Abstract:
ESG (Environmental, Social and Governance) term refers to the issues relevant to the impact, an organization has on environment, society and if the organization abides by the rules. The focus of businesses on ESG matters has increased in the recent years as the environmental concerns have been raised, social issues coming to light such as gender inequality, child labour, etc., and corruption on rise.
With the issues aforesaid coming more into light, the consumers, investors and shareholders seek for businesses who abide by the rules and standards set by the government in accordance with the same to invest in or/and buy from. The investors and shareholders who are already a part of any organization pressurizes the organization to add the clause to their commercial contracts for the organization to abide.
With the need to comply with the ESG considerations plenitude of disputes arise related to the transparency towards the society, duty towards environment and working according the rules set by the government for the welfare of the employees, etc. The shareholders and investors seek to associate with companies who contribute towards easing the issues arising related to ESG.
Choosing arbitration as the dispute resolution mechanism for ESG disputes can be due to many prominent reasons. It is argued that for ESG disputes arbitration is the most appropriate dispute resolution mechanism by the author.
Keywords:
ESG (Environmental, Social and Governance), Arbitration, Commercial contracts, Dispute resolution, public interest.
Introduction:
ESG stands for Environment, Social, and Governance, and is a set of criteria that investors are considering in searching and filtering companies that are “socially responsible”. These standards create a holistic approach for business strategies and investor screening by accounting for all the stakeholders — investors, company staff, environment, and society. Marked by its acronym, ESG focuses to approach and address issues fitting into the categories of environment, social, and governance. Intensified scrutiny of corporate conduct, governance and investment behaviours during the pandemic only served to accelerate the conversation around environmental, social and governance (ESG) issues.
In 2021, ESG issues have remained at the top of the agenda for many governments, investors and businesses. A wave of new ESG regulation around the globe calls for more extensive and detailed corporate disclosures. In parts of Europe, mandatory ESG due diligence rules have been introduced to force a more active approach to ESG risk management.
While ESG factors have not traditionally been seen as financial performance indicators, there is increasing acceptance of their potential to pose material financial risks. For this reason, governments and regulators are focusing on the need to promote effective ESG risk management, both to achieve sustainability goals and also to manage risks to investors, capital markets and the financial system more broadly. Within the broader issue of ESG, there is also the concept of ESG provisions, which are incorporated into business contracts to facilitate “risk allocation” or integrated into a company’s structure to track its progress toward achieving ESG-related objectives.
The word Environmental in ESG suggests the impact a business, organization or corporation has on the environment. These ordinarily includes climate change and greenhouse gas (GHG) emissions, energy efficiency, resource depletion, including water, hazardous waste, air and water pollution, deforestation, etc.
Issues under the social component of the ESG are human rights, working conditions, including slavery and child labour, local and indigenous communities, conflict, health and safety, employee relations, diversity and inclusion.
The word Governance in ESG sums up the issues such as bribery and corruption, tax strategy, transparency, shareholders rights, executive pay and diversity and structure. This is to ensure the business or organization or corporation is accountable to their shareholders and uphold their integrity when selecting the leader.
Despite the growing importance of ESG, many challenges still need to be addressed. One such challenge is the resolution of ESG disputes that may arise from time to time among stakeholders such as shareholders, investors, regulators, and communities. In a bid to address the disputes that may arise among them, conflicts may arise and disputes may escalate. In this context, several experts suggest that Arbitration may be an effective tool for resolving ESG disputes. It is a form of alternative dispute resolution that provides the parties with flexibility, confidentiality, and the opportunity to choose arbitrators with relevant expertise. Taking recourse to Arbitration allows the parties to design their dispute resolution process, including the laws applicable, the language of proceedings, and the rules of evidence.
ESG disputes can be of various types. These may result from duties imposed on parties by legally binding agreements, such as regional instruments like the Sustainable Finance Disclosures Regulation, which controls investment activities that lead to social injustice or environmental degradation, or international treaties and conventions like the Paris Agreement on Climate Change. Parties may also be subject to ESG requirements under national laws. For example, the Disclosure Guidance and Transparency Rules and the UK Listing Rules specify goals related to governance elements like as board composition. ESG clauses, which establish obligations on parties and may give rise to a claim if not fulfilled with, are another source of disputes in contracts.
