- Soumya Vemulakonda*
THE IMPACT OF ESG FACTORS ON INVESTMENT TREATY ARBITRATION
Before diving into this sub-topic, it is crucial to understand the meaning of investment treaty arbitration. Basically, this concept involves two parties which are the investor and the host state which includes the respective company. This treaty provides assistance in deciphering the issues appertaining to the claims of a foreign investor and a respondent state. The claim of the investor alleges that the host state violated the rights of the investor which are prescribed under an investment treaty with the respective states or a group of states in accordance with an arbitration agreement. Some examples of investment treaties are Bilateral Investment treaties, multilateral investment treaties etc.[1] Apart from regular contractual claims, there are Treaty-based claims as well. In order to ensure the enforcement and strict compliance of ESG, treaties are created to protect the persons or entities which can be affected by the breaches of a particular company. There is a separate forum set up to resolve the dispute-related investment. The forum is called the International Centre for Settlement of Investment Disputes (ICSID)[2].
There have been a few instances of ESG and treaty disputes. One of the disputes is The Energy Charter Treaty. This treaty is created in order to promote securing energy by the functioning of competitive energy markets. This treaty focalizes on the protection of foreign investors from non-commercial risks and non-financial risks. It aims to resolve disputes between member states which are concerned with investments and promote efficient and proper usage of energy and reduce the negative impact on the environment.[3]
This is another way of implementing ESG practices in companies. Treaties add an exclusivity factor to the parties involved. The member states can raise an issue in cases where ESG compliances have not been followed through. Along with exclusivity, entering into a treaty also shows a strong commitment towards adhering to the agreed conditions under the treaty. Treaties which include member states, automatically create a community of states which ensure that each state is complying with the agreed terms of the treaty.
In the case of Urbaser v. Argentina ICSID, the government of Argentina decided to sever the corporations' concession agreements for water and sanitation services in Buenos Aires, which gave rise to the dispute. The companies argued that the termination was illegal and in violation of the bilateral investment agreement between Argentina and Spain. The bilateral investment agreement protected their investment and guaranteed them non-discriminatory treatment, full protection, and security. The tribunal determined that it had violated the bilateral investment treaty by allowing the Argentine government to terminate the concession contracts in an illegal manner. The tribunal gave the businesses a settlement of over 40 million euros, along with interest and court fees, for their losses.[4]
In another case, BEG SpA v. Italy, a disagreement between an Italian corporation named BEG SpA and the Italian government was brought before ICSID. A contract for the construction and operation of a waste-to-energy facility in Naples was signed by the parties. The factory was never built due to many administrative and regulatory difficulties, and BEG SpA asserted that this caused the company to suffer financial losses. Under the Energy Charter Treaty, the arbitration proceedings commenced on the grounds that Italy had failed to uphold its duties to treat foreign investors fairly and equitably. BEG SpA received damages in the amount of €40 million in 2009 from an arbitration tribunal. Italy argued that the tribunal incorrectly interpreted the law and therefore revoke the said award. Italy's request was denied, and the decision in favour of BEG SpA was affirmed.[5]
Another major investment treaty is between Singapore and Australia. These two countries had passed the Green Economy Agreement. It is a bilateral agreement that is focused on minimizing and eliminating the emissions by introducing green technology which would include low carbon usage[6]. These treaties help in enforcing ESG factors by involving an effective arbitration proceeding in case of a violation. In case of a dispute between investors and the host state, arbitration can be used as a methodology to loosen the tight knots. If the treaties include an ESG dispute resolution clause it would make the resolution process much simpler and faster.
