ESG clauses in commercial contracts
Companies are increasingly coming under the microscope when it comes to addressing and implementing environmental, social and governance (ESG) standards. This can be explained in part by the recent implementation of ESG-related regulation, such as the EU’s Corporate Sustainability Reporting Directive, and the increased consciousness amongst investors, stakeholders and the wider public for businesses to contribute to positive environmental change.
What are ESG clauses?
ESG refers primarily to a company’s management of its environmental, social and governance issues. This is a two-way consideration which concerns the company’s own environmental and social impact, as well as the impact that external environmental and social factors have on the company’s performance.
The environmental element of ESG:
- measures a company’s impact on the environment, its carbon footprint / energy efficiency, its impact on the ecosystem and biodiversity, and any pollution caused by the Company; and
- an environmental ESG clause tends to focus on decarbonisation targets, setting net zero targets, sourcing sustainable materials and reporting on environmental matters.
The social element:
- measures treatment of customers, employees or wider community engagement; and
- provisions in a contract often relate to health and safety, working conditions, modern slavery and diversity, equity and inclusion (DEI).
The governance element:
- relates to how an organisation functions internally, including its decision-making processes, financial strategies and shareholder rights; and
- clauses will relate to anti-money laundering, bribery and corruption provisions.
Why do we have ESG clauses in commercial contracts?
Whilst many ESG requirements are increasingly factored into companies’ governance and decision-making, many companies fail to reflect these requirements in their commercial contracting arrangements. Even where such requirements are specifically included, enforcement has been lacking.
ESG clauses are included in contracts to manage legal risks, align with reporting standards (whether voluntary or mandatory) and/or address stakeholder expectations. There are various factors which can affect the type of ESG clauses which may be incorporated into a contract, including the size of the parties and the nature and value of the transaction.
Best practice when drafting ESG clauses
When drafting ESG policies or clauses, it is important consider the following best practice:
- clearly define any ESG objectives, reference applicable regulatory frameworks and standards (where relevant) and include clear compliance and reporting obligations;
- incorporate flexibility for evolving ESG standards;
- clearly specify consequences that may flow from a breach and any contractual remedies (for example, an agreed remediation process, payment of damages, or termination); and
- ensure consistency and alignment with the company’s broader contractual obligations.
Consequences of poorly drafted ESG clauses
The increased focus on environmental, social and governance standards has resulted in a rise in ESG-related litigation and enforcement. “Greenwashing” has been a key focus of the UK Advertising Standards Authority for the last few years, with companies such as Renault, Virgin Atlantic, Innocent drinks, HSBC, Ethiad Airways and Tesco (to name just a few) coming under the spotlight.
From 6 April 2025, the Competitions and Markets Authority (CMA) has the power to issue penalties for breach of the Digital Markets, Competition and Consumers Act 2024 (including the prohibition on misleading advertising) – £300,000 or 10% of global group turnover (if higher), with the potential for further fines for continuing breaches and the ability to fine directors or senior managers personally.
What can businesses do?
To minimise the risks posed by greenwashing litigation and regulatory focus, businesses should review the scope of their operations and identify those areas which are most likely to be the focus of criticism or challenge. This includes any public statements or assurances regarding an environmental footprint. Any such claims, to avoid scrutiny by the CMA, must be clear and capable of unambiguous substantiation. Procedures and manufacturing processes often cannot be changed overnight, but businesses must be open and upfront about their credentials, rather than seeking to obscure, mislead or make unsubstantiated claims.
How we can help?
There are a variety of issues that fall under the umbrella term “ESG”. Whilst many of these are imposed by law, others may be contractual considerations or may pose risks from a sanctions/litigation perspective.
For support with managing and mitigating these risks, including incorporating ESG-related issues into commercial contracts, implementing specific ESG policies, conducting due diligence, developing DEI strategies and advice on ESG-related litigation strategies, please do not hesitate to get in touch with the team at Pannone Corporate.
If you would like to discuss anything in this article further, please contact:
Bill Dunkerley
Danielle Amor
Imogen Eastwood
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