Through this article the author explores why and how the arbitration is an effective mechanism to resolve ESG disputes, how it can be beneficial for the companies and the stakeholders, what are the possible advantages and disadvantages of using arbitration as ESG dispute resolution method and the way forward.
Research methodology:
This paper is of descriptive nature and the research is based on secondary sources for the deep analysis of the ESG and arbitration as a mechanism to solve disputes related to it. Secondary sources of information like journals, and websites are used for the research.
Review of literature:
- In Praise and Criticism of Arbitration as a Means of Resolving ESG Disputes by John P Gaffney
The article abovementioned talks about the basic and brief information about ESG and emphasises more on the merits and demerits of Arbitration as a mechanism to resolve the ESG disputes. With this article the author is trying to give a critical perspective on arbitration as a mechanism to resolve ESG disputes.
- ESG-disputes in international arbitration by Samy Akeb
The article abovementioned helps us with the international perspective on Arbitration as a mechanism to resolve ESG disputes, while it provides us with valuable input in understanding the international standing on this topic, this article will help to understand India’s perspective on this subject.
- ESG In India
The article abovementioned briefly makes us understand the position of India upon this subject, giving us a glimpse of the larger picture, with this article author is trying to put forward the larger picture in a concise manner to understand the actual limits and advantages of Arbitration as a mechanism to resolve ESG disputes.
- Understanding the Concept of ESG
The abbreviation ESG, which stands for Environmental, Social, and Governance, was initially used in the nearly two decades ago “Who Cares Wins” research. The abundance of interest in ESG in recent years has been attributed to a number of factors, including the drastic changes in the climate that will make the issue much worse than it is now, the numerous injustices reported by labourers employed by corporations, businesses, etc., and the ongoing rise in corruption that has been going on for a while. In addition to this, there are a plethora of other factors that have prompted the government to urge businesses, enterprises, and organizations to incorporate ESG provisions into their contracts and adhere to the ESG guidelines.
Businesses are letting them influence choices more and more, particularly when it comes to acquisitions, divestitures, and mergers. ESG serves as a benchmark for the business, helping it to operate more efficiently while also taking greater responsibility for its social responsibility, organizational governance, and environmental effect.
There is little doubt that the significance of ESG in the business sector is about to peak. The environmental, social, and governance practises of companies, regardless of size—from small, specialist units to massive global corporations—are coming under greater scrutiny from investors, regulators, and customers. These days, investors use environmental, social, and governance (ESG) as one of the most important non-financial considerations to help them identify material risks and growth potential before making an investment.
This growing importance and acceptance for ESG only reflects that everyone is recognizing the importance of the growing need of being sustainable and responsible while making decisions concerning environment, society at large, employees & labourers, and the corporate rules led down in the long run for companies as well as the world as whole.
Earlier the companies focused on the financial aspect of the business more than any other issues rising within. The issues which would not impact their financial growth were not given much importance before the obvious signs started showing about the environmental damage, employee exploitation, corruption, etc.
- Types of ESG disputes in businesses
Contracts often include ESG clauses that provide targets or assurances for ESG matters, as well as disclosure and reporting requirements. They can be included in business contracts, agreements for sales and supplies, contracts for mergers and acquisitions, etc. They make sure that businesses and other pertinent parties follow the ESG obligations and requirements. Environmental, health, and safety clauses are more common in contracts as ESG concerns gain prominence on the international scene. These clauses guarantee that the contracting parties abide by the relevant ESG policies of a company or a nation.
Because ESG clauses are new and complicated, disagreements about how to interpret and implement them are likely to arise.
Types of ESG disputes in Commercial Arbitration
ESG disputes in commercial arbitration can cover a wide range of disputes arising from non-compliance with national or international environmental or social standards, from environmental or social obligations that have been broken, or from promises or representations about sustainability or ESG performance.
It is acknowledged by the Arbitration and Conciliation Act of 1996 that some issues cannot be arbitrated. Sections 34(2)(b)(i) and 48(2) of the aforementioned Act allow the court to set aside an award if it determines that the dispute’s subject matter cannot be resolved through arbitration. Nevertheless, the Act is silent on the types of conflicts that are not subject to arbitration.
Therefore, as long as parties remember that the subject matter of the ESG provision is arbitrable, they can use arbitration to resolve disagreements pertaining to ESG clauses in their agreements.
Arbitration has not been used in India to directly address ESG disputes. However, because the available ESG factors are extensive, each has been addressed separately under the headings of E, S, and G.
