Sustainable Finance Study Flags “Green Default” Compliance Gap

A new Journal of Environmental Law article published by Oren Perez and Paul Verbruggen identifies a compliance problem in sustainable finance: an issuer or borrower can make every interest and principal payment while failing to deliver the environmental, social, or sustainability-linked commitments that gave the instrument its label. 

The authors call that failure a “green default” and argue that it exposes a gap between ordinary debt enforcement and the broader public goals sustainable finance is designed to advance.

S&P Global Ratings projected global sustainable bond issuance of $800 billion to $900 billion in 2026, underscoring the scale of the market affected by these questions. The firm said sustainable bonds, including green, social, sustainability, and sustainability-linked instruments, remain a key financing tool for climate and social projects, even as issuance levels consolidate and policy priorities diverge by region.

How Green Default Differs From Financial Default

In a conventional default, the compliance failure is primarily financial. 

Borrowers miss interest payments, fail to repay principal, breach covenants, or otherwise impair investors’ contractual rights. The remedy structure is that creditors may accelerate debt, enforce security interests, sue for damages, or pursue negotiated workouts.

A green default is different because the issuer may remain financially current. 

The default arises from failure to meet the sustainability commitments embedded in the debt instrument, such as the use of proceeds for eligible green projects, achievement of sustainability performance targets, or accurate reporting of climate and social outcomes. That structure creates a mismatch between the party with contractual rights and the parties most affected by the sustainability failure.

Local communities, ecosystems, and future generations may be intended beneficiaries of the commitment, but they usually are not parties to the bond or loan documentation. Investors may care deeply about the sustainability label, but they can struggle to prove a quantifiable financial loss when the issuer continues paying on time.

Perez and Verbruggen argue that this hybrid structure is central to the compliance problem. 

Sustainable debt instruments are private-law contracts, yet they are marketed and structured to advance public goods, including environmental protection, social equity, and better governance. The result is an accountability gap when the sustainability promise fails, but the financial promise remains intact.

Contract Terms Can Limit Enforcement

The article points to drafting practices that can weaken enforcement before any sustainability failure occurs. An empirical study by Quinn Curtis, W. Mark C. Weidemaier, and Mitu Gulati found that 13.2% of bonds with promissory language also included duty or breach disclaimers, while 33.8% included Event of Default disclaimers. 

Those provisions can state that a failure to meet green commitments does not amount to an Event of Default, limiting bondholders’ ability to accelerate the debt based on a sustainability breach.

Sustainability-linked bonds and loans can present a related problem. 

These instruments often impose financial consequences when issuers miss key performance indicators or sustainability performance targets, typically through coupon or interest-rate step-ups. But the article notes that issuers may select opaque or low-ambition metrics, set penalties too low to affect behavior, fail to report performance clearly, or use call options to redeem bonds before penalties take effect.

Those design choices matter because they can separate the marketing value of a sustainability label from enforceable accountability. In practical terms, an issuer could receive reputational or pricing benefits from a green or sustainability-linked instrument while leaving investors and affected third parties with limited remedies if the sustainability objective is not met.

Private Law Remedies Remain Uncertain

The Oxford Business Law Review examines three private-law avenues for redress: contract, tort, and unjust enrichment. 

Contract claims face the obstacle that third parties typically lack privity, and investors may be constrained by the very bond language that excludes sustainability failures from standard default remedies. 

Tort claims may face causation, duty, and damages hurdles, particularly where the alleged injury is diffuse, environmental, or identity-based rather than a conventional economic loss.

The authors identify unjust enrichment as one of the more promising theories for affected third parties. The theory focuses less on the claimant’s measurable loss and more on the issuer’s gain. If an issuer raised cheaper capital or gained reputational value through sustainability commitments it did not honor, affected communities could argue that the issuer retained a benefit without a proper basis.

The article says the theory remains underdeveloped in sustainable finance, but recent English supply-chain litigation, including Hamida Begum v. Maran and Limbu v. Dyson Technology, suggests courts may be willing to consider third-party accountability theories in contract-based sustainability settings.

The authors do not suggest that unjust enrichment is a settled answer. 

Courts may resist using restitution claims to reallocate risk in sophisticated financial instruments, particularly when the bond or loan documents already set out penalties or disclaimers. The significance is that private law may need doctrinal development to address a compliance failure whose main victims are often outside the contract.

Why It Matters for Compliance Teams

The green default problem places sustainability claims in the same compliance category as other representations that can create legal, regulatory, and reputational exposure. For issuers and borrowers, the key risk is the gap between promotional language and enforceable operating controls. If the sustainability claim is material to the instrument, compliance teams need documentation that supports the claim before issuance, tracks performance after issuance, and addresses what happens when targets are missed.

For investors, creditors, and intermediaries, the issue raises due diligence questions. 

A labeled sustainable instrument may require review of use-of-proceeds language, KPI materiality, reporting commitments, third-party verification, step-up mechanics, call rights, and default disclaimers. A bond can be financially sound while presenting sustainability-related enforcement risk.

For regulators and courts, the issue is whether existing legal doctrines can handle a failure that does not fit neatly into conventional financial default. 

Perez and Verbruggen’s central warning is that, without stronger alignment between contract terms, private standards, and public regulation, the market may continue to blur the line between credible sustainable debt and low-credibility “green junk.” That distinction matters as sustainable finance remains a major source of capital for climate, social, and governance-related commitments.