Climate change continues to significantly alter the nature, efficient pricing and allocation of material contractual risks. At the same time, there is heightened scrutiny on organisations to take meaningful steps to implement their publicly stated climate ambitions. This includes cascading these ambitions across operations, projects and procurement. However, prevailing approaches to contract drafting – both legal and commercial – often fail to provide for contemporary climate issues, nor their dynamics.
From frustration and force majeure, to termination and take-or-pay, a 'drafting as usual' approach can have both significant commercial corollaries, and increase the potential for contractual disputation.
How do your current precedent contracts deal with the risks (and opportunities) of a changing climate? The following five considerations will help guide your approach to 'climate-conscious' contractual drafting and negotiation.
1. Don't rely on precedent contract drafting to deal with unprecedented and accelerating risks
Climate change is already here. The recent IPCC’s Sixth Assessment report has confirmed that global temperatures are now on average 1.1C warmer than pre-industrial times. This translates to 1.4C over Australian land. Increased physical risks – such as more frequent and intense extreme weather events like heatwaves, drought, bushfires, extreme precipitation, cyclones, storm surge and inland flooding – present unprecedented and accelerating risks to long-lived asset impairment, project delivery impacts and supply chain disruptions. It is not prudent to rely on precedent contract drafting to deal with unprecedented and accelerating risks. The updated science on physical risks provides a clear and unequivocal basis to review the physical risks to an organisation's assets and related infrastructure (including along the value chain), present and future. A climate-conscious, forward-looking approach is now critical to both efficiently identify, price and allocate material transactional risks, and to minimise the potential for legal disputation.
2. Take a bespoke approach that considers both averages and extremes
Climate risks of varying magnitude and likelihood can arise at any part of a value chain; from upstream procurement to long term supply agreements, across core operations, to downstream sales and logistics, or investment decision-making. Not all transactions present the same level of climate change risk. In addition, the IPCC's Sixth Assessment Report confirms that the nature of relevant physical impacts is highly localised. A bespoke approach is required – one that considers both averages and extremes – for a particular asset, its critical infrastructure cross-dependencies (such as power, water and transport) and logistics chains.
As a mechanism to allocate risk between commercial parties, contracts need to consider and protect an organisation’s interests across a broad range of plausible climate futures. This goes from one that involves a sharp, disorderly transition to a net zero economy (higher economic transition risks) to one in which high-emissions trajectories lead to extreme physical risks. Under any scenario, the forward-looking commercial context will be different from historical experience. Impacts may be foreseeable even where they are not considered likely. And while climate change may not be within a party's control, adaptation to its foreseeable impacts may be.
Therefore, organisations need to take a tailored approach to identifying the types of transactions that have a higher level of climate-related risk. Detailed consideration of climate-related risks under a range of plausible climate futures is important to efficiently identify and price relevant risks, and capture value-creation opportunities.
3. Apply robust climate risk assessment practices and tools from the earliest stages of the transaction lifecycle
Efficient management of climate-related risks in contracts is not an issue that begins and ends with contract negotiations and drafting. There is limited utility in assessing climate-related risks to your organisation, a project or transaction if the first time these issues are identified is at the contract review stage, when there is less competitive tension. The RFP process may have already been concluded without climate-related design – or performance – specifications or assessment criteria.
Robust climate risk assessment practices and tools can and should be applied from the earliest stages of the transaction lifecycle. Then it should be considered and addressed an each intervention point across the project delivery, and beyond. Addressing climate change-related risks and opportunities across the contract life-cycle can underwrite your competitive positioning, lower transactional and project risks, and mitigate potential legal exposures by facilitating the efficient risk identification, allocation and pricing across this dynamic risk landscape.
4. Use contracts as way to deliver opportunities
Beyond risk allocation, contracts can also be used as a mechanism to drive opportunity. They can be used to both implement sustainability and net zero strategies, goals and targets, and to generate sustainability opportunities and benefits (and co-benefits) without undermining the commercial risk/return calculus. For example, understanding where variation terms can add flexibility to long-term commitments in a hugely dynamic and uncertain environment.
5. Take a collaborative approach
Climate change is a complex and cross-disciplinary issue which requires coordinated, cross-disciplinary action to address. Depending on where you are on your climate change and sustainability journey, addressing climate change risks and opportunities may require your organisation (including your board, management, legal and commercial teams) and counterparties to embark on a steep learning curve.
To achieve the required and rapid step-change in commercial climate change acumen, parties will benefit from taking a collaborative approach to integrating and dealing with climate-related risk issues. This is both internally and externally with their industry and relevant stakeholders.
MinterEllison is a proud partner of The Chancery Lane Project – a global pro bono initiative that supports legal, business and sustainability professionals to draft and use climate-aligned contractual clauses. On 19 October 2021, MinterEllison hosted the launch of the Net zero toolkit, a practical toolkit containing climate-aligned contract clauses and tools to assist organisations to deliver to their net zero commitments through contracts.
Download the Net zero toolkit.
Please reach out to us if you would like to discuss how you can incorporate climate change clauses in your precedents, contracts and negotiations.