Specific Issues to Negotiate in a IJI Contract

Which Country's Laws Apply

In designing a IJI project, would-be partners need to determine upfront which country's laws should apply and incorporate specific dispute resolution language into the contract. In most cases, the laws of the country having the most at stake (i.e., financial investments) will apply. There are some circumstances under which host country law may be most appropriate. For example, disputes may need to be resolved in the host country, and potential witnesses are probably located there. In addition, enforcement of the law is often limited by the legal environment of the host country. That is, if a U.S. party should need to make a claim in the host country, judgments will likely be executed there. Depending on the complexity of the project and the level of risk involved, parties may agree to refer any disagreements to a neutral third party, who would be called upon to mediate. Partners in the RUSAFOR project, for instance, agreed that the laws of Russia would apply to the project, but that any disputes would be subjected to the jurisdiction of the courts of Oregon State. A handful of organizations specialize in dispute resolution. One such body is the American Arbitration Association (AAA) (see note 2), a not-for-profit, public service organization with offices in major cities around the U.S. Among other things, AAA provides arbitration of international commercial cases. AAA also provides guidance on writing dispute resolution clauses. The International Chamber of Commerce's Court of Arbitration in New York City also provides arbitration services (see note 3). While dispute resolution provisions can prove invaluable a few years down the road, they can also add to upfront project costs. This is another reason why parties should agree to as much as possible in the early stages of project development.

Risk Management

Because of the many unknowns involved in developing a IJI project, including changes in the international attitude toward the threat of global warming, political vulnerabilities associated with some developing countries, and natural disasters, developers should consider mechanisms for managing risk, including financial, technological, and political risks.

IJI participants may wish to consider purchasing insurance to cover unexpected eventualities. Government-backed international investors, such as the Overseas Private Investment Corporation (OPIC) insure Iong-term U.S. investments abroad. At this time, however, OPIC only offers political risk insurance. It covers losses resulting from currency inconvertibility, loss of investment due to expropriation, nationalization or confiscation by a foreign government, and loss of income or assets due to war, political insurrection, and/or terrorism. OPIC investment insurance would therefore not cover losses resulting from natural disasters or such "unofficial" activities as destruction of a forest by local loggers or farmers.

Project developers may be able to protect themselves by shifting responsibility for the project's success to those actually implementing the project. This can be done by including in the contract a penalty for failure to perform.- For example, one could demand repayment of money invested (plus interest) if the project fails. The disadvantage of this type of approach is that developing economies are not always able to pay large sums of money. Another way of putting the onus on the project implementor would be to include language guaranteeing that if the project fails, the host country will provide an alternate opportunity for equivalent expected greenhouse gas benefits. For example, the contract could contain a clause stating that if a forest in a land-use project is cut down, the host country government will make another parcel of land available to the U.S. partner for afforestation.

Similar risk minimization effects can be achieved through the use of incentives. By attributing to the host country part of the credit for emissions reduction, investors can provide an incentive to induce the host country to protect and sustain the project independently. Developers of the RUSAFOR project assigned carbon offsets on a 50/50 basis, thereby ensuring that the Russian partner would have an interest in maintaining the offset over time. In many cases, involving the host country as an active participant in the project can provide some measure of project security. Past project developers have emphasized the importance of obtaining the support of the local community to ensure long-term success of an overseas venture.

While it may be difficult to obtain comprehensive protection of a project from the risk of complete failure it may be possible to insure individual elements of the project. For example, seedlings purchased for afforestation projects often come with a guarantee from the nursery to cover replacement should the seedlings not survive the first several months after transplantation. Project developers can also purchase cargo insurance to cover the transfer equipment from the U.S. to the foreign country. Some large brokerage firms, such as the Roanoke Companies, Alexander and Alexander, or Marsh and Mclennan, specialize in this type of coverage (see note 4).

There are other creative approaches to managing risk as well. Developers planning projects in the same country, for example, may wish to diversify risk by pooling their projects in such a way that if one project fails, the developer will still receive the benefits arising out of the other successful projects. However, the specifics of these arrangements can be quite complex and will require some legal expertise and creativity. Many contracts also contain force majeure clauses, which allow for termination or suspension of a contract in the event of extraordinary circumstances, such as a natural disaster, war, terrorism, governmental actions, labor strikes, or other unforeseen eventualities. These clauses limit the liability of the party executing the force majeure.

However, not all aspects of risk can be managed contractually. The most important thing for potential project developers to bear in mind is that they need to fully understand what they are getting into. All projects involve some element of risk, and the best way to minimize it is to do extensive research beforehand. Likewise, it is important to listen carefully to the foreign partners to fully understand their interests and expectations. A successful project is one that meets the needs of all parties; establishing these at the outset will help reduce the chances of misunderstandings and disputes later on.

