1. Legal Aspects of the Emission Reduction Purchase Agreement
CDM Financial Mechanism Training Course
Climate Change Information Center
Manila Observatory

2. “The Kyoto Protocol is not yet in force, the exact nature of domestic legal regimes governing reductions in emissions of Greenhouse Gases (GHGs) is (in most countries) still not known, there is no regulated scheme for transactions involving project based emission reductions and the market for such emission reductions (ERs) is not yet liquid. As such, the proper drafting of contracts for the transfer of ERs from one party to another party is vitally important.”
IETA Discussion Paper “Carbon Contracts Cornerstones”

3. Legal Context Ownership of Atmosphere: The Property Rights Issues
Atmosphere is a global common property
Atmosphere is a scarce resource
Utilization of the resource is skewed
New area of law that is unique and cross-jurisdictional in nature combining principles of public international law
Limitation of property regime definition
Long-term Emissions Regime issues

4. Legal Context The Role of Carbon Contracts
Provide a documented framework within which “emission rights” are bought, sold, acquired, transferred
Negotiated outcomes that will determine the allocation of risk and which will be critical in determining issue of price and bankability of project against which to raise further debt/equity/financing

5. Legal Context Nature of Carbon Contracts
Springs out of current efforts by Government and institutions developing contracts with clear pricing and risk profiles
Standard contracts will increase with standardized rights (CERs, AAUs)

6. Legal Context
Ownership of Emission Reductions (ERs) and Legal Process of Transfer
Emission Reduction (ER) has an international origin under Kyoto Protocol
ER is a product of a CDM/JI Project
If Project is “legal” in domestic jurisdiction and ERs are “certified” and “verified” by authorized agents, then ERs are legal commodities
Distribution of ERs is a contract among stakeholders
Rules pertaining to export of a legal commodity in a country are applicable for transfer to an international agent

7. Legal Context Would specific law be needed in Non-Annex I Countries?
ERs are new commodities, but not different.
Therefore, present laws/rules may be applicable
State/Central government laws/rules
Project clearances
Project contracts/agreements (complex structure)
However, the existing structure is complex, thereby creating high transaction costs.

8. Legal Context Domestic Incorporation of CDM
For ERs , new rules may have to be added. Question is whether these can be handled within existing machinery or is a new institution needed (e.g. Independent CDM Authority)
Policy guidelines will be useful in developing contracts, whether standardized or as contracted individually.

9. What is an ERPA? Emission Reduction Purchase Agreement
Carbon Purchase Agreement - this is the contract between the carbon buyer and seller.
Purpose
Record agreement
Identify responsibilities
Establish rights
Manage risk

10. Legal Agreements for PCF Projects
Host Country
3. Host Country Agreement
National Legislative Framework / Agreement / Authorization
1. Letter of Project Endorsement
2. Letter of Intent
PCF Trustee
Project Entity
4. Emission Reductions Purchase Agreement

11. Basic framework under PCF
Emission Reductions Purchase Agreement
Purchase Price
PCF Trustee
Project Entity
Exclusive Right of Certification and Verification of purchased ERs (ERs)
Transfer of ERs

12. Main Elements of Emission Reductions Purchase Agreement (ERPA)
Purchase of ERs from the Project Entity / Payment for achieving ERs
Arrangement for initial and periodical verification, validation and certification.
Transfer of ERs

13. Key Contractual Provisions
Parties
Those with a potential claim to any ERs and possibly others who have key obligations or responsibilities in relation to the project (e.g. host government)
Private contracts – public participation?
If State is a party, special provisions will apply for the contract’s enforceability (e.g. “The State may not be sued without its consent.” under Section 3, Article XVI, 1987 Philippine Constitution)

14. Key Contractual Provisions
Parties
“Contracts take effect only between the parties, their assigns and heirs, except where the rights and obligations arising from the contracts are not transmissible by their nature, or by stipulation or by provisions of law. x x x”
(Article 1311, Civil Code of the Philippines)

15. Key Contractual Provisions
Recitals or Whereas Clauses
Definition of Terms
Vital to contain clear and concise definition of what exactly is being bought or sold
Does it give rise to a legislative right or contractual right? Must clearly identify the nature and scope of the rights as they have been agreed between the parties.

16. What is an ER?
“Emission Reductions or “ERs” means reduction in emissions of Greenhouse Gases generated by the Project and monitored in accordance with the Monitoring Plan and the relevant guidelines, modalities and procedures under the regulatory framework of the UNFCCC and/or the Kyoto Protocol, and in absence thereof any other regulatory framework as agreed between the Parties.” (Definition –PCF)
“Emission Reductions” or “ERs” means the GHG Reductions achieved by a Project and verified by an Independent Third Party or an Operational Entity as meeting a set of standards consistent with those contained in the regulatory framework of the UNFCCC and/or the Kyoto Protocol.” (Definition –CDCF)

17. Key Contractual Provisions
Definition of Terms
Baseline: level of GHG emissions from which GHG ERs resulting from the project activity are to be measured
Greenhouse Gas: maybe as defined in the Kyoto Protocol
Unit of Measurement: specify the measurement in which the emissions are to be acquired
Kyoto Protocol: should include any amendments made to it and decisions

18. Key Contractual Provisions
Sale and Purchase
Define and specify the number and the vintage (i.e. year in which the Project or source activities will reduce GHG emissions that are the basis for the ERs) of ERs arising from the project activity to be sold to the Buyer
Specify clearly what rights the parties have to future ERs or to other environmental benefits or values resulting from the project.

