Environmental, social, and governance (ESG) matters, including climate-related obligations, have become an increasingly important issue in supply chain relationships. In many cases, the charge has been led by large companies with significant negotiating leverage.

The traditional way for large buyers (including retailers) to upstream ESG requirements to vendors is by implementing a supplier code of conduct (sometimes called a vendor code of conduct). These codes typically set out the minimum requirements regarding fair and safe labor and environmental practices, among other concerns, that manufacturers, suppliers, and other vendors must meet to sell goods to or otherwise do business with the buyer.

The codes typically sit on company websites and are sometimes incorporated by reference into the contracts they enter to purchase goods and services. Non-compliance may subject the vendor to penalties, including termination. While the codes can showcase a company's commitment to ESG, it is not known for certain how effective they are in fostering ESG values throughout the supply chain. For more information about supplier codes of conduct, see Standard Documents, Supplier Code of Conduct Policy and Supplier Code of Conduct Poster.

ESG-related requirements can also be directly embedded in supply chain contracts. This can be seen in the increasing use of representations and covenants in supply contracts to supplement the contract's compliance with law provisions. A breach of the representation or covenant is a breach of contract that subjects the breaching party to contractual liability in addition to whatever public or private remedies are provided by law.

Examples of ESG-related provisions include:

For more information on Practical Law resources on ESG-related supply chain issues, see ESG in the Supply Chain Toolkit. For more information about compliance with law provisions, see Standard Clause, General Contract Clauses: Compliance with Laws.

Detailed climate-conscious clauses in purchase contracts, such as clauses requiring a supplier to reduce their greenhouse gas (GHG) emissions, are still not commonplace. But this may be changing. Paving the way is the increasing standardization of the terminology used, especially regarding GHG emissions.

For example, it is widely accepted practice to group a company's emissions for reporting purposes according to the three categories defined by the Greenhouse Gas Protocol, a corporate accounting and reporting standard that helps companies and other organizations to identify, calculate, and report their GHG emissions. These include a company's self-generated emissions (Scope 1) and indirect emissions from the company's purchased energy (Scope 2). The third category (Scope 3) is the most expansive and difficult to measure. Scope 3 includes all other emissions that a company is indirectly responsible for across its value chain, such as emissions from the manufacture of purchased goods or emissions from the customer acquiring the goods.

Another catalyst for increased usage of climate-conscious clauses in supply chain contracts may be the SEC's proposed climate risk disclosure rules for public companies (see Legal Update, SEC Proposes Mandatory Climate Disclosure Rules). This can also affect privately held companies that are not directly subject to the SEC's proposed rule but are part of public company supply chains. For example, public companies may have the incentive to use their negotiating leverage to impose on their smaller partners climate-related obligations to help the public companies fulfill their SEC disclosure obligations and inform their investors.