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Navigating ESG Tensions: Resolving Disputes through International Arbitration in Commercial and Investment Contexts | Part-I

- Soumya Vemulakonda*

ABSTRACT

Ever since the dawn of Liberalization, Privatization and Globalization (LPG), people have abused the liberty that LPG has provided, through violation of human rights of the employees, internal corruption of private companies, exploitation of the environment, economic instability etc. Presently, the world is engrossed in building a better, sustainable environment, with sustainable practices which are highly concentrated on coping with climate change impacting on a global level. Along with the focus on the environment, the field of human rights and mental health is also receiving the spotlight due to the increase in its recognition and consciousness; this aspect is focused on the well-being of an individual. Along with the aforementioned, companies also hold control over several aspects such as the treatment of employees, company policies, management etc., which pays attention to the well-being of an organization. The preceding aspects cover the overall prosperity and welfare of the people. Private companies being the biggest players in the market, serving a huge number of the world's population, have a sense of responsibility to make this world a better place to live. The investors have based their decisions to invest in companies considering how they deal with the social, political, legal, environmental and governance aspects. Therefore, several big companies are focusing on improving and implementing ESG (Environment, Social, Governance) within their organizational practices. Establishing ESG and compelling the companies to oblige to it, is simpler than its execution. For ensuring better enforcement of ESG, international arbitration makes its way into the limelight. In this paper, the convergence of international arbitration with respect to ESG would be discussed. Along with the above, the compliances such as the appointment of arbitrators will be elaborated on with its particulars. Couple of other ingredients associated with ESG and international arbitration is, investment treaty arbitration which deals with disputes between two states which signed a treaty establishing certain rules regarding their business with each other. In case of any violation of the treaty by any of the states, arbitration would be used as a remedial tool for a fair resolution. For achieving resolution, it is also crucial to evaluate the damages and come to a conclusion. Mainly, the challenges and drawbacks which are floating in the arena of ESG and international arbitration will be focalized. To understand and comprehend the subject better, real-life illustrations, and case laws, will be portrayed. The aforementioned chapter will finally come to an end with a conclusion that would include a brief summary followed by possible suggestions with respect to improving, widening ESG and how can international arbitration play a better role in legitimizing international transactions and trade between the states.


INTRODUCTION

There has been an immense proliferation of ESG in the modern era, specifically in the corporate field. As the public provides continuous support to the companies, the companies should develop a sense of responsibility to do the same and contribute to the welfare of the society. This contribution can be in favour of donations, social work and helping in the alleviation of the underprivileged. However, apart from the aforementioned ways, the concept of ESG emerged which created a tradition and a legacy for companies all around the world to abide by. The aim of ESG is to ensure a smooth running of the corporate sector in terms of sustainability, careful usage of resources, maintaining work life balance for the employees, and a liberal and positive governance. The basic gist of ESG is connected with how responsibly the companies handle the sentiments of the society and their employees by including the aspect of compassion and protection towards the same. Another purpose of ESG is to aid investors gather information with regard to sustainability, governance and corporate social responsibility. Apart from analyzing the financial data which is the main focus, the investors also concentrate on the external factors such as working conditions, safety of the employee, human rights protection, diversity, environment protection, sustainability, customer satisfaction etc., which contribute to the success of the company. The proper recognition of the company would not just be based on the profit it generates, it would also be based on how much the company involves itself in the society. Therefore, the investors take into consideration the ESG factors. According to a global survey conducted by PwC’s 2021, interviews of around 325 long-term investors worldwide were organized. The result of the survey showed that, around 79% of the investors consider ESG risk factors while investing in the companies.[1]

In order to understand the true value of a company, the investors, dive deep into the company’s non-financial activities, there has been a recent rise in ESG disclosures and ratings.[2] Rating agencies  provide ratings on a company’s environment, social and governance factors in depth. These agencies are utilized by the investors to make a prudent and reasonable decision on their investment. The ESG ratings might differ based on different rating agencies. Another reason which can lead to inconsistent ratings or ratings which might solely focus on the sustainability aspect, is the performance of the companies. Every company would have its own unique rating which might not include all the aspects of ESG. The rating agencies also include comparative analysis of the companies based on the respective criterion for the same.[3] The following are the main determinants:

Environment factor: In this particular criterion, many ingredients such as consumption of energy, deforestation, chemical waste, pollution, climate change etc. These aspects harm the environment which is in turn not beneficial for the public at large. The companies should refrain from conducting activities that contribute to the above consequences which would be conducted at the expense of the environment and the society.