Assignment of Greenhouse Gas Reductions/Sequestration Benefits

One area which most participants will want to treat by contracts is the assignment of greenhouse gas reduction or sequestration benefits among parties. While at first glance assignment of such benefits may seem fairly straightforward, it is a topic deserving thoughtful consideration by all participants. At issue is the fact that from now until the end of the pilot phase, no international credits are being offered for greenhouse gas emissions reductions. However. this may change in the post-pilot phase, and the value of greenhouse gas reductions may be high. For this reason it is important that project developers reach agreement on greenhouse gas apportionment and include language in the contract, so that there is no dispute later on. Project developers should also document all their consultations with respect to future value of greenhouse gas credits. Another option for dealing with a reassessment of greenhouse gas value is to draw up a "changing values" contract, in which terms are established that take into account dynamic situations and allow parties to reevaluate the terms of their contract after a mutually agreed upon period of years. One way of dealing potentially dynamic circumstances would be to include language indicating the potential for values to change over time and how parties will address such changes. For example, if one participant has agreed to contribute dollars in exchange for a percentage share of the greenhouse gas reductions, it may be desirable to insert minimum levels of reductions to protect the interest of such partners. If these levels are not achieved, then both parties could have the option to cancel the agreement, in which case neither party shall have further obligations under the contract.

In another scenario, participants may anticipate there will be a greenhouse gas credit trading system in the future. If this is the case, the partners may wish to establish a target price per ton of carbon dioxide annually over the life of the project. Then, if the trading price is above or below this target for any given year, contract provisions can allow for readjustment of the parties' obligations and/or the extent to which they receive ownership of the reductions.

Yet another approach to dealing with the possibility of changing greenhouse gas values may be to develop agreements with appropriate levels of government (e.g., national, provincial, and municipal) in the host country to elicit a guarantee that greenhouse gas reductions will not be taxed, especially as their value goes up.

Assignment of emissions reduction benefits may be established on the basis of financial contribution or some ex ante target price per ton of greenhouse gas reduced or sequestered. However, project participants have wide latitude in assigning benefits. For example, there is a proportional allocation, e.g., 50 percent to each of the parties. This arrangement assigns equal risk to both parties. Alternatively, some agreements may allocate the first several thousand tons to one party, and all subsequent tons to another. This provides a near-term guarantee that the first party will receive its emissions reductions and shifts the risk of underperformance to the second party. Other arrangements may simply assign all greenhouse gas reduction benefits to be assigned to one party. Ensuring Project Survival over the Long Term. As mentioned earlier, IJI contracts must incorporate mechanisms that ensure that the project will be able to continue once the proposer's initial work has been accomplished. Not only is it important to ensure continued reduction or sequestration of greenhouse gases, but it is also important to protect investor assets abroad. Contracts should therefore contain language that guarantees performance. For example, if the project fails, who will take over ownership? These issues are most appropriately considered early in the contracting process.

The issue of project success is further complicated by the long-term nature of IJI contracts and the fact the international regulatory environment may change over time. Projects must be designed to deal with this uncertainty. There are several possible ways of doing this. One might be to design the project in such a way that it is in everyone's best interest to keep the project alive, that is, it should be a project that is good in and of itself, even if no international consensus on IJI evolves. One way of doing this would be to build local incentives into the project, so that local people will be motivated to keep the project going indefinitely. In a forestry project, the project could be designed in such a way that the local inhabitants will not want to cut the trees before the time intended by the IJI project. For example, Belize law says that forests must be preserved forever. Hence, strong incentives exist for Belizeans to engage in long-term forestry projects, irrespective of international pressure to reduce or sequester carbon.

Another way of responding to the uncertain future of the greenhouse gas market is the use of "option contracts," which hedge on the future value of a commodity (in this case, greenhouse gases) by allowing investors to participate for a relatively small fee and giving them an option to renew the contract every five or ten years or so, effectively recalibrating the value of the commodity'. However, this can be complicated, since it is difficult to predict the future value of greenhouse gases.

Other proposers try to ensure long-term viability of a project by entering into an arrangement with a host government or some other secure local entity, such as an NGO, that is charged with overseeing the project. This body would guarantee that the project is protected over many years. In this situation, the developer puts trust in the local institution and must, therefore, fully investigate the stability of this entity and whether it has the resources necessary to perform the agreed-upon tasks.

Project Monitoring

Another important aspect of the IJI process is project monitoring and verification. Monitoring involves the periodic collection and analysis of data on the project's effects; it is usually conducted by the project developer himself, although some IJI participants may wish to engage outside parties to perform monitoring. Some developers may also consider hiring a third party with special expertise in the area of data collection and analysis to design a monitoring regime for the project at its commencement.

Verification occurs when a third party is hired to measure project effects. The third party may consist of the USIJI Evaluation Panel. a USIJI designee, or another party selected by the project developer. This independent audit, as described elsewhere in this book, will ensure that data, procedures, and methodology being used are adequate for the project's goals.

