Climate change and sustainability disputes: International arbitration perspectives
Global | Publication | July 2021
- Climate-related disputes and legal risk
- Legal action as an instrument to drive change
- Legal action as a means of seeking financial redress for climate change and sustainability damages
- Contract based disputes arising out of the energy and all industries transitions
- Contractual disputes resulting from climate-related events
- Investor-state arbitration
- State-state arbitration
The scrutiny of state and corporate action (or inaction) as contributors to climate change and sustainability risk is intensifying. For companies – regardless of the sector in which they operate – climate change manifests as a complex myriad of physical, transitional, legal, regulatory, financial, and reputational risk. The number of climate-related cases commenced to date is now well over 1,600, and that number continues to rise. Most cases fall beneath the radar (low key skirmishes over statutory permissions or breaches) but in recent years a number of high stakes claims have been fought very publicly before the highest courts and regularly in the courts of public opinion. Regardless of success, such claims inspire imitative cases all over the globe. Put plainly, climate-related disputes risk is now part of corporate reality. Whilst most legal challenges to date have been brought before national courts, there is a substantial role for arbitration as a forum for resolving climate change and sustainability related disputes. Indeed, arbitration has the potential to become a key mechanism for the enforcement of environmental law and policy.
Climate-related disputes and legal risk
The range of climate change and sustainability disputes brought to date is vast – it is a global phenomenon, where legal issues traverse multiple fields of law and various causes of action, and involve a wide range of claimants and defendants from multiple sectors. The risk of such disputes is not simply an energy sector issue, though for obvious reasons that sector has become a primary target. All sectors are at risk and activists have targeted sectors spanning banking and finance, pension funds and asset managers, insurance companies, manufacturers, and agribusiness, to name but a few.
The risk profile is not only complex but in a state of flux. This is partly due to innovative claims being brought by claimants as they seek to get around the legal hurdles frequently faced by such claims (such as standing, justiciability, causation, quantification of loss and meeting the evidential burden). It is also due to the ongoing evolution of climate-related regulation, on the national and international stage, as states grapple with how to address climate change and who should shoulder the fiscal burden.
Climate change and sustainability disputes can be roughly divided into the following categories:
- cases brought to either mandate or change climate-related policy or conduct;
- cases brought to seek financial redress for damages associated with climate change;
- contractual disputes arising out of the extensive transitions which the energy sector – and indeed all major industries – are currently undergoing;
- contractual disputes resulting from climate-related events;
- disputes between foreign investors and host states; and
- disputes between states, and between other transnational actors.
The potential role for arbitration varies significantly depending on the category of dispute.
Legal action as an instrument to drive change
The first category includes cases pursued by NGOs, pressure groups (often crowd-funded), and even governmental authorities against governments or corporations to enforce existing climate policies or accelerate policy change or behaviour. The Urgenda case is a notable example. The Urgenda Foundation successfully sued the Netherlands and obtained a court order compelling the government to implement more stringent climate change policies. Urgenda spawned numerous copycat proceedings across the globe, with mixed rates of success. Notably, this case also set the foundation for a claim in the Netherlands against a corporation on similar grounds, which has thus far succeeded at the District court level (though reportedly the company will be appealing the decision). That case is a landmark decision in that Dutch the court ordered the company to reduce its global greenhouse gas emissions (including phases 1 through 3) drastically in a very short period of time.
Also in this category are claims focussed on regulatory compliance, corporate governance and consumer protection, brought either by regulatory authorities or aggrieved shareholders primarily in relation to the disclosure and mitigation of climate related risk or the veracity of climate change and sustainability commitments. There have been regulatory investigations of corporations over disclosure and mitigation of material climate related risk. As more corporations commit to emission reduction targets and other sustainability measures, there is increasing regulatory scrutiny of the veracity of corporate statements and their potential to mislead consumers and shareholders.