Social Factor: A company that is a part of the society should actively participate in public welfare. The company has a social responsibility of satisfying the society and conduct its activities involving the willing public without intending to cause damage. The investors aim to invest in companies that are capable and competent to generate positive social impact, this is known as social value creation. This concept is based on the protection of human rights of the employees of the company as well as the society. In the modern era, the value of human rights, especially in terms of employment has increased due to a high rise of awareness of the same. Apart from the aforementioned reasons, companies should also make an attempt to figure out the problems faced by the public at large, which they can help resolve. By doing this, a trusting relationship is built between the public and the company. Companies should prepare strategies which aim at benefitting the consumers in the most reasonable way instead of focalizing on profit making. For example, Vaseline conducted a set of interviews with medical professionals in the field of disaster relief, specifically in Doctors without borders, UN refugee agency etc. The conclusion of the interview revealed that the Vaseline jelly is a vital part of a doctor’s first aid kit. The Vaseline jelly aided in healing cracking and blistering of the skin, burns on the skin which were caused due to gas stoves, kerosene lamps. After being made aware of these agonizing realities faced by millions of underprivileged people, Vaseline made a wise decision to start the “Healing Project”. The healing project aimed to heal the skin of approximately 5 million people by the year 2020, by partnering with a humanitarian organization. By donating its products, sponsoring medical supplies, hygiene supplies, Vaseline is creating a real impact in the society.[4] From the abovementioned example it can be concluded that, a positive social impact can be successfully made if the companies keep the welfare of the society in mind instead of profit making or contributing in social cause by virtue of ESG reports. Another such example is of Adidas. Adidas created an initiative called the SOS Children’s village, which helps orphaned children find a nurturing family.[5] Similarly, Reliance Foundation also started several initiatives such as sustainable livelihood programme, projects of improving public infrastructure, offering scholarships etc.[6]

Governance factor: Corporate governance is a concept that lays down rules, regulations, customs, traditions, laws etc., which deals with the running of an organization or a company. It mentions the steps for regulating a company and how it is supposed to act and control the daily activities. It mainly deals with its employees, stakeholders, etc. This concept of governance is crucial as it ensures development of the company and its employees. Good corporate governance is one of the factors which the investors deeply consider prior to the investment.[7]

Before diving into the particulars of the paper, there are a few recent developments in ESG that need to be fathomed. ESG has dispersed worldwide. The impact of ESG is such that a company would be tagged as a top tier if it has commendable ESG ratings. New Zealand made it mandatory for around 200 entities to produce climate risk disclosures. The Ministry of Environment imposed such rules on different types of organizations.[8] Hong Kong declared it compulsory for all the companies and financial institutions to submit an impact of climate change on their businesses. The deadline for this has been assigned as 2025 by Hong Kong Special Administrative Region (SAR).[9] Another development in Asia is that the Asian Development Bank and the Governments of Korea and Japan have issued social bonds. This provision is being released in order to increase the involvement of private and public capital.[10] Along with the above, there are different initiatives arranged to track ESG in various countries and companies. Some of those are Carbon Disclosure Project, Climate Disclosure Standards Board etc.[11] Recently, the US executive government, made it mandatory for the federal government to assess, and disclose all the possible risks involved with regard to the impact on climate. After deciding on the above, the Securities Exchange Commission assembled a climate and ESG task force in the Division of Enforcement. This task force was established in order to fight the challenges in climate protection. It also plans to scrutinize the disclosures submitted by the companies regarding their approach towards ESG and their proposals which the companies would attempt to achieve by the end of the year.[12]

How does international commercial arbitration play a role in enforcing ESG? International commercial arbitration begins with the parties. The parties form an arbitration agreement with regard to commercial transactions which are between two companies or entities of two different countries. The procedure can be regulated by the national laws of the country. The law which would govern the procedure of arbitration and the seat is at the party’s discretion to decide on.[13] The question is how does international arbitration ensure the enforceability of ESG. Simply put, international arbitration persuades and imposes an obligation on the parties to enforce their responsibility of obeying and complying with ESG.


