India: Cracking The ESG Conundrum: Is Arbitration The Key To Resolution Of ESG Disputes?

ABSTRACT

International Commercial Arbitration as a dispute resolution mechanism is indeed a much educational, fascinating, and compelling field, and looking for other areas that may become its subject would be interesting. As long as commercial contracts continue to evolve, Arbitration should remain open to including all such matters voluntarily agreed upon and consented to by the parties to the dispute as being arbitrable.

This article seeks to analyze how the currently growing interest of business entities in the emerging concept of ESG (Environment, Social, and Governance) issues can be an important subject of Arbitration and how Arbitration as a mode of alternative dispute resolution is well placed in addressing ESG issues An acceptance of the same would help in contributing towards the formation of even stronger arbitration practice at the international level and, at the same time, help in the development and enrichment of ESG jurisprudence.

This discussion on whether ESG can become a subject of international commercial Arbitration might be of great use and interest to students and practitioners of law worldwide. It will explore Arbitration's potential benefits and limitations for resolving ESG disputes. This would add to the ongoing discourse on addressing ESG issues in today's business world. By considering the potential role arbitration can play in resolving ESG disputes, the author hopes to shed light on this promising approach which has thus far been largely overlooked.

1. INTRODUCTION

Environment, Social, and Governance (ESG) issue has lately become a critical aspect of business operations and investment decisions in the corporate world around the globe. Companies, in general, are under immense pressure to ensure that their operations remain sustainable, socially responsible, and governed ethically. ESG consideration is essential to corporate strategies, risk management, and decision-making.

However, despite the growing importance of ESG, many challenges still need to be addressed. One such challenge is the resolution of ESG disputes that may arise from time to time among stakeholders such as shareholders, investors, regulators, and communities. ¹ In a bid to address the disputes that may arise among them, conflicts may arise and disputes may escalate.

The traditional method of Litigation may not be well suited for addressing the unique issues that may arise in ESG disputes as it often involves multiple legal, social, and ethical issues. Since these disputes often involve multiple parties and stakeholders with different perspectives, arriving at a satisfactory resolution often seems difficult.

In this context, several experts suggest that Arbitration may be an effective tool for resolving ESG disputes. It is a form of alternative dispute resolution that provides the parties with flexibility, confidentiality, and the opportunity to choose arbitrators with relevant expertise. Taking recourse to Arbitration allows the parties to design their dispute resolution process, including the laws applicable, the language of proceedings, and the rules of evidence.

This article explores the potential role of Arbitration in resolving ESG disputes. It would examine the challenges associated with the resolution of ESG disputes and further assess the advantages and disadvantages of using Arbitration as a dispute resolution mechanism in resolving such disputes. It also highlights some key considerations that need to be considered before taking recourse to Arbitration for resolving disputes, including transparency, accountability, and the involvement of relevant stakeholders.

2. ESG: UNDERSTANDING THE CONCEPT

ESG, the chief area of interest of what is called 'Socially responsible investors', is the Environmental, Social, and (Corporate) Governance acronym. ESG investing has gained immense popularity in recent years as investors now look for companies that generate profit and operate in a sustainable and socially responsible way. These investors consider incorporating their values and social and environmental concerns in their selection of investments rather than simply considering the potential profitability and risk posited by an investment opportunity.

The term ESG was first coined in a 2005 study titled 'Who Cares Wins'². Since it was coined, it has attained much popularity in the corporate world around the globe. They are increasingly shaping companies' decisions, especially concerning mergers, acquisitions, and divestitures. ESG forms the standard for the company's operation in guiding the company to work better and, at the same, be more accountable for their environmental impact, social responsibility, and organizational governance.

The importance of ESG in the corporate world is undoubtedly at its tipping point. Whether a small, specialized unit or a large multinational company, the customers, regulators, and investors are getting increasingly vocal about the company's environmental, social, and governance practices. ESG today forms one of the most significant non-financial factors increasingly applied by investors in identifying material risks and opportunities for growth before investing. ³

The immense popularity and acceptance of ESG reflect and showcase the growing recognition that sustainable and responsible practices are essential for long-term business success and that companies need to take a more proactive approach to environmental and social issues to remain competitive and relevant in the rapidly changing world of the 21^st Century.

