Green Defaults: The Hidden Compliance Problem in Sustainable Finance

Sustainable finance has become a significant force in global capital markets. In its 2026 outlook, S&P Global Ratings projected sustainable bond issuance at $800–900 billion, implying a market share of roughly 8–9 per cent relative to the more than $10 trillion global bond market. But as this market has grown, it has also exposed a distinctive compliance challenge that existing legal frameworks are struggling to address. In our recent article in the Journal of Environmental Law, we call it ‘green default’. Our argument is that unless this challenge is addressed, the boundary between genuinely robust sustainable debt and low-credibility ‘green junk’ will remain dangerously blurred.

Defining Green Default

A green default occurs when the issuer of a sustainable debt instrument honours its financial obligations—paying interest on time and repaying principal at maturity—but fails to deliver on the sustainability commitments embedded in the instrument and constitutive of its ‘green’, ‘social’, or ‘sustainability-linked’ character.

At the heart of the green default problem lies the dual structure of sustainable finance. Green, social, and sustainability-linked debt instruments combine private and public dimensions. On the one hand, they are instruments of private law: contractual devices designed to govern relations between private parties. On the other hand, they are intended to advance global public goods, such as environmental protection, social equity, and good governance, and thus extend their effects beyond the contracting parties.

That hybrid character creates a distinctive legal challenge. In an ordinary financial default, the party harmed is the contractual counterparty, and the law provides a familiar set of remedies. In a green default, by contrast, the principal harms often fall on third parties—local communities, ecosystems, and future generations—who have no contractual relationship with the issuer but stand to benefit from the green commitments embedded in the instrument. That hybridity generates an accountability gap: the legal mechanisms designed for ordinary financial default are poorly suited to a breach whose principal victims lie outside the contract.

But investors with a ‘green’ appetite—those who chose sustainable financial instruments precisely because of their sustainability character—also face remedial difficulties. They may struggle to establish that a green default constitutes a material financial loss or to quantify the resulting damages. Framing the loss as an immaterial or identity-based harm capable of grounding a cognisable legal claim is no easy option either. For both third parties and investors, then, green defaults raise the question of whether private law can be extended beyond its conventional boundaries, a question we discuss below and develop more fully in the article.

The Regulatory Triangle of Sustainable Finance

Our article analyses the green default problem through what we call the regulatory triangle of sustainable finance: private law, transnational private standards, and public regulation.

Private law is the first vertex. It offers three potential avenues for redress—contract, tort, and unjust enrichment. One structural obstacle facing all three arises from deliberate drafting strategies: Curtis, Weidemaier, and Gulati’s empirical study of nearly one thousand green and sustainability-linked bonds found widespread use of clauses designed to blunt enforcement, including provisions stating that a breach of green commitments does not constitute an Event of Default. 

For third parties, unjust enrichment may be the most promising path. Unlike contract and tort, its logic does not depend on proving a cognisable loss suffered by the claimant. Instead, it focuses on the defendant’s gain: where an issuer raises cheaper capital on sustainability promises it then fails to honour, it may be said to have retained a financial benefit at the expense of the communities meant to benefit from those commitments. That shift in focus, from claimant’s loss to defendant's gain, is precisely what makes the doctrine attractive where third-party harm is diffuse and hard to quantify. Recent English decisions in Hamida Begum v Maran and Limbu v Dyson Technology, both litigated in the supply-chain context, suggest growing judicial openness to such arguments, though the doctrine remains underdeveloped in sustainable finance.

The second vertex consists of transnational private standards such as the ICMA Green Bond Principles and the Climate Bond Standard. These frameworks impose pre- and post-issuance requirements that can reduce the scope for vague or unverifiable commitments. But participation remains optional. As of late 2024, certified debt represented approximately five per cent of cumulative labelled sustainable bond issuance. 

The third vertex is public regulation, most fully developed in the EU, where the Taxonomy Regulation, the European Green Bond Regulation, and the Empowering Consumers for the Green Transition Directive together impose increasingly demanding obligations on issuers to substantiate sustainability claims.

The Promise and Limits of Polycentric Governance 

These three regimes exhibit signs of mutual reinforcement. Pre-issuance obligations tighten the definition of green commitments and lower doctrinal barriers to private law claims. The growing threat of litigation incentivises issuers to seek credible certification even without a legal mandate. Yet the limits are equally real. Voluntary frameworks can be bypassed. Neither the Climate Bond Standard nor the EU Green Bond framework prohibits Event of Default disclaimers, or the structuring of KPIs to cover only low-materiality emissions scopes while leaving the most significant ones, as the New York Attorney General’s settlement agreement with the world largest beef producer JBS demonstrates, entirely outside the bond's accountability architecture. The current US administration’s shifting approach to ESG policy, and signs of backtracking within the EU itself, risk further weakening the litigation ecosystem on which much of the compliance logic depends.

Whether this polycentric governance architecture fulfils its promise will depend on courts developing private law doctrines, above all unjust enrichment, to match the distinctive structure of green defaults; on litigation entrepreneurs willing to bring such claims on behalf of affected third parties; and on sustainability-committed jurisdictions holding course against mounting political pressure. Without these conditions, the boundary between genuinely robust sustainable debt and low-credibility ‘green junk’ will remain dangerously blurred.

The authors’ article in the Journal of Environmental Law (2026), ‘Green defaults in sustainable finance: compliance challenges at the intersection of private and public law’, can be accessed here. 

Oren Perez is Professor of Law and Director of the Center for Environmental and Climate Law at Bar-Ilan University. 

Paul Verbruggen is Professor of Private Law at Tilburg Law School, Tilburg University.