APPOINTMENT OF ARBITRATORS FOR ESG MATTERS

Appointment of arbitrators depends on the discretion and convenience of every company. In terms of international commercial arbitration, companies tend to appoint experienced arbitrators to deal with issues arising the same. As the awareness with regard to ESG has been rapidly increasing, big companies focus on not allowing any disputes regarding commercial transactions to affect their image of maintaining a proper ESG. Ever since the increase in awareness about ESG, the cases filed regarding the same have doubled since the year 2015. 1/4th of the cases were filed in the years 2020, 2021 and 2022.[14] Therefore, many companies intend on appointing arbitrators with high expertise in the field of ESG.

An arbitrator should be chosen who would understand and is able to interpret the technical jargons involved in ESG matters. As majority of the cases could be in convergence to international law, another crucial factor while appointing an arbitrator for ESG matters is that the arbitrator appointed should have a proper and thorough knowledge of international law, international commercial arbitration, UNCITRAL model, and should also be familiar with the New York Convention. There may be cases of ESG which have grave urgency involving risk to the environment and need to be dealt with immediately. When such a situation arises, the arbitral tribunal has a procedure for emergency cases. Under this emergency procedure, the parties have the option to appoint an emergency arbitrator to resolve the dispute.[15] Along with the arbitrators, the parties are also free to include third parties such as specialists, experts on human rights, environment etc.[16]


ROLE OF INTERNATIONAL COMMERCIAL ARBITRATION IN ENFORCING ESG

International Commercial Arbitration, when relating it to ESG, could contribute as a useful tool to enforce ESG standards. Utilizing arbitration as a means to resolve disputes related to ESG compliance would make it convenient for the parties in terms of saving time and obtaining a faster relief as compared to litigation. In ESG matters, there is high possibility that the parties belong to different countries. Fortunately, due to the New York Convention 1958, the enforcement of foreign awards has become opportune. Arbitration helps in enforcing the companies to follow and execute ESG standards in their company. In case of a violation, arbitration helps by passing an award that renders it mandatory for the companies to comply with the ESG procedure and standards. For example, if a company has violated any environmental commitments or regulations, or if it has committed any social misconduct such as human rights violations, an arbitration proceeding can be launched against the company.

Let us take the case of Bear Creek v. Peru as an example. In this case, a Canadian mining firm, Bear creek sought permission from the Peruvian government to mine silver. However, the Peruvian government revoked the authorization provided to Bear creek as the it was concerned about the adverse effect it might create on the ecosystem. Bear Creek disagreed with the decision and filed a $1.2 billion lawsuit against the Peruvian government, alleging that the latter's conduct breached a free trade pact between Canada and Peru. An international tribunal heard the case and ultimately found in favour of Peru, concluding that the government's measures were necessary to defend the health and welfare of its population.[17]

This case is significant because it brings attention to the conflicts that might arise between economic growth and environmental preservation, as well as the function of international trade agreements in resolving such conflicts. In this case, even though the Peruvian government did violate the free trade pact between Canada and Peru, the international tribunal found in favour of Peru as the protection of the ecosystem takes precedence. This judgement set an exceptional precedent for protection of environment. Looking at this case legally and according to the agreement entered into the parties, the decision should be ruled in favour of Bear creek. This case portrays the importance of environment protection and the measures taken by the parties to protect the same. The international tribunal made a logical and reasonable decision by being mindful about the protection of ecosystems.

