What role do legal contracts have in a truly sustainable transition? A bigger one than you’d think, says David Frydlinger
To transition to a financially, environmentally, and socially sustainable economy, we must fundamentally change both the formal and informal rules that shape markets and corporate behaviour. The “Too Little Too Late” scenario in the Earth4All model is a direct result of the current rules, and achieving the “Giant Leap” scenario will certainly require new legislation. However, there is another crucial, yet largely overlooked, shift needed in the legal framework of the market: how contracts between businesses are structured.
The formal rules for sustainable business—laws and contracts—are at the heart of the emerging field of sustainability law, where the European Union, with its Green Deal, is leading the way globally. On September 2, 2024, a new book titled Rules of the Game for Sustainable Business: Laws, Contracts, and Morality, authored by the writer of this article, was published. This book aims to give readers a deep understanding of this evolving area of law, while also serving as a practical guide for companies looking to become more sustainable. The Earth4All model is used throughout to provide context and enhance understanding.
Johan Rockström—co-author of Earth for All: A Survival Guide for Humanity, Director of the Potsdam Institute for Climate Impact Research, and Professor in Earth System Science at the University of Potsdam—writes in the foreword of the book:
“Society’s institutions and rules have long been highlighted as important for sustainable development. Now, we are in the precarious position that six out of nine planetary boundaries have been crossed. Not only are we at risk of even more socially and economically damaging shocks, such as extreme heat waves, droughts, floods and diseases. We also risk destabilising Earth itself, with far-reaching consequences for all future generations of the world.
So, new rules of the game are needed for the economy, business and society, and new formal and informal institutions that consider the well-being of all people and their relationship with nature.”
The transition to the new rules that Rockström describes requires a paradigm shift on multiple levels. In this book, I focus on two such shifts, both of which have significant practical implications.
The first shift involves our overall perspective on what law is and how it should be interpreted, which is fundamentally a question of sustainability. The nearly century-old debate about the purpose of business—whether it is to maximise profits for shareholders, provide value for stakeholders, or serve some other purpose—tilted towards shareholder primacy by the end of the 20th century. This view has persisted, largely due to the rise of the legal theory known as “law and economics,” which sees law as a tool to maximise economic efficiency. This perspective supports a narrow view of what a corporation is and should be—a “nexus of contracts” owned by shareholders, with the sole purpose of maximising shareholder value. This view, although widely accepted, is not strongly supported by the actual laws around the world and contributes significantly to the “Too Little Too Late” scenario in the Earth4All model.
Sustainability law loses its meaning if it is not seen as enforcing the moral norms articulated in fundamental human rights and environmental treaties on the market. Ultimately, sustainability is about protection of freedom and equality. Therefore, the legal theories of “law and economics” (as well as legal positivism) must be replaced with another influential perspective known as interpretivism. This shift in interpretation would redefine corporate law and the purpose of business—not merely as an academic exercise, but as a change with substantial, practical implications for sustainability.
The second paradigm shift concerns our approach to contracts. A significant portion of a company’s revenues and expenses flow through various contracts, which play a crucial role in shaping incentives and guiding market behaviour. Currently, many contracts establish rules that generate negative environmental and social outcomes, often referred to as externalities by economists. The perspective from which we approach contracts is therefore critically important. Within the legal community, this choice is between classical contract theory and relational contract theory. However, this is not just a theoretical debate; the choice directly impacts how contracts are negotiated, drafted, and managed in practice. Rather than generating externalities, contracts should ensure that these are internalised. Contracts play a significant role in both the sustainability challenges facing the world and their solutions. Rules of the Game for Sustainable Business: Laws, Contracts, and Morality aims to highlight this by placing contracts—along with legal rules and moral norms—at the center of the sustainability discussion.
