Proposed Rule Turns Up the Heat on Climate-Related Disclosures for U.S. Government Contractors

The largely unprecedented rule, which implements the Biden Administration’s Executive Order 14030, Climate-Related Financial Risk, discussed in detail here, stands to be a substantial and burdensome development for federal contractors receiving at least US$7.5 million in Federal contract obligations. Below, the Hogan Lovells team breaks down the key compliance requirements and notable risks for federal contractors. 

Overview of the proposed rule

The proposed rule will create a new FAR subpart at 23.XX, entitled “Public Disclosure of Climate Information,” to expand the existing climate-related representations in the solicitation provisions at FAR 52.223-22, Public Disclosure of Climate Information—Representation, and 52.212-3, Offeror Representations and Certifications—Commercial Products and Commercial Services.¹ The rule will also establish a new standard of responsibility for certain contractors in FAR subpart 9.1.

The proposed rule targets two categories of federal contractors: “significant contractors” and “major contractors.” “Significant contractors” include companies that have received at least US$7.5 million and up to US$50 million in “Federal contract obligations” during the prior Federal fiscal year. A “major contractor,” on the other hand, is a company that received greater than US$50 million in “Federal contract obligations” during that time period.  

Contractors must report their status as a significant or major contractor in the System for Award Management (SAM) – that is, if they can even determine their status in the first place. Although the rule purports to adopt the OMB Circular A-11 definition of “Federal contract obligations,” that Circular does not define the term at all, leaving it unclear to contractors as to whether they must comply with the rule, and to what extent, or not. Contractors who are subject to the rule, however, would be required to represent their compliance with required reporting requirements, as follows.

Scope 1 and Scope 2 Emission Disclosure Requirements for Significant and Major Contractors

Both significant and major contractors will be required annually to inventory their Scope 1 and Scope 2 GHG emissions within the current or prior fiscal year. Scope 1 emissions include GHG emissions from sources that are owned or controlled by the reporting entity. Scope 2 emissions include indirect GHG emissions associated with the generation of electricity, heating and cooling, or steam, when purchased or acquired for the reporting entity’s own consumption but occur at sources owned or controlled by another entity, e.g., emissions from purchased or acquired electricity, steam, heat, and cooling. Contractors also must disclose their emissions information on SAM. 

The emissions inventory must capture emissions over a continuous 12-month period, ending not more than 12 months prior to the inventory completion. The rule would require contractors to follow the “GHG Protocol Corporate Accounting and Reporting Standard” when developing emissions inventory.  This requirement goes into effect one year following publication of the final rule. 

Affected contractors must use four standards to inventory and publicly disclose their annual climate data:  (i) the GHG Protocol Corporate Accounting and Reporting Standards and Guidance;[2] (ii) the 2017 Recommendations of the Task Force on Climate-Related Financial Disclosures (TFCD); (iii) the CDP Climate Change Questionnaire; and (iv) the Science Based Targets initiative (SBTi) criteria.

Scope 3 Emission Disclosure Requirements, Annual Climate Disclosures, and Science-Based Emission Reduction Targets for Major Contractors

In addition to reporting on Scope 1 and Scope 2 emissions, major contractors also must disclose their Scope 3 GHG emissions and complete an annual inventory of these emissions, again within its current or prior fiscal year. Scope 3 emissions include greenhouse gas emissions other than Scope 2 emissions that are a consequence of the reporting entity’s operations, but that occur at sources other than those owned or controlled by the reporting entity, e.g., transportation or distribution centers.

Major contractors also would be required to complete a broader “annual climate disclosure” within their current or previous fiscal year. The annual climate disclosure must include an inventory of Scope 1, Scope 2, and relevant Scope 3 emissions, as well as describe the contractor’s “climate risk assessment process” and any identified risks. Under the proposed rule as written, contractors would fulfill this requirement by completing those portions of the CDP Climate Change Questionnaire that align with the TCFD as identified by CDP. Major contractors must publish the annual climate disclosure on a publicly accessible website.

Beyond the disclosure requirements, major contractors must develop “science-based targets” to reduce their GHG emissions to meet the goals of the Paris Agreement. Those targets must be validated by the third-party SBTi within the last five fiscal years, and then published on a publicly accessible website. The proposed rule defines science-based target as “a target for reducing GHG emissions that is in line with reductions that the latest climate science deems necessary to meet the goals of the Paris Agreement to limit global warming to well below 2 ℃ above pre-industrial levels and pursue efforts to limit warming to 1.5 ℃.” 