19. Key Contractual Provisions
Delivery
Necessary to determine when the defined rights will accrue to the Buyer
Timing both of accrual and delivery is highly important to the potential value of ER and the Buyer’s capacity to sell either the base product or a derivative
Determine whether to set out a delivery date or rely on a trigger event for the rights to accrue

20. Key Contractual Provisions
Delivery Mechanism and Transfer of Title
The legal mechanism used to transfer the ERs will depend on the type of rights being transferred
The contract must specify the point at which title is transferred. Possibilities include upon execution of the contract, payment being made, or upon change of ownership being entered on a register.
If involve future delivery of ERs, contract must specify the mechanism needed to ensure that delivery occurs, taking into account possible changes in legislation.

21. Key Contractual Provisions
Shortfall or Failure to Deliver
Need for appropriate arrangements to ensure that the specified quantity of ERs is indeed delivered
If CERs not created/transferred, giving rise to non-performance of obligations, appropriate remedies should be considered, particularly in the event that the ER rights never materialize.
Should have an option to manage shortfalls through an number of mechanisms (e.g.physical replacement of the volume of the shortfall of ERs from other projects or future years, repayments)
Appropriate indemnities should be incorporated

22. Key Contractual Provisions
Evidencing the validity of the ERs being contracted
Documentation showing that the emission reductions, the subject of the contract, actually occurred
Must be clear as to who is responsible for carrying out initial and ongoing validation of the project and for the associated costs.
Whether third party verification is required should likewise be specified, including an outline of the criteria for this

23. Key Contractual Provisions
Evidencing the validity of the ERs being contracted
At the moment, the evidentiary burden is usually discharged via a demonstration that, when measured against an appropriate baseline, the particular project activity has delivered real and measurable reductions of GHG emissions

24. Key Contractual Provisions
Baseline Measurement, Verification and Certification
Clauses should ensure that there is an appropriate baseline measurement and there is a procedure for independent verification of the practical emission reduction process
May need to include conditions for a verification report
May need to include definitions for such terms like real reductions, measurable reductions, surplus reductions, additionality
Might be advisable to set out appendices to the contract as to third party verification

25. Key Contractual Provisions
Changes to the Scientific Processes for Quantifying and Verifying ERs
To take account of scientific uncertainties, the contract could include a “reopener” clause permitting the recalculation of tonnes if different numbers are adopted by relevant authorities
Specify measurement and assurance standards that are to be used.

26. Key Contractual Provisions
Risk
Elements of Risk in Carbon Deals
Finance, Approvals, Construction, Production
Has impact on existence of the Project; therefore existence and production of ERs
Issue: what if CDM EB rejects the project
Host Country approval,compliance, eligibility, transfer
Has impact on existence and compliance of ERs and price
Issue: what if carbon assets are nationalized
Project Risk
Protocol Risk

27. Key Contractual Provisions
Risk
Acceptance of the resultant risk is a commercial issue to be determined between the parties; therefore, important to identify all risks and to carefully and clearly allocate them between the parties involved (i.e. Buyer’s risks, Seller’s risks
Risk is best allocated to the party most able to bear it
Need to provide risk mitigation strategies such as insurance

28. Key Contractual Provisions
Price and Terms of Payment
Set out the price to be paid for the ERs; may vary
If any ERs are covered by an option, the price thereof should be set out, as applicable
Terms and method of payment need to be clearly stipulated. May take several forms (e.g. full upfront payment, option, payment triggered by an event)
Credit risk, issues such as penalties for late payments, increases for inflation and other charge related items should also be addressed

29. Key Contractual Provisions
Warranties and Representations
Warranties should include, among others:
Usual commercial warranties of corporate power and creation
Creation of the ERs and Title to the ERs
Rights being free of any encumbrance
Validity of the rights
Undertaking of the ER activity
Certainty that the activity has not been used to generate any other form of ER
Reduction is permanent

30. Key Contractual Provisions
Warranties and Representations
Should also address the timing of representations (e.g.representation true for the entire term of the agreement)
Seller may wish to exclude any warranties as to the merchantability or fitness for a particular purpose of the ERs

31. Key Contractual Provisions
Liability and Indemnities
Parties will have to determine to what extent, if any, the liability of either or both parties should be limited.
Damages may arise out of or by reason of: breach of obligations, events of default, negligent act or omission, representations and warranties
May include a waiver of “special” damages
Should decide whether indemnities are required, including indemnities relating to carbon debits and potential losses relating to leakage