3. WHAT KINDS OF ESG DISPUTES CAN ARISEIN BUSINESSES?

Amid the growing interest of governments, regulators, non-governmental organizations, and private companies in the concept of ESG, there is an exponential rise in the number of disputes with ESG components. The surge in ESG disputes globally can be inferred from the fact that within the environmental dimension, from 2015 to 2021, more than 1000 lawsuits were registered across different jurisdictions. ESG obligations are industry specific, and there is a potential of arising an extensive range of disputes.

The relative novelty of ESG as a concept and the fact that it is still a developing field allows the identification of some potential issues that may arise in future disputes. A few of them are highlighted below⁴:

ESG being a relatively new phenomenon, disputes are likely to arise over their interpretation and what actions would be required for their compliance on a case-to-case basis. This would be especially true in agreements containing certain broadly drafted or vaguely worded ESG clauses.

In contracts that require ESG benchmarking or verification of ESG compliance by third-party, one of the biggest questions is how the ESG impact can be measured. There needs to be more standardization and consistency in ESG metrics and a considerable lack of transparency in arriving at ratings. Therefore, ESG auditing would undoubtedly emerge as a significant area of compliance and expert evidence in arbitral proceedings.

One of the critical sources of ESG disputes is Climate Change. NGOs often raise arguments to pressure governments and corporations to increase their efforts to minimize greenhouse gas emissions.⁵ They cite various sources of such climate change-related obligations, including those sourced from multiple international treaties and conferences and national and state legislations.

Another significant kind of ESG dispute that is on the rise, considering the trend of the recent past, is in connection with the supply chain issue. These involve concerns about forced labor, human rights abuse, and greenhouse gas emissions due to business activities. Although international corporations have just adopted voluntary global reporting and due diligence standards, the issue is now gaining prominence in legislative attention.⁶

4. ESG CONCERNS AND THEIR ARBITRABILITY

As per Google trends, the concept of 'Environmental, Social and Corporate Governance' has never attained as much popularity as they today enjoy. It is one of the key emerging trends in the corporate world worldwide, and the COVID-19 pandemic has, in particular, further intensified the discussion around the interconnectedness between sustainability and the financial system.

ESG Concerns, in simple words, are the catena of non-financial factors that can have a considerable impact on the long-term sustainability as well as the performance of a company. These involve concerns about environmental issues like climate change, pollution, and overutilization of resources; social issues like labor exploitation, human rights, and community engagement; and governance issues like board composition, executive compensation, and transparency.

The contractual provisions agreed upon by the businesses are increasingly adapting to mitigating and allocating risks arising from these ESG concerns.⁷ Resultantly, the disputes arising from these provisions are also rising faster. International Commercial Arbitration, as a field of alternative dispute resolution, will likely emerge as the most preferred mode and forum for resolving such disputes.

International Commercial Arbitration refers to a mode of alternative dispute resolution, as against the traditional method of dispute settlement of litigation by approaching the court, where the parties involved appoint a neutral and independent arbitrator or Tribunal or Panel of arbitrators, to make a final and binding decision, called an award, and thereby resolving the dispute. This dispute-resolution mechanism is primarily controlled by the terms previously agreed upon by the parties to the contract rather than the national legislation or procedural rules. ⁸ For ESG disputes to come within the coverage of Arbitration, it is crucial to understand the concept of Arbitrability and determine the Arbitrability of ESG issues.

Arbitrability signifies a claim or dispute's legal capacity or ability to be subjected and resolved through Arbitration, a relatively private and legally binding form of dispute resolution mechanism often used in commercial contracts. While there almost exists a consensus that the disputes which are pure of commercial nature are indeed arbitrable, there is a divergence in the view regarding the Arbitrability of matters that are not purely commercial, as in cases of labor, IPR, insolvency, and antitrust issues.

