FEATURED ~ SOCIETY FOR EXCELLENCE IN ARBITRATION LAW

By: Rashika Bajpai and Khushboo Sharma

Introduction

ESG (environmental, social, and governance) disputes refer to conflicts arising due to environmental sustainability, social responsibility, and corporate governance issues. It is a novel concept used to assess companies’ sustainability and ethical performance for investment decision-making. 

Businesses have seen a paradigm change where the emphasis on value creation now includes both positive social impact and economic and financial parameters. As ESG issues gain prominence, they raise new questions and challenges, including whether ESG disputes can and should be resolved through arbitration. This article examines the key considerations around the arbitrability of ESG disputes and the current state of the law in this area.

The possibility of using arbitration to settle ESG-related disputes

The use of arbitration to resolve ESG-related disputes can be an effective solution for companies and investors. Arbitration offers several advantages over traditional forms of dispute resolution for resolving ESG disputes, including the following-

1. Expertise: The parties to an ESG arbitration can select arbitrators with a high level of experience in ESG problems which can comprehend highly specialised and technically complex arguments and evidence.

2. Expeditious injunctive relief: ESG disputes often require an initial adjudication that cannot wait. For instance, there may be a serious and imminent risk of irreversible environmental damage resulting from a business practice. At the stage prior to the constitution of the arbitral tribunal, most arbitration rules have developed emergency arbitration procedures, under which parties can secure the appointment of an ‘emergency arbitrator’ to decide on requests for urgent provisional relief prior to the constitution of the arbitral tribunal. 

3. Speed and Efficiency: One of the main arguments in favour of the arbitrability of ESG issues is the speed and efficiency of arbitration in contrast to litigation. Massachusetts v. United States, one of the earliest climate change lawsuits, took over two decades to resolve, which is 85% longer than the typical length of cases at the International Court of Justice (ICC) and the International Centre for Settlement of Investment Disputes (ICSID).

4. Enforceability: It is common for ESG cases to contain a strong international component. The New York Convention of 1958 enables the enforcement of arbitral awards in over 170 countries, eliminating the requirement for parties to use bilateral mutual assistance agreements or national enforcement decrees for international enforcement of arbitral awards.

ESG conflicts may face limitations in arbitration due to:

Lack of transparency: ESG concerns have public interest, but arbitration’s confidentiality hinders open and accessible decision-making, making it difficult for the public to understand and evaluate the dispute’s outcome.

Third-party intervention: Involving third parties in ESG arbitration can be complex, as these disputes often involve the rights and interests of individuals, communities, and the environment. The extent of third-party involvement varies across jurisdictions.

Limited public interest: ESG disputes involve issues affecting a broader community and resolving them through arbitration may not be in the public’s best interest. Some jurisdictions may contest private proceedings for matters involving public rights and concerns.

Global Stance on Arbitrability of ESG disputes

Arbitration is increasingly used to settle ESG issues despite its limitations. Efforts have been made to enhance arbitration’s appeal in the ESG context through the modification of institutional norms. 

One significant example is the PCA Environmental Rules, 2001. These rules are often debated in relation to ESG, specifically climate change. They are the first arbitration rules on climate change issued by any arbitral organization and aim to address any gaps in existing arbitral rules that may arise in environmental disputes. The PCA Environmental Rules are based on the UNCITRAL Arbitration Rules and include a roster of specialized arbitrators and scientific experts. This roster is reviewed every four years to ensure the appointment of individuals with relevant environmental expertise, thus enhancing the effectiveness of the arbitration proceedings.

The Hague Rules, released in December 2019 to further streamline Human Rights related arbitration claims, are likewise based on the UNCITRAL Arbitration Rules. It acknowledges the significance of increasing the conventional level of transparency often used in arbitration when a human rights issue is at stake – more transparency is necessary in such cases, given that public interests are likely to be at stake. In accordance with the broad authority granted by Article 38(2), tribunals may modify the level of transparency of proceedings while still weighing factors like the participants’ safety, privacy, and secrecy. Hague Rules also addresses the issue of third-party intervention by allowing one or more third parties to participate in the arbitration, according to Article 19 of the Hague Rules.

Types of ESG Claims in Commercial Arbitration

In commercial arbitration, ESG claims can encompass a range of disputes which may arise from breaches of environmental or social obligations, non-compliance with national or international environmental or social standards, or from representations or warranties related to sustainability or ESG performance. 