When developing contracts for monitoring and/or verification, project developers may select an external auditor who will be a part of the project from inception on through final implementation, since monitoring and verification of greenhouse gas impacts essentially begin with the project design and initial estimation of effects. Those who are involved in original estimates of carbon impacts will have a better understanding of what needs to be monitored over the long term. Important considerations in designing monitoring and/or verification contracts include:

  • Schedule (when should monitoring occur and how often.
  • Frequency likely will depend on the type of project)
  • Methodology and data collection procedures (what should be monitored and how)
  • Reporting arrangements
  • Funding/cost arrangements (what will be billed and paid for)

Although, as recommended above, it may be beneficial to have the verification party involved early in the project, such an arrangement is not always feasible, since in some cases, as with a forestry project, verification procedures will not commence for many years into the future. Consequently, it may be difficult to design contracts appropriate for such timeframes. Land Ownership/Management. Some joint implementation projects will involve the purchase of land in a foreign country. In some cases, land will be purchased from the host country government; in other cases land will be bought directly from farmers or other local inhabitants. A central element of the Ecoland Project in Costa Rica, for example, was the purchase of 2,000-3,200 hectares of privately held tropical forest. Legal arrangements needed to be made for the purchase of land, logging concessions, and the transfer of title. Depending on the type of project, some contracting issues related to land use include leases/easements; land management/preservation activities; restrictions on use of timber and/or slash Cliffris; and replanting activities in case of loss by fire, disease, or insects. Land-use contracts provide the USIJI Evaluation Panel the reassurance that sequestration activities can be sustained well into the future.

Energy. Energy-related IJI contracts may call for Power Purchase Agreements (PPA) and/or Engineering, Procurement, and Construction (EPC) contracts between the developer and a host country entity. Although these contracts are not unique to the IJI process, they are important indicators of the project's stage of development.

A Power Purchase Agreement is usually a Iong-term contract for the sale and purchase of capacity and/or energy from a power producer to a purchasing utility. In the case of IJI projects, the purchasing utility is often a national entity. In most instances, the PPA will be not differ significantly from similar agreements negotiated between domestic partners in the United States. The main difference, according to past IJI participants, is that PPAs in developing countries tend to be broader and less specific than those in the United States, owing to a less mature power market in developing countries.

An EPC contract typically provides guarantees covering completion, performance, electricity output, and emissions levels. These contracts can also encompass elements such as project design, contract price, payment schedule, completion schedule, performance tests and guarantees, final acceptance, force majeure, warranties, subcontractors, limitations on liability, termination, and dispute resolution clauses. Like PPAs, EPC contracts associated with IJI usually resemble similar contracts between two U.S. parties. For both types of projects, past project developers stress the importance of having good local counsel on hand during negotiations.

Agreements with Host Country Governments

In the course of their activities, many USIJI participants will doubtless have occasion to negotiate with representatives of the host country government to facilitate project development. Agreements can be signed covering such issues as tariff relief? relaxation of restrictions on local ownership, local content requirements, tax relief, property rights, and other matters. Once again, a local advisor will be a useful resource in helping to navigate the local government.

A Memorandum of Understanding (MoU) establishes a formal framework for collaboration between two parties and signifies a willingness on the part of both to collaborate on some specified objective. An MoU does not specify a particular technical project on which collaboration will occur, nor does it indicate other modalities of cooperation, such as technical agencies involved, management, or financial agencies. Rather, it is a statement of intent which sets the stage for future projects. In some cases, the United States government can assist project developers by signing a broad umbrella agreement with the host country. For example, the United States Department of Energy has Memoranda of Understanding in place with the government of Costa Rica, which has led to a more favorable environment for IJI projects within that country. In addition, a similar agreement has been entered into with the government of Chile, which should facilitate the IJI process there as well. Other MoUs may be signed with other governments in the near future. Also under development is a regional MoU between the United States and a consortium of foreign governments, such as the collective governments of Central America.

Notes

2. The American Arbitration Association's main office is in New York City. The telephone number there is (212) 4844000. AAA also has offices located in 36 other cities around the United States.

3. The International Chamber of Commerce Arbitration Courrt can be reached at (212) 354-4480.

4. Phone numbers for these organizations are as follows: the Roanoke Companies (708) 490-9540 or (800) 422-9944; Alexander and Alexander (202) 296-6440; Marsh and Mclennan (202) 828-7900.

5. The U.S. Carnet program also provides duty and VAT-exemption on goods, such as test equipment or construction tools that are taken abroad on a temporary basis. The carnet, valid in fifty countries, is in effect a passport for merchandise, and it exempts the U.S. importer from duties and taxes while the goods are in the foreign country. Carnets can be issued through the U.S. Council for International Business or through some insurance brokers.

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