Contract Law and Climate Change


    You are viewing part of the Law and Climate Atlas

    Executive summary

    Addressing climate change requires action from governments, businesses and individuals. Contracts govern many interactions between and within all three of these groups. Contracts are of course vital to specific actions that reduce emissions, for example to develop or fund renewable energy projects. Contracts that are not directly related to climate change may also have a significant impact on greenhouse gas emissions or climate adaptation – these contracts may range from house sales to large corporate mergers and acquisitions. Many sections of this resource will address contracts related to specific issues and areas of law, but this section provides an introduction into why climate change is relevant to contracts generally.

    Climate change is unlikely to impact overarching principles of English contract law, nor are these principles likely to change due to policies implemented during the net zero transition. Instead, contract law’s impact on climate change can be evaluated by looking at how existing contracts may be influenced by climate change, and then exploring how various actors might use contracts to help drive the net zero transition. While climate discussions often centre on risk, contract law offers many different actors clear opportunities for dealing with climate change. The Chancery Lane Project helps to seize these opportunities by creating, compiling, and disseminating climate clauses that can be used in many different areas of law.

    Key points in this section:

    • Climate change may impact existing contracts through extreme weather events and changing asset values. This can pose financial risks to contracting parties that have not accounted for climate change and the net zero transition.
    • Climate-related goods and services, such as renewable energy innovations, are leading to new technical issues in disputes.
    • Contracts are vital to channeling the necessary investment and deploying the right technologies to reduce emissions. Public procurement rules and model contracts can drive systemic change in this regard.
    • Contractual clauses, including those created and compiled by The Chancery Lane Project, allow many different actors to create binding climate commitments in agreements ranging from large corporate mergers to small real estate transactions.

    How climate change is impacting contracts

    Climate risks to contracting parties  

    Climate change is likely to impact a wide range of obligations under existing contracts. Exact impacts vary greatly depending on the relevant effect of climate change and the type of contract. These impacts can be broadly evaluated by considering two different types of climate risk – physical and transition risks.[1]

    Physical risks, which stem from direct climate impacts such as temperature increases and more frequent extreme weather events, may have a significant effect on some existing contractual arrangements. Relevant contracts might relate to physical assets that are negatively impacted by weather extremes, or services which become more difficult to perform in high temperatures. Of course, parties will generally have considered these types of risks and agreed on a way of sharing risk between them. Climate change is a risk multiplier – parties who have underestimated any increases in physical risks due to climate change in existing contractual arrangements may suffer financial loss. In extreme cases, events caused or aggravated by climate change may lead to terminating the contract through a force majeure clause, or the common law principle of frustration. This could happen if, for example, a rare weather event destroys relevant property rendering the completion of a contract impossible. Some contracts, such as insurance contracts, are particularly exposed to these risks. Less directly, climate change is causing supply chain disruptions that can make it difficult for certain parties to fulfil their contractual obligations.[2] Although a very different type of existential problem, experiences with commercial contracts impacted by COVID-19 may be indicative of future effects linked to climate change. Industry surveys confirm that ESG risks are already negatively impacting many mergers and acquisitions.[3]

    Transition risks, caused by society’s response to climate change, may also impact contractual obligations. One way in which this can happen is through changes in asset values which, if significant enough, may lead to defaults or stranded assets.[4] These value changes could be due to consumer or investor sentiment shifting towards renewable or sustainable alternatives. The broader global effort to address climate change, alongside physical risks, can also increase commodity prices.[5] Government action in the UK and abroad can impact prices – carbon pricing, incentives, and traditional regulation may all impact the value of goods and services.[6] In some cases, command-and-control regulation such as technical bans or limits may make contractual obligations difficult or even impossible to perform legally. In other cases, policies targeted at climate change may reduce prices, for example because of incentives for green industries. This may also lead to contractual disputes if a buyer seeks a price revision due to lower production costs.[7]

    Ultimately, the wide-ranging effects of climate change are reflected in potential impacts on existing contracts. While many individuals and organisations are already ensuring that they consider climate impacts and related issues when drafting contracts, those that are not may be exposing themselves to risk. Creating climate-aligned contracts and clauses can involve mitigating these risks, or going further and seizing climate opportunities.

    Climate-related contractual disputes

    As explained above, climate change may impact a wide range of existing contracts which could lead to parties breaching or terminating contracts. Some of these disputes may be litigated in English courts, but in many relevant sectors the dispute resolution method of choice may more likely be arbitration.[8] Where disputes directly involve green technology companies, a 2019 report from the Stockholm Chamber of Commerce revealed that arbitration is becoming more attractive, in part due to the technical nature of these issues.[9]

    How contracts can help drive climate action

    Contracts related to climate change efforts

    Climate mitigation and adaptation efforts have created new products and services which require contracts for their production and use. Renewable energy is now commonplace, and with it come contracts relating to, inter alia, financing, generating, distributing, and selling power. Power purchase agreements can give large renewable electricity generators certainty of income over multiple years, and the net zero transition has slightly shifted this paradigm as individual households may now generate electricity through solar panels. The government supports renewable energy development through contracts for difference, which protect against energy market volatility and give generators price security. Common themes in contractual disputes related to renewable energy include disputes surrounding which party should take responsibility for the impacts of adverse weather, whether proper notice has been served, and those related to price review clauses.[10]

    Renewable energy helps to reduce emissions and mitigate climate impacts, but other contracts may relate to climate adaptation – preparing for climate impacts. Significant infrastructure projects to address flood risks may involve contracts between public and private actors. Insurance is highly relevant to adaptation, and the industry is considering ways in which insurance contracts may better share climate risk. Many other new technologies and sectors, such as greenhouse gas removal, are ushering in new contractual obligations and may result in novel technical issues where disputes arise.

