Climate contracting in real estate: the role of greener deals in reducing global carbon emissions

Climate contracting integrates decarbonisation and sustainability goals into legal agreements. In a recent webinar, in partnership with The Chancery Lane Project, a panel of experts discuss how climate clauses can be effectively implemented into contracts.

What are climate clauses?

Many companies will have considered implementing or expanding plans to incorporate climate, nature, or broader sustainability goals, whether at the asset portfolio or organisational level. However, less thought may have been given to the practical mechanics of how to implement these steps.

Every decision your organisation makes has a carbon footprint, from supplier selection to energy choice to how you transport your goods, explains webinar moderator Meena Kamath, head of built environment at not-for-profit organisation The Chancery Lane Project, the world’s largest network of legal and business professionals focusing on climate contracting. Underlying every one of those decisions is a contract, which may run from weeks to a few years, or even longer, especially in the built environment. If those contracts are not reflective of the climate goals set, emissions associated with those decisions are locked in potentially for many years, says Meena. ‘Using contracts to enshrine sustainability goals isn't just about compliance, it's about demonstrating real commitment to investors, regulators and stakeholders. Contracts help you to prove not just what your goals are, but exactly how you plan to meet them’, she says.

Climate risk is a business risk

‘Climate risk is a business risk and climate clauses can help businesses manage the potential legal and financial liabilities that are associated with climate change impacts’, says Chirag Rao, lead counsel at Field Energy. It is not only about future-proofing contracts but also incorporating performance metrics, transparency and accountability in climate contracts, and being attractive to investors, who are becoming increasingly sustainability-conscious, he says. Climate clauses also increase a company’s credibility, as greenwashing scrutiny intensifies, adds Diane Dickson MRICS, commercial director at MAK Contracting Ltd.

Political developments in some countries may threaten to slow progress with corporate sustainability goals, but sustainability remains a global agenda, says Becky Annison, head of supply chains, at The Chancery Lane Project. This is especially so with potential new EU legislation, such as the Directive on corporate sustainability due diligence (Directive 2024/1760), that could also affect non-EU businesses with operations in the EU. It makes good business sense for companies to start aligning contracts with likely future regulatory requirements, she says.

Additionally, many companies and investors are now prioritising environmental, social and governance (ESG) performance in procurement and funding decisions. Companies with strong sustainability commitments and those offering climate contracting may have an advantage in the scoring systems during the bidding process, says Diane.

Examples of clauses in use

In terms of clauses already being used today, Chirag cites the example of an interest ratchet clause for a loan agreement, called ‘Laith and Irsa’s clause’. This clause was developed closely with The Chancery Lane Project, and, in practice, could lower the cost of carbon for companies that reduce emissions in their operations. The clause also acts as a catalyst for stakeholders to develop accurate and verifiable methods for measuring and tracking carbon. Chirag also talked about ‘Aatmay’s clause’ and how it was being used by the UK’s Environment Agency, to require contractors to embed circular economy principles by specifying a certain percentage of recycled materials. The Chancery Lane Project has over 170 clauses that companies can use in contracts, free of charge. He adds that gaining buy-in from key internal senior stakeholders and internal comms is important to ensure the business is fully aligned on why it wants to use climate clauses and what it aims to achieve from them.

In 2021, the UK government introduced Procurement Policy Note 06/21, which requires suppliers tendering for contracts over £5m per year to have a carbon reduction plan in place for their entire organisation and commit to achieving net zero by 2050 or earlier, explains Veronica McGarry, policy advisor at the Cabinet Office for the UK government. However, the plan only applies to a supplier’s whole UK carbon footprint and is not contract specific, adds Veronica.

To develop a contract-level model, Veronica explains how she adapted ‘Jess and Rory’s clause’, developed by The Chancery Lane Project. This clause incentivises the reduction of emissions by offering a share of the financial gain resulting from those reductions. Veronica also incorporated an amended version of ‘Luna’s clause’, which aligns construction practices with net-zero objectives, as well as several other clauses. Given that government departments and suppliers were at different stages of sustainability maturity, many clauses were made optional to ensure that requirements remained achievable within each supply chain.

How can the main challenges be overcome?

Diane echoes the importance of fairness, highlighting that a key challenge is the perception of climate clauses as an additional risk to one party. This is especially true in the supply chain, where obligations and terms can be unfairly or unrealistically passed down the supply chain. She advises that contractors should ensure climate clauses are fair and proportionate to the supplier’s role, scope of work and level of influence.

She also identifies a lack of stakeholder awareness as another challenge and believes that this is something the industry could help address, as a lack of knowledge can lead to resistance.

Diane also stresses the importance of balancing ambition with practicality. ‘If climate clauses are too stringent, they run the risk of non-compliance, but too vague and they are likely to be ineffective, so they need to be tailored to the specific project’, she says. Dialogue and collaboration between parties, and taking a bespoke approach where necessary, is critical to overcoming these challenges.

Commitment to climate contracting

Becky emphasises the fragility of global supply chains to climate change and its effects, such as flooding and wildfires, and the related physical risk this presents to built assets. She believes businesses need to become more aware of the financial risks that climate change poses to their bottom line. She notes that the companies most committed to tackling climate change have accepted that some level of cost will be necessary to mitigate these risks. However, she also says that costs may not always increase, particularly where strong circularity principles are being adopted.

Monitoring the effectiveness of these clauses is important. Chirag explains how Field Energy uses data from reputable and independent sources to monitor the outcomes of climate clauses. The methodology that analyses both historical and future performance, but historical data is what is relevant, as it provides a baseline for evaluation and for contractual adjustments to be made where necessary.

Climate contracting works alongside existing industry frameworks and standards, such as RICS’ Whole life carbon assessment standard and the NEC X29 Climate Change clause, explains Diane. Climate contracting moves these standards beyond voluntary guidance, turning them into legally enforceable commitments, she adds.

As the webinar wraps up, Diane stresses the importance of ensuring climate clauses are fair and proportionate to each supplier. Becky emphasises climate clauses cannot just be inserted into contracts and expected to work; suppliers need to be engaged, and procurement teams need to fully understand what they are asking. Veronica highlights that contracting authorities and suppliers need to talk to each other and be honest about what is achievable. Chirag’s vision is for climate clauses to become embedded into contracts as an integral and normal part of the process, without being distinguished as climate clauses.

Climate contracting integrates decarbonisation and sustainability goals into legal agreements, aiming to reduce carbon emissions and minimising environmental impacts in the built environment. By embedding sustainability clauses into contracts and fostering collaboration across the entire value chain, organisations can effectively lower their carbon footprints.