Ricocheting in the supply chain – Why climate change has caused a surge in contract disputes

Climate change represents a serious challenge for how businesses interact not only with policy makers, regulators and civil society, but also other commercial entities. Previous articles in this series have explored the ways in which businesses may find themselves involved in disputes arising from regulatory regimes and government decision-making. But while such disputes are among the most high-profile contentious matters arising from climate issues, they represent only a small fraction of the disputes which will emerge – and are already manifesting – from the ways in which climate change is affecting our world.

Specifically, there is enormous potential for a wide range of business-to-business disputes arising from the challenges of adapting and responding to climate change.

A growing category of climate disputes hidden from view

These disputes may play out in domestic courts. But many will be resolved in less public forums, including negotiation, mediation and commercial arbitration. Because these types of commercial disputes are often resolved behind closed doors, their outcome and even existence may not be visible other than to the parties involved. This is no different to the vast majority of conventional commercial disputes, which have for decades been resolved in privacy. It does mean, however, that the scale, diversity and significance of these forms of climate-related disputes will be concealed from view. Influential reports on climate disputes like those published by the Grantham Institute cannot account for the extent of commercial disputes resolved in private and estimates of the volume of disputes arising from climate change are likely to greatly understate the true picture.

Nevertheless, there is ample evidence within the legal and business community of the growth of these matters, as well as through occasional glimpses in the press of such commercial disputes. We see this reflected in our own practice as well.

These sorts of disputes arise between a commercial party and other stakeholders in its sphere of operations – including its joint venture partners, counterparties, suppliers, customers, lenders and investors – in the context of existing and new contractual relationships, supply chains, investments and joint ventures.

Applying and interpreting existing contracts in a decarbonising world

Many of these matters may look like business-as-usual disputes and take the form of conventional contractual disputes – the difference being that the conflicts giving rise to those disputes are generated by the complexity of managing and responding to climate change risks.

For example, commercial parties may have adopted different decarbonisation goals and policies, formulated in different terms and with different time scales – whether "carbon neutral", "net zero", by reference to Scope 1, 2 and/or 3 emissions, and potentially qualified by reference to certain types of assets or other criteria. They are also likely to have a degree of discretion as to how their climate change and decarbonisation goals are then implemented, whether these arise from their own corporate policies or from regulation.

Within commercial partnerships, contractual relationships and joint ventures, there may therefore be vastly different views on what is an appropriate action in pursuit of climate objectives. There is clear potential for commercial parties to disagree as to the scope of services required, the level of necessary investment, the factors relevant to calculate prices and the extent to which profitability should legitimately weigh against the pursuit of these goals. Where parties share costs (and risks), there may be disagreement as to how the costs associated with these objectives should be allocated, particularly where one party has made more ambitious climate commitments than another.

For example, is it consistent with the "reasonable and prudent operator" standard for an operator to install new technology for the measurement of emissions which impacts the efficiency of output, where such technology is not yet mandated by regulation but is likely to be in three years' time? Such questions are likely to test the limits of contractual language around necessity, risk management and proportionality.

Similarly, where lenders and investors attach ESG-related conditions to their investments, the commercial parties reliant on those investments may face difficulties in reconciling any misalignment between their own policies, those of their lenders and those of their partners. For example, where one party to a business venture needs that venture to meet specific emissions standards to secure its own funding but its commercial partner does not, there is scope for conflict as to how the costs of meeting those standards should be shared.

Many provisions in existing contracts will not have been drafted with these types of challenges in mind. Change in law clauses may not be well suited to help parties allocate cost and risk arising from changes in their own corporate policies, even where those policies are driven – but not directly stipulated – by the wider regulatory landscape.

Existing warranties, indemnities and limitations of liability are also likely to be tested in the context of climate change-related representations and disclosures. As decarbonisation and climate pressures increasingly shape the economics of projects, commercial parties are seeking to test the limits of force majeure clauses, hardship and material adverse change clauses. They are increasingly looking to their price review clauses, and even termination rights, for opportunities to protect their positions as the base assumptions on which the projects were founded change.

Disputes arising from transition-related contracts and other adaptation efforts

There is also evidence of commercial disputes arising from the pace of change involved in adapting to climate change. As decarbonisation initiatives gather momentum, there is a vast volume of new projects undertaken, and acquisitions made, as companies seek to meet their targets. Construction and environmental disputes are already arising, notably from low carbon or renewables projects planned and built at speed.

For example, the wind power sector has seen a large number of disputes around both the economics of projects and the suitability of new technologies as projects are pushed to generate ever greater volumes of power while margins dwindle. In the M&A context, parties are looking to recover value where deals for new technologies or green projects have been too keenly priced or their green credentials misrepresented. Access to novel technologies designed to address industrial climate change impacts is becoming a more contested issue, with licensing and intellectual property disputes on the rise. And as pressure increases to reuse and repurpose infrastructure and materials rather than decommission or discard it as part of aspirations towards a circular economy, issues around the limits of contractual liability associated with supplying and managing such infrastructure and materials will become more acute.

Looking to the future

Beyond these fairly familiar types of contractual disputes, there may be more novel conflicts emerging. Most notably, this will include disputes arising from the need to verify and authenticate the green credentials of projects, products and businesses. Regulations will increasingly require disclosures by companies of the carbon (and other emissions) impacts of their operations. Many commercial parties will need to rely on reporting by their suppliers, and will similarly need to report to their customers, investors and shareholders. This will increasingly be built into contractual frameworks, including in the form of warranties and ongoing reporting obligations. The consequences of breaching these requirements, including through greenwashing, misstatements and even fraud, will ricochet up and down supply chains, and we are likely to see a large volume of contractual disputes unwinding these impacts. This is already evident in the context of carbon offsets as the integrity of projects and products are scrutinised, with parties invested in such initiatives facing the consequences of disclosures based on those offsets.

In short, commercial parties increasingly find themselves, and their businesses, under pressure as they face up to the challenge of operating in a radically changed environment. In such straitened circumstances, contractual disputes are inevitable. If you are unprepared, the same may not be true of your counterparty.

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