Along with Investment treaties, Model clauses are also brought into the picture while attempting to enforce and maintain ESG within companies. One such model clause is the Working Group of the American Bar Association Business Law Section. The purpose of this model is to protect the human rights of the workers, working in a supply chain, which contributes towards the social and governance factor of ESG. The provisions of this model are used in supply contracts, sales of goods contracts etc. The belief of this model was also that, implementing such a model would increase the awareness regarding protecting the human rights of the workers and imposing a responsibility among companies to follow the model to avoid any repercussions.[7] International arbitration would contribute when any of the clauses of a model law or an investment treaty are violated. It provides a speedy remedy to the affected party and ensures proper implementation of ESG factors in the companies.
CHALLENGES AND SUGGESTIONS RELATED TO ESG AND INTERNATIONAL COMMERCIAL ARBITRATION
ESG and international arbitration give rise to several issues. One such issue is with regard to disclosures of the company on whether the company is maintaining ESG standards. These disclosures could violate the confidentiality aspect of the company. This would make the company vulnerable to the public. Even though, the disclosures help the investors in making a prudent decision, it can impact the companies. The sensitive information is out in the open, which could also be accessed by competitors. Confidentiality aspect is only followed when the arbitral proceedings are taking place. However, the disclosures are to be made by the companies mandatorily after certain periods of time. Therefore, the confidentiality aspect in the arbitration proceedings and disclosure though might seem similar are different. The proceedings are confidential because the ESG violations are not confirmed until the end of the proceedings.
Another issue with regard to disclosures is that it could be sometimes a bit cumbersome to comprehend. As there is no proper template for disclosures and their content, every disclosure is different from other companies. This renders it difficult for the investors to even compare the performance with other companies.[8] Sometimes it could also be difficult for the arbitrators to understand and interpret the disclosures.
Universally applicable ESG standards set by an authority should be applicable to all the countries. Analysing this suggestion practically, reveals a technicality. The Environment and the Governance standard could be easily made universal as it is a common issue everywhere. If we analyse any country, environmental issues such as irresponsible water usage, water and air pollution, release of harmful chemicals and countless other problems are found. Similarly, in the Governance aspect, issues such as lack of transparency, corruption, unfair trade practices, etc. could be found. However, when it comes to the Social aspect of ESG, the socio-economic conditions and cultural factors can differ from country to country. This can depend on the labour laws of the specific country, racial diversity, gender progress in each country. For example, a developed country like the United States would have much more cultural and racial diversity compared to Asian countries like India, Japan, South Korea etc. There are many practices, beliefs which are openly accepted in the west as compared to India. India is comparatively slightly sensitive with regards to culture, religion etc. Companies in India or foreign companies which have their branches in India should be considerate and aware of the cultural, religious and social cultures. Therefore, while considering implementation of universally applicable ESG standards, the aforementioned challenges should be kept it mind.
These standards should be made to enforce the ESG factors in every company and impose penalties on the companies which do not follow the same. Developing a certain set of standards would also make it simpler to determine the valuation of damages caused after a breach. There are often many issues concerning the valuation of damages. For this purpose, there should be trained experts who would help in determining the damages caused to the investors. Other issues such as a lack of knowledge of arbitrators in ESG matters can also arise. The experts who would be selected to assist in the proceedings must also have the expert technical know-how. The costs which would be incurred for third party involvement which would include experts, should also be considered.[9] Another major issue which has already been covered previously is that arbitration proceedings are confidential which makes it impossible for the public to be aware of the activities of the companies. There is no transparency involved due to the secrecy. As issues related to ESG involve the public interest, confidentiality prohibits the investors and the community to be aware of whether the company has violated any factors of ESG.[10]
CONCLUSION
With this paper, the importance of valuing the environmental, social and governance aspects of a company has gravely increased. It is a basic understanding of all companies that, if the ESG factors of a company are up to the mark then the investors would not hesitate while making the decision of investing. The paper provides backing on the percentage of investors who prefer companies with high ESG ratings, which has made ESG a basic norm that companies must follow in order to receive generous investments and gain profits. This paper also highlighted the importance of international commercial arbitration which aids in enforcing the ESG factors. A few instances of case laws have also been mentioned in detail. Issues such as transparency, disclosures, and ESG standards which are mentioned in the challenges should be resolved. Uniform ESG standards should be created and innovative solutions should be drafted which would solve the issues of transparency and disclosures.
