisions, for instance, as governmental policies encourage sustainable technologies and activities though sustainable finance strategies. In addition, these factors cover current priority areas of concern such as human rights, money laundering, and climate change. ESG-related disputes will consequently continue to develop, including in arbitration—at least if both arbitral procedures and the application of the relevant laws are perceived as adequate or are adapted to such disputes.

ESG, Arbitration's Next Frontier

Governmental entities increasingly encourage private companies to consider ESG factors when making decisions. For instance, the G20’s Task Force on Climate Related Disclosures, an arm of the Financial Stability Board, promotes sustainable finance strategies, including consideration of ESG factors. These efforts help organizations both assess climate change impacts on their financial situations and disclose relevant information under their general corporate disclosure obligations. These finance strategies also trigger potential liabilities for large or listed corporations and for participants in financial markets such as insurance companies, investment funds, and financial consultants, as well as for their directors and officers.

In the US, the Securities and Exchange Commission is also considering whether to require companies within its jurisdiction to provide ESG-related information in their registration statements and annual reports. Such information may include climate-related risks reasonably likely to have a material impact on their business, results of operations or financial condition, greenhouse gas emissions, and certain climate-related financial metrics.

The European Union already implements extensive legislation along these lines. Large companies must disclose both environmental impacts on their activities “outside-in” and the impact of their activities on the public and the environment “inside-out.” Further, participants in financial markets must support the credibility of claims that promote allegedly sustainable investments. A controversial “Taxonomy Regulation” purports to create a level-playing field through a classification of activities deemed to contribute significantly to sustainability objectives. In addition, a new legislative scheme is expected to require the investigation, verification, and disclosure of how a company’s activities impact sustainable development, from its suppliers upstream to its customers downstream, including those of its subsidiaries and partners anywhere in the world.

These and other similar legislative developments must be considered in the broader context of the United Nations Guiding Principles on Business and Human Rights (UNGPs). The UNGPs contemplate effective remedies for victims of human rights violations, including state or “non-[s]tate-based non-judicial grievance mechanisms” and access to justice. Thus, a company could offer to arbitrate ESG-related claims that are not settled through non-litigious mechanisms.

Indeed, a synergy is developing between highly sensitive public interest concerns. Climate change may have adverse impacts on human rights, health, labor, or the environment. Conversely, a wave of “climate litigation” relies on a wide array of legal bases, including fundamental rights, in an attempt to trigger stronger responses from public authorities and the private sector. ESG standards thus involve many binding obligations, and noncompliance may give rise not only to administrative or criminal action, but also to civil and commercial disputes.

Human rights and environmental considerations already play a role in current international arbitral practice. In the investor-state dispute resolution system, foreign investors must be aware that environmental and human health protection may be strengthened in host states. Thus, in the absence of any host state specific commitments or host state culpable behavior, the host state’s legitimate and rational actions do not normally amount to breaches of the investor’s rights based on legitimate expectations of political, economic, and social stability. In other cases, investors assert claims against host states based on their failure to adequately protect the natural environment. Host states conversely assert counterclaims against investors, seeking compensation for environmental damages incurred in their operations.

In the more traditional field of commercial disputes, warranty claims based on corporate agreements for the sale and acquisition of contaminated sites are often arbitrated. Other cases concern construction and infrastructure projects, such as waste disposal or treatment facilities, water treatment, solar parks, wind farms, and hydroelectricity projects. Yet other cases concern the prospection, extraction, transportation, storage, and distribution of natural resources, including oil and gas. Human rights have also occasionally been at issue in investment arbitration, as well as in commercial arbitration.

The question then arises whether arbitration is an appropriate forum for resolving ESG-related corporate governance disputes, as compared to other disputes involving strong public interests. As a voluntary alternative dispute resolution system, arbitration is, of course, optional for the parties. And in the context of ESG disputes, which are of significant public interest, parties will only choose arbitration if it is perceived as a socially acceptable and adequate dispute resolution forum. Such social acceptability depends on both procedural and substantive law prerequisites: procedures must be perceived as fair and transparent, and the public policies behind applicable substantive laws must be honored.

