Our key takeaway: Why do responsible contracts matter to investors? It matters a lot, says the Interfaith Center on Corporate Responsibility and the Responsible Contracting Project. Responsible contracts underpin effective human rights and environmental due diligence (HREDD), which stems from the UN Guiding Principles on Business and Human Rights (UN Guiding Principles) and is increasingly becoming law in various jurisdictions. Take the EU Corporate Sustainability Due Diligence Directive (CSDDD) for example. This is because responsible contracts move away from a traditional one-sided and strict compliance approach, towards one that is due diligence-aligned and based on cooperation between suppliers and buyers. The latter is more effective at preventing and mitigating adverse risks before they evolve into actual impacts. Investors, through their corporate engagements, can support companies in conducting effective HREDD. Investors, for instance, can use their leverage to ask questions of portfolio companies to determine whether they are using responsible contracts in their supplier engagements and, thus, shine the light on this topic. In short, investors, through their corporate engagements and dialogues on responsible contracts, can shift corporate incentives to align with sustainability outcomes rather than business outcomes that are harmful to people and planet.
The Interfaith Center on Corporate Responsibility and the Responsible Contracting Project have collaborated to publish The Investor Guidance on Responsible Contracting (April 2024). This Investor Guidance provides practical tools to investors on how to engage with their portfolio companies on the use of supplier contracts to support effective human rights and environmental due diligence (HREDD), which is increasingly becoming a legal obligation:
- Why should investors care about responsible contracts? The Guidance highlights several reasons why contracts matter to investors in relation to their own obligations as responsible investors and in their corporate engagements. Under the UN Guiding Principles, the responsibility to respect human rights applies to all sectors while not explicitly referring to investor activities. The OECD’s report on Responsible Business Conduct for Institutional Investors makes it clear that institutional investors have a responsibility to conduct HREDD across their investment portfolios to assess the risks of investments. In addition, many laws are now requiring mandatory HREDD in line with the UN Guiding Principles and OECD Guidelines. An example is the German Supply Chain Due Diligence Act (LkSG). The Guidance further states that responsible contracts are key to effective HREDD because it supports the prevention and mitigation of HRE risks before it escalates into actual adverse impacts. More specifically, supplier contracts should move away from traditional risk-shifting contracts (which shifts all risks and responsibilities onto suppliers), towards shared-responsibility contracts (which commits both parties to cooperate in ongoing HREDD and providing remedy where adverse impacts have occurred.) This approach improves HRE outcomes in supply chains and ensures companies are meeting their legal obligations under existing and upcoming sustainability laws and regulations: “[t]he shared-responsibility approach supports more balanced buyer-supplier relations and more effective implementation of human rights policies and risk management processes that can in turn support better HRE outcomes in global supply chains. It also enables better legal compliance.”
- What are responsible contracts? The Guidance refers to the Responsible Contracting Project (RCP), which provides practical tools on how to create and implement responsible contracts to support effective HREDD in alignment with the UN Guiding Principles. Under RCP’s core principles, responsible contracts should reflect the following: 1) Responsible allocation of risks and responsibilities. This means abandoning “static, one-sided, supplier-only promises (“representations & warranties”) of perfect HRE compliance” and making “a joint commitment to cooperate in conducting ongoing, risk-based, HREDD”; 2) Responsible purchasing practices. This means buyers agreeing “to support their suppliers’ HRE performance…by engaging in responsible purchasing practices”; and 3) Remediation first and responsible exit as a last resort. This means prioritising rights holder-centred remediation over traditional contract remedies like suspending payments and terminating contracts when an adverse impact occurs. RCP’s Toolkit provides model responsible contract clauses, which can be accessed here.
- Recommendations for investors: The Guidance recommends that investors engage with their portfolio companies on responsible supplier contracts. The Guidance provides a non-exhaustive list of questions that investors can ask in their corporate engagements to assess the use of responsible contracts. Examples include: a) “What role do your contracts play in your HREDD regime?”; b) "If human rights and environmental (HRE) issues are reflected in your contracts, how do you go about doing that?”; c) “What do your contracts say about how you will react if an actual adverse HRE impact occurs in relation to your contract?”; d) “What documentation do you request of your supplier(s) to ensure HREDD is working?”; and e) “Is an individual within the senior management team tasked with overseeing HRE-related risks?” The Guidance also provides letter templates that investors and shareholders can use in their corporate engagements (pages 15-18) and FAQs to respond to companies’ questions in relation to responsible contracts (page 19).