The utilization of Arbitration for dealing with issues related to ESG is convenient and it also takes off the burden from the court. The majority of the companies usually have employment agreements that have an arbitration clause. This clause aids the employees to defend themselves in case of any violation with regard to their human rights or any social issue. This provides a platform for individuals to speak out their issues clearly and openly. Arbitration is one such concept that is mostly controlled by the parties. The parties can decide on what they would want to convey, unlike litigation. Litigation is a negative and time-consuming method that should not be utilized by companies regarding ESG disputes. As litigation consumes a tremendous amount of time, money and resources, it is not a practical methodology to resolve ESG disputes. Another element of litigation which is disadvantageous in dispute resolution is that, the judge has the complete control over the case, the dates of hearing, etc. Along with the same, the judge also decides when the parties can speak and express their concerns. Party autonomy also plays a major role in resolving the disputes. The parties will be more willing to make an amicable settlement when they are in control of the proceedings.

International commercial arbitration can ensure to enforce the companies to adopt a healthy and positive method of governance which is employee satisfaction. Inappropriate governance leads to lower productivity of the employees which would lead to a negative impact on the company’s activities. Let us understand the case of Metal-Tech v. Uzbekistan[18]. In the year 2000 a company known as Metal-Tech entered into a joint venture Uzmetal with 2 state owned enterprises. Metal-Tech entered into 3 agreements with the state owned companies. In the year 2006, the state owned companies, in order to receive their dividends, initiated court proceedings against Uzmetal. The court ordered Uzmetal to pay the dividends, which was not complied by Uzmetal. This resulted in the state owned companies launching bankruptcy proceedings against Uzmetal. In the year 2010, the Metal-Tech initiated arbitration proceedings and claimed that Uzbekistan violated the Israel-Uzbekistan investment treaty and demanded around $174 million. Uzbekistan claimed that tribunal does not have jurisdiction as Metal-Tech’s investment was corrupt. The tribunal ended up finding trace of corruption in two of the agreements and therefore, leading to the end of jurisdiction. In this case, arbitration helped in eliminating corrupt practices in the governance segment, it created a precedent for other companies to follow a good governance structure and comply with the same.

A strong ADR structure in a company would ensure a secure governance that would be ethical, democratic, transparent, accountable and delivers good service to the stakeholders.[19] Most international commercial contracts include contractual clauses regarding ESG. The companies use arbitration to prepare for any sort of uncertainty in advance and deal with the issues which could arise through arbitration. Cross-border contracts also include the same contractual clauses about ESG. For example, if international commercial contracts contain provisions about ESG, which the company due to some or other reason must have breached, the company and the second party are free to utilize the ticket of arbitration to resolve the same. Utilizing arbitration instead of litigation regarding ESG disputes is preferable due to the reason that arbitration provides scope for understanding and accommodating the requests of both the parties. Not only the above, arbitration is well suitable for ESG since there is an availability of specialists in this field and there is an existence of a flexible procedure. The flexibility also provides locational flexibility which includes executing the awards in any country of choice of the parties. The non-restrictive feature of arbitration makes it easier for the parties to open. For example, in cases of human rights violation of employees of company, which violates the governance aspect of ESG, the parties tend to reveal their issues during an arbitration proceeding since it provides a comfortable environment for them unlike litigation. Human rights violations can also be dealt with in arbitration as it was done in the case of Urbaser v. Argentina[20], where a counter-claim for a huge amount was filed as the right to access water was violated. The tribunal did not accept the counter-claim however it had the jurisdiction to deal with the issue.

There is also an advantage of confidentiality in arbitration. For example, in cases where the companies have contributed to environmental damage while carrying out their functions, it is possible that this information would taint the image of the company if this issue would be dealt with litigation. However, arbitration ensures confidentiality and provides the party with another chance to improve their services to the community.[21] On the other hand, keeping the matters confidential which violate ESG, would also keep the public, investors out of the loop with regard to the activities of the companies. Along with keeping the confidentiality, it reduces transparency in the company. For decades, companies like Exxon and Shell dealing with oil, gas have damaged the environment by adversely affecting the ecosystems, habitat, and frequent changes in sea-levels. Apart from the above both the companies possessed reports of how their business activities would negatively affect the planet, the way of life of human beings, certain habitats etc. Both the companies kept the reports confidential as it might affect their business practices and profitability if revealed[22]. Therefore, confidentiality in ESG matters is not advantageous, especially for the environment, investors and public.


Endnotes:


[1] James Chalmers, Emma Cox, Nadja Picard, The economic realities of ESG, (PwC’s Global investors survey, 28 October 2021) https://www.pwc.com/gx/en/services/audit-assurance/corporate-reporting/esg-investor-survey.html accessed 9 August 2023.

