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Financial institution staff can incorporate environmental and social clauses into legal agreements with clients/investees to require clients/investees to comply with the financial institution’s environmental and social requirements. Doing so helps a financial institution reduce its exposure to the environmental and social risks associated with a client’s/investee’s operations throughout the lifetime of a transaction and gives the financial institution legal recourse in the case of non-compliance.

A financial institution’s Environmental and Social Management System should state the circumstances under which specific environmental and social conditions such as the need for a corrective action plan should be inserted into the legal agreement for a proposed transaction.

The Legal Department should be involved in developing and inserting the necessary clauses on environmental and social matters into legal agreements. The specific language will depend on the type of transaction and potential environmental and social risks identified during the due diligence process but generally addresses the following areas:

  • Positive Covenants: Measures or actions to be taken by the client/investee. These may include the requirement for compliance with national environmental and social regulations and international standards, and periodic reporting on environmental and social performance. In the event of significant accidents and incidents, with potentially adverse environmental and social effects such as spills or workplace accidents resulting in death, serious or multiple injuries or major pollution, the client/investee is required to notify the financial institution in a timely manner, such as within 3 days.
  • Negative Covenants: Actions that the client/investee should refrain from undertaking. These include the financial institution’s environmental and social requirements.
  • Conditions Precedent: Conditions and requirements that the client/investee has to fulfill prior to disbursement of funds by the financial institution. These may include proof of valid permits and licenses, preparation of government-requested reports and delivery of completion of mitigation actions stipulated in the corrective action plan.
  • Event of Default: An event that entitles the financial institution to cancel a transaction and declare all amounts owed by the client/investee to become immediately due and payable. For transactions that involve complex environmental and social issues, this may include specifying a time period such as 30 days during which the client/investee can resolve the issue after notification by the financial institution.
  • Corrective Action Plan: The Plan is typically included as an annex to the legal agreement, outlining the specific mitigation actions to be taken by the client/investee according to an agreed timeframe for implementation.

To assess compliance with the environmental and social clauses stipulated in the legal agreement, financial institution staff should periodically monitor clients/investees and, as necessary, require the preparation of a periodic environmental and social performance report for review by the financial institution. The financial institution should consider material non-compliances with the environmental and social clauses as a breach of contract, which constitutes an Event of Default under the terms of the legal agreement.

In case of such an event, financial institution staff needs to work with clients/investees to resolve non-compliance issues in order to ensure that any potential exposure of the financial institution to the client’s/investee’s environmental and social risks is mitigated. Where resolving the non-compliance issue is not possible, the financial institution may be required to take legal action against the client/investee to reduce its exposure to the environmental and social risks associated with the transaction.

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