In the fight against climate change and other sustainability concerns, challenges faced by companies in navigating their supply chain woes cannot be ignored. Companies are facing increased scrutiny in respect of their greenhouse gas emissions – not just from end-consumers, but regulators and other companies as well. Climate change also promises ever-more unpredictable weather events which have potentially catastrophic consequences on global supply chains, requiring significant forethought in the drafting of supply contracts and specifically the dispute resolution clauses contained therein.
Regulatory shifts on emission disclosure
The recommendations from the Task Force on Climate-related Financial Disclosures (TCFD) are aimed at getting corporations to be accountable for their greenhouse gas emissions (including Scope 3 emissions which are emissions that occur across a corporate’s value chain).
Various jurisdictions, including France, New Zealand, the United Kingdom, Japan, Brazil and Singapore, have passed implementing legislation that brings into force the TCFD Recommendations into domestic law. Such legislation requires mandatory climate related disclosures for certain listed companies.
In Singapore, for example, every listed company must prepare an annual sustainability report for each financial year, and such a sustainability report needs to be based on 27 core ESG metrics, including greenhouse gas emissions, energy consumption, water consumption and waste generation (Rule 711A of the Singapore Exchange Listing Rules). A Singapore listed company’s sustainability report will also need to disclose the company’s sustainability practices on a “comply or explain” basis. Although the Listing Rules are not statutory, SGX may nonetheless sanction non-compliance through reprimands or delisting.
For example, if a mobile phone manufacturer were to face regulatory action for incorrectly disclosing its Scope 3 emissions, owing to an upstream semiconductor manufacturer incorrectly stating its own carbon-emissions data, this in itself could result in at least two disputes – between the mobile phone manufacturer and the regulator, as well as the mobile phone manufacturer and semiconductor manufacturer. Moreover, if as a result of this, the mobile phone manufacturer were forced to publicly revise its own Scope 3 emissions for the year, this may open the mobile phone manufacturer up to a claim brought by a similarly-impacted downstream company.
Effect of new climate related regulations on contracts
A company that is required to comply with reducing Scope 3 emissions or make good their commitments to sustainability practices will need to ensure that its supply chain likewise complies with such commitments.
Suppliers, both upstream and downstream of a company, would need to accurately report their maximum allowable amount of carbon emissions for the relevant goods and/or services rendered. Accuracy is key as a company may have made representations in respect of carbon emissions to the securities exchange on which it is listed (as addressed above), downstream companies, and consumers. If the representations are inaccurate, they may render a company potentially liable.
Contractually, one way to ensure that such representations are accurate and legally binding is to include them as part of the written representations and warranties in a contract. A company may also seek to introduce contractual obligations for the disclosure of Scope 3 emissions on a regular basis, or information covenants that require a supplier to provide information as and when required by the company. Additionally, a company may need to negotiate for an indemnity from the supplier for any third party actions as a result of any inaccuracies in such representations.
These contractual provisions would allow a company to be able to bring legal action for misrepresentation or breach of contract, or even include the breach of such obligations as material breaches of contract which entitles the company to terminate the contract.
Mitigating climate change risks in the supply chain
Apart from complying with climate related regulations, a company may also need to consider mitigating climate change risks in the supply chain within a supply contract.
Climate change will result in unpredictable weather changes which can suddenly disrupt supply chains. With a global rise in temperatures of approximately 1.5 degree Celsius by 2040, the probability of a hurricane of sufficient intensity to disrupt semiconductor manufacturers based in Korea, Japan, Taiwan, and other countries in the western Pacific may potentially quadruple. Droughts, flooding, and other freak weather events will become increasingly commonplace. Companies need to be flexible, so that they can quickly pivot to another supplier to maintain supply of a product in the event of a disaster brought on by climate-change.
A company looking to mitigate climate change risks in the supply chain should consider the following inclusions in a contract:
- ensure the force majeure clause covers unpredictable weather conditions and disruptions that these can cause to the supply chain, including a notice provision for such force majeure events;
- consider the scope of a material adverse change clause to cover such changes in weather conditions;
- limiting liability in damages for delays in supply as a result of unpredictable weather conditions; and
- re-considering exclusive supply contracts (if there are any) so that a company is not restricted to only one supplier for a particular component.
Companies may also wish to consider contingent business interruption insurance (“CBI Insurance”), and/or specialized supply-chain insurance. CBI Insurance is especially useful where risk is heavily concentrated on a few points of failure. In situations where, for example, the insured is heavily dependent on a single supplier for materials, or on a single recipient business to purchase the insured’s products, CBI insurance may go a long way in ensuring that the threat to the company’s cash flow is amply mitigated.
A more considered approach to dispute resolution clauses
One of the greatest risks that may materialize due to supply chain disruption is that of parallel proceedings. A supplier in the middle of a disrupted supply chain may find themselves caught in the middle between cross-border disputes emerging upstream and downstream. Aside from the high risk of conflicting decisions, parallel proceedings effectively double the cost of proceedings as well.
Another risk that may materialize is that the arbitral process may prove too slow to grant a company relief that it urgently needs, due to an unpredictable disruption. For example, if a company needs to force delivery-up of a good that is suddenly in short supply, it is likely that only an emergency arbitrator would be able to give this interim relief effectively and in time.
The logical solution to this is to select an arbitral institution with favourable procedural rules regarding consolidation, joinder, and emergency arbitration. Practically, there are three challenges in implementing this solution.
First, dispute resolution clauses cannot remain an afterthought in contractual negotiation. The appropriate arbitral institution has to be selected deliberately and with intent. For example, certain arbitral institutions, such as HKIAC, have significantly more liberal rules on consolidation than others.
Second, procedures such as joinder and consolidation often require consent of the parties, in accordance with Article V(1)(d) of the New York Convention. Consent for joinder and consolidation should be drafted into the arbitration agreement itself for two reasons.
- It makes little sense to try and obtain consent from a counterparty only after a dispute has arisen and relations have likely soured.
- To avoid jurisdictional challenges during the arbitration or at the enforcement stage.
Enforcement difficulties may arise because of how the arbitration agreement is defined under the New York Convention. Article II(1) of the New York Convention defines an arbitration agreement as “an agreement in writing under which the parties undertake to submit to arbitration”. If a party needs to be joined into an arbitration that has already commenced, it would most likely not be a party to the arbitration agreement in the first place. Even if an adverse award is eventually rendered against the joined party, enforcement against the joined party may prove difficult due to this wording in the New York Convention.
The supply chain represents great risk, but also great opportunity for solutions to climate change and sustainability. This paradigm shift towards carbon-neutrality will reverberate throughout the supply chain and companies need to be prepared for the accompanying risks. As to climate-related disruptions, navigating an increasingly volatile and unpredictable market will demand better-drafted contracts which adequately allocate and limit risk, while also providing companies with the breathing room for speed and flexibility.