The Arbitrability of ESG concerns has lately become a topic of great interest and importance, given the mounting pressure the companies face at the hands of their stakeholders for adequately addressing and complying with these issues. While there exist challenges in arbitrating ESG issues, it's still one of the most effective means of resolution of ESG-related disputes.

There are several reasons why ESG disputes may seem challenging to arbitrate⁹. The first reason is the involvement of complex scientific and technical issues that the arbitrators may find challenging to understand and evaluate. For instance, there may arise an ESG dispute where the arbitrator may need to determine whether the carbon emission of a company is inadequate compliance with the international climate targets, he may find it very difficult as the same requires a deep understanding of climate science and policy.

However, there exist several ways of addressing this challenge. Arbitrators with relevant expertise can be selected and appointed by the parties for resolving their disputes. Also, ESG expert witnesses can be relied upon for providing technical guidance to the arbitrator.

Further, another reason is that ESG issues often involve a broad range of stakeholders, including investors, employees, consumers, and communities. As such, diverse perspectives and interests are always involved, making it difficult to reach a consensus in resolving the dispute. Finally, their Arbitrability also lies in difficulty because ESG issues often involve non-contractual issues not addressed in commercial agreements.

For instance, there may emerge a situation such that a company may be accused of violating human rights in its supply chain. Such an issue is generally not covered under the arbitration clause of the commercial contracts and as such the ESG issues face concerns regarding their Arbitrability. However, Arbitration provides a neutral forum for the parties to engage in a structured and confidential process and find a mutually acceptable resolution to the dispute at hand. As such, the Arbitrability of ESG issues is not too difficult.¹⁰

Despite the above challenges, there are several reasons why ESG concerns can still be considered arbitrable. The first is that commercial contracts generally include arbitration clauses requiring the disputes to be resolved via Arbitration. The arbitrators can interpret these clauses broadly and encompass the ESG concerns that may arise from time to time. Secondly, Arbitration is much more efficient and cost-effective for dispute resolution than litigation. Adding to that is the high level of confidentiality and flexibility that arbitration forums provide, thus facilitating the parties to reach a mutually acceptable resolution of the dispute involved conveniently.

Thus, the Arbitrability of ESG issues is indeed a complex issue that requires careful consideration of multiple factors, including the nature of the dispute, the stakeholders involved, and the terms the underlying commercial agreement contains. While there exist challenges in arbitrating ESG issues, there exist compelling reasons why Arbitration may be an effective means of resolving disputes. Ultimately, the Arbitrability of ESG issues would depend on the specific circumstances on a case-to-case basis, and the parties are the ones who have to carefully evaluate their options before deciding on a course of action.

5. HOW ARBITRATION IS WELL PLACED TO ADDRESS ESG ISSUES?

The vast increase in the popularity and emphasis on ESG obligations has resulted in frequent practice of inclusion of ESG risk allocation clauses in commercial contracts. Companies, particularly during mergers and acquisitions transactions, have addressed ESG issues via representations and warranties. Similarly, in recent times, it is common for companies to seek to mitigate and manage ESG risks in the contracts they enter with their suppliers and the whole production line.¹¹. Given the inclusion of such clauses, disputes are bound to arise.

ESG-related disputes can be best resolved by adopting the dispute resolution mechanism of Arbitration. It is worth noting that the International Chamber of Commerce Taskforce on 'Resolving Climate Change Disputes through Arbitration and ADR,' in its 2019 report¹², specifically brought to light the fact of an increasing trend of ESG disputes being resolved via Arbitration and recognized that Arbitration is much well placed to serve the purpose of resolving ESG disputes, most particularly for the below-mentioned reasons:

1. Consensual Selection of Expert Arbitrators
   
   The first reason Arbitration is well placed for addressing ESG issues is that it allows the parties to the dispute to select specific adjudicators with the relevant and needed expertise and the skill of tailoring the proceedings per the need of the case. The same is particularly relevant in ESG disputes, given the legal and technical complexity of the issues at stake.
   
   As such, by subjecting ESG issues to Arbitration, the parties would have autonomy in consensually choosing arbitrators who have a high degree of expertise in the subtleties of ESG issues that are under dispute and who can make a better decision by analyzing the highly specialized and technically complex arguments and pieces of evidence.
   
