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Copyright © International Chamber of Commerce (ICC). All rights reserved.
( Source of the document: ICC Digital Library )
by Martijn Wilder*Partner, Head of Global Environmental Markets, Baker & McKenzie
This chapter starts with some observations about contracting in the climate change and carbon markets, which is an area set within the context of international climate law. The focus of this chapter is on the sale and purchase contracts for carbon commodities, which have, at times, ended in dispute.
It should be emphasised that when discussing international climate change law, the focus is on applying international law principles. For example, provisions of the UNFCCC are incorporated into contracts, which in turn affect the outcome of a contract or the way in which a dispute is resolved. These contracts are between governments, sovereigns, international organisations as well as members of the private sector. An example of such a contract is an early Certified Emission Reduction (“CER”) contract. It is important to note that many of these contracts occur in the context of both developed and developing countries.
It can be argued that despite what lawyers commonly assume clear or straightforward arbitration clauses do not always work so well. In some of the very early carbon contracts that came out of the Kyoto protocol (and these agreements were really contracts by the World Bank to deal with trading, Clean Development Mechanism (“CDM”) project carbon credits, called certified emission reductions), this international treaty was being applied for the first time to private transactions, usually involving developing countries and private sector participants. One of the first challenges that the World Bank faced in those early contracts, which included arbitration clauses, was whether there should be a designated governing law? The Bank wanted to use international law, or have no governing law clause at all — both of which were a challenge, given the involvement of private parties.
When dealing with contracts worth millions of dollars involving parties which are often private sector counterparties, those provisions may appear problematic. As those contracts moved forward, the market developed. There was an increase in the number of contracts entered into and a change in approach where a number of the sovereign governments moved away from including sovereign immunity clauses and adopted more commercial contracts. If you look, for example, on the website of Norway on their carbon procurement programme, their contracts have no sovereign immunity clauses, and are very commercial contracts, full of very clear defaults leading to arbitration.
The other interesting aspect of these contracts, is that as disputes started arising, the issues in question required consideration of international law. For instance, one contractual dispute was focused on the question of whether or not there was a force majeure event which would lead to arbitration as a result of a new international agreement. Specifically, the debate was whether Kyoto II was a new international agreement? So in this sphere, when one is dealing with arbitration, the text of international agreements is not sufficiently precise. The uncertainty over what the provisions of international agreement mean increases the complexity of arbitration.
Another frequent challenge that comes up in these contracts is cultural differences. Often the way in which these agreements are negotiated and drafted and the clauses are prepared can be affected by local cultural and practices. For instance, when one deals with a contract in China, the arbitration clause you have appears to be less important because the moment you sign the contract is when the relationship begins, and it is all very fluid after that point. Trying to enforce contracts in places like China or India can be extremely difficult. So the relationship there is incredibly important, and ironically, when you have sovereigns in these agreements, it is the environmental clauses that are crucial because it might be quite difficult to walk away from a particular issue such as a non-fault or non-delivery. It is much easier to walk away when there is a major environmental issue. For instance, there was a major project involving a sovereign Mexican entity and a landfill methane capture project. A major incident occurred and the counterparty lost all its licenses and was able to walk away. Thus, the environmental safeguards are very important.
Culturally the way in which these clauses are interpreted, particularly in arbitration, is very important. Increasingly the market is seeing increased interaction between the private sector and these new national organisations. This started quite early when under a lot of the regulation, early climate change contracts under the CDM were governed by an institution called the CDM Executive Board. That Board would make decisions. It could basically negate a multi-million dollar contract without any way forward, so one of the things considered was the extent to which the executive board members could be sued. There were even early activities into suing members of the board for the decisions that they made.
Eventually, most people agreed that the board members had immunity, but this issue remains an interesting point especially for the Green Climate Fund, where you have directors who are not trained financiers; they are negotiators making decisions on large investments. If one is a private sector party who has a contract with the Green Climate Fund with US$40 million, and that contract could easily be terminated, a lot more thought will be put into how to negotiate with that organisation.
It is equally the case with a brand new organisation such as the Asia Infrastructure Investment Bank (“AIIB”). It is a new organisation but not an international treaty organisation. It is a different sort of organisation and at the moment it is developing its environmental and special safeguards. Apparently, if one does not meet the environmental safeguards the AIIB can exercise its contractual remit under its legal agreement. The AIIB appears to be taking a more “legal” approach.
On the point of safeguards, what is also particularly interesting is that when one comes to contracts with these organisations that include safeguards, increasingly, the safeguards are the international institutions (and interestingly the consultation draft of the AIIB safeguards are behind where the private sector is).
Another interesting issue involving environmental safeguards is that when one is dealing with developing countries, it may be very unrealistic to expect that a lot of these safeguards, even the ones included in the contract, will actually be met. Experience has shown that in terms of safeguards, the issues of greatest concern to multinational corporations in the arrangement are actually anti-corruption provisions. It appears that corporations are actually going further on what they expect in terms of managing corruption than a lot of the international organisations, but the national organisations will not increase or elevate their current standards. They simply will not negotiate at all, based on the principle that, if they negotiate with one person, they have to negotiate with everybody else. It would be interesting to see how this develops.
Many arbitration disputes arising from contracts in the climate change context have been settled pre-arbitration. In this author’s view, there are three main issues when dealing with arbitration disputes in the environmental context. The most interesting issue is the interpretation and application of international law in a domestic context. Next, cultural issues and determining who is at fault and why they may be at fault are crucial. This is critical from a contractual perspective. Third and more broadly, is the issue of environmental justice in some of these large agreements, in particular, as to who is right and who is wrong. It is crucial to note that some of these contracts are multi-billion dollar contracts, such as the ones the World Bank entered into with China, and HFC 23. So these are extremely interesting and as the area of law develops, and the level of sophistication grows, it is this author’s view that such contracts will become more private orientated than public orientated.
©  Martijn Wilder