For these types of dispute (at least for the time being), national courts will continue to be the fora of choice, and arbitration will play a more limited role. Many of these claims will be based on statute or constitutional or administrative law challenges rather than contractual disputes, and some may well be brought by national regulatory authorities under their mandates. More fundamentally, as arbitration is a contractual process, public interest groups often will not have legal standing to pursue arbitration. Likewise, there can be problems with arbitrability of such disputes.
In addition, a big part of the attractiveness of litigation for claimants in such disputes is the public nature of proceedings – public relations and reputational pressure is brought to bear on defendants, and claimants also seek to raise the profile of, and galvanise public support for, what is often a political or public interest cause. Pressure groups readily admit that publicity is often a significant win, even if the case is lost on its legal merits. In contrast, arbitration has an inherently private nature. Of course, not all arbitrations are confidential (though many are), but almost all arbitrations are private – in that only parties can participate in proceedings, access pleadings and evidence, attend hearings, and see the final awards. To the extent that awards or arbitration related judgments are published, these are often anonymized.
Legal action as a means of seeking financial redress for climate change and sustainability damages
In the second category are claims against corporations where the main purpose is to seek damages for direct or indirect effects of climate change on the claimant’s property or investments (often in conjunction with other relief). A number of such claims have also been brought by individuals and pressure groups (again often crowd funded) as well as sub-national governmental authorities. For example, the various high profile lawsuits brought by US cities and communities against oil and gas majors, before both federal and state US courts. In recent years, there have also been claims brought by trade or industry groups.
Arguably also within this category are claims by foreign investors against states, which seek to apportion liability for the impact of climate-related state conduct (e.g. change in policy or law) on their investments. In the short term, at least, arbitration’s role will be in resolving such investor-state disputes as discussed in more detail further below.
Contract based disputes arising out of the energy and all industries transitions
In the third category are claims that arise out of contracts related to the fast, deep transitions across all industry sectors that are needed to meet global climate targets, as well as contracts related to adaption and resilience measures (i.e. reducing countries’ and communities’ vulnerability to climate change by increasing their ability to absorb or withstand the impacts).
The IPCC Special Report on the impacts of global warming of 1.5°C predicted the need for “rapid, far-reaching and unprecedented changes in all aspects of society”, which includes, in particular,“rapid and far-reaching transitions in land, energy, industry, buildings, transport and cities”. Transitions in these key sectors, individually and collectively, will impact every private, commercial and public endeavour.
One hundred years ago, transitions in energy, industry and transport led to fundamental societal change. The advent of the automobile, for example, enabled speedier and safer travel over larger distances, transformed industry and trade, and reshaped our cities as well as our private lives. Modern transitions to limit global warming, not least the transition to alternative sources of energy, call for an equally radical reorganisation of the way our societies, cities, and lives are configured and run. And they call for this far-reaching change to occur at a pace that has never been attempted or achieved in the history of humanity.
According to the 2020 UNEP Adaptation Gap Report, annual adaptation costs in developing countries are estimated at USD 70 billion. This figure is expected to reach USD 140-300 billion in 2030 and USD 280-500 billion in 2050. The energy transition, for obvious reasons, will have a huge impact on its own – and it will impact all sectors. According to a recent report by the IEA, to reach net zero emissions by 2050, the cost of annual clean energy investment worldwide will need to more than triple by 2030 to around $4 trillion. It also requires massive deployment of all available clean energy technologies– such as renewables, EVs and energy efficient building retrofits – and huge investment in research and development for new technologies between now and 2030. The transitions needed across other major industries (and infrastructure) will likewise necessitate very significant levels of investment.
This presents significant opportunities for businesses. It will, however, also result in an increased risk of disputes. This is in part due to a simple increase in the number of transactions, of which a percentage will invariably end up in some form of dispute. However, there is an increased risk of disputes given the particular characteristics of the transition.