Although burdensome, this requirement would not apply until two years following publication of the final rule. That means if the final rule is published sometime next year, major contractors will have until at least 2025 to develop, validate, and make publicly available their science-based emissions reduction goals. 

Exceptions

The proposed rule exempts certain categories of federal contractors from compliance, including

• Alaska Native Corporations, Native Hawaiian Organizations, and Tribally owned concerns;
• higher education institutions;
• nonprofit research entities; and
• entities that derive 80 percent or more of their annual revenue from Federal management and operating contracts subject to annual sustainability reporting requirements.[3]

Additionally, small businesses that exceed the US$50 million threshold and would otherwise qualify as “major contractors” would not be required to report Scope 3 emissions or set science-based reduction targets; however, these contractors still would be required to meet the Scope 1 and Scope 2 emissions reporting obligations of significant contractors.[4]

There is no exception for acquisitions of commercial products or commercial services, or for those valued at or below the simplified acquisition threshold. 

The proposed rule allows for waivers in limited circumstances, including for purposes of national security, emergencies, and other mission essential purposes. Senior procurement executives also may waive an entity’s compliance for up to one year as the entity comes into compliance with the rule.

Enforcement

Contractors that fail to comply with the relevant requirements risk being deemed “nonresponsible” and therefore ineligible to receive federal contract awards. Contracting officers have discretion to waive a contractor’s noncompliance with the disclosure requirements pursuant to a determination that: (i) the noncompliance resulted from circumstances outside the contractor’s control; (ii) the contractor demonstrates substantial efforts taken to comply; and (iii) the contractor publicly commits to comply within one calendar year. There is, of course, also the specter of fraud allegations where contractors misrepresent their compliance with the public disclosure requirements of the rule. 

Key takeaways and next steps

The proposed rule represents the Biden Administration’s latest step to combat climate change through a “whole of government” approach. In fact, the proposed FAR rule bears certain similarities to the controversial March 2022 Securities and Exchange Commission (SEC) proposed rules (previously discussed here) that sought to require investors to make certain climate-related disclosures in their registration statements and periodic reports. While both the SEC and FAR rules seek to leverage existing third-party standards to standardize the disclosure and reporting of climate-related financial risk, the proposed FAR rule takes it one step further by requiring major contractors to establish emission reduction targets. It is anticipated that the proposed FAR rule will prove similarly, if not more, controversial to federal contractors. 

Contractors should keep in mind, however, that this is a proposed rule and much could change in a final rule. Several outstanding questions that the final rule might address include:

• How will the final rule define “Federal contract obligations”? How will this account for options, modifications, and task or delivery orders?
• To what extent will contractors be required to collect third-party emissions data in order to meet their reporting obligations for indirect Scope 3 emissions? The rule does not address subcontractor applicability or prime contractor flowdown obligations, but presumably affected contractors will need to obtain certain indirect emissions information from subcontractors and suppliers throughout their supply chains in order to comply with their own Scope 2 and Scope 3 reporting obligations.  
• What ramifications, if any, will there be for major contractors who fail to achieve their established science-based emissions reduction targets, and how will such ramifications be enforced? 
• Will the rule permit contractors to allocate the considerable costs of compliance back to the U.S. Government, such as by including a percentage of these expenses in general and administrative costs?
• While the rule teases that one-time waivers to come into compliance may be available, what is the process to obtain a waiver and with what frequency will waivers be granted?

Despite these many unknowns, it is clear that, as written, the proposed rule stands to impose significant, costly, and possibly impractical compliance burdens for federal contractors. We encourage contractors to carefully consider the compliance implications of the proposed rule and to take advantage of the public comment period, which remains open through January 13, 2023.

Meanwhile, contractors should begin to plan for the considerable cost and time burdens necessary to come into compliance. In particular, federal contractors receiving greater than US$50 million in annual federal contracts should consider the disclosure requirements applicable to their company and whether they have the requisite internal framework and processes to comply with applicable emissions reporting requirements. 

* * *

Hogan Lovells continues to monitor the proposed rule and developments. If you have questions about how the proposed rule will affect your company and how to prepare for it, please contact one of the authors of this alert, or the Hogan Lovells lawyer with whom you work.

Authored by Bill Ferreira, Mike Mason, Stacy Hadeka, and Lauren Olmsted.