How best to integrating climate-conscious clauses in supply chain contracts

A boardroom is seen at the legal offices of the law firm Polsinelli in New York City
A boardroom is seen at the legal offices of the law firm Polsinelli in New York City, New York, U.S., June 3, 2021. REUTERS/Andrew Kelly - RC26TN9OOM5C

Climate-conscious clause are becoming more common in supply chain contracts & companies should be aware of the complexity they may introduce.

As companies increasingly use climate-conscious clauses in their supply chain contracts, several factors will play an important role, including companies’ implementation of public green-house gas (GHG) emissions targets or pledges, and increasing standardization of climate-related terminology.

While these contract clauses are not yet commonplace, companies should be aware that adding these provisions will introduce a host of new concepts, terminology, and practical implications, which may make their contract drafting and review process more complex.

There are two basic issues to consider when drafting or reviewing climate-conscious clauses in supply chain contracts, such as sale of goods contracts. First, the parties must consider the enforceability of the clauses; and then, the parties must draft the clauses to work well together with the rest of the contract.

<b>Enforceability of climate-conscious clauses</b>

When drafting or reviewing climate-conscious clauses, counsel must first consider their enforceability. For example, the parties should pay attention to climate-conscious clauses that set out their own contractual remedies, such as liquidated damages provisions. A liquidated damages clause requires the breaching party to pay a predetermined amount to the non-breaching party for the types of breaches that are specified in the clause. The predetermined amount can be a fixed amount, or an amount based on a predetermined formula.

Liquidated damages clauses are only enforceable if they reflect the parties’ compensatory rather than punitive intent. The primary purpose of these clauses must be to compensate the non-breaching party for losses, not to punish the breaching party. This means that climate-conscious liquidated damages clauses that require the breaching party to make payment to the non-breaching party’s favorite environmental nonprofit organization (rather than directly to the non-breaching party) may be unenforceable.

The enforceability of liquidated damages clauses also generally requires that the clause specifies that the liquidated damages are the exclusive remedy for the specified type of breach.

<b>Internal consistency in contracts</b>

Before inserting any new clauses into a contract form, counsel first should check how well they work together with the contract’s existing clauses. For example, most contracts include a general termination provision that allows a party to terminate the contract if the other party breaches it. The provisions are typically tailored to include different notice, cure period, and other requirements for different kinds of termination-triggering events. In addition to breach of contract, these may include, for example, a party’s insolvency or change in control.

Broadly drafted general termination provisions typically include catch-all language to capture all breaches of contract that are not more explicitly set out as a termination-triggering event in the clause. Many broadly drafted general termination provisions may therefore already cover breaches of newly included climate-conscious obligations.

Problems can arise if, in addition to a general termination clause, the contract also includes a dedicated clause providing early termination rights for breach of climate-conscious obligations with its own requirements. Unless climate-related breaches are specifically carved out from the general provision, it may be unclear which provision applies.

A thorough review and comparison of the contract’s climate-conscious and other clauses will enable the parties to detect these and other unintended inconsistencies. Indeed, other unintended inconsistencies can arise if the contract includes such items as:

      • Different standards to determine whether different types of breaches have occurred. For example, the contract might include a materiality qualifier for the breach of the supplier’s delivery obligations but not for the breach of the supplier’s climate-conscious obligations.
      • A dedicated limitation of liability clause that aims to limit the types or amounts of damages recoverable for the breach of climate-conscious obligations in addition to a general limitation of liability clause.
      • A dedicated indemnification provision for breach of climate-conscious obligations in addition to a general indemnification provision.
      • Special price adjustment provisions that are triggered by climate-related events as well as a general price adjustment clause.

As climate-conscious clauses in supply chain contracts become more commonplace, companies should make themselves aware of how adding these provisions may make their contract drafting and review process more difficult and prepare now for that.

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