This is partially because many investments and projects will be peppered with novel aspects, such as: new innovations (be they technologies, products, or processes), new infrastructure and systems, new collaborations, including between non-traditional partners (such as energy and technology companies), new suppliers and manufacturers, new markets and customers, and new competitors. Disputes are also likely to arise in the context of a rapidly changing regulatory environment as new regulatory regimes are introduced or old regimes adapted to be fit for purpose. Indeed, as is the case with clean energy technology, project partners may simply find themselves navigating a heavily regulated industry for the first time. Last, but certainly not least, is the pace at which these transitions are occurring, which will have a significant impact on risk profile – mistakes are bound to happen in the course of large scale disruption.
Each of these elements alone would increase the disputes risk profile of projects but, in combination, the risk profile increases dramatically. There is no cause for alarm – no transaction is without risk – however parties would be well advised to consider dispute resolution mitigation and resolution strategies at the outset of every transaction.
International arbitration is frequently the dispute resolution mechanism of choice for cross-border transactions, particularly where a party is a state or state-owned entity or an emerging market is involved (as is often the case in the energy sector). It is also the mechanism of choice where confidentiality and privacy is important to disputant parties – as is the case with contracts involving technology and innovation.
The confidential nature of commercial arbitration bites both ways in that it is difficult to track the extent to which climate-related issues are already being raised. Based on what is publicly available, however, and given the sheer scope of potential disputes risk, it is clear that more disputes with climate change and sustainability elements will be decided by commercial arbitration.
Contractual disputes resulting from climate-related events
The effects of climate change are already impacting commercial enterprises – simply looking at insurance companies’ reports shows significant increases in losses which they attribute to climate change and extreme weather-related events. These impacts are predicted to worsen in the coming years. The impacts could be physical, but they could also be transitional (such as loss of an existing market or new competitors) and legal or regulatory (such as inability to renew permits or greater restrictions on doing business that impact profitability). Changes in policy, technology, and physical risks could also prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent. There is clearly a myriad of ways that climate-related issues might negatively affect contracts and result in commercial disputes. One obvious example, is force majeure claims arising out of weather-related events.
In addition, where new risks manifest, parties will invariably seek to mitigate and allocate such risks as between them contractually. Unsurprisingly, many contracts now include obligations to comply with and/or warrant compliance with environmental, human rights or sustainability obligations, and commitments to put in place back-to back arrangements with counterparties further down the line. Disputes over these provisions will invariably arise.
Again, commercial arbitration will be a forum of choice for many of these contracts and there will be an accordant rise in disputes being brought in arbitration as the effects of climate change continue to manifest around the globe.
Significant investment will be needed to fund global climate goals. In 2017, the OECD estimated that $6.3 trillion of investment is needed annually until 2030, of which only a small proportion will be met by states. The gap will be filled by private investment, including foreign direct investment (FDI). Reports are already showing a significant rise in FDI in low carbon initiatives and climate financing. With any increase in new FDI, there will be an increase in disputes between investors and host states.
Disputes will also likely arise in the context of pre-existing investments. Over the last ten years, legal, regulatory, and other changes in response to environmental issues have been implemented at an unprecedented rate, at national and international levels. These will increase as states introduce measures to meet the Paris Agreement commitments and seek to allocate the financial costs of dealing with climate change. Changes to the investment environment often also lead to disputes between investors and host states. Bilateral or multilateral treaties (BITs or MITs) offer foreign investors a further layer of protection against host state conduct. In particular, they generally afford investors the direct right to bring proceedings against host states, usually in investor-state arbitration (ISDS). A prime example is the significant number of claims (40 at last count) brought against Spain under the Energy Charter Treaty (ECT) following reforms to Spain’s renewable energy policies. We are also now seeing a small number of claims brought in relation to decisions by states to phase out fossil fuels (in particular coal). Claims related to climate change and sustainability issues in investor-state arbitration are certain to increase.
