Net zero – commercial drafting considerations
Net zero, the state where greenhouse gas (GHG) emissions are balanced by GHG removal, ensuring an overall net zero emission, is legally mandated in the UK by the Climate Change Act 2008, with the UK being committed to achieving net zero by 2050. And in Net Zero Wales, published in 2021, the Welsh Government stated its commitment to effect a ‘just transition’ away from a fossil-fuelled economy to a new low carbon future. With its recently published Just Transition Framework, the Welsh Government is currently consulting on the nature of the strategic policy approach it will take to achieve net zero in Wales. Official policy aside, companies are increasingly recognising that more needs to be done to mitigate the effects of climate change sooner, in order to do their part in reducing global emissions. Contracts and the negotiations underpinning them can be, with careful use, an effective way to aid business’ transition to net zero emissions and a low carbon economy. Why is this the case?
Contracts are powerful tools in the fight against climate change
Contracts can be formulated at any time, enabling companies and organisations to mandate net zero commitments into their business methods right now. Businesses can act immediately by devising contractual models that build climate considerations into their operational or commercial undertaking, without having to wait for official policy to develop and legislation to be passed. Studies have shown that this can create a ‘ripple effect’ whereby suppliers and partners emulate these policies throughout their own operations. In addition, contracts provide a flexible, bespoke route to achieve these aims; contracts can offer built in incentives and enforcement mechanisms that work best for the scenario in question and ensure that obligations are allocated to the correct party who will bear responsibility for compliance. And, very importantly, contract law in this country has developed into a robust, certain, and well tested legal framework. This can be adapted to meet climate friendly targets with the knowledge that, with the correct drafting, they will be legally enforceable.
Examples of contracts being used to drive net zero goals
The drive towards renewable energy sources has necessitated a whole new suite of contractual arrangements. Contracts are needed relating to the financing, generating, distributing, and selling of power. Power purchase agreements can give large renewable electricity generators certainty of income over multiple years. And the UK government supports renewable energy development through contracts for difference, which protect against energy market volatility and give generators price security. Another example is voluntary carbon markets. These involve entities buying or selling ‘carbon credits’ that represent a certain volume of emissions avoided or removed. Contracts are pivotal in creating and verifying credits and in their sale. The Taskforce on Scaling Voluntary Carbon Markets, a private sector-led initiative, is working to scale an effective and efficient voluntary carbon market to help meet the goals of the Paris Agreement. And in the public sector, government procurement offers a direct route for government to encourage climate responsible behaviour; policy can require bidders to meet certain emissions criteria and comply with reporting standards. For example, the government has published Procurement Policy Note 06/21: Taking account of Carbon Reduction Plans in the procurement of major government contracts. This Policy Note applies to all central government departments, their executive agencies and non-departmental public bodies. It requires all organisations wishing to procure public sector contracts with a value of more than £5 million to have an annually updated Carbon Reduction Plan (CRP) in place and commit to achieving Net Zero by 2050 at the latest.
How can businesses address emissions in their own contractual arrangements?
The Chancery Lane Project (TCLP) has put together a freely accessible net zero toolkit to provide lawyers and businesses with climate clauses that can be used to achieve climate related objectives. The toolkit contains over 100 climate clauses and various net zero implementation tools to help parties understand the concept of net zero, accurately define climate terms, and understand the key issues to look out for when including net zero commitments in contracts. Climate conscious objectives that could be inserted into contracts include:
- Clauses requiring the parties to set greenhouse gas (GHG) emission targets
- Clauses requiring the parties to monitor, report and reduce their GHG emissions
- A commitment to use renewable energy for all energy requirements
- ‘Coolerplate’ clauses (generic boilerplate clauses aligned to climate issues and your net zero targets). ‘Coolerplate’ clauses allow your climate initiatives to flow throughout the contract, from recitals to execution
- Late payment clauses requiring defaulting parties to make payments to green causes or a carbon off-setter (but see ‘Are these terms enforceable’ below)
- Green ‘governing law’ clauses requiring that the governing law is interpreted in a manner consistent with the objectives of the United Nations Framework Convention on Climate Change (UNFCCC) and the Paris Agreement
- Termination rights where a party does not meet its climate obligations
Are these terms enforceable?
Some of the above concepts can seem rather unusual, indeed alien, in relation to contract drafting. And terms such as ‘net zero’ and ‘carbon neutral’ have no set definition which can cause difficulties in interpretation when contracts need to be clear and the parties capable of fully understanding the terms agreed. Another point to make is that clauses setting out a non-breaching party’s rights to a monetary sum (liquidated damages) must be drafted to ensure they compensate for losses incurred, not to punish the breaching party. This may mean that climate-related liquidated damages clauses that require the breaching party to make payment to third party environmental organisations (rather than directly to the non-breaching party), whilst laudable, may be unenforceable. And care must be taken to ensure that climate specific clauses work together with, and don’t conflict with, other terms of the contract. For example, existing broadly drafted catch all provisions relating to termination for breach of contract may already cover breaches of climate obligations. Dedicated clauses specifying termination for breach of these obligations will need to be carved out from the general provision to ensure clarity as to which terms prevail.
The legal position of a party that claims damages for a breach of a green clause, or failure to meet specified environmental targets, is currently untested judicially with no guidance from the courts as to how they would apply damages for any such breach. However, as more individuals and organisation adopt and use climate-aligned clauses, they will become a standard and routine part of a contract or transaction. New areas of loss and litigation will inevitably open up as these provisions gain general commercial acceptance.