- Arbitration for Environmental concerns
Due to restrictions like arbitration confidentially, there isn’t much information on the arbitrability of environmental claims in India. Nonetheless, India has been attempting to use ADR procedures to settle environmental conflicts. For example, the Indus Waters Kishenganga (Pakistan v. India) case was settled by arbitration by the PCA, despite the fact that this is an example of investment-treaty arbitration.
- Arbitration for Social concerns
Human rights, working conditions (including child labor and slavery), local and indigenous communities, conflict, health and safety, employee relations, diversity, and inclusion are all essentially included in the social component. Gender diversity in the workforce, customer satisfaction, corporate sexual harassment policies, human rights, fair labor practices, and labor conflicts between employers and employees are the main social indicators of a firm.
The Labour Court, Industrial Tribunal, National Tribunal, and National Industrial Tribunal are the adjudicatory tribunals for labor issues in India.
However, on the basis of the arbitration clause in the employer-employee agreement, the Industrial Disputes Act, 1947, has been used in certain cases to refer disputes arising from the agreements to arbitration.
In the case of Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd.49, it was held that the characterization of a claim is based on whether it is a right in rem or right in personam, and the one involving right in rem is non-arbitrable. As a result, agreements between employers and employees cannot always be categorized as private because some conflicts may include a right in rem and the public interest.
Section 10A of the ID Act also allows parties to refer their dispute to arbitration based on the arbitration agreement before referring it to a Labour Court or Tribunals. Such a reference will be to persons, including presiding officers of a Labour Court or Tribunal. Thus, at this stage, the arbitrability of the dispute concerning public impact can be decided. Secondly, the non-demarcation between arbitrable and non-arbitrable disputes under the Arbitration and Conciliation Act provides flexibility to determine the ambit of disputes to be arbitrated by relying on other statutes.
The aspect of right in rem is also relevant for discussion in cases of customer satisfaction. This aspect will be examined from the lens of consumer rights under the Consumer Protection Act, 2019. In the case of Emaar MGF v Aftab Singh, the Supreme Court held that consumer disputes are non-arbitrable due to the test of right-in-rem and right-in-personam.
- Arbitration for Governance concerns
The word Governance in ESG sums up the issues such as bribery and corruption, tax strategy, transparency, shareholders rights, executive pay and diversity and structure.
The disputes pertaining to the governance of a company are dealt with in a parallel structure of tribunals under the Companies Act 2013. Though the National Company Law Tribunals (“NCLT”) are quasi-judicial authorities, they have the power to refer parties to arbitration. It is emphasised that the interplay of shareholder rights and arbitration has been gaining importance.
The parties’ intentions ought to be taken very seriously. The failure of the SHA to include it in the AoA should not prevent the court from sending a dispute to arbitration where the SHA indicates that it intends to submit all issues arising from it to arbitration.
- Global Stance on Arbitrability of ESG disputes
Despite its drawbacks, arbitration is being used more and more to resolve ESG disputes. Attempts have been made to change institutional norms in order to increase the appeal of arbitration in the ESG setting.
One significant example is the PCA Environmental Rules, 2001. These regulations are frequently discussed in connection with ESG, particularly climate change. These aim to fill up any gaps in the current arbitral rules that can come up in environmental disputes. They are the first arbitration rules on climate change released by any arbitral organization. The UNCITRAL Arbitration Rules serve as the foundation for the PCA Environmental Rules, which also feature a list of qualified arbitrators and scientific specialists. To guarantee the nomination of people with pertinent environmental experience and improve the efficacy of the arbitration processes, this roster is reviewed every four years.
- Advantages and Disadvantages of Arbitration as a mechanism to resolve ESG disputes
- Advantages of Arbitration as a mechanism to resolve ESG disputes
The increasing prevalence and significance of environmental, social, and governance (ESG) obligations has led to the common practice of incorporating ESG risk distribution clauses into commercial contracts. Businesses, organizations, and companies have handled environmental, social, and governance (ESG) challenges through warranties and representations, particularly in mergers and acquisitions deals. Similarly, it’s been noticed that businesses frequently try to reduce and manage environmental, social, and governance (ESG) risks in the agreements they make with their suppliers and the production process as a whole. Conflicts are inevitable when such clauses are included.
