THE CLEAN DEVELOPMENT MECHANISM: Legal Considerations for Buyers and Sellers

Introductory Workshop on CDM/JI

March 1, 2006

Inn at the Forks

Winnipeg, Manitoba

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TOPICS

Lawyer’s Role Categories of Risk Nature of CDM Emission Reduction Purchase Agreements

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LAWYER’S ROLE

address risk maximize likelihood of value capture facilitate the settlement of deal terms documenting transaction

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CATEGORIES OF RISK

1. political and regulatory Host Country uncertainties;

2. general project risks that are common to all projects; and

3. unique risks due to the fact that a CDM project relies upon a new and developing international legal framework.

There are three main risk categories which a CDM project presents for participants and stakeholders:

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CATEGORIES OF RISK (Cont’d)

Host Country risks changes in foreign investment policies or laws the imposition of a tax on CER revenue from

the project or the CERs generated by the project

failure to approve the CDM project through its DNA

administrative procedures imposed by the Host Country could involve a significant amount of time and expenditures

absence of an efficient legal system in which parties can enforce their rights

community opposition to CDM project

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CATEGORIES OF RISK (Cont’d)

General project risks risks that impact on the ability of the project to

operate as intended cost overuns – delayed construction commissioning of the project is delayed disputes between project participants failure to comply with local laws and regulatory

requirements of the Host Country

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CATEGORIES OF RISK (Cont’d)

Kyoto Protocol risks risk that CDM project may be rejected by the

CDM Executive Board inaccurate monitoring or verification of ERs disputes over legal title to CERs

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RISK ISSUES FOR SELLERS

Project construction prepayment for financing (?) but lower price

CER delivery failure liability for liquidated damages?

Buyer payment failure credit assessment of Buyers security (letters of credit?) pools/funds

Surplus CERs options to purchase third party sales discussions

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RISK ISSUES FOR SELLERS (Cont’d) Buyers’ involvement in project

validator and verifier additions to PDD focal point

Price fluctuations floor sliding scale price based on % of market price

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NATURE OF CDM

UNFCCC, Kyoto Protocol, COP/MOP Decisions (including adoption of the 19 decisions of the Marrakesh Accords), Executive Board Decisions

Canadian law status? new Government, new Minister of the Environment no Canadian statute approving or incorporating

Kyoto Protocol or imposing GHG reduction obligations

EU Countries – under EU ETS Registries Regulation, each member state establishes a national registry that links to the others and to the Community International Transaction Log

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EMISSION REDUCTION PURCHASE AGREEMENTS Carbon purchase agreement between a

Buyer and a Seller Purposes

record terms of agreement identify responsibilities/address risk establish rights

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ERPAs (Cont’d)

Conditions precedent to obligation of Seller to sell, and Buyer to purchase, CERs preparation of project design document obtaining all necessary consents project having been Validated and Registered Host Country having authorized Seller to

participate in the project and Buyer having been designated as a PP and authorized by its DNA to participate in the project

project commissioning (completion of the Project)

due diligence

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ERPAs (Cont’d)

CDM Process Considerations Validation

• independent evaluation of the project activity against the requirements of the CDM on the basis of the PDD

• carried out by a DOE Registration

• formal acceptance of a validated project by the CDM executive board as a CDM project activity

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ERPAs (Cont’d)

CDM Process Considerations (cont’d) Monitoring of the Project

• collection by Seller of data necessary to calculate GHG reductions in accordance with the monitoring plan

Verification and Certification• periodic independent review by a DOE and ex

post determination of the monitored GHG emission reductions

• certification – written assurance by a DOE that the project activity has achieved the reductions in GHG as verified

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ERPAs (Cont’d)

CDM Process Considerations (cont’d) Issuance of CERS

• EB will issue CERs equal to the certified amount of GHG emission reductions into the pending account of the EB in the CDM Registry

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ERPAs (Cont’d)

CDM Process Considerations (cont’d) CDM Registry has the following accounts:

• pending account for the EB• holding accounts for non-Annex I Parties• temporary accounts for Annex I Parties and

PPs from such Parties until national registries for such Parties are operational for the purposes of receiving CERs

in order to transfer CERs from the CDM pending account to the temporary account of Buyer, Buyer must be a project participant and must be authorized by its DNA to participate in the Project

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ERPAs (Cont’d)

CDM Process Considerations (cont’d) Share of Proceeds (Costs of Administration)