Although international commercial arbitration and investment arbitration provide with a suitable mechanism for resolving ESG disputes, it also comes with several challenges along with it, such as jurisdictional technicalities, the travelling difficulties for the parties, public involvement etc.. It is possible that, the right expertise suitable for the case is not found. Experts also come with other challenges such as high fees, locational difficulties, etc. While dealing with top tier companies and their ESG obligations, it is a high possibility that the companies might have lack of transparency within itself and it could be unfaithful to the public with regard to several things. Therefore, investigating such issues could become cumbersome. Although the path of an alternative dispute resolution such as Arbitration could be a better option as compared to litigation, it is not a cake walk. With the increase in awareness of ESG, it is highly crucial to jot down guidelines with regard to dispute resolution of ESG matters. It is highly suggested that a commission is established which would deal with ESG matters, including separate departments which would engage and respond to specific types of ESG matters. This would create a structured platform for dealing with the same. The aforementioned can retain arbitrators and experts with immense practical and theoretical knowledge and could be assigned cases based on their fields of expertise. Therefore, it is crucial to research in depth about all the possible issues which can arise while resolving ESG disputes through arbitration and create guidelines. The guidelines should be formulated in such a way which would be applicable to all the countries, and also include the socio-economic and political differences that differ from country to country.
Endnotes:
[1]Tirado, J., & Vicente, E. (2023, June 18). Investment treaty arbitration-an introduction: Legal guidance. LexisNexis. https://www.lexisnexis.co.uk/legal/guidance/investment-treaty-arbitration-an-introduction Accessed 10 August 2023.
[2]Stebbing, H., & Furse, I. (2022, November). ESG disputes in International Arbitration. United Kingdom | Global law firm | Norton Rose Fulbright. https://www.nortonrosefulbright.com/engb/knowledge/publications/e01e3d5a/esg-disputes-in-international-arbitration Accessed on 10 August 2023.
[3] The Energy Charter Treaty. Energy charter treaty - energy charter. Delegates. (2019, February 18). <https://www.energycharter.org/process/energy-charter-treaty-1994/energy-charter-treaty/ > Accessed on 10 August 2023.
[4] Supra 20.
[6] Supra 16.
[7]ABA Business Law Section Working Group has developed model contract clauses to protect workers in international supply chains. American Bar Association. (2021, April 22). <https://www.americanbar.org/groups/human_rights/business-human-rights-initiative/contractual-clauses-project/aba-business-law-section-working-group-releases-model-contract-c/> Accessed 10 August 2023.
[8]Bassen, Alexander, Kovács, & Ana Maria. (2008). Environmental, social and Governance Key Performance Indicators from a from a capital market perspective. https://link.springer.com/content/pdf/10.1007/978-3-658-16205-4_66.pdf?pdf=inline%20link Accessed 10 August 2023.
[9]Okoko, D. (2023, January 20). International Arbitration & ESG : A new trend in Dispute Resolution - Arbitration & Dispute Resolution - Nigeria. International Arbitration & ESG : A New Trend In Dispute Resolution - Arbitration & Dispute Resolution - Nigeria. https://www.mondaq.com/nigeria/arbitration--dispute-resolution/1273354/international-arbitration--esg--a-new-trend-in-dispute-resolution-.
[10]Hawes Associate at Allen & Overy, S. G. (2018, July 6). What role will arbitration have in future disputes involving climate change? Arbitration Blog. <http://arbitrationblog.practicallaw.com/what-role-will-arbitration-have-in-future-disputes-involving-climate-change/> Accessed 10 August 2023.
Soumya Vemulakonda is a fourth-year law student at Bennett University at the time of this publication. You may reach her here.
*This blog is a part of a two-blog series. All errors are attributable entirely to the author.