Contract Provisions for ESG in Your Supply Chain
Environmental, Social and Governance (ESG) factors are becoming increasingly important in supply chains. Consumers are demanding more transparency and better practices than ever before. Meanwhile, millennials are putting their money where their mouths are and increasingly investing in companies that align with their environmental and societal values.
But developing supply chains that comply with these increasing standards isn’t always easy – as is shown by the recent lawsuit filed by the International Rights Advocates against Nestle (and others) for its part in forced child labor practices.
In this article, we’ll outline some contractual provisions that you can implement to strengthen ESG in your supply chains in order to improve worker quality of life. These improved working conditions and living wages can lead to the following benefits:
- More consistent quality in the products being supplied
- Improved reputation and competitive advantage for your company
- Decreased staff turnover
- Improved quality of life for workers in your supply chain
Additionally, the provisions can also help to minimize risk from supply chain disruptions caused by worker unrest or changing industry standards, like the sweeping changes we saw in Bangladesh following the catastrophic 2013 factory collapse that killed more than 1,000 workers.
Transparency is recognized as being a significant piece of the puzzle in improving worker wages and conditions. After all, companies cannot improve poor conditions where they aren’t aware they exist.
A starting point for embedding transparency into your contracts is to require suppliers to disclose their sub-suppliers, including reporting from those sub-suppliers about working conditions and wages. From there, you can identify potential risks and information gaps and develop a framework for working with your suppliers to improve conditions over time. You should do so with the ultimate goal of providing for living wages for all workers in the supply chain and fair working conditions, including no forced or child labor.
Reduce Your Supply Chain Carbon Footprint with Carbon Targets
CDP Worldwide, a non-profit that aids in the management of environmental impacts, recognizes increased transparency and increased supplier engagement targets as being beneficial in reducing emissions in the supply chain. The organization also notes in its Committing to Climate Action in the Supply Chain report that less than one-third of the 4,000 companies surveyed engaged their suppliers on carbon emissions.
You can begin to address emissions by embedding contractual provisions that target supplier action in reducing emissions. For instance, we’re seeing companies start to include termination for greener supplier clauses, which allow companies to terminate supplier contracts without incurring an early-exit penalty if a “greener” supplier is found.
Similarly, you can rely on flow-down provisions that enable you to bind subcontractors.
To give these provisions more teeth, you should include positive/negative consequences for compliance/non-compliance with this provision. This may include:
- Preferential ordering from suppliers that meet targets
- Financial penalty for non-compliance
- Making failure to comply grounds for termination of the contract
Enhance Sustainability Through Increased Quality of Supplies and Processes
Another contractual mechanism you can use to improve ESG in your supply chain is to mandate the use of supplies that meet certain standards. For instance, you may require suppliers to use organic wool, organic cotton or a certain amount of recycled materials when producing your products.
Similarly, you can require that the suppliers avoid products that contain microplastics, glitter, or other substances or supplies that have been treated with certain chemicals. To achieve this, you should be outline in the contract exactly which products are to be prioritized and which must be avoided. We are seeing some companies incentivize the use (or avoidance) of certain materials through rewards schemes for suppliers who meet or exceed the targets laid out in the contract.
Finally, you can also require your suppliers to routinely engage production experts to analyze production methods and offer recommendations to reduce the environmental impact of production. Again, you can make the failure to implement the recommended changes a material breach of the contract or you can incentivize the improvements via a reward scheme.
Improving ESG Through Contracts, Community Engagement and Collaboration
Your contracts can support your company’s ESG priorities, but they aren’t a stand-alone solution. To achieve ESG that will stand up to increasing millennial scrutiny, you need to engage with your competitors, consumers, and suppliers to bridge the gap between ideal practices and real-world obstacles. Most importantly, you need to transparently discuss your progress, flaws and all, as you develop your greener and more ethical supply chain.