There have been instances where environmental disputes have been resolved through the road of Arbitration. The Stockholm Chamber of Commerce (SCC), the PCA, and the Hong Kong International Arbitration Centre (HKIAC) have all heard cases pertaining to the Kyoto Protocol. At least nine independent instances of environmental issues resulting from the Kyoto Protocol in the PCA have been resolved by commercial arbitration. These cases range from a commercial contract dispute involving an Asian and European hydropower corporation to a disagreement over the number of units required to offset emissions against carbon credits.

Disputes relating to the Kyoto Protocol have also been heard by the SCC. Core Carbon v. Rosgaz and Centregas Service, a case involving damages resulting from a Kyoto Protocol carbon emission reduction plan, was heard by the SCC in 2014.

Revolutionizing the ISDS System: The Role of Arbitrating ESG Disputes in Promoting Sustainability and Accountability

ESG disputes have now found their way in the Investor-State Dispute settlement (“ISDS”) mechanism as well. In the ISDS mechanism, that has typically been seen as investor favouring, there is a growing recognition of holding investors accountable and responsible for the acts committed by them in the host states. This is usually done by imposing certain conditions on the investors as a pre-requisite of accessing the ISDS mechanism. However, there is still some lack of clarity surrounding what “responsibility” means in ISDS.  While obligations are imposed on investors through burdening their access to ISDS, the use of the term “responsibility” in the context of ISDS reforms has not clarified efforts to impose obligations on investors.

Companies are expected to engage in environmentally sound practices, promote human rights, and contribute to sustainable development to even be considered an “investor.” Corporate social responsibility has raised the bar on what is expected of investors in exchange for their right to sue.

Some notable examples of ESG related issues in ISDS are as follows:

1. The 2019 Netherlands Model BIT provides in Article 7(1), that “investors and their investments shall comply with domestic laws and regulations of the host state, including laws and regulations on human rights, environmental protection and labor laws.” 

2. Article 810 of the Canada-Peru FTA is a visible example of this, which states: “Each Party should encourage enterprises operating within its territory or subject to its jurisdiction to voluntarily incorporate internationally recognized standards of corporate social responsibility in their internal policies, such as statements of principle that have been endorsed or are supported by the Parties. These principles address ESG issues such as labour, the environment, human rights, community relations and anti-corruption.”

3. The concept of investor responsibility was read in the definition of “investment” in Mitchell v. Democratic Republic of Congo, a case involving the alleged expropriation of a law firm in the Democratic Republic of the Congo. The arbitral tribunal held that the practice of law does not qualify as an “investment” as it did not contribute to the economic development of the host.

4. In Cortec Mining v. Kenya, the investor was denied treaty protection as it failed to comply with the host state’s law and obtained a mining license without conducting an environmental impact assessment.

5. ESG obligations are also imposed on investors in their home states as provided in the domestic laws of the home states. Article 20 of the Morocco-Nigeria BIT states investors “shall be subject to civil actions for liability in the judicial process of their home state for the acts or decisions made in relation to the investment where such acts or decisions lead to significant damage personal injuries or loss of life in the host state.”

6. In World Duty Free Co. v. Kenya, the arbitral tribunal found that there could not be a basis for a valid claim when the investment had originated from the corrupt acts of the investor. In cases like Perenco v. Ecuador and Burlington v. Ecuador, ESG considerations have led to successful counterclaims by the host states.

Integrating ESG considerations into ISDS cases could play a critical role in extending the responsibility of the host state to the investor. While investors currently have the right to invoke a treaty breach directly, incorporating ESG factors into the dispute resolution process could expand the scope to include the broader community and stakeholders affected by the investment project. This would help to ensure a more sustainable and ethical decision-making process, which provides remedies for third parties harmed by investment projects.

A Way Forward

As a way forward, it is crucial to continue developing and amending the framework for arbitration of ESG disputes. Consideration should be given to adopting mechanisms that allow for appropriate disclosure of information without completely compromising on the confidentiality of the arbitral proceedings. Moreover, the involvement of third parties in ESG arbitration could be further explored and clarified.

Moreover, incorporating ESG considerations into ISDS cases could promote greater accountability and ethical behaviour among investors, as well as address concerns about the current system’s sustainability and fairness. This would help ensure that the interests of the broader community and stakeholders affected by investment projects are properly considered and protected.

Author’s Bio

The blog is co-authored by Rashika Bajpai (associate at Khaitan & Co.) and Khushboo Sharma (a third-year student from Dr. Ram Manohar Lohiya National Law University, Lucknow, India).