ESG contractual clauses – ensuring compliance within your supply chains

Life Sciences & Healthcare companies are responding to pressure from a variety of stakeholders to adopt ESG strategies by reviewing all aspects of their business - from procurement to product development, supply chain to service delivery.  Examining existing and future relationships with suppliers is a key part of ESG-compliance.  A common method adopted by Life Sciences & Healthcare companies is the inclusion of ‘ESG clauses’.  These clauses can legally require the supplier to align with ESG requirements, including: 

• reporting on environmental matters; 
• reducing greenhouse gas emissions;
• setting targets for a transition to net zero emissions; and
• maintaining a minimum ESG sustainability rating for the life of the contract.

This article explores the various types of ESG clauses, how they can be enforced and the next steps for businesses operating in the Life Sciences & Healthcare sector.

ESG clauses can be used to effectively ensure that suppliers comply with an ESG requirement. However, the type and implementation of ESG clauses can vary considerably from one contract to another depending on several factors, including a company’s size and the nature of the transaction.  For many suppliers these clauses represent a degree of uncertainty as requirements vary from one deal to the next and it is important to understand the types of ESG clauses, how they can be implemented, and the potential considerations prior to and post implementation.

Types of ESG clauses

There is no one-size-fits-all approach as to the types of ESG clauses that should be inserted into a contract. However, they are usually aligned with the type of product and/or service required of the supplier and the particular industry of the customer.

By way of example, ESG clauses can cover the following topics:

• modern slavery and its prevention;
• anti-bribery and anti-money laundering;
• greenhouse gas emissions;
• net zero targets; and
• waste disposal practices.

Implementation

Some ESG clauses require representations to be made, meaning that the supplier provides a legal “promise” to comply with particular ESG requirements during the lifetime of the contract. For example, a contract involving the disposal of potentially hazardous items could include a representation that: 

“The Supplier represents that it will comply with all applicable laws regarding the environment, including in relation to waste disposal and the handling of hazardous and toxic materials.”

Other clauses can require the supplier to provide progress reports on various ESG topics after the contract has commenced. For example, if a contract required reporting on the reduction of greenhouse gas emissions, the clause could be:

“Within thirty days of the Contract Date, the Supplier will submit a credible GHG Emissions Reduction Plan to the Customer. The Supplier will provide the Customer, on request, with progress reports (in the format required by the Customer) on its implementation and operation of the GHG Emissions Reduction Plan during the Term.”

Or, as is more typical in long term arrangements, some ESG clauses can require repeating commitments from the supplier. For example, by combining the two examples above, the clause could be:

“On each anniversary of the Contract Date, the Supplier shall complete and submit to the Customer a report in relation to its:

1. GHG Emissions in the preceding Contract Year (including whether this reflects an increase or reduction in previously reported GHG Emissions);
2. volume of waste created; and
3. details of how the waste was disposed.”

As can be seen with the examples above, not only can the topics of ESG clauses vary, but also the expression and form of commitment. As such, prior to inserting these clauses, companies should determine which type of ESG clause is most appropriate by commercially evaluating the length, value, and nature of the contract. 

Aside from the commercial considerations, because many ESG clauses are not standardised legal requirements, they must be drafted clearly to demonstrate what is required by the supplier and the associated consequences of any breach. 

There are significant reputational or contractual implications if a company fails to meet its ESG requirements. If a company inadvertently breaches its contractual obligations with a customer because its supply chain fails to meet the necessary ESG standards it could result in a loss of that contract or worse.

Consequently, the clause in question must be enforceable and have a real impact.  The inclusion of ongoing audit rights and clauses which mitigate the company’s risk (e.g. indemnities and specific performance) are worth considering alongside rights to terminate for breach of the ESG clauses.

In line with the discussions above, the question for many Life Sciences & Healthcare companies should be “what steps should we take to ensure ESG compliance within our supply chain?”. 

One such step is to review the current contractual arrangements in place with suppliers specifically with ESG requirements and enforcement methods in mind. It is commonplace for supplier contracts to have been in place for many years and, as such, it is possible that they no longer accurately reflect current modern cultural sensitivities, legal requirements, or procurement requirements.   It is important to note that for any multi-jurisdictional supply chains, ESG may be less of a priority or harder to monitor in certain jurisdictions and this should be factored into any commercial discussions with suppliers.

A clear picture of the supply chain will allow companies to accurately highlight and address any gaps that may be present and contractually align its supply chain with customer requirements or internal standards.