• issuance of CERs in accordance with the request of PPs shall only be effected when share of proceeds to cover administrative expenses has been received: USD 0.10 per CER issued for the first 15,000

tonnes of CO2 equivalent for which issuance is requested in any given year

USD 0.20 per CER issued for any amounts in excess of 15,000 tonnes of CO2 equivalent for which issuance is requested in a given year

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ERPAs (Cont’d)

CDM Process Considerations (cont’d) Share of Proceeds (Costs of Adaptation)

• among issued CERs, 2% of the CERs will be deducted for the share of proceeds to assist developing Parties that are particularly vulnerable to the adverse effects of climate change to meet the costs of adaptation

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ERPAs (Cont’d)

Transfer of Legal Title to CERs ERPAs normally provide that legal and

beneficial title to CERs pass at the time the CERs are delivered into the Buyer’s account

Sole Communicator (Buyer/Seller?) Use of escrow agreements Delays at EB

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ERPAs (Cont’d)

Quantity of CERs being acquired: ERPA should specify the quantity of CERs

being acquired by Seller and the timeframe ERPA should specify a delivery schedule for

CERs which accords with the anticipated performance of the Project

Minimum delivery requirements Option to purchase excess CERs?

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ERPAs (Cont’d)

What happens in the event of a delivery failure? negotiation of an amended delivery schedule substitute CERs from third parties for project

CERs termination of the ERPA by the Buyer

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ERPAs (Cont’d)

Price of CERs fixed floating – Project Entity partially participates in

any increase in a benchmark index

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ERPAs (Cont’d)

Representations and warranties of the Seller and the Buyer due incorporation, organization and subsisting all necessary consents for the Seller to

perform its obligations under the ERPA have been obtained

agreement enforceable in accordance with its terms

in the case of the Seller, title to the CERs

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ERPAs (Cont’d)

Representations and warranties of the Seller and the Buyer (cont’d) no insolvency proceedings pending or

threatened no conflict Seller has, and will continue to have

throughout the term of the ERPA, adequate and sufficient funding in place

Project has been registered

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ERPAs (Cont’d)

Payment of Costs ERPA should contain provisions relating to the

payment of costs leading to the creation of CERs (including monitoring, verification, certification and issuance of CERs)

General approach in that the Seller is responsible for covering all costs associated with the Project and creating the CERs and that these costs are factored into the purchase price for the CERs

Buyer is responsible for costs associated with establishment of Buyer’s accounts in the CDM Registry

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ERPAs (Cont’d)

Force Majeure clause – scope When will the Buyer and Seller be excused

from their obligations? Natural force majeure events, such as fires,

storms, etc. Any other events beyond the control of either

party including acts of governments (regulatory risk)

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ERPAs (Cont’d)

Events of Default non-payment any representation or warranty made is false

or materially misleading failure to perform a material obligation commencement of insolvency proceedings material adverse changes delivery failure

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ERPAs (Cont’d)

Liability and Indemnity Parties will have to determine to what extent, if

any, the liability of either or both parties shall be limited

Damages may arise out of or by reason of breach of obligations and/or breach of representations and warranties

Seller may only be liable for a delivery failure if the delivery failure is a result of “wilful misconduct” or “gross negligence”

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ERPAs (Cont’d)

Liability and Indemnity (cont’d) “Wilful misconduct” – act or omission which

would be regarded by those familiar with projects of the nature of the Project and with the circumstances of the particular case as amounting to misconduct and which was intentional

“Gross negligence” – act or omission, whether deliberate or not, which in the circumstances would be regarded by those familiar with projects of the nature of the Project and with the circumstances of the case as amounting to more than a mere failure to exercise proper skill and care

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EMISSION REDUCTION PURCHASE AGREEMENTS (Cont’d) Dispute Resolution

Buyer and Seller should be obligated to sit down together and try to work out a mutually acceptable solution

if unable to resolve dispute – resort to arbitration

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CONCLUSION

Carbon credit business has boomed since the ratification of the Kyoto Protocol

Demand for carbon credits is likely to continue to grow

390 million tonnes of CO2 were traded worldwide in 2005, up from 9.65 million tonnes traded in 2004

Exciting, new and dynamic market IETA ERPA

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CONTACT INFO

Andrew Kingsmill

Bennett Jones LLP

3400 One First Canadian Place

Toronto, Ontario

Canada M5X 1A4

Direct No. 416.777.4807

Main No. 416.863.1200 Ext 4807