ESG and Contract Management. Set against the backdrop of an increasingly dire climate landscape and growing mistrust in businesses and institutions, market participants are evaluating organizations based on additional factors beyond their growth potential and economic performance.
Increasingly, environmental, social and governance (ESG) factors are the defining reasons why an investor chooses to buy shares, why a consumer chooses to purchase a product or why leaders choose to do business with one another. These criteria correspond to how well an organization serves as a steward of the environment, what impact they have upon society and how ethically they conduct business.
There are plenty of ways a business can incorporate ESG principles into their operations, whether that’s ensuring diversity on the board, tracking greenhouse gas emissions or auditing their supply chain. To support these efforts, the legal department can practice ESG contract management.
Why apply ESG principles to contract management?
No business is an island — every organization is impacted by the agreements it makes with vendors, suppliers, landlords, partners, merged and acquired businesses and so on. The first place to improve your own organization’s evaluation against ESG criteria is to ensure those criteria are reflected within your contract portfolio.
What’s more, as a member of your organization’s in-house counsel, your primary responsibility is to mitigate the total amount of risk your organization is exposed to. Negotiating, tracking and managing ESG criteria within your contracts automatically reduces risk. You’ll be:
- More likely to meet regulatory requirements
- Less likely to incur lawsuits
- Less likely to suffer reputational damage
Enshrining these principles within your contract management practices ensures that there are documented and enforceable steps taken towards conducting business sustainably and ethically.
How to manage contracts with an eye towards ESG
When negotiating or renegotiating a contract, you’ll have the opportunity to push for terms that can improve your business’s standing from an ESG perspective. Some of these clauses may be uncommon, and so will likely incur pushback from the counterparty’s counsel. However, ESG-focused clauses are gaining in popularity and make good business sense. And if the counterparty has an allergic reaction to such a clause, they may not represent an organization that you want to do business with in the first place.
There are a variety of projects and organizations spearheading the development of standard clauses that you can argue for in your contracts, including:
- The Chancery Lane Project, a collaborative effort by UK lawyers to develop contract clauses to help fight climate change;
- The Responsible Business Alliance, whose widely used code of conduct is used by some businesses to establish standard contract terms that guarantee their suppliers abide by certain labor, health and safety, environmental, ethics, and management requirements;
- ESG-focused investment, finance and private equity groups, which often provide guidance on their standards for inclusion into their portfolio;
- And many others.
Using these and similar resources, in-house counsel can negotiate for ESG-minded terms in their agreements. For example, a renter could negotiate for the right to make environmentally favorable changes to their commercial real estate. Conversely, a landlord could stipulate that no renovations carried out by the renter may affect the building’s adherence to environmental standards.
In supply chain contract management, you could negotiate for a term that permits an exit from the contract without penalty should you identify a supplier with lower greenhouse gas emissions. Or, if you’re the selling party in an M&A deal, you could incorporate language guaranteeing that the buyer must continue the ESG practices that your business is known for.
Depending upon your business’s priorities and industry, your legal department can identify any number of ways to strengthen the organization’s ESG standing through contract negotiations. But equally important is establishing the contract management practices that will allow you to effectively track, manage and identify ESG considerations in your contract portfolio.
How contract management solutions can help
Any effort to practice ESG contract management will require the right system in place to support those efforts. Today, most businesses appreciate the need for a secure and centralized contract repository, but modern contract management solutions (CMSs) provide functionality that extends beyond contract storage.
Using a modern CMS, you’ll be able to onboard new contracts in a standardized and searchable format, search for key data points, extract those data points for analysis and report on your findings. In the context of ESG contract management, this could include the identification of contracts that are coming up for renewal which fail to meet the standards your organization adopts. These can then be prioritized, and your legal department can establish a strategy for renegotiating these contracts as the renewal date approaches.
Similarly, you can identify contracts that are hurting the most from the absence of ESG clauses. This could be based upon deal value, the nature of your industry, the nature of your counterparty, contract type or any number of assessable data points. As an example, businesses selling medical devices could push for clauses that forbid their contract manufacturer from using toxic sterilization agents.
Equally important is tracking whether your contract counterparties have adhered to the obligations they agreed to. Surfacing and visualizing the various obligations your counterparties hold with you (or that you have towards them) and comparing it against their performance will help you assess whether the organization you’ve partnered with is worth renewing with or should be abandoned in favor of a more serious partner.
The specific nature in which a CMS can support your efforts at ESG contract management will vary upon the nature of your contract portfolio, industry and business. To explore this subject further, don’t hesitate to reach out to an Exigent expert.
