Introduction
Overview
Disputes arising out of contracts relating to transition, adaptation and resilience measures
Comment
It is impossible to ignore that climate change and sustainability issues are hot topics. On a daily basis, these issues are debated across a variety of platforms, including at industry roundtables, boardrooms and on the floor of parliaments globally. Inevitably, these issues have also become part of the legal landscape and they are being argued before courts and tribunals. The range of related legal disputes is vast; climate change is a global phenomenon where legal issues traverse multiple fields of law and various causes of action, involving a wide range of claimants and defendants from multiple sectors. The disputes-risk profile for companies is not only complex but also in a state of flux as claimants and defendants present ever more novel arguments; legislatures, regulators, courts and tribunals must grapple with how to address these complex issues and who should bear the significant legal and fiscal burdens. For many in-house counsel, the sheer breadth of these issues is nightmare inducing and it makes it difficult to assess the likely legal and regulatory risks in order to formulate strategies to mitigate those risks.
This article analyses examples from recent cases referred to international arbitration to offer an introduction to the types of disputes relating to climate change and sustainability issues.
There is no single definition of what constitutes a dispute relating to climate change. The International Chamber of Commerce's Commission Report offers a helpful definition, which took a broad view of such disputes as including "any dispute arising out of or in relation to the effect of climate change and climate change policy, the United Nations Framework Convention on Climate Change ("UNFCCC") and the Paris Agreement". For the purposes of this discussion, the above definition is broadly used, with the addition of "sustainability". This is in recognition of the fact that these disputes often encompass other distinct issues that fall within the broader sustainability sphere.
For example, human rights and other fundamental rights have traditionally been viewed as a distinct category, but these are inherently related to and impacted by climate change. Commentators tracking trends in disputes relating to climate change have been (accurately) predicting for years that there will be an increase in claims that are essentially disputes relating to climate change, but they are formulated as fundamental rights arguments. This is a trend that will increase in the coming years, not least because such arguments have already enjoyed some success. Other examples are biodiversity and land degradation issues that are impacted by climate change (and, in turn, compound the effects of climate change) but which are also impacted by many other factors. In brief, the term "climate change" on its own is now unhelpfully narrow.
It can be useful to roughly divide disputes relating to climate change and sustainability by certain practical, identifying features:
- category one – cases brought to either mandate or change climate-related policy or conduct;
- category two – cases brought to seek financial redress for damages associated with the effects of climate change;
- category three – contractual disputes arising out of the industry transitions which the energy sector and all major industries are currently undergoing;
- category four – contractual disputes resulting from climate-related weather events;
- category five – related disputes between foreign investors and host states;
- category six – related disputes between states; and
- category seven – related disputes between other transnational actors.
A key reason for selecting these categories is that the potential role for arbitration varies significantly depending on the category of dispute, with arbitration having a greater role (potentially and in practice) in categories three to seven. This is largely because claims that fall within categories one and two tend to be based on statute, constitutional or administrative law rather than contract law. Those disputes usually end up before national courts (if not deferred to political fora). More fundamentally, as arbitration is a contractual process, public interest groups will often not have legal standing in arbitration.(1) There can also be problems with the arbitrability of certain disputes that fall within categories one and two.
This article focuses on categories three and four – contractual disputes.
Disputes arising out of contracts relating to transition, adaptation and resilience measures
The massive increase globally in transactions related to the transition of energy and all industries, as well as adaptation and mitigation measures, is one reason why there has been an increased number of related disputes; a percentage of these transactions will invariably result in some form of disagreement. In addition, there is an increased risk of disputes given the particular characteristics of these transactions. Many will involve novel aspects, such as new:
- innovations (eg, technologies, products or processes);
- infrastructure and systems;
- collaborations (including between non-traditional partners such as energy and technology companies);
- suppliers and manufacturers;
- markets and customers; and
- competitors.
These are also occurring in the context of a rapidly changing regulatory environment as new regimes are introduced or old regimes are adapted to be fit for purpose. As is the case with clean-energy technology, project partners will find themselves navigating a heavily regulated industry, perhaps for the first time. The pace at which these transitions are occurring will have a significant effect on the risk profile – mistakes are bound to happen in the course of rapid, large-scale disruptions.
International arbitration is frequently the dispute resolution mechanism of choice for many of the sectors undergoing these transitions, particularly:
- energy;
- natural resources;
- infrastructure; and
- transport.
