What are climate-aligned contracts?
We specialize in climate-aligned contracts, so what are we even talking about?
Contracts generally
Many aspects of everyday life are governed by contracts. In the business world, contracts make things more predictable by formalizing agreements and capturing key terms like price, delivery dates, quantity, quality of product or service, etc. They also manage various risks through language that creates indemnity obligations or mandates certain insurance requirements.
How is climate change impacting contracts?
While many aspects of contracts and contract law have stayed relatively constant, the overall context in which contracts are negotiated, performed and enforced has changed; largely due to the ever-increasing risks associated with a rapidly changing climate.
To manage business in this new context, contracts also need an overhaul. And they need to be part of a climate-first solution.
Many of the increased, climate-related risks, have come to the forefront as Environmental, Social and Governance (ESG) is now a part of standard business language.
What are climate-aligned contracts?
There are many ways that contracts can align with climate goals, or, more specifically, help companies align their business operations with climate goals and requirements: these types of contracts are generally referred to as climate-aligned contracts.
Let’s focus on two examples:
Commercial Leases:
To manage the risks of a changing climate, federal, state and local governments are implementing restrictions on carbon-intense activities. One specific example is building performance standards. Building Performance Standards, or BPSs, are laws that require existing buildings to meet certain energy or performance requirements, which become progressively more stringent over time, to reduce climate impacts and help states and cities meet climate targets. Existing buildings are an important focus of climate work, because existing buildings - which were generally permitted under outdated energy codes and have been around for some time, often without updating equipment or regular maintenance - are responsible for a significant percentage of climate emissions.
This graph from the City of Seattle explains how BPSs tie in with climate-related goals (energy performance standards, on the right, will help the City work towards its 2030 and 2050 goals, though, as you can see, there’s a lot of work to be done to reach those goals).
What do BPSs have to do with contracts?
How buildings are operated and maintained is governed by a variety of contracts, including leases (between the landlord and tenant(s)).
The issue is that “traditional” leases were never designed to manage the issues associated with mandating that buildings perform to a certain level, and assessing penalties for buildings that fail to do so - a common feature of most BPSs.
Commercial leases need an overhaul to manage this new context. Climate-aligned leases are one way to commit both landlords and tenants to working towards shared compliance and leadership goals.
Supply chain contracts
Outside of the regulatory context, many companies are choosing to voluntarily make “climate commitments,” generally pledging to go “net zero by 2030,” or a similar target. However, for this type of goal to be considered credible, most practitioners would argue that it needs to encompass all of a company’s climate emissions; but that can be more difficult than it sounds (though it doesn’t have to be).
Understanding the importance of supply chain commitments requires a quick lesson in how we categorize and measure climate emissions. Generally speaking, we group climate emissions into three “buckets,” which we call Scopes 1, 2 and 3.
As shown in the graphic, Scope 1 is all onside emissions from assets (buildings) and equipment a company owns; Scope 2 is all the purchased electricity consumed by the company; and Scope 3 is everything else up and down the company’s supply chain.
Scope 3 is a big deal, because for many companies it is the largest source of emissions. Walmart, for example, estimates that about 95% of its emissions fall into Scope 3. So, as you can imagine, if a company makes a “net zero” commitment, but does not include Scope 3 in that commitment, it’s not a very robust commitment.
So how can climate-aligned contracts help companies make and meet climate commitments? Through climate-aligned supply chain contracts contracts that align vendor’s and supplier’s operations with the company’s climate goals.
Salesforce has been a leader in this space, so let’s take a closer look at Salesforce’s climate-aligned contract.
In the spring of 2021, Salesforce announced that it had committed to a Science-based target, and that part of its plan to meet this target included introduction of a “Sustainability Exhibit,” into its supply chain contracts.
The Sustainability Exhibit is designed to drive broader change at scale and manage Salesforce’s Scope 3 emissions (and reach its goal that suppliers that represent 60% of Salesforce’s Scope 3 emissions will set Science-based targets). Essentially, the Sustainability Exhibit is a contract addendum that requires suppliers to: set their own Science-based targets; actively work towards those targets; disclose their Scope 1, 2 and 3 emissions; and if the supplier is unable to meet these requirements, face penalties which include the cost of carbon offsets that Salesforce would have to buy to account for that supplier.
Salesforce has widely shared the Sustainability Exhibit, in the hopes that it drives deeper change.
So where is all of this going?
Clarity benefits everyone. And climate-aligned contracts are ab increasingly important tool to move from unenforceable “goals” to robust climate commitments.
Whether a climate commitment is voluntary or imposed by law, all potentially impacted parties need to be on the same page by agreeing to clear and transparent contractual terms. Contracts lend a level of formality and enforceability to business relationships. And if aspects like penalties are appropriate - or if it’s appropriate to pass part of a penalty through to a tenant or supplier - those aspects need to be clear.
Good, climate-aligned contracts are clear, yet flexible enough to manage evolving regulatory and market demands, as well as future issues like water rationing, embodied carbon, and others.
Why is it worth it to take a look at your contracts and revise them?
Two words: risk management.
Contract review can take time, effort and money; we get it. That said, with the way the market and regulatory context is changing, in most instances, the benefits outweigh the costs, as there are significant unknowns that can be managed with clear, climate-aligned contracts. Through clear lease terms, building owners can manage tenant use of the space and ensure compliance with performance requirements. Similarly, companies can manage the risk of failing to meet their own climate commitment, by getting their supply chain on board and working together towards shared, enforceable climate goals.
And finally, as Environmental, Social and Governance (ESG) becomes and ever-increasing part of business as usual, climate-aligned contracts are a key tool that transforms “conversations” into clear and enforceable expectations that demonstrate to stakeholders (and regulators like the Securities and Exchange Commission) that your company is series about its climate and related work.
There can be significant business risk in failing to meet public commitments, as well as increasing regulatory risks as the Securities and Exchange Commission continues to develop rules and step up enforcement of climate disclosures and commitments.
This is a new space, but resources and case studies are available. We can show you how.
Cover photo by Luca Bravo on Unsplash
This blog is made available solely for educational purposes to provide general information about general legal principles and not to provide specific legal advice applicable to any particular circumstance. By using this blog, you understand that there is no attorney client relationship intended or formed between you and the blog publisher or any contributing lawyer. The blog should not be used as a substitute for competent legal advice from a lawyer you have retained and who has agreed to represent you.