ALLOCATING THE RISK OF CLIMATE CHANGE-RELATED EVENTS. BY ELIZABETH OGER-GROSS, KIRSTEN ODYNSKI AND MARIÈLE COULET-DIAZ
Extreme weather events are a defining feature of the new, changing climate. The unpredictable nature and the widespread impact of such events pose a myriad of risks to contractual counterparties. States’ commitments to combat climate change may also affect contractual performance. New legislation requiring the reduction of greenhouse gas emissions, for example, may have a significant impact on the operations of oil and gas companies. As parties traditionally allocate business risks when contracting, these climate change-related risks now more than ever require careful consideration by contracting parties generally and oil and gas companies in particular. One doctrine that can be used to try to proactively address changing contractual assumptions is hardship.
The potential impact of climate-change on contracting parties
The effects of climate change are widespread and significant, causing a range of environmental problems, including rising temperatures, rising sea levels and increased frequency and/or severity of extreme weather events (such as excessive rains, wildfires, droughts and cyclones). These events could result in infrastructure damage and severely disrupt oil production and distribution. Extreme weather events, in turn, have a number of consequences on both natural and human systems, which the Intergovernmental Panel on Climate Change (IPCC) has defined as the alteration of ecosystems, disruption of food production and water supply, damage to infrastructure and settlements, illness and mortality, and consequences for mental health and human well-being. The IPCC has also indicated that climate change could indirectly increase the risk of violent conflicts (such as civil war and inter-group violence) by amplifying the drivers of these conflicts, such as poverty and economic shocks. As such, climate-change-related events may adversely impact the ability of oil and gas companies to fulfil their contractual obligations. The political instability and greater uncertainty associated with these events may also impede or reduce investment and economic growth.
Moreover, countries bound by the Paris Agreement have agreed to take “mitigation” steps to reduce greenhouse gas emissions and enhance sinks (e.g. increasing the area of forests). They have also agreed to adopt “adaptation” measures to respond to climate change and to prepare for future impacts. These measures may also affect parties’ ability to fulfil their contractual obligations. For example, mitigation measures promoting a greater use of renewable energy may adversely impact the production and/or rendering of services that rely on fossil fuels. Likewise, measures intended to protect certain biological and physical environments may prevent or slow down commercial activities that put those environments at risk.
The doctrine of hardship
Hardship is a legal doctrine that provides an exception to the basic rule that parties are bound by their agreement: It aims at maintaining the original contractual balance in situations where a change of circumstance causes significant disruption to the performance of the contract, by entitling the aggrieved party to renegotiate (or even to terminate) the contract.
Domestic laws in many civil law countries include provisions recognising hardship. Moreover, and regardless of whether the law applicable to the contract contains any such provisions, parties may include in their contracts clauses that provide for the possibility of renegotiating or terminating the contract for reasons of hardship.
While the precise test will vary in accordance with the applicable law and the terms of the contract, hardship is traditionally triggered upon the meeting of specified cumulative requirements, notably including that the change in circumstances be “fundamental” and “unforeseeable.”
Can climate change constitute hardship?
The “unforeseeability” and “fundamental” nature requirements of the traditional hardship test warrant particular attention when considering the doctrine of hardship in the climate change context. Indeed, the question as to whether parties can successfully invoke traditional hardship provisions (whether legal or contractual), to address the types of risks that climate change will exacerbate, remains uncertain.
There is a good argument that extreme weather events can no longer be considered “unforeseen”. The ICPP’s assessment of the actual and predictable impacts of climate change on natural and human systems is arguably evidence that the occurrence of extreme weather events and their consequences are more foreseeable than not. For example, the IPCC identifies that the occurrence of extreme weather events, such as flooding, will likely have major economic costs, both in terms of immediate impacts (e.g., capital destruction, disruption) and necessary adaptation measures (e.g., construction, defensive investment). Oil and gas companies can and should anticipate some of the various impacts that climate change will have on their operations and ability to comply with contractual undertakings.
Similarly, there is also a good argument that State measures to fight climate change are more foreseeable than not. Given the terms of the Paris Agreement, contracting parties should be aware that many countries may impose or increase taxes on greenhouse gas emissions, such as carbon taxes or taxes levied on plastic packaging. In this respect, oil and gas companies, should anticipate that States will implement measures to reduce greenhouse gas emissions and require the development of new technologies and practices adapted to the new climate context. Contracting parties should also be aware that countries are likely to implement national security policies to adapt infrastructure and territorial integrity to the new climate context. For example, in regions at significant flood risk (e.g., small islands or countries with extensive coastlines), governments may restrict, prohibit or even expropriate commercial or industrial activities.
How should companies adapt?
To account for the uncertainty caused by climate-change related events when concluding contracts, oil and gas companies should consider including specifically tailored hardship clauses in their contracts, even when the applicable law contains a hardship provision. Specifying expressly what constitutes hardship and what will happen if the hardship test is met allows parties to ensure that, insofar as a dispute arises, courts and arbitral tribunals will admit hardship and the consequences contracted for.
Properly drafted hardship clauses allow the parties to allocate the consequences of particular events, including those related to climate change. Potential drafting tools include:
Defining hardship so that it does not include – or even expressly excludes – the requirements that the event be “unforeseeable” and/or that the event “fundamentally” alters the equilibrium of the contract.
Outlining specific risks and events that may trigger hardship, including those related to climate change.
Defining the standard against which the “foreseeability” of the triggering event should be assessed, e.g., expressly stipulating that certain unspecified weather events will be deemed unforeseeable where certain contractually specified conditions are met.
Defining the required degree of severity of the triggering event. A clause requiring “excessive burden” will be more restrictive, for example, than one requiring a “substantial financial burden” or one contemplating merely a “material disadvantage”.
Including a price adjustment mechanism to mitigate the risk that State action to combat climate change substantially alters the cost or price of specific goods or materials.
In light of the uncertainty about whether the hardship doctrine will evolve so as to encompass the potential impacts associated with climate change – and the risk that it does not – contracting parties (and oil and gas companies, in particular), should adapt and tailor their hardship clauses to the new climate context to ensure that climate change-related events and related State action taken to achieve net-zero targets will trigger – if they so wish – the renegotiation of the contract.
WHITE & CASE LLP
Elizabeth Oger-Gross and Kirsten Odynski are Partners and Marièle Coulet-Diaz is an Associate at White & Case LLP. White & Case is a leading global law firm with lawyers in 44 offices across 30 countries. Among the first US-based law firms to establish a truly global presence, it provides counsel and representation in virtually every area of law that affects cross-border business.
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