Statistics provided by the major arbitral institutions evidence that a consistently high proportion of disputes administered by those institutions involve the above sectors. It is also the mechanism of choice for cross-border transactions, particularly where a party is a state or state-owned entity, or where an emerging market is involved (as is often the case in the energy, natural resources and infrastructure sectors). Parties also favour arbitration where confidentiality and privacy are important to disputant parties (as is often the case with contracts involving technology and innovation). Many disputes relating to climate change and sustainability are also technical in nature, and therefore arbitration once more offers an edge over litigation because parties can select arbitrators with the relevant expertise to adjudicate the dispute. This is borne of a 2019 Stockholm Chamber of Commerce report, which concluded that more green technology companies are resorting to arbitration to resolve their disputes. Therefore, a significant number of the disputes arising out of industry transitions and other adaptation and resilience activities have and will continue to end up in international arbitration proceedings.
Construction and infrastructure disputes
There are many examples of construction disputes that relate to transition, resilience and adaptation projects being referred to arbitration. The Stockholm Chamber of Commerce report mentioned above cited a number of cases that involved renewable energy facilities (from wind farm to biogas installations), noting that over 60% of the green-technology disputes reviewed involved renewables. It stated that typical issues raised involved whether the facility satisfied the contractual standards – for example, in the production of the agreed amount of power or preventing environmental risks (for further details please see "Renewable energy project disputes: navigating the dark side of the energy transition").
Construction always proves fertile ground for disputes, with disputes usually relating to:
- quality;
- liability for additional costs;
- work; and
- delay (including liquidated damages claims).
A high-profile example is that of the disputes brought in the wake of a disaster during the construction of the multibillion Hidroituango hydroelectric dam in Colombia, which collapsed, causing a major flood. A more mundane example is where the works performed suffer errors so significant that the facility could not be used as intended.
Infrastructure is another area where climate-related disputes are increasing. Massive investment in new and improved infrastructure will be needed to ensure that critical infrastructure is resilient to the physical effects of climate change. Infrastructure arrangements are also likely to have an impact on other projects, given that in many instances, infrastructure for transition-related projects may be limited or need to be introduced specifically for these projects. As an example, a dispute under a partnership agreement to build a wind farm was referred to arbitration after the claimant alleged that, because the grid connection was no longer available for the wind farm, an event of default under the agreement had occurred and it therefore had the right to transfer its shares in the project back to the respondent.
In addition, disputes being referred to arbitration in relation to important infrastructure such as ports and railway lines that have suffered devastating damage from flooding have already been seen. In the wake of these events, the transport companies and states were unable to agree on who should be liable for the costs of repairs and whether the flooding constituted a force majeure. The climate science is clear that there will be more frequent and extreme weather events due to climate change, which will mean more business interruption, operational risk and contractual and other disputes.
Supply chain disputes
This is a critical area of disputes risk and, like infrastructure, it has a broad impact on many areas. Supply chains are being significantly disrupted by climate-related impacts, with more disruption to be expected as the effects of climate change become more extreme. The covid-19 pandemic offered insight into the potential scale of global disruption that climate change could have, and it has particularly highlighted the vulnerability of supply chains (for further details please see "Supply chain disputes: avoidance, mitigation and resolution"). A November 2021 report by Moody's found that critical industries have substantial exposure to physical climate risks, including supply chain risk. Among the most exposed sectors are:
- manufacturing, particularly electronic and electrical product manufacturing;
- petroleum and coal;
- non-metallic mineral products;
- food;
- chemicals;
- utilities;
- mining; and
- transport.
For many of these sectors, a significant part of their revenue is in regions with a high exposure to the physical risks of climate change, and their supply chains are dependent on resources and regions threatened by climate change. These risks are compounded by the impact of climate change on international transport – in particular, sea level rise and extreme weather events.
Supply chain disputes relating to climate change or sustainability-related contacts are already commonplace, typically involving issues with:
- performance;
- delivery;
- quality;
- quantity; and
- payment.
Supply chains often involve cross-border parties, emerging markets and multi-party, complex chains of contracts, which often makes international arbitration the preferred option. The flexibility of international arbitral procedural rules also allows the parties to tailor the proceedings to their needs, such as to dramatically fast-track proceedings, which is often critical in supply chain disputes. Supply chain disputes are likely to continue to be a significant source of the disputes being referred to arbitration in the years to come.
Pricing disputes
Due to the effects of climate change, commodities may be harder to source or transport due to more extreme weather conditions, and there will be fluctuations in demand and prices (eg, due to technological advances, changes in policy or law, or consumer sentiment) and in some instances certain commodities may no longer be commercially viable as a result. Given the fluctuations to commodity prices that have been seen in recent years, and further anticipated fluctuations in global markets, it is expected that there will be an increase in price review disputes and disputes over performance and termination of commodities contracts. For instance, a dispute between a German manufacturer and supplier and a Taiwanese photovoltaic company that related to the performance of a long-term supply agreement for silicon wafers (an essential component of the cells that are used to generate solar electricity) was referred to arbitration after the photovoltaic company refused to continue to perform the contract following a rapid plunge in the cost of silicon and wafers.
