Legal Aspects of the
Emission Reduction Purchase
Agreement
CDM Financial Mechanism Training Course
Climate Change Information Center
Manila Observatory
“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 02-02 “Carbon Contracts Cornerstones”
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 crossjurisdictional in nature combining
principles of public international law
 Limitation of property regime definition
 Long-term Emissions Regime issues
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
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)
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
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.
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.
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
Legal Agreements for PCF Projects
3. Host
Country
Agreement
PCF
Trustee
Host Country
1. Letter of
Project
Endorsement
2. Letter of Intent
4. Emission Reductions
Purchase Agreement
National
Legislative
Framework /
Agreement /
Authorization
Project
Entity
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
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
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)
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)
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.
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)
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
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.
Key Contractual Provisions

Delivery
 Necessary to determine when the defined rights
will accrue to the Buyer
o 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
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.
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 nonperformance 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
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
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
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
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.
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
 Protocol Risk


Host Country
approval,compliance,
eligibility, transfer

Has impact on
existence and
compliance of ERs
and price

Issue: what if carbon
assets are
nationalized
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
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
Key Contractual Provisions

Warranties and Representations
 Warranties should include, among others:
o Usual commercial warranties of corporate
power and creation
o Creation of the ERs and Title to the ERs
o Rights being free of any encumbrance
o Validity of the rights
o Undertaking of the ER activity
o Certainty that the activity has not been used
to generate any other form of ER
o Reduction is permanent
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
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
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
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
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
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
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 www.pca-cpa.org)
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
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)
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
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
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)
Key Contractual Provisions

Miscellaneous provisions (“Boiler Plate” clauses)
 Entire agreement
 Assignment
 Governing law and
enforceability
 Jurisdiction
 Variation/amendments
 Successors and
Assigns
 Severability
 Delay or Omissions
 Waiver
 Public Relations
 Survival
 Notice
Key Contractual Provisions

Domestic law
 Trading Licenses
 Taxation
 Corporate securities
 Philippine Energy laws
 Philippine Environment
legislation
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.
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….
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
Atty. Angela Consuelo S. Ibay
Program Coordinator
Climate Change Information Center
Manila Observatory, Ateneo de Manila Campus
Tel + 63 2 426-5921
Fax + 63 2 426-0847
gia@observatory.ph