How construction is incorporating ESG into contracts

Environmental, social and governance (ESG) considerations are increasingly important in the construction industry.

As laws and client expectations evolve, the pertinent question is whether construction contracts are being used as vehicles to ensure that ESG standards and Corporate Social Responsibility (CSR) goals are being properly met and, if so, to what extent.

A mix of forces is thrusting ESG to the forefront of business and government agendas, including the UK’s push for net-zero by 2050, evolving legal requirements and industry stakeholders demanding evidence that companies are acting responsibly.

ESG is becoming essential to winning contracts and staying competitive in a market where commercial awareness is at the forefront of corporate agendas.

ESG refers to three main pillars by which a company is assessed on its wider societal impact: environmental, social and governance.

It is a broad set of principles that gives an overview of an organisation’s impact, both internally and externally.

The fundamental concept behind ESG is that organisations should not only focus on financial turnover, but also on their wider impact on the environment, society and their employees.

There are a number of reasons why ESG impacts construction, including:

Environmental  

The construction industry significantly impacts the environment through carbon emissions, resource consumption and waste generation.

The Climate Change Act 2008 sets legally binding carbon reduction targets, which are relevant as the UK built environment is responsible for approximately 25% of the country’s total greenhouse gas emissions.

With the government’s net-zero targets, there is growing pressure for construction companies to be mindful of the environment in which their projects are situated and to focus on greener methods to implement them.

Social  

Social value is now of growing importance in public and private sector projects because they can have considerable impacts on local, wider communities and stakeholders.

They also bring potential short- to long-term benefits, ranging from employment or housing to public amenities and sustainability.

There are also labour laws to adhere to, ensuring fair (and minimum) wages, working hours and conditions, and protections under the Equality Act.

Worker safety must also be ensured through compliance with relevant employment laws and health and safety regulations, with direct social benefits of reducing workplace injuries and fatalities.  

Governance  

Good governance is critical for ensuring that projects are delivered effectively, ethically and in compliance with UK laws and regulations. For example, companies should ensure that projects meet Building Regulations 2010 requirements.

Governance allows all parties to remain accountable for their roles and responsibilities, promoting good behaviours and reducing the risk of corruption, malpractice or non-compliance with the relevant laws and regulations.

Some ESG-related provisions are now relatively commonplace in UK construction contracts, like CDM Regulations and sustainability clauses. However, different, more focused terms are now appearing.

Environmental provisions

We have seen requirements that commit contractors to protect the environment during the works; comply with environmental impact statements; inform the employer of any dangerous substances; ensure there is no release or disposal of dangerous substances; ensure there is no contamination of the site; do not breach environmental laws; advise of any environmental claims in relation to the site or the works; notify of any breach of environmental consents; and comply with the employer’s environmental policy (for which the contractor was not entitled to claim any additional time or any more money). 

Additionally, contracts are now seen specifying the use of eco-friendly materials like recycled or low-carbon concrete and steel, FSC-certified timber, and non-toxic and energy-efficient building materials.  

Social provisions

The use of social value clauses is also increasing (although not to the same extent as the inclusion of environmental clauses).

These clauses are often regulated by the Public Services (Social Value) Act 2012, which can set out the specific goals related to employment, skills development and community impact. And more clauses may now appear following the Procurement Act coming into force this year.

In terms of bespoke drafting that we have seen, the main social commitments on contractors are for them to implement and deliver the employer’s social value delivery strategy before the expiry of the completion period for the works.

This involves a detailed written strategy, produced in a form acceptable to the employer, setting out how the contractor will deliver the LSE (learning, skills and employment) deliverables in accordance with the contract.

The contractor also has to achieve outputs for each LSE deliverable. Finally, the contractor can be required to produce regular LSE reports on the implementation of the strategy.

Governance provisions

With regard to governance, employers are including express obligations on contractors to comply with their corporate polices and minimum requirements, which are becoming increasingly significant for clients as they seek to meet their own ESG targets.

Contracts are also requiring the contractor to ensure that its subcontractors and all other parties for whom the contractor is responsible also comply with these policies.

In terms of where ESG sits in the contract, drafting can either be found in the front-end contract terms or at the end of the contract, embedded within the technical documents.

If it’s in the front end, what are generally seeing is wider catch-all drafting that places an obligation on the performing party to acknowledge and comply with the employer’s policies and codes of conduct, and to ensure it doesn’t place the client in breach of any other ESG obligations it is bound to comply with elsewhere, such as in a third-party agreement (like a funding or property agreement).

This approach places greater emphasis on the performing party to fully digest and understand the ESG obligations that are included in the technical documents at a far more granular level.

While the use of ESG clauses in construction contracts was initially slow, they are now being seen more frequently. Changes to laws and mindsets are taking hold. 

Industry stakeholders that integrate these principles into their culture and contracts are highlighting their leadership, demonstrating their commitment to meet regulatory standards, gaining a competitive advantage and protecting themselves.

Indeed, non-compliance with ESG can lead to a range of legal, financial and reputational risks, which can result in liquidated damages, withheld payments, loss of future work and employee claims.

While there is not much in the way of detailed industry standard ESG drafting at the moment, our view is that we can expect to see an increase in the use of bespoke ESG clauses in the short term.

In particular, and as we would expect, public bodies are almost always including their ESG requirements at the tender stage. We expect private sector clients to increasingly include their ESG requirements at the tender stage too, and this is likely to result in more detailed ESG drafting in the contracts.

Amy Hodge is a managing associate and Ciara Fieldsend is a solicitor apprentice at Womble Bond Dickinson.