   
2. Cross Border Enforceability of Arbitration
   
   It is standard that in ESG cases, a robust international component exists as the companies often have their supply chains operating across different countries. As such, various countries' international laws and regulations must be analyzed. In such cross-border disputes, Arbitration is often regarded as the best method of resolving the same. In most cases, their awards can be enforced more quickly than court judgments across jurisdictions.¹³
   
   
3. Obtaining Emergency Relief is Easier
   
   Another prominent feature that makes Arbitration the most suitable mode for resolving ESG disputes is that there is a better possibility via Arbitration to obtain injunctive relief expeditiously and efficiently. ESG disputes, in general, require an initial adjudication that must be completed on time. In some instances, there may be an imminent risk of irreversible environmental damage from the business practice, and as such, there exists a need for some pre-emptive emergency measures.
   
   Most arbitration rules have specific emergency arbitration procedures within them. An emergency arbitrator can be appointed on request to decide and provide urgent relief before actual arbitral proceedings start in the tribunal.
   
   
4. Predominant use in Investment Treaties
   
   Further, ESG issues frequently arise in investment treaty arbitrations, including environmental protection, human rights, conflict within indigenous communities, and corruption. The New generational international investment agreements and revisions to existing investment treaties are increasing, including ESG provisions. Arbitration has historically been the principal mode of international dispute resolution involving investment treaties, and it is undoubtedly best suited for resolving ESG issues and disputes.
   
   
5. Neutrality and Flexibility
   
   The unique features of Arbitration, i.e., the neutrality of its forum and flexibility of its procedure, provide the parties to dispute a dispute resolution process accommodating the newly emerging needs and nature of disputes and is suited for deciding and resolving ESG disputes. The quality of arbitration proceedings to allow parties to set the rules that best meet their case needs further makes it a popular choice.
   
   The arbitration proceedings, explicitly tailored for suiting the specific needs of the parties involved, makes it particularly useful in addressing ESG issues which can be highly varied and complex.

6. WHAT CHALLENGES MAY ARISE IN ARBITRATIONS CONCERNING ESG ISSUES?

While it is true that Arbitration is undoubtedly the most suited mode of dispute resolution relating to ESG issues, arbitration practitioners have time and again recognized certain limitations in the compatibility of Arbitration vis-à-vis ESG issues. Several challenges may arise in Arbitration¹⁴. Some of these challenges include:

ESG issues are, in themselves, often much more complex and subjective. There still needs to be a standardized framework for evaluating them. Different stakeholders may have varying perspectives regarding what may constitute responsible behavior. Given this lack of clarity around ESG issues, it poses a serious difficulty for the arbitrators in assessing the merits of the cases that may come before them and coming to a conclusive decision.

ESG claims often involve complex calculations for quantifying damages. As such, quantifying such injuries in the arbitration proceedings is one of the major difficulties, most notably concerning environmental or social harms. There exists, as of now, no consensus over the methodologies for arriving at the same, which poses a significant challenge for Arbitration as an ADR mechanism for resolving ESG disputes.

ESG issues usually involve multiple jurisdictions and regulatory regimes and as such challenges may arise concerning the determination of law and jurisdiction which should be applied in resolving the dispute. Further, challenges may arise in enforcing the arbitral awards across multiple jurisdictions.

Often complex scientific and technical evidence is involved in ESG claims; thus, it can be challenging for arbitrators to understand and evaluate the same. This can lead to much longer hearings and higher costs.

ESG issues often attract much public interest, which can, in turn, pressurize and influence the arbitrators towards making such decisions that align with the prevailing public opinion.¹⁵ This can further give rise to additional challenges, including maintaining impartiality and fairness in the arbitration proceedings.

The parties to ESG-related disputes may sometimes be different in terms of the level of power and resources at their behest. This can severely affect the fairness and effectiveness of the arbitration process as a whole. For instance, while one party may be a large multi-national corporation (MNC) having great resources and legal expertise, the same may not be true for the other party in case it is just a community organization with meager resources, thus influencing the outcome of the arbitration proceeding.

