Contracting for ESG
Shona Frame, Partner, and Charlotte Eccles, Senior Associate, CMS Cameron McKenna Nabarro Olswang
ENVIRONMENTAL, social and governance (ESG) considerations have become increasingly prominent in many aspects of society and construction is no exception. ESG is of course a broad church encompassing three diverse aspects of corporate behaviours.
In terms of contractual provisions, the construction industry is already well-used to seeing clauses dealing with topics such as health and safety, anti-bribery and corruption and modern slavery which are part of the governance aspects of ESG. Those are fairly well-suited to contractual terms given that the legislative landscape and the obligations related to these are clear.
Trickier to pin down in an objective way are the social aspects, many of which tend to be more subjective, such as equality, diversity and inclusion, social impact and outcomes, working conditions and employee engagement.
There can also be requirements such as the provision of community benefits and employment of locally sourced apprentices. These are the types of factors which tend to feature in procurement processes as opposed to being reflected as contractual rights and obligations.
However, these can open (or close) the gateway to future work opportunities making them no less important than other aspects.
Perhaps the most difficult, and certainly much discussed in the context of ESG is the Environmental aspects. There are now almost daily news articles on the urgency of the climate crisis and the need to decarbonise across all aspects of life.
The construction industry is keen to play its part in this challenge with commitments by many leading contractors to be net-zero within the decade, and some businesses are linking their financing terms to the meeting of ESG targets.
Developers are increasingly alive to the need for strong ESG credentials to future-proof the value of their assets and are looking at all aspects of projects, throughout their whole life cycle, in doing so. In the context of repurposing, refurbishment or demolition, that means understanding the impact of embedded carbon in existing elements in addition to the carbon footprint of the work itself.
To date we have seen various publications, including proposed clauses, intended to drive sustainability and climate-positive behaviour through contracts, but there is not yet any settled industry practice on how such risks should be identified and allocated.This brings with it a need to consider the ability to recycle or reuse elements being disposed of as well as the construction of the new build aspects and their performance in the operational phase of the build.
In addition, the government, in pursuit of its net-zero by 2050 target, has introduced green rules which require companies bidding for government contracts worth over £5m annually to commit to achieving net zero emissions by 2050 and to reporting on emissions such as employee commuting, business travel and distribution of waste.
The government also made ‘build back greener’ one of the key tenets of its ‘Construction Playbook’ and provided commentary on how each of the 14 key policies in the playbook can drive ‘faster, better and greener’ delivery.
In Scotland the Climate Change (Scotland) Act 2009 legislates, amongst other things, for targets related to the reduction of greenhouse gas emissions.
And change is crucial. Construction is one of the world’s leading polluters. In 2020, the United Nations Environment Programme calculated that the building sector was responsible for 38% of global energy-related CO2 emissions.
The upside of this is that it means the industry’s contribution to reaching net-zero can be significant and crucial.
The obligation to meet these targets sits on the shoulders of everyone in the industry. Inevitably, on the back of these comes a debate as to how, if at all, to reflect these environmental considerations in contractual arrangements. To date, we have seen various publications, including proposed clauses, intended to drive sustainability and climate-positive behaviour through contracts, but there is not yet any settled industry practice on how such risks should be identified and allocated.
NEC
In April 2022, NEC published a consultation on a new, optional, ‘sustainability’ clause, X29.
This was published in final form in July 2022 and includes:
- A requirement to include ‘climate change requirements’ in the scope.
- A performance table which incentivises the contractor’s performance of certain targets. These are not explicitly linked to the ‘climate change requirements’ and so the incentivisation can relate to different targets than those required by the scope. The performance table is capable of being adjusted through compensation events.
- The need for an early warning to be provided where it is considered that the ‘climate change requirements’ cannot be met.
- An obligation for a ‘climate change execution plan’ to be produced and updated from time to time.
- The ability for the contractor to propose changes which reduce the impact of the project on the climate – either during the build or the future use of the project.
FIDIC
In November 2021 FIDIC published a ‘Climate Change Charter’. Its aims include the reduction of the carbon footprint of the industry and providing support for climate change adaptation through the design of resilient infrastructure. FIDIC has recognised that achieving these goals will require the input of everyone involved in the construction supply chain and has set actions for a range of bodies including project teams using FIDIC, engineers, companies and member associations.
One of the key aspects of monitoring performance is the collection of data.FIDIC has also pledged to provide best practice templates and clauses. It has tasked its sustainable development committee with developing guidance and resources for stakeholders including governments, clients, engineers and financial institutions.
