Avery Livengood
LAW 455 Environmental Markets
March 25, 2013
Nutrient Credits Purchase Agreement
Background
The U.S. EPA policy on Water Quality Trading supports trading of nutrient load reductions within
watersheds to maintain water quality standards with economic savings and greater potential
environmental benefit (U.S. EPA 2003). The Tar-Pamlico Nutrient Reduction Trading Program and
Neuse River Basin Nutrient Sensitive Water Management Strategies were established by the State
of North Carolina as water quality trading programs in 1990 and 1997 respectively (U.S. EPA 2007).
These programs allowed for point sources (PS) to offset nitrogen loading with non-point source
(NPS) nitrogen loading reductions through an in-lieu fee program, in addition to PS to PS trades.
Through the in-lieu fee program, the PS pays an offset fee for each mass unit of pollutant in excess
of its allowance, which goes toward a State-level cost share program that pays willing agricultural
operators in the appropriate river basin to install and maintain agricultural Best Management
Practices (BMPs).
After demonstrated success with these earlier programs, the Division of Water Quality (Division)
subsequently established and funded the Jordan Water Supply Nutrient Trading Strategy in 2008
(EMC 2008). Like the earlier programs, the Jordan Strategy provides an in-lieu fee option for
developers, waste water treatment plant operators, and state and federal entities to offset nutrient
loads (State of North Carolina 2009). Agricultural operators are required to reduce nutrient
concentrations in their own discharge, grouped by sub-watershed unit (State of North Carolina
2009). Though no PS to NPS direct trades have occurred to-date, agricultural operators may
generate nitrogen loading reduction credits for sale to other regulated parties in the Jordan
watershed when certain conditions of additionality are met and after the local Watershed Oversight
Committee approves tracking methods that ensure “genuine, accurate, and verifiable achievement”
of NPS load reductions (State of North Carolina 2009).
The attached Nutrient Offset Purchase Agreement envisions a situation in which nitrogen loading
reduction credits are purchased directly from a regulated agricultural operator by a point source,
for the purposes of fulfilling the point source nitrogen load reduction obligations.
Representations and Warranties
The language of the representations and warranties and the covenants in the attached Agreement is
heavily borrowed from two contracts used by the Pennsylvania Infrastructure Investment
Authority (PENNVEST) for the sale and purchase of nutrient credits through Pennsylvania’s
Nutrient Credit Trading Program (PENNVEST n.d.), and amended to fit the specifics of the Jordan
Water Supply Nutrient Trading Strategy Rules.
Because the structure of the trading system in Pennsylvania differs significantly from the structure
of any potential trades in North Carolina’s Jordan Lake watershed, the representations and
warranties and covenants contained in the reference agreements were not wholly applicable to the
attached Agreement. All trades within Pennsylvania’s Nutrient Credit Trading Program occur with
the PENNVEST Clearinghouse. The Clearinghouse buys nutrient credits from sellers and auctions
nutrient credits to buyers, but does not facilitate direct transactions between the two (though
private purchase and sale of credits is not prohibited). This structure is meant to reduce the
transaction costs of the individual parties and to reduce the risk of Credit non-compliance
(PENNVEST 2012). In contrast, the State of North Carolina does not provide for a central
clearinghouse to verify, buy, and sell nutrient credits. Thus, the buyer and seller bear the full risk of
the transaction.
EPA has identified multiple risks involved in NPS-PS nutrient credit transactions: revocation risk,
where the NPS is not duly compensated by the PS for BMP investments; “discharger status risk”
where, by engaging in credit trades, NPS increase regulatory oversight in their operations and
effectively lose their unregulated status; the risk of non-performance of the BMPs, which would
make credits unmarketable; and litigation defense risk, including the risk of lawsuit by third-party
environmental watchdog groups dissatisfied with BMP performance; among other types of risk
(U.S. EPA 2007). The PS buyer also bears risks, including performance risk and litigation defense
risk if the legitimacy of said credits is questioned. As such, each party to the Agreement would
likely be less willing to engage in a credit transaction without adequate representations and
warranties, covenants and remedial provisions to reduce their respective risk.
Term
The term of the attached Agreement is ten years, which also increases the risk for both buyer and
seller as conditions are likely to change over that time period. A one-year term would likely not be
economically efficient, as BMP implementation has large up-front costs. However, an agricultural
operator would not likely be able or willing implement BMPs for ten years before receiving any
payment. Similarly, if the buyer made up-front payment for BMP implementation over a ten year
term, the seller would have less incentive to maintain the BMPs for the term of the contract and the
buyer would bear more risk. This Agreement is an attempt to compromise these two risks, with a
delivery and payment schedule that assumes each year of BMP compliance will result in delivery of
and payment for nutrient load reduction credits. The longer term of the contract necessitated
specific maintenance and monitoring covenants be included in the Agreement.
Covenants
According to EPA, most agricultural operators would prefer to have nutrient load reductions
determined by modeling or a standard formula by BMP-type, rather than direct measurement, to
avoid discharger status risk (U.S. EPA 2007). Monitoring criteria are recommended to focus on the
implementation of BMPs, or those changes to reduce discharges, rather than the nutrient content of
the discharge itself. Nutrient concentrations tend to have wide variation hour-to-hour, day-to-day,
seasonally, and pre-storm and post-storm, making discharge monitoring costly and difficult
(Roberts, Mulholland, & Hill 2007). NPS have traditionally not been regulated due to the difficulty
of establishing adequate measurement criteria. Thus, the attached Agreement assumes that the
existence of agricultural BMPs in conjunction with a State-approved Inspection and Maintenance
Agreement will suffice as evidence of nutrient load reductions.