ESG-related disputes can be best resolved by adopting the dispute resolution mechanism of Arbitration. It is worth noting that the International Chamber of Commerce Taskforce on ‘Resolving Climate Change Disputes through Arbitration and ADR,’ in its 2019 report, specifically emphasized on the fact of an increasing trend of ESG disputes being resolved via Arbitration and recognized that Arbitration is much well placed to serve the purpose of resolving ESG disputes. Some of the reasons are explained below:
- Consensual Selection of Expert Arbitrators
The primary reason arbitration is a good option for resolving ESG disputes is that, if the parties choose arbitrators jointly, they will have the freedom to select arbitrators who are highly skilled in the nuances of the ESG issues at hand and who are able to analyse the intricate and highly specialized arguments and supporting documentation to reach a more informed conclusion.
- Cross Border Enforceability of Arbitration
Since the companies’ supply networks frequently span multiple nations, it is customary for ESG cases to have a strong international component. It is necessary, therefore, to examine the international rules and regulations of different nations. Arbitration is frequently thought to be the most effective means of settling these kinds of international conflicts. Their awards are typically more readily enforced than judgments from different courts in different jurisdictions.
- Obtaining Emergency Relief is Easier
Obtaining injunctive relief quickly and effectively is more likely to occur through arbitration. In general, ESG disputes call for a preliminary adjudication that needs to be finished promptly. Preventive emergency measures are necessary in certain cases where there is an immediate risk of irreparable environmental damage resulting from the economic practice.
- Predominant use in Investment Treaties
Furthermore, environmental protection, human rights, conflict within indigenous groups, and corruption are among the ESG concerns that commonly surface in investment treaty arbitrations. There is a growing number of new generational international investment agreements and changes to current investment treaties, with ESG provisions included.
- Neutrality and Flexibility
Arbitration’s special qualities—namely, its impartial forum and flexible procedure—offer the disputing parties a dispute resolution method that can adapt to the changing needs and nature of conflicts, making it appropriate for settling and resolving ESG problems.
- Disadvantages of Arbitration as a mechanism to resolve ESG disputes
Around the world, arbitration has been employed as a means of resolving ESG issues. It is only appropriate to evaluate whether arbitration may be used to settle ESG conflicts in India, though. Some constraints that must be addressed in order to improve this kind of resolution mechanism are as follows:
- Lack of transparency
There is an indisputable connection between arbitration’s secrecy and lack of transparency. It is still a private procedure even though it is not totally confidential. But arbitral organizations are addressing this by taking steps to increase the transparency of their procedures. Publication and dissemination of some information, for example, are permitted under the ICC’s Note to Parties and Arbitral Tribunal on the Conduct of Arbitration under the ICC Rules of Arbitration, as long as no party objects.
- Power Imbalances
In terms of the amount of authority and resources at their disposal, the parties to issues pertaining to ESG may occasionally differ. The fairness and efficiency of the arbitration procedure as a whole may be seriously impacted by this.
- Difficulty in Quantification of Damages
ESG claims frequently need intricate harm calculations. Therefore, one of the main challenges in the arbitration proceedings is estimating such injuries, particularly when it comes to social or environmental harms. Arbitration as an alternative dispute resolution (ADR) process for ESG conflicts has a great deal of difficulty because there is currently no agreement on the methods for arriving at the same.
- Jurisdictional Challenges
The resolution of ESG concerns sometimes involves navigating many regulatory frameworks and countries. Consequently, there may be difficulties in determining which legal framework and jurisdiction to apply. Furthermore, it could be difficult to enforce the arbitral rulings in several countries.
- Complexity of Evidence
ESG claims can require complex scientific and technical data, which makes it difficult for arbitrators to comprehend and assess. Hearings may become significantly longer as a result, and expenses may increase.
5. Conclusion:
Given how quickly ESG is ingrained in corporate culture and business culture, the number of ESG disputes is expected to rise. Based on an analysis of the arbitration process as it stands now and the regulations pertaining to ESG, appropriate rules governing the arbitration process should be in place to settle disputes involving ESG clauses. With the ever-changing world and the speed with which it evolves Arbitration and rules regarding this matter should also be evolved, some of the potential changes can be:
- Develop ESG-specific arbitration rules
- Inclusion of ESG consideration in the selection of arbitrators
- Train existing arbitrators in ESG
- Incorporating technology into the arbitration process
- Encouraging the parties to use other ADR methods
Tanvi Vartak
University of Mumbai, Thane Sub-campus