Gas price review arbitrations offer a real insight into the level of disputes that could be seen. Most gas price review disputes are driven largely by external events such as changes to markets and economic crises (ie, exactly the sort of disruption that has been seen due to climate change, with much more to come) and as a group, they resulted in some of the highest-value disputes worldwide.
Financing disputes
In addition to these issues, there will be disputes over financing arrangements. Recent developments at both the global and regional levels have led to some companies struggling to find financing for projects, which has led to (at best) delays or (at worst) the termination of contracts. Such cases may be referred to arbitration. In parallel with trillions of dollars needed to fund the transition and resilience measures of energy and all other industries, there is a steep uptick in the financing of transition projects or adaptation and resilience projects. There will also be an increase in the usual sorts of disputes related to the terms of financing. However, disputes over failure to meet the technical specifications needed to achieve green or sustainability-linked financing or the appropriate use of sustainable finance or climate-related funding should also be expected.
Similarly, disputes will increasingly arise under the carbon credits and the emissions trading schemes – some have already been referred to arbitration.
Other corporate disputes
Other commercial disputes concerning licensing, distribution, joint ventures and partnership agreements relating to climate change and sustainability projects should also be expected.
In addition, as governments invest in new projects and infrastructure relating to the transition of energy and other industries or to the mitigation of the effects of climate change, it is inevitable that contractual disputes involving states and state-owned entities will arise. As an example, a German renewables company successfully pursued ad hoc arbitration against Lesotho after the state refused to perform a contract to purchase solar energy equipment. Some of these will be dealt with in commercial arbitration, whereas others may result in investment treaty claims which will be referred to investment arbitration.
In addition, where new risks arise, parties will invariably seek to contractually mitigate and allocate such risks between themselves. Unsurprisingly, many contracts now include obligations to comply or warrant compliance with environmental, human rights or sustainability obligations. Usually, contracts now also contain commitments to put in place back-to-back arrangements with counterparties further down the line. Disputes over these provisions will invariably arise.
Weather-related disputes
The effects of climate change are already impacting commercial enterprises. Most major insurance companies are reporting significant increases in losses due to extreme weather-related events. These effects are predicted to further worsen in the coming years. The effects could go beyond the physical; they could also be:
- transitional (eg, the loss of an existing market or new competitors);
- legal; or
- regulatory (eg, the inability to renew permits or greater restrictions on doing business that will affect profitability).
There are myriad ways that weather-related issues might negatively affect contracts and result in commercial disputes. Obvious examples are claims of force majeure, frustration or termination. Disputes relating to insurance arrangements will also arise. As mentioned above, supply chain disputes are a real risk. More broadly, changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent, leading to contractual defaults or distressed or stranded assets.
Climate change and sustainability disputes are the new corporate reality. Commercial arbitration will be the dispute resolution mechanism of choice for many of these contracts, and there will be an accordant increase in disputes being brought to arbitration as the effects of climate change continue to manifest globally.
There is no cause for alarm – no transaction is without risk. However, parties do need to prepare for this increased risk of disputes. They should consider dispute resolution mitigation and resolution strategies at the outset of every transaction. A well-drafted arbitration agreement is a key contractual risk allocation mechanism. As a neutral forum, offering access to expert adjudicators, arbitration is arguably well placed to play a leading role as an arena for resolving many disputes relating to climate change and sustainability that arise out of contractual relationships. Other important mechanisms include conducting risk audits of the company's global and regional operations as regards potential disputes relating to climate change and sustainability. Companies may also do well to establish protocols for dealing with disputes as soon as they arise. If done well, such protocols can save significant time, costs and reputation, in addition to preserving relationships with counterparties. The latter is a critical point in climate change and sustainability contractual disputes, given that many such contracts will be long-term arrangements involving significant levels of investment both at the outset and throughout the project. Considering disputes risk at the outset of a transaction as well as in the ordinary course of business is the best way to avoid a climate change disputes disaster.
For further information on this topic please contact C Mark Baker at Norton Rose Fulbright's Houston office by telephone (+1 713 651 7708) or email ([email protected]). Alternatively, contact Cara Dowling at Norton Rose Fulbright's Vancouver office by telephone (+1 604 641 4874) or email ([email protected]), Dylan McKimmie at Norton Rose Fulbright's Perth office by telephone (+61 8 6212 3299) or email ([email protected]) or Tamlyn Mills at Norton Rose Fulbright's Sydney office by telephone (+61 2 9330 8000) or email ([email protected]). The Norton Rose Fulbright website can be accessed at www.nortonrosefulbright.com.
Endnotes
(1) It is not so simple given that, in some instances, non-parties to the arbitration agreement can participate by applying to intervene as amicus curiae (in investment arbitration), or joinder of third parties with the consent of the parties (in commercial arbitrations).
Kevin O'Gorman, office administrative partner, Holly Stebbing, partner, and Martin J. Valasek, partner, assisted in the preparation of this article.