7. HOW CAN ARBITRATION INSTITUTIONS REMAIN EFFECTIVE IN RESOLVING ESG DISPUTES?

Given the pace at which ESG is becoming an integral part of the global corporate world and the corresponding possibility of the rise of more and more ESG-related disputes, arbitration institutions and rules also need to adapt and evolve accordingly. They are under an imminent need for innovation to remain effective in resolving the ever-growing number of ESG disputes. The following are some potential strategies for the same¹⁶:

The arbitration institutes need to develop certain ESG-specific arbitration rules, tailor-made specifically to take the unique characteristics of ESG disputes into account. The rules involve those addressing the issues relating to the selection of arbitrators having relevant expertise in ESG matters, the use of specialized ESG experts as a witness, and incorporating ESG-related considerations while pronouncing arbitral awards, among others.

The Arbitration institutions can also focus on recruiting arbitrators with good command over ESG matters i.e., environmental law, social responsibility, and corporate governance. The arbitrators could be assessed on their knowledge and experience in ESG issues and their track record in handling such disputes, which can be taken into account before their selection. This would benefit the whole International commercial arbitration system as a dispute resolution mechanism as their deep understanding of such complex issues would help them develop better and more equitable arbitral awards.

To ensure that Arbitration remains an effective mechanism for resolving ESG-related disputes, it is crucial to ensure that the existing arbitrators are also well-equipped to handle ESG issues. The same could be achieved by developing specific training programs explicitly focusing on ESG issues and making them available. These could involve climate change, Corporate Social Responsibility (CSR), human rights, etc.

Incorporating technology in Arbitration by Arbitration institutions would be much beneficial in streamlining the arbitration process and making it much more efficient. The usage of online platforms for document management, videoconferencing in remote hearings and the use of Artificial Intelligence in reviewing documents and analyzing them are some of the applications of technology in the Arbitration process which could make it much more convenient and efficient.

The Arbitration institution should also encourage the parties to refer to other ADR mechanisms like Mediation and Conciliation before Arbitration, for resorting to Arbitration for resolving the ESG disputes. This would help curb the overburdening of Arbitration institutions with such conflicts, which may be solved more conveniently through other ADR mechanisms.

The Arbitration institutions can also collaborate with ESG stakeholders such as NGOs, industrial associations, and ESG academicians and experts to develop best practices for resolving ESG disputes. This would help ensure that the arbitration process remains well-aligned with evolving ESG standards and expectations.

8. CONCLUSION

Given the rising importance of ESG in the commercial context, various ESG-related disputes are likely to grow manifold. Considering the elements of Arbitrability, precisely the Objective Arbitrability, which requires that the subject matter be arbitrable, ESG issues can be regarded as arbitrable. Suppose the commercial contract contains ESG obligations, whether in representations or warranties or compliance with specific environmental rules, governance policies, or adherence to the social contract. In that case, any dispute can be arbitrated.

Arbitration offers an exemplary method for resolving ESG disputes, given that it provides the advantage of having a neutral as well as an expert panel of adjudicators to be selected per the parties' consensus.¹⁷ There is not even the requirement of any specific reference to the ESG clause in the arbitration clauses as long as it is drafted and contains all the details necessary for enabling the parties to approach the arbitral institutions or tribunals.

The procedural flexibility, the presence of highly specialized arbitrators, and the possibility of executing the awards across the boundaries as per the New York convention make Arbitration an attractive and practical choice to resort to for resolving disputes, including ESG disputes. Arbitrators must gain more familiarity with the prevalent ESG regulations and standards, proactively adopt arbitration procedures in resolving ESG-related disputes, and maintain their effectiveness and demand in this fastly developing arena.