32. Key Contractual Provisions
Default, Termination and Remedies
Specify “Events of default” such as termination of business or bankruptcy, material breach of representation, failure of Seller to deliver ER rights, failure of Buyer to make payments when due, failure of Seller to comply with validation/verification obligations, failure to secure HC approval or to satisfy requirements under Kyoto Protocol for CDM projects
Consequences of an event of default should be set out, may be to include provision for payment of damages

33. Key Contractual Provisions
Default, Termination and Remedies
In case of remedies, there is a range of options including good-faith cooperation or negotiation, designation of early termination date, withholding of payments by non-defaulting party
Might need to consider whether contract remedies are exclusive for events of default or whether it is in addition to any other remedy available by law

34. Key Contractual Provisions
Progress Reports and Audit Rights
Given the long term nature of the ERPA
Only reasonable way for Buyer to be able to assess whether the Seller will be able to perform
Buyer’s right to terminate contract in the event that reports prove unsatisfactory
Interim reports may reveal a higher level of reduction than anticipated thereby being beneficial to the Seller

35. Key Contractual Provisions
Confidentiality
Parties to determine and define what constitutes confidential information in respect of the agreement
Determination should include what obligations to impose and whether confidentiality obligations are mutual or falling only on one party
Should address the term of the confidentiality obligation, among others

36. Key Contractual Provisions
Arbitration and Dispute Resolution
Due to uncertainties concerning carbon transactions, important to set out procedures for dispute resolution
Parties may develop their own dispute resolution or adjudication process
Identify place of the arbitration and the arbitration system to be used
Optional Rules for Arbitration of Disputes Relating to Natural Resources and/or the Environment (Permanent Court of International Arbitration. Go to

37. Key Contractual Provisions
Taxes, Levies and Charges
Often arise from the registration and transfer of rights
Determine what fees to be paid for the creation and registration of ERs and who bears the cost of any transfer fees or cost of compliance
Issue of taxation related to pricing (whether price is inclusive or exclusive of goods and service tax and other charges)
Should address issues concerning local taxes, future legislation imposing taxes or charges on ER transactions

38. Key Contractual Provisions
Taxes, Levies and Charges
Should address the possibility of future legislation imposing various taxes or charges on ER transactions
Important note: CDM projects under Kyoto Protocol will have to direct a particular “share of proceeds” to specified funds to cover administrative expenses as well as to assist developing countries that are particularly vulnerable to the adverse effects of climate change to meet the costs of adaptation (Article 12, para 8, KP)

39. Key Contractual Provisions
Force Majeure
Determine what constitutes a “force majeure” event and the consequences of such an event
Parties may, however, decide not to assert a claim of “force majeure” or any similar claim to excuse any non-performance of their duties and obligations under the agreement

40. Key Contractual Provisions
Third Parties
Clear provision as to whether third parties have right to enforce or take benefit from the terms of the ERPA.
Involvement of third parties in contracts for sale of ERs may include roles as facility owner, verifier, reducer, financier, government authorities, NGOs

41. Key Contractual Provisions
Third Parties
Consider due diligence checks and attaining assurances from the third party to address possible issues on permanence, competing claims and access rights
If a contract should contain some stipulation in favor of a third person, he may demand its fulfillment provided he communicated his acceptance to the obligor before its revocation. A mere incidental benefit or interest of a person is not sufficient. The contracting parties must have clearly and deliberately conferred a favor upon a third person. (Article 1311, 2nd paragraph, Civil Code of the Philippines)

42. Key Contractual Provisions
Miscellaneous provisions (“Boiler Plate” clauses)
Entire agreement
Governing law and enforceability
Variation/amendments
Severability
Waiver
Survival
Notice
Assignment
Jurisdiction
Successors and Assigns
Delay or Omissions
Public Relations

43. Key Contractual Provisions
Domestic law
Trading Licenses
Taxation
Corporate securities
Philippine Energy laws
Philippine Environment legislation

44. Future Legal Dynamics
Emerging innovative structures (e.g. forward sales and option arrangements, creation of carbon pools, CER bonds and warrants, tax-driven deal structures)
Ability to understand and interlink and manipulate regulatory regimes is key
Liability and opportunity driven by emerging legal regimes
Demand, supply and price will be driven by project success and market liquidity
Range of drivers: reallocation of insurable risks, redirection and revaluation of investments, climate litigation, shareholder expectations, etc.

45. Future Legal Dynamics
Should start to put in place a regulatory framework for the Transfer and Trade in ERs
Definition of ERs
Establishment of original ownership of ERs
Regulations on the transfer of ERs
Putting in place registries
Taxation
Others….

46. Conclusions
CDM Project operates within the domestic jurisdiction, therefore all the dynamics of the domestic regime will influence ERs
Domestic legal regimes need to establish explicit laws/rules/institutions/authorities to recognize ER legally
International regime needs to take into account the diversity of domestic legal systems
Harmonization of international and domestic legal regimes apart, the near-term the effectiveness of ERs and ER transactions can best be achieved by overcoming barriers by contracting and arbitration process

47. Thank You! Atty. Angela Consuelo S. Ibay Program Coordinator
Climate Change Information Center
Manila Observatory, Ateneo de Manila Campus
Tel
Fax