It pays to get ahead! In June 2019 the Government set a 'net zero target by 2050' for the UK for the reduction of greenhouse gases produced through human activity.
As part of that strategy, in the spring of 2022, it imposed reporting requirements on large institutions - listed UK companies, LLPs and UK companies with over 500 employees and over £500m in turnover.
While UK companies that don’t meet these criteria are not currently subject to reporting requirements, the writing is on the wall - it’s anticipated that all UK companies will have to undertake ESG reporting by 2025. In order to be ready for that, below we discuss what you need to understand now and how your lawyer can play a key role in demonstrating and enforcing your ESG goals.
If you're ready to include environmental and/or sustainability obligations into your supply chain contracts our team of friendly, knowledgeable commercial solicitors can help.
Contents:
What are 'ESG' considerations?
- Environmental - this concerns the mitigation of climate change and adaptation, the preservation of biodiversity and the prevention of pollution. You may have seen “Sustainability” clauses in contracts.
- Social - this concerns inequality, inclusiveness, labour relations and human rights. You may have seen 'Modern Slavery' and 'Bribery' clauses in contracts.
- Governance - administration of public and private institutions (eg. companies) including their management structures, their commitment to diversity, employee relations and executive remuneration.
'ESG reporting' provides a framework within which companies must be transparent about the impact that their activities are having on the environment and local communities, make commitments to reduce that impact and to be accountable for the manner in which they treat their employees and the wider community.
How does ESG apply to me?
It’s not just that there is a competitive advantage in preparing in advance for what you will be required to do in the future. There is a moral and social pressure on all of us, which we ignore at our peril, to consume less and to live fairly and responsibly as the effects of the over-reliance on fossil fuels, environmental and human exploitation and the degradation of the natural world are visible for all to see.
By taking steps now to identify your ESG responsibilities and to create a plan to fulfil them, you will be ahead of the game - seen to be socially responsible, innovative, future-orientated and - we hope! - far more attractive to investors and customers as a result.
What do I have to do about it now?
Be proactive. Now is the time to scrutinise your business plan and set your own ESG targets. Think of this time as your opportunity to get very clear on how you can help drive ESG considerations forward in every aspect of your business.
Set out below are some areas you might want to consider.
ESG and commercial contracts
You will be familiar with the concept of 'traceability' in the UK’s beef and dairy industry. Much value is placed on the existence of information that can trace an animal from A to X. That it can be done is not in doubt, if the will is there.
And it could be said that principle is now being applied to businesses.
Your supply chain can cause difficulty when attempting to ensure ESG considerations are sufficiently reflected because
- Your contracts may be several years’ old and may not reflect current sensitivities.
- Your counterparty may have committed to operate sustainably but further down the supply chain it is not clear that similar targets are being adopted or followed.
- Your counterparty may be in a jurisdiction in which legal weight is not given to ESG considerations.
If you find that your supply chain is opaque, you have to ask yourself why and whether you are comfortable with that?
You’ll need to give some thought to the relative importance of
- cost
- availability of the product elsewhere, and
- the consequences of a breach or otherwise falling short of commitments set out in your constitutional documents.
Requesting transparency can be controversial but recall how difficult it can be for reputational damage to be overcome, given the speed at which stories (inaccurate or not) can circulate on social media - you cannot control what is out there and so you are far better to be sure you do everything you can to get it right first time - think 'Accountability, Transparency and Communication'.
Our commercial team can suggest a number of questionnaires to ensure that you are conducting as much due diligence as possible on your supply chain.
Amendments to existing supply chain contracts can include ESG-driven clauses, such as:
- Agreeing a Net Zero Standard for all suppliers.
- Setting a Net Zero target for your supply chain on a back-to-back basis.
- Inserting a commitment to use renewable energy for all energy requirements.
- Inserting sustainability clauses in supply chain contracts with parties in jurisdictions in which there is less legal weight behind climate issues.
Ensuring your contracts don't leave your business exposed can be tricky. See our tips for managing risk in supply chain contracts.