Anti-ISDS proponents warn of the “chilling effect” of ISDS on public interest regulatory action. That chilling effect is often wrongly blamed on ISDS as a system, and is often misstated or overstated. Any chilling effect would not be the result of arbitration as a process, rather the result of the substantive terms agreed in the BITs. Generally BITs preserve states’ rights to pursue legitimate policy objectives, such as, among others, the protection of public order, security, morality and health, and taxation, amongst others. More recent BITs, such as the Netherlands’ draft model BIT, expressly reference states’ rights to regulate and address to deal with environmental and human rights issues. Moreover, there is little to no evidence to support the claim that companies are in fact abusing ISDS. Often overlooked is the potential for BITs and ISDS to facilitate and enforce sustainable development and “climate-positive” policies. BITs can, for example, impose obligations on states to promote sustainable development, climate-positive trade or sharing of environmental technologies. The Netherlands’ draft model BIT is again a good example – states must ensure “high levels of environment and labor protection” and “reaffirm their commitment” to international human rights and environmental treaties, including the Paris Agreement. It also allows tribunals to take into account investors’ conduct where they have not complied with the UN Guiding Principles on Businesses and Human Rights and the OECD Guidelines for Multinational Enterprises. ISDS tribunals have already shown a willingness to engage with such issues. In Urbaser SA & Ors v Argentina, in the context of investor claims under the Spain-Argentina BIT, Argentina counterclaimed that the investors had breached international human rights obligations (the right to water). The tribunal held that it had jurisdiction over the counterclaim and that consideration of international human rights obligations was within its competence. Ultimately, Argentina failed to establish any breach of obligations owed by the claimants, but the tribunal’s willingness to accept jurisdiction was itself a significant development.
There is little doubt that arbitration has a role to play in resolving disputes between investors and states that involve climate change and sustainability related issues. The full scope and breadth of that role remains to be seen and will no doubt fluctuate over time along with political and economic realities as well as changes in public perception.
Arbitration already plays a role in resolving state-to-state disputes, under both BITs and MLTs. One well-touted example in the environmental context is the Indus Waters Kishenganga arbitration (Pakistan v India, PCA 2011-01) commenced under the Indus Waters Treaty. There is obvious scope for arbitration to play a similar role in respect of climate-related state-state disputes.
There are two key climate treaties – the Paris Agreement, aimed at enabling states to combat climate change and adapt to its effects, and its parent framework, the UN Framework Convention on Climate Change (UNFCCC). These mark a significant leap forward in global climate change policy. Currently, however, there is a lacuna in respect of enforcement. The Paris Agreement contains optional provisions for state-state arbitration, to be conducted in accordance with yet-to-be agreed arbitral procedure. It also incorporates the dispute settlement provisions of the UNFCCC (with minor necessary alterations). But to date the majority of state parties (with the exception of the Netherlands, Tuvalu and the Solomon Islands) have chosen not to opt-in to these procedures. The difficulty is that there is little impetus (and significant disincentive) for states to open themselves up to claims from other states, particularly given the potentially catastrophic impact of climate change which some states already claim threatens their very existence.
It will likely take substantial public and political pressure, at international and national levels, before the majority of states agree some form of dispute resolution provisions for climate-related disputes. In parts of the globe, the trend towards nationalism and hostility towards international treaties (and international arbitration as a process) may make this difficult to achieve any time soon.
However, if and when such consensus is reached, arbitration is well-placed to fill the breach, not least because it is a neutral, impartial forum.
Climate change is leading to new economic realities and legal frameworks to which all state and corporate entities must adapt. Climate change and sustainability disputes are the new corporate reality. There is no cause for alarm – no transaction is without risk. However, parties are well advised to consider dispute resolution mitigation and resolution strategies at the outset of every transaction. As a neutral forum, that allows parties to choose expert adjudicators, arbitration is well placed to play a leading role as an arena for resolving many climate change and sustainability disputes arising in the context of contractual relationships, investment treaties or state-to-state obligations. Furthermore, it has the potential to fill an existing lacuna and become a key mechanism for the enforcement of international environmental law.