Adaptation of Arbitral Procedures to Issues of Significant Public Interest

For the past two decades, arbitration procedural frameworks have been improving as mechanisms to resolve environmental and human rights-related disputes. As early as 2001, the Permanent Court of Arbitration adopted Optional Rules for Arbitration of Disputes Relating to Natural Resources and/or the Environment, for both state and non-state actors. Further, the 2019 Hague Rules on Business and Human Rights Arbitration provide for arbitration of disputes related to the impact of business activities on human rights. Also in 2019, the International Chamber of Commerce (ICC) issued a task-force report that affirmed the suitability of arbitration in general, and of ICC arbitration specifically, for climate-related disputes. In particular, the report explored potential procedural innovations and offered guidance for use of arbitration and ADR.

The past decade has also seen ongoing procedural changes in investment arbitration. In 2014, the United Nations Commission on International Trade Law (UNCITRAL) took a major step forward when it adopted Rules on Transparency in Treaty-Based Investor-State Arbitration. In 2022, the International Centre for Settlement of Investment Disputes similarly amended its Arbitration Rules. UNCITRAL’s Working Group III is also discussing an “Investor-State Dispute Settlement Reform.”

These procedural changes partly align with the recommendations of the ICC Task Force Report. This is worth noting because criticisms against investment arbitration procedures have the potential to spill over into commercial arbitration, and improvements in investment arbitration procedures could lead to similar improvements in commercial arbitration. Indeed, the ICC Task-force Report considers both commercial and investment arbitration.

These developments show three major trends aiming to improve the general social acceptability of arbitration, which may affect its use in ESG-related disputes. First, if a claim is manifestly ill-founded or frivolous, a tribunal can dispose of it early and parties can be compensated for related procedural costs. Second, with publication not only of basic data, but also of redacted awards, party submissions, expert reports, and hearing transcripts, arbitration is made more transparent to the public. Some hearings may even be made public. Third, rules allowing amicus curiae submissions and formal involvement of third parties, e.g., affected persons, opens arbitration to public participation to a far greater extent than the mere consolidation of separate arbitrations has previously allowed.

Arbitration may thus provide adequate responses in ESG-related disputes, allowing parties, counsel, and arbitrators to take advantage of a flexible procedural framework. However, parties’ willingness to participate in arbitration may depend on the arbitrator’s and the courts’ treatment of the applicable substantive rules.

Arbitration’s Responsiveness to Strong Public Policy in Legal Sources

There are thousands of international environmental treaties—multilateral, regional, and bilateral—including the well-known Paris Agreement on Climate Change. Further, numerous national laws and regulations are adopted or revised every year, such as the Clean Air Act, the Clean Water Act, and the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) in the US. An exhaustive list of hard- and soft-law human rights protection instruments and other substantive ESG-related rules could probably not be made. But two examples illustrate the magnitude of actual and potential legal risks these measures pose for businesses, which demonstrates their significant normative strength.

First, the European Green Deal (EGD) drew significant attention when it was adopted in 2019. The EGD provides a “roadmap for making the EU’s economy sustainable by turning climate and environmental challenges into opportunities across all policy areas and making the transition just and inclusive for all.” The EGD aims to achieve climate neutrality in the EU by 2050, a goal consistent with the long-term temperature goal set out in the Paris Agreement. Comparable to the US administration’s policy in substance, this climate neutrality objective was made legally binding by the European Climate Law in 2021.

The EGD also announced the strengthening of legislation that will impact manufacturing industries. This includes a revision of circular economy requirements, such as provisions on waste and construction products; protections of biodiversity, such as the restoration of damaged ecosystems, “net zero artificialization of soils,” and “net zero deforestation”; and a goal of “zero pollution” for air quality, governing emissions from large industrial facilities and chemical substances.

Second, the United Nations Guiding Principles would also require businesses to respect human rights through three explicit objectives: Protect, Respect, and Remedy. In other words, the UNGPs advocate for (1) public authorities’ duty to protect individuals from human rights abuses by business; (2) corporate responsibility; and (3) effective remedies, including judicial or nonjudicial grievance mechanisms and access to justice. Relying on these principles, a state court in the Netherlands found that, while human rights cannot be invoked as such against private companies, their underlying values can be factored into the general civil liability unwritten standard of care. The court reasoned that this interpretation of the standard of care can be deduced from soft-law instruments such as the UNGPs, which require companies to respect human rights.

