Legal Aspects of Forest Carbon Projects

An overview for project participants

Regulatory: project & host-

country government

Organizational: intra-project

Transactional: project & buyer

Overview

Forest carbon projects raise a range of complex and overlapping legal issues, including difficult regulatory, organizational, and transactional questions

I. REGULATORY ISSUES

Between project parties and government entities, based on applicable host-country laws and regulations

Key regulatory questions:1. Do project participants have

adequate land tenure in the project area?

2. What laws apply to, and which government bodies have authority over, project activities?

3. What are relevant regulatory requirements?

4. What taxes will be assessed?

National & local government

Project participants

Supporting entities

Tenure: definition

• Land tenure - legal or customary relationship of an individual or group with respect to land and other natural resources.

• Tenure rules determine who can use what resources for how long, under what conditions.

• Adequate tenure is an essential precondition for a forest carbon project

Tenure: rights in land, forest & carbonRights in land and forest• Minimum:

– use rights sufficient to support project activities

– right to exclude incompatible uses

– for the duration of project activities

• Customary rights may be sufficient if secure and recognized by law

Rights in carbon• Minimum:

– right to carbon benefits from project activities

– right to transfer carbon benefits

• Generally must be implied from law– May be closely tied to private

rights in land– May belong to the people as a

whole– Or another arrangement

Tenure problems

• Land title not validly vested in local users• Land use arrangements poorly defined or recorded• Unclear who has rights to forest carbon

Applicable law, regulatory authorities• Sources of applicable law

– Framework environmental andforestry laws

– Laws on:• land and natural resources,

including mining, timber, oil, gas• agriculture• planning and infrastructure• indigenous peoples

• Regulatory authorities– Major players: Departments or Ministries of Environment and

Agriculture– Designated National Authority (DNA)

Regulatory requirements

Will vary in each country, locality, and even project. May include:• Permits for project activities

– E.g. tree harvesting, exploitation of non-timber forest products, agricultural activities

• Environmental Impact Assessment (EIA)

• Registration of supporting entities

Sustainable forest management certification (e.g. FSC), if sought, means additional requirements

Potential taxes

Taxes may owed on the carbon credit transaction as well as underlying project activities – for example, timber harvests and sales are generally subject to taxTypes of taxes that may apply:• Sales and VAT taxes - Charged on value of good, service, or property, at the

time of its transfer• Income taxes - Based on financial income (including carbon revenue) of

persons or legal entities• Property taxes - Based on property value• Duties/tariffs - Taxes on value of imported or exported goods• Carbon revenue taxes - Apply to carbon credits or projects in some countries

– Guarantees part of carbon revenues to government

II. ORGANIZATIONAL ISSUES

Between project participants, any representative organization, and supporting entities, based upon written or oral agreements

Include:• Project governance

• Benefit sharing

• Fund management

Participating landholders,

representative organization

Financial institution

Project developer

Law firm

Advisors

Project governance & benefit sharing• Good project governance reduces costs of project administration

and risk of project failure• If project participants are numerous:

– May want to officially form an organization, consortium, or business– Should appoint an individual, entity, or small group to act on behalf of

project participants

• Project participants, supporting entities should agree in advance:– Roles and responsibilities for underlying project activities and carbon

transaction– Procedures for inclusive, transparent decision-making and dispute

resolution– Revenue-sharing with community, between project participants, and /

or with the government

Fund management

Centralized, fund management is important as the number of parties and/or complexity of the transaction increases, e.g. due to:• Numerous project participants

• Advance payments

• Use of payment “netting”

Fund management is generally entrusted to a bank or other financial institution, with specific duties, rights, and responsibilities agreed by contract

3. Transactional issues

Between forest carbon sellers and buyers or investors, based on oral or written agreements

Sellers / project

participants

Buyers or investors

ERPA: Purchase of verified emission reductions (VER)• Standardized document commonly used in carbon transactions• Payment largely due on delivery, but advance payments possible