Enforcement of ESG clauses
Those UK companies subject to the reporting requirements can be fined for failures to report correctly.
If you find yourself negotiating with a counterparty who
- is unable or unwilling to commit to supply chain transparency or
- is unable to make or procure the commitments that you require,
it is important to include a suspension and termination right for both parties.
Other clauses can be introduced into your contracts covering remedies for breach such as 'climate remediation fees' in which an agreed sum can be paid to a climate charity for breaches of the ESG commitments in the agreement.
Damages for breach of contract may be your final resolution but that obviously requires litigation.
Harper James can assist with negotiation and/or suggest clauses(see above)that can be brought into new contracts or added as addenda to existing contracts to cover ESG concerns, including difficult supply chains.
What if I am asked to sign up to someone else’s ESG targets?
If you sign up to another company’s ESG targets you will obviously be in breach of contract if you fail to take the necessary steps to help achieve those targets.
The parties’ negotiating power is relevant, of course - you may really want the business! - but you should seek a “win-win” situation, in which both parties feel they have committed to something achievable on both sides.
Again, think 'Accountability, Transparency and Communication' - share your own ESG targets, ensure your monitoring processes are accurate and functioning and request that your counterparty consider its position based on that information. You can offer to take 'all reasonable efforts' or to use your 'best endeavours' (NB. this is a higher standard and not be entered into lightly. Please see our article on endeavours clauses for more information) but remember the limits on your ability to control behaviour further down your supply chain.
There is always a way through and, ultimately, it can only be beneficial to remember that the negotiation is concerned primarily with securing degrees of ESG responsibility than on pure competitive advantage.
As you can see, this is a new and complex area in which practices are fluid - contact our Commercial Team in the first instance to discuss your situation and what you want to achieve.
We are happy to review all of your contracts to ensure they are up-to-date and that any inconsistencies can be ironed out.
Corporate governance
Businesses are being assessed by both investors and customers on their degree of social accountability and whether their values and their actions are aligned.
For this reason, big business is taking it seriously eg. Amazon has a dedicated 'sustainability' website and its own 'net zero target by 2040'.
Customers and investors really value socially-responsible motivation - according to the CBI two-thirds of investors take ESG factors into consideration when deciding where to place their money.
You can interpret the ESG responsibilities as widely or as narrowly as you wish but if you interpret them narrowly you may need to make further adjustments when the reporting requirements extend to all businesses by 2025.
So:
- Reflect on what you want your business’s response to the changing climate (both environmental and social) to be.
- Consider making commitments in areas you can control (eg. to the use of renewable energy, the reduction of transport costs, the use of suppliers with similar targets, the improvement of the energy efficiency of any offices or production centres you use, the way in which you recruit and treat staff and what training in ESG considerations you will provide for those employees).
- Consider how you will monitor all of the above.
- Reflect any such commitments in your constitutional documents.
If you are already established you may need a special resolution to change your Objects clause and/or Articles. If you are starting up, you will need an Objects clause and Articles that express your commitment and intention.
Our corporate team can be a sounding board to discuss your plans and advise on any amendments to your constitutional documents that you require.
The future - what else do you need to consider?
- Consider whether you have a strategy in place to manage the changes which will be coming in the next few years?
- Consider putting policies and controls in place as part of governance.
- Consider your level of tech investment to facilitate monitoring and reporting.
- Are your employees aware of and understand your ESG responsibilities and targets? What do they expect of the company?
- Investors - what do they expect to see?
- Customers - what do they expect to see? Consider raising your ESG profile by launching a marketing information campaign showing how you are championing ESG responsibilities. Beware the risk of “greenwashing” in which companies have given the impression that they are acting more sustainably than they are (eg. the recent Volkswagen Emissions fiasco).
In conclusion, whether or not the reporting requirements actually apply to you at the moment, the ESG principles demand
- Accountability
- Transparency
- Communication
no less in the corporate world than in the domestic world.