Substantive ESG-related legal norms are generally articulated in legal contexts both nationally and internationally, and this raises the question of their mandatory status in arbitration. Indeed, ESG-related legal rules may qualify as public policy, although this idea is debated in case-law and scholarly work. In a nutshell, many such rules may be mandatory for domestic disputes purposes—that is, parties cannot agree to disregard them. However, the legal authority of such rules is more questionable in an international context.

Considering that the goal of arbitration is to achieve outcomes that will be recognized and enforced, applying some ESG-related rules in arbitration may seem imperative. But should all ESG-related rules be so assessed, regardless of the parties’ actions or resulting damages? In countries where courts give much room and weight to public policy when they are requested to set aside, recognize, or enforce an arbitral award—e.g., France as opposed to the US—whether an ESG rule is a mandatory norm may depend on the situation. Even more uncertain are situations where a public authority or agency such as the US EPA has previously taken environmental action—for instance to determine the nature and extent of rehabilitation of a contaminated site. In such situations, arbitrators would not normally apply the relevant legal rules directly; but the parties may expect arbitrators to consider the consequences of such administrative decisions when resolving their contractual disputes.

Some ESG legislation may be characterized as establishing “overriding mandatory rules” because it pursues crucial objectives within its scope of application. Arguably, such rules should apply regardless of the conflict of laws rules of the forum or the law chosen by the parties. Other ESG legislation may seek to protect fundamental core values, and, if ignored, may trigger rejection of an arbitral award.

Ultimately, the foundation underlying ESG rules should be of paramount importance in determining their legal strength, as with comparable legislation on corruption, money laundering, and competition. On the one hand, in corruption or money laundering matters, the facts may seem irrelevant to the outcome of the dispute; all such behaviours are unequivocally unacceptable. In contrast, all antitrust laws should not bring about similar responses, because some of them, e.g., vertical restraints, have less-damaging effects than others, such as horizontal cartels seeking to delay the introduction of greener products on the market.

Similarly, ESG concerns may not call for a single straightforward treatment. Rather an ESG rule may need to be considered from the viewpoint of the entire legal situation, including the facts giving rise to the dispute. For instance, some unlawful transborder shipments of waste, releases of polluting substances into groundwaters or surface waters, or instances of forced labor should probably be deemed breaches of public policy, both in domestic and transnational disputes. But at the other end of the spectrum, the disposal of non-hazardous extraction or construction waste may not warrant the same response.

A most perplexing example is that of emissions trading schemes (ETS)—such as those used by a dozen Eastern states partnering within the Regional Greenhouse Gas Initiative and by California, the EU, and other countries—to curb GHG emissions of the main heavy industry emitters. ETS are the single most powerful instrument for climate mitigation where they are in use. Yet, ETS are sometimes decried as “carbon taxes” or “permits to pollute,” because a manufacturer or importer that lacks sufficient allowances to match its actual emissions can purchase them on the market. In view of the importance, on the one hand, and the flexibility, on the other, of ETS, it is unclear whether such an emitter would be deemed in breach of a public policy rule.

Overall, these examples show that the application of legal ESG-related rules depends on the type of policy instrument considered, the nature of the specific behavior, and the ecological risks to the the affected environment.

Finally, even before they issue an award, during the arbitration, arbitrators must consider whether they are willing to investigate and act with respect to ESG-related public policy legal rules. When red flags of corruption or money laundering appear, the question arises whether an arbitrator has a duty to investigate. What if conclusive evidence is absent? Should they refer the matter to governmental authorities? Such a step may seem more natural to state judges than to arbitrators. These and other similar concerns are likely to become controversial in ESG-related arbitrations.

Conclusions

Because of the growing use of ESG factors, including by governments as policy instruments in matters such as corruption and money laundering, forced labor, and climate change, ESG-related disputes may well develop as arbitration’s newest game field. However, as an optional mode of dispute resolution, arbitration requires the consent of the parties to a dispute, and parties should only consent if they feel comfortable with the process and if it is socially acceptable to stakeholders. Arbitral procedures may thus have to adapt and become more efficient, transparent, and open to the public. Arbitration awards must also meet the courts’ requirements if they are to avoid set-aside and be recognized and enforced. In this respect, the strength of the ESG legal rules applied in a case may be a factor, like in other areas involving significant public policy.

    Author