Footnotes

1. Anagha Bharadwaj, International Commercial Arbitration: An Overview, PRIME LEGAL (Sept. 24, 2022) https://primelegal.in/2022/09/24/international-commercial-arbitration-an-overview/

2. George Kell, The Remarkable Rise of ESG, FORBES (July 11, 2018, !0:09 a.m.) www.forbes.com/sites/georgkell/2018/07/11/the-remarkable-rise-of-esg/

3. Kyle Peterdy, Noah Miller, ESG (Environmental, Social, and Governance). CORPORATE FINANCE INSTITUTE, (Frebruar22, 2023), corporatefinanceinstitute.com/resources/esg/esg-environmental-social-governance/

4. Emily Hay, ESG Clauses and Dispute Risks, KLUWER ARBITRATION BLOG (December 11, 2022) https://arbitrationblog.kluwerarbitration.com/2022/12/11/esg-clauses-and-dispute-risks/

5. Felipe Caldas Veras, Commercial Arbitration and the fight against climate change: what role can it play?, LSE LAW REVIEW, (March 5, 2022) https://blog.lselawreview.com/2022/03/commercial-arbitration-fight-against-climate-change-role-actually-play

6. Andrew Mizner, ESG Disputes on the rise and why supply chains are next, LIDW (Feb 23, 2022) https://lidw.co.uk/esg-disputes-on-the-rise-and-why-supply-chains-are-next/

7. Roderick Salazar, The Arbitrability of Environmental, Social, and Governance (ESG) Issues FORTUN NARVASA & SALAZAR (Feb 11, 2022), https://www.fnslaw.com.ph/the-arbitrability-of-environmental-social-and-governance-ESG-issues/

8. Montserrat Manzano, Ana Toimil, The role of Arbitration in ESG disputes, VON WOBESER, https://www.vonwobeser.com/index.php/publication?p_id=1650

9. Richard Allen, ESG Trends in Asia Pacific: Disputes, Reporting, and Beyond, BAKER MCKENZIE (October 25, 2022), https://www.bakermckenzie.com/en/insight/publications/2022/10/esg-trends-in-asia-pacific-disputes-reporting-and-beyond

10. Ari Mackinnon, Martin Vanstein, The Rise of ESG Disputes and the role of Arbitration in resolving them, CLEARY GOTTLIEB (December 6, 2022) https://www.clearygottlieb.com/news-and-insights/publication-listing/the-rise-of-esg-disputes-and-the-role-of-arbitration-in-resolving-them

11. Jonathan Hamilton, Arbitration & the ESG Era, WHITECASE.COM, (7 June 2022) www.whitecase.com/news/media/arbitration-esg-era.

12. ICC Arbitration and ADR Commission Report on Resolving Climate Change-Related Disputes through Arbitration and ADR (6 Dec. 2022), iccwbo.org/publication/icc-arbitration-and-ADR-commission-report-on-resolving-climate-change-related disputes-through-arbitration-and-adr/

13. Montserrat Manzano, Ana Tamil, "The role of arbitration in ESG disputes" VON WOBESER, 2021, https://www.vonwobeser.com/images/PDF_news/2021/21_11_12_ARBITRAJE_ESG_ING.pdf. Accessed 8 Jan. 2023

14. Holly Stebbing, India Furse, ESG Disputes in International Arbitration, NORTON ROSE FULBRIGHT (November 2022) https://www.nortonrosefulbright.com/en/knOwledge/publications/e01e3d5a/ESG-disputes-in-international-arbitration

15. Nastasja Suhadolnik, ESG Arbitration: Is Arbitration the answer? CORRS (Nov 25, 2021), https://www.corrs.com.au/insights/esg-disputes-is-arbitration-the-answer

16. Patricia Nacimiento, The Rising Importance of ESG and Its Impact on International Arbitration, HERBERT SMITH FREEHILLS (27 July 2021), www.herbertsmithfreehills.com/insight/the-rising-importance-of-ESG-and-its-impact-on-international-arbitration. Accessed 8 Jan. 2023.

17. Alternative Dispute Resolution: Significance of ESG in Arbitration, THAC (October 26, 2022) https://thac.or.th/alternative-dispute-resolution-significance-esg-arbitration/

Shreyansh is a student of Rajiv Gandhi National University of Law, Patiala (Punjab) and Winner of the Finalist Prize of the 9th Ed. of Arb Excel Essay Writing Competition.

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