[2] Tarmuji I, Maelah R and Tarmuji NH, ‘The Impact of Environment, Social and Governance Practices (ESG) on Economic Performance: Evidence from ESG Score’ (2016) 7 International Journal of Trade, Economics and Finance 67.

[3] Clementino E Perkins R, ‘How Do Companies Respond to Environmental, Social and Governance (ESG) ratings? Evidence from Italy (2020) 171 Journal of Business Ethics 379.

[4]  Review of social impact efforts that create real value. (Paper presented at the Academy of Management Annual Meeting, Boston, MA).

[5] Blaise Hope, Top 10: Global Companies with best social impact initiatives, (Sustainability, April 5, 2022) <https://sustainabilitymag.com/top10/top-10-global-companies-with-best-social-impact-initiatives-esg> Accessed 8 August, 2023.

[6] India CSR, India CSR Corporate Social Responsibility, July 3, 2022 https://indiacsr.in/these-are-the-csr-projects-of-reliance-for-fy-2022-23/. Accessed August 8, 2023.

[7] Khan, H., A Literature Review of Corporate Governance, 2011.

[8] Ministry of Environment, New Zealand, “Mandatory climate-related disclosures”. 18th January 2023 < https://environment.govt.nz/what-government-is-doing/areas-of-work/climate-change/mandatory-climate-related-financial-disclosures/>.

[9] Scatigna, M., Xia D., Zabai, A., & Zulaica, O. (2021, December 6) Review of Achievements and Challenges in ESG markets.

[10] Ibid.

[11] Sulkowski, A. J. (2021, November 18).  Sustainability (or ESG) Reporting: Recent Developments and the Potential for Better, More Proactive Management Enabled by Blockchain, SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3948654.

[12]Silk, D. M., Lu, C. X. W., Wachtell, Lipton, Rosen, &amp; Katz (Eds.). (2022). Environmental, Social &amp; Governance Law 2022. WLRK. https://www.acc.com/sites/default/files/resources/upload/ICLG%20-%20Environmental%2C%20Social%20%26%20Governance%20Law%202022.pdf> Accessed 10 August 2023.

[13]Yu, H.-L. (2009, July 7). A theoretical overview of the foundations of International Commercial Arbitration. Contemporary Asia Arbitration Journal.

[14] MacKinnon, A. D., Vainstein, M., Steen, C.G., & Hamilton LLP (2022, December). The rise of ESG disputes and the role of arbitration in resolving them, Financier Worldwide Magazine, (December 2022).

[15]Ibid.

[16]Ðordevic , N. L., & Nikolić, D. (2023, February 1). ESG-related arbitrations: A new kid on the block. Lexology. <https://www.lexology.com/library/detail.aspx?g=b225ace1-dbc9-4769-b36f-a9aea1283d28> Accessed 10 August 2023.

[17] Bear Creek v.Peru 2014 ICSID (International Centre for Settlement of Investment Disputes) Case No. ARB/14/21).

[18] Metal-Tech v. Republic of Uzbekistan, 2013 ICSID (International Centre for Settlement of Investment Disputes), Case no. ARB/10/3.

[19] ESG and ADR. ESG and ADR | ADR.ORG. (2022, September 5). https://www.adr.org/blog/ESG-and-ADR.

[20] Urbaser Ltd. v Argentina, 2012 ICSID (International Centre for Settlement of Investment Disputes) Case No. ARB/07/26.

[21]Salazar III, R. R. C. (2022, November 2). The Arbitrability of environmental, social and governance (ESG) issues. Fortun Narvasa &amp; Salazar.< https://www.fnslaw.com.ph/the-arbitrability-of-environmental-social-and-governance-esg-issues/> accessed 10 August 2023.

[22] Benjamin Franta, Shell and Exxon’s secret 1980s climate change warnings (The Guardians, 19th September 2018, https://www.theguardian.com/environment/climate-consensus-97-per-cent/2018/sep/19/shell-and-exxons-secret-1980s-climate-change-warnings Accessed 6th 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.

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