    In addition to changes to existing sectors, new markets have emerged from the net zero transition. The UK’s main pricing carbon mechanism is its emissions trading system, under which certain entities can trade allowances which they must retire if they wish to emit greenhouse gases. This has created a compliance-based ‘carbon market’, as well as a secondary futures market. The UK Emission Trading System has a similar scope and design to the EU Emissions Trading System, which the UK left following Brexit. The voluntary carbon market involves entities buying or selling ‘carbon credits’ that represent a certain volume of emissions avoided or removed. Contracts are involved in creating and verifying credits, and of course in their sale. Global voluntary carbon markets, which may grow significantly,[11] have already seen disputes around performance of obligations, alongside theft and fraud issues. The financial law section of this resource explores a range of emerging sustainable financial products, including green loans and securities, that will see new contracts between financial institutions and investors. On balance, contracts are vital to operationalising various aspects of the net zero transition and lawyers may see new fact patterns emerge from growing climate-related industries.

    Public procurement and climate change

    While the government can create market conditions or implement regulations that are likely to impact contracts between private parties, it can most directly use contracts to address climate change through public procurement. Many actions that will drive the net zero transition, such as changes to transport infrastructure and energy systems, will require significant public investment. Other projects funded through public procurement also have the potential to cause high amounts of emissions – for example by using cement – and are therefore also highly relevant to the net zero transition. To tackle these emissions, the UK Cabinet Office has set out important requirements for potential contractors in Procurement Policy Note 06/21. The new policy requires that bidders for public contracts worth more than £5 million commit to achieving net zero by 2050, and that they set out key measures that they will take to reduce environmental impact when carrying out the contract. They also set additional emissions reporting standards, including for some indirect (Scope 3) emissions. While these rules only apply to large contracts, they may help reduce emissions not only originating from contractors, but also throughout their supply chains. The EU has similarly stressed the benefits of green public procurement to its member states through a nonbinding communication to its member states.

    A range of other contractual tools might help the government achieve its climate goals. Climate Change Agreements are one relevant example. Under these agreements, industry groups and businesses commit to reducing their impact on the climate in exchange for paying a lower Climate Change Levy rate. 

    Climate clauses

    Contracts specifically relating to green technologies or other aspects of climate action represent only a fraction of contracts which can help address the net zero transition. Many other agreements, from contracts for home renovations to large corporate deals, can contribute to the fight against climate change. In the UK, the inclusion of climate-related clauses in contracts has been to a large extent pioneered by The Chancery Lane Project, which provides a collection of clauses that can be used in a variety of sectors and practice areas, and toolkits to improve climate change implementation when drafting.

    Examples of climate clauses include clauses requiring the use of green energy in supply chains, promoting regenerative farming in pasturage agreements, and integrating environmental targets in limited partnership agreements. The Chancery Lane Project provides numerous case studies showing how these clauses have been implemented – highlighting their use by public organisations such as the Environment Agency and New Zealand Green Investment Finance, as well as companies and law firms. In addition to clauses that can be included in contracts between organisations, climate clauses may also drive change within organisations through, for example, employment contracts.

    In some cases, coordinated industry action might help include climate clauses in contracts. Where an organisation sets an industry standard for contracts, that organisation might decide to include climate-related provisions in its standard clauses. NEC4 contracts are widely used in the construction industry and have recently introduced flexible ‘X29’ clauses which set rules directly relevant to climate change. Another example in the same industry is sub-clause 4.18 of the International Federation of Consulting Engineers (FIDIC)’s ‘Red Book’ which sets an international standard for construction contracts. That sub-clause requires contractors to “take all reasonable steps to protect the environment (both on and off the Site)”. This clause can reasonably be interpreted to include preventing emissions, as it specifies that environmental protection is not limited to the site itself, but some argue that it should go further and make specific reference to climate change. Other industry groups may follow a similar path. Though not representing a single sector, the B Corp (benefit corporation) movement is another example of clauses that may help the climate being disseminated from a single source. Its ‘legal requirement’ specifies language to use when creating a benefit corporation.

    The inclusion of climate-related clauses, alongside increasing climate risks, may lead to more disputes where climate change is a key issue. As with disputes over existing contracts, arbitration is likely to play a key role in resolving these issues.

    [1] For a more thorough evaluation of climate risks, see Chapter 2 of the World Economic Forum’s Global Risk Report.

    [2] Jacques Leslie, ‘How Climate Change is Disrupting the Global Supply Chain’ in Yale Environment 360. 2020.

    [3] Datasite. M&A Trends Report: Climate Change and the Mergers and Acquisitions Landscape. 2021. <–climate-change-and-the-mergers-and-acquisitio.html>.

    [4] Norton Rose Fulbright, ‘What are climate change and sustainability disputes?’ (International Arbitration Report, 2021).

    [5] Ibid.

    [6] Joseph Chi, Mathieu Pellerin and Jacobo Rodriguez. The Economics of Climate Change. (Dimensional Fund Advisors, 2020).

    [7] Sukma Dwi Andrina, Green Technology Disputes in Stockholm. (Stockholm Chamber of Commerce, 2019).

    [8] Norton Rose Fulbright (n 4).

    [9] Andrina (n 7).

    [10] International Chamber of Commerce, Resolving Climate Change Related Disputes through Arbitration and ADR (International Chamber of Commerce, 2019).

    [11]  See initiatives such as the Taskforce for Scaling Voluntary Carbon Markets.