Assuming that the buyer is principally concerned with the validity of the credits as additional and
eligible for trade, the covenants of the Agreement specify that “The Seller shall obtain approval on
an annual basis from the Division for all credits delivered under this agreement and provide a copy
of the Division’s approval letter to the Purchaser.” By requiring Division approval of the credits for
each compliance year, the buyer shifts some of its revocation risk and liability defense risk to the
Division. Thus, if the Division approves the credits for a given compliance year and the buyer
makes payment to the seller for those credits, the buyer is protected from revocation of eligibility of
those credits by the Division. The responsibility for enforcement of the Implementation and
Maintenance Agreement, which ensures the continuing eligibility of the credits, is outsourced to the
Division.
This does not abrogate the buyer’s performance risk. Because the buyer may incur substantial
costs if the seller fails to deliver credits at the expected time, either by having to purchase other
credits at higher cost or by paying a fine for violation of water quality regulations, the buyer will
require insurance against and remedies in the event of delivery failure. Thus, the covenants of the
Agreement specify that “For any Credits not delivered to the Purchaser in accordance with the
Delivery Schedule, the Seller agrees that it will owe the Purchaser a penalty in the amount of ten
percent (10%) of the value of the undelivered Credits, which shall be immediately due and payable
to the Purchaser. The Purchaser shall be entitled to withhold such penalty amount from any
amount due and payable to the Seller.”
Similarly, the seller will be concerned that the buyer has the financial capacity to make payment at
the time of delivery else investments in BMP implementation will not be paid for. Therefore, the
Agreement provides that “In the event that the Purchaser fails to make payment in accordance with
the Payment Schedule, such amounts shall become immediately due and payable to the Seller and
any subsequent payment received from the Purchaser will be applied first to any accrued or unpaid
amounts.” The covenants of the Agreement also specify that both the buyer and seller must
maintain a performance bond (or in the case of the buyer, a letter of credit as proof of financial
capacity) for the duration of the contract.
Remedies
All trades within Pennsylvania’s Nutrient Credit Trading Program occur with the PENNVEST
Clearinghouse, and contracts between PENNVEST and buyers and sellers indemnify the State
agency but not the buyers and sellers. Independent buyers and sellers engaging in a bilateral
agreement would not likely indemnify the other without similar protections for themselves. In
addition, the PENNVEST contracts do not list remedial provisions in the event of false
representations or disagreements between the parties. Remedial provisions for the attached
Agreement borrowed from a sample contract for the North Carolina Department of Agriculture’s
Conservation Reserve Enhancement Program, which is one of the cost-share agricultural BMP
programs currently in effect for nutrient load reduction (NCDA&CS 2009).
Lastly, the attached Agreement lists four exhibits/attachments necessary for execution of the
Agreement, including the Delivery and Payment Schedule, the organizational documents of both the
buyer and seller, the list of permits and approvals required by both the buyer and seller to comply
with all local, state and federal regulations relating to execution of the Agreement, and a Statement
of Change in Financial Condition/List of Liens for each entity to ensure the representations of
authorization and financial condition are correct and accurate. These attachments can be amended as
needed, and as agreed to by both parties as specified by the modification provisions in the Agreement.
The attached Agreement is designed to be flexible, understanding that agricultural BMPs require
significant up-front investment and may not function 100% of the time through no fault or intent of
the seller. The flexibility allows for termination or modification of the Agreement as needed or as
desired by both of the parties, while providing assurances against unilateral breach of the contract.
References
EMC. (2007) Resolution of the North Carolina Environmental Management Commission
Requesting the North Carolina General Assembly To Provide Funding Support for Implementation
of Nutrient Rules for the Jordan Reservoir Watershed. North Carolina Environmental Management
Commission.
NCDA&CS. (2009) CREP – State Contract. Downloaded from “Cost Share Programs - Conservation
Reserve Enhancement Program.” at
http://www.ncagr.gov/SWC/costshareprograms/CREP/index.html
PENNVEST. (n.d.) Sample Nutrient Credit Purchase Agreement and Sample Nutrient Credit Sales
Agreement. Pennsylvania Infrastructure Investment Authority. Accessed at
http://www.portal.state.pa.us/portal/server.pt/community/nutrient_credit_trading/19518/nct_d
ocuments
PENNVEST. (2012) PENNVEST Nutrient Credit Clearinghouse Rulebook, Version 6. September 6,
2012
Roberts, B.J., Mulholland, P.J. & Hill, W.R. (2007) Multiple Scales of Temporal Variability in
Ecosystem Metabolism Rates: Results from 2 Years of Continuous Monitoring in a Forested
Headwater Stream. Ecosystems, 10, 588–606.
State of North Carolina. (2009) 15A NCAC 02B. North Carolina Administrative Code.
U.S. EPA. (2003) Final Water Quality Trading Policy. U.S. EPA Office of Water, Water Quality Trading
Policy, January 13, 2003. Accessed at
http://www.epa.gov/owow/watershed/trading/finalpolicy2003.html
U.S. EPA. (2007) Wetlands and Water Quality Trading: Review of Current Science and Economic
Practices with Selected Case Studies. U.S. EPA Ground Water and Ecosystems Restoration Division,
Office of Research and Development. EPA/600/R-06/155. July 2007. www.epa.gov/ada