Environmental, Social, and Governance (ESG) contract clauses are becoming increasingly popular as businesses strive to make a positive impact on the world around them.
But one issue a lot of Contracts and Procurement Professionals are facing is that they are in new territory with this.
Or rather, they’ve been doing bits of what is now ESG but it’s grown bigger and there’s a feeling of needing to react to this new wave."
So let’s break this down, take the scariness away from it, and deep dive into ESG contracts.
See, companies are under increasing pressure to adopt sustainable practices and demonstrate their commitment to responsible business conduct.
One way to ensure that suppliers are aligned with these goals is to incorporate ESG clauses into contracts.
And when this ties into the Vendor ESG Due Diligence you’ve already done or are doing (if you work in an agile way), you will see that you are on the right path.
Understanding ESG Clauses
ESG clauses are contractual instruments used by companies to encourage, demand, or oblige their suppliers to improve their ecological and/or social governance.
It also ensures they take sustainable, climate-friendly, and ethically aligned actions. In short, they are no different to any other type of contract clause that seeks to do this.
These clauses can cover a wide range of topics, including environmental decisions such as:
- The use of specific products or packaging
- Shipment requirements
- Human rights and the prohibition of engaging in child labour
- The obligation to provide a healthy and safe work environment
Many of you are probably familiar with clauses around bribery, modern slavery, and disposal.
The clauses used may also include obligations to withhold from engaging in or working with companies linked to corruption, drugs, or arms trafficking.
Seems weird that we even need to include things like this but this is the reality of the world we’re in."
You’ll probably be thinking right now that you already cover a bunch of this. It’s just that ESG now encapsulates a bunch of stuff you were already doing with contracts but it does so with more rigour.
Importance of ESG Clauses
Organisations such as the Organization for Economic Co-operation and Development (OECD) and the United Nations (UN) have recommended that companies influence their suppliers through contractual agreements to maintain and improve sustainability and responsible business conduct.
Governments cannot do this in isolation and one way they will enable their sustainability targets is to legislate and regulate. Hello, new compliance headaches".
There’s a sense that in the UK, from 2025, companies of any size will have to do some form of ESG reporting.
So the writing’s on the wall - get ready now for legislation that compels you to do it. Getting ahead now is a pragmatic activity.
The European Union is set to require companies to seek contractual assurance from their business partners to ensure compliance with their sustainability goals and to perform ESG due diligence throughout their supply chain.
And that’s why ESG contract clauses are an essential component of these agreements and are becoming increasingly important for companies to demonstrate their commitment to sustainability and responsible business conduct.
If your contract doesn’t ensure you’re getting the correct behaviours from your vendors to be compliant with ESG requirements, then you’ll be the one dealing with the consequences.
How to Get Started with ESG Clauses
Before incorporating ESG clauses into your contracts, it is important to understand the legal implications and to ensure that the clauses are clear and well-defined.
I know this sounds obvious but consider the “ESG Jargon”. What does Net Zero mean to you? What does “Supply Chain Visibility” mean to you? See, we might run into definition issues here so we need to keep that in mind.
Companies will need to decide whether the ESG commitments of their suppliers should be an obligation of means or an obligation of result. It may also be helpful to include specific measurable indicators to assess the supplier's efforts. This is best practice vendor and contract management. You should be putting measurable performance targets inside your contracts.
Additionally, it is important to link a specific consequence to the breach of an ESG clause to encourage compliance. You could opt for damages or termination as a specific consequence, or a combination of both.
Parties can also include a lump-sum indemnity which will be automatically due in case of a breach of the ESG clause. You’ll need to see what works with your vendors who may need some assistance getting up to speed with this.
Including ESG in Existing Contracts
One opportunity you have is to update existing contracts. I wouldn’t worry about those that are coming up for renewal in the next 12 months as you can renegotiate then.
Although, letting those vendors know upfront that if you are going to renew, you need those commitments in the contract well in advance is a sensible thing to do.
Your vendors may need to make changes based on your ESG requirements and you’ll discover whether they can. If they cannot do this, you’ll need to conduct a new sourcing exercise to find some ESG-friendly vendors.
But for those you want to change, a contract amendment is a good place to start.
You can utilise the Gatekeeper Best Practice Workflow for Contract Amendments to make those changes and update your contract record. This is an easy way to keep tabs on your ESG contract amendments (and any other amendments you may need to make).
Contract Amendment Best Practice Workflow
In Summary
Incorporating ESG clauses into contracts is becoming increasingly important for companies to demonstrate their commitment to sustainability and responsible business conduct.
ESG clauses can help companies ensure that their suppliers are aligned with their sustainability goals and are committed to responsible business conduct.
However, it is important to understand the legal implications and to ensure that the clauses are clear and well-defined.
By following these steps, companies can ensure that they are doing their part in making a positive impact on the environment, society, and governance.
If your business is looking to improve contracting with vendors when it comes to ESG, it should seriously consider leveraging the power of VCLM software, like Gatekeeper. Book a call with one of our vendor and contract experts to discuss your ESG contract requirements.
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