This guidance should provide information as to how, for example, risk allocation models can support carbon reduction through innovation; and how embodied and operational carbon can be reduced.
It has also indicated it is likely in the future to publish more detailed contractual clauses to supplement its current ‘protection of the environment’ provisions.
JCT
The JCT is yet to publish any specific sustainability drafting and its historic position has been that any sustainability considerations should be addressed in the specification of the works. Its nod to drafting is the optional ‘sustainable development and environmental considerations’ supplemental provision.
If selected, this allows the contractor to suggest amendments to the works which may result in an improvement in the environmental performance of the carrying out of the works, or in the completed works. If the employer accepts those proposals, they are treated as a change.
This approach has been adopted in part by the NEC in its X29 clause. The NEC suggests that the contractor’s margin and profit share from the improvement is added onto the price paid by the employer. This is on the basis that the value in the improvement, e.g. a more efficient building delivering long-term carbon savings, is likely to be seen by the employer.
Given the massive increase in interest in sustainability considerations, it will be interesting to see whether JCT changes its approach and broadens the drafting options on offer when its new suite is published.
The Chancery Lane Project
The Chancery Lane Project (TCLP) is a pro-bono project which brings together lawyers to draft contract clauses to incentivise sustainable practices. The clauses are designed for use across a range of commercial contracts, with 10 construction clauses in total.
The clauses include:
- Ashkan’s clause which rewards a contractor for complying with a ‘green working practices’ schedule, similar to the principles in the NEC’s X29 performance table.
- Edgar’s clause which requires landscape design to be carried out with climate resilience in mind and allows an employer to set targets for biodiversity.
- Estelle’s clause which requires, amongst other things, carbon offsetting and for the completed works to be designed to withstand the anticipated effects of climate change as set out in the intergovernmental panel on climate change’s 2021 report.
- Tristan’s clause which sets a ‘carbon budget’ for each project and imposes liquidated damages if it is exceeded.
Many of the clauses proposed by TCLP seek to risk-allocate down the supply chain.
However, it is questionable whether this is the best approach for dealing with a challenge of this scale and whether, instead, a more collaborative, risk-share approach will in fact deliver better outcomes. Legal and other advisers need to gain a full understanding of the impact of ESG clauses being proposed and, when relying on traditional precedents, be cognisant of the effects that current contracts and their traditional risk allocation structure have on the supply chain and its ability to absorb the types of risks it is being asked to assume.
Meeting collective climate change goals will require a high degree of innovation around new and innovative methods of working and constructing. That requires financial investment in research and development (meaning having a construction industry with the wherewithal to make that investment) and a willingness of all parties in the construction process to work together to achieve the end goal.
Given the massive increase in interest in sustainability considerations, it will be interesting to see whether JCT changes its approach and broadens the drafting options on offer when its new suite is published.For example, discussions may be required as to who takes the risk of an innovative, carbon-saving product or process. The usual structure would sit this risk with the contractor but this disincentivises the very innovation required.
One of the key aspects of monitoring performance is the collection of data. It will be hard to fully and effectively make use of many of the clauses discussed above without meaningful and credible data collection. Data must also be consistent so that it can be compared on a like-for-like basis.
There are currently no agreed industry-wide data standards on carbon emissions. This causes problems in setting contractual benchmarks and makes it difficult to know whether actual carbon reduction is being achieved. It also makes it difficult to use offsetting clauses as the parties will not know what emissions to offset.
Further, parties need to be able to assess all of their carbon emissions for a project. Emissions are commonly talked about as either scope 1, 2 or 3. Scope 1 and 2 are direct emissions generated by a company.
However, scope 3 – indirect emissions from the supply chain – are often the largest portion of emissions but can be the most difficult for a contractor to measure. To do so it will need detailed information from its supply chain. This will not be straightforward but, without this data, it will be difficult to drive meaningful change.
While companies themselves may have, and be hitting, ambitious ESG targets, there can be less transparency further down the supply chain. This issue is compounded by the international nature of construction supply chains, which brings specific challenges in relation to reporting and disclosure. Different regulatory frameworks, clients and market practices across the globe make for even further inconsistency in the approach to ESG measurements.
Much remains to be settled and this is an area which is fast-moving but it is clear there is a need for a greater level of understanding as to what is to be measured and tracked and how this is being done with moves towards standardisation and consistency in approach. There is a real case for greater collaboration in the industry and development of suitable contractual structures to support and incentivise positive progress and change.
Shona Frame, Partner, and Charlotte Eccles, Senior Associate, CMS Cameron McKenna Nabarro Olswang
Article published in Construction Law, October 2022 Edition.