Emissions Reduction Purchase Agreement

Forward Purchase• Carbon credits yet to be issued

and/or generated• Buyer shares risk• Lower credit prices• Advantages for small-scale sellers

include:– Predictable revenue– Up-front funding

Spot Purchase• Carbon credits already generated

and issued• Low risk to buyer• High credit prices

Forward purchase agreement: key challengesSome particularly important – and difficult – contract clauses in forward purchase agreements for forest carbon:• timing and structure of payments• allocation of project development

transaction costs• allocation of risk and delivery

liabilities• dealing with default and remedies

Price and payments: key issues

1. Setting the price• Market price• Cost of underlying project• Assumption of risk, liability

2. Fixed price vs. indexed or floating price • Fixed price is predictable• Indexed price means parties share in upside or downside of market shifts

3. Seniority among multiple buyers• May create credit tranches at different prices to create seniority among multiple buyers

4. Timing, procedure for advance payments• Up front funding is a major challenge for many projects• Advance payments expose buyer to more risk, prices likely significantly lower

Allocation of project development transaction costs

• Include costs of:– Obtaining 3rd party validation

& verification– Registration of carbon credits– Issuance of carbon credits

• May also include costs of:– Writing Project Design

Document– Monitoring project activities

• May be significant: allocation will affect price

Allocation of risk and delivery liabilities• Credits not delivered because,

e.g.:– Project underperforms– Standards body validates, verifies

few or no credits– Events outside of control of

project participants disrupt project activities

– Change in law adversely affects the project

– Credits issued, but not delivered as promised

• Risk must be allocated between buyer and seller

• Buyer generally not entitled to reimbursement for advance payments, costs– Exposed to project risks

insofar as prepaid for expected credits or paid transaction costs

Example: Force Majeure, change in law• Force Majeure

– “Act of God” outside of control of participants

– Neither party liable for loss caused by force majeure

– Termination of agreement may be available

• Insects, forest fire– High risk factors– May require proof that extra

precautions were taken before sellers excused from delivery due to forest fire, insect infestation

• Change in law– Generally very complex, heavily

negotiated

• Many possible contingencies– Carbon cap in seller’s country

destroys additionality– Carbon regulation in buyer’s

country does not recognize project’s emission reductions

– Seller’s government expropriates land or carbon

– New taxes destroy the value of the transaction for one or more parties

– Many more possibilities…

Default & Remedies

• Triggers remedies like:– Termination of agreement– Monetary damages

• Against seller:– Liability for replacement credits– Exclusion from planned

subsequent transaction– Payment withholding

• Against buyer:– Recovery of credits– Recovery of outstanding

payments

• “Event of Default,” e.g.:– Failure to ensure project

implementation as promised– Failure to pay when due– Termination or bankruptcy

of a party– Material breach of a

representation– Failure to comply with

validation, verification, monitoring obligations

Strategizing Around Legal Costs

• Specialized legal support vital to:– Assess tenure rights, strategies for legal compliance– Create robust project governance and fund

management structures– Secure carbon financing

• Legal support at key stages:– Lays a firm foundation for project activities– Avoids future costs– Reduces risks of dispute, project failure

• Limiting legal costs– Cooperation, collaboration between similar projects– Free or low cost resources from non profits, government– Additional support for lawyers wishing to enter the field

Key Resources

• Costenbader J, ed. 2010. Legal Frameworks for REDD: Design and Implementation at the National Level. Environmental Policy and Law Paper No. 77. IUCN: Gland.

• Takacs D, ed. 2009. Key Legal Questions in Allocating Forest Carbon-as-Property, pp. 13-20 in Forest Carbon: Law + Property Rights. Conservation International: Arlington, VA.

• Hawkins S. et al. 2010. Contracting for Forest Carbon: Elements of a Model Forest Carbon Purchase Agreement. Forest Trends: Washington, DC.

• Katoomba Group Online PES Contract Toolkit: http://www.katoombagroup.org/legal_contracts.

• CERSPA Initiative: http://www.cerspa.com.

Thank you!Slayde Hawkins, Legal Advisor & Policy Analyst, Forest Trends

shawkins@forest-trends.org