17 May 2011

Preparing for a carbon price: legal issues

by Patricia Williams

A carbon price is looming but is by no means a certainty. What steps from a legal point of view can be taken to protect where possible against the introduction of a carbon price without constraining activities or documents should a carbon price not eventuate?

There are ways of drafting documents which can accommodate the possibility of a carbon price but which would simply be inoperative (or operate more narrowly) should a carbon price not eventuate.

Given the lack of specifics at the time of writing, a big picture approach needs to be considered by companies at this stage to deal with possible consequences of the advent of a carbon price. The issues will of course be different depending on the activities of the businesses being considered, but the following are some issues which could be relevant.

Contractual issues

"Parent-trap": Drafts of the previous proposed CPRS legislation provided for a parent company to be liable to acquit permits equivalent to the direct emissions of facilities operated by the corporate group, even though its subsidiary may be the operator of the emitting facility or may be the joint venture party to an arrangement which operates such a facility.

This raised questions about how the subsidiary, as the party to an agreement in relation to the operation or products of the facility, could recover the cost of the permits as a cost of providing its services or as costs of the joint venture, when its parent was bearing the costs.

At the time of the proposed CPRS, there was consultation about ways of dealing with this issue, such as:

  • the ability of the parent to transfer the liability to the relevant subsidiary via a liability transfer certificate mechanism (as a way of ensuring that the subsidiary would bear the cost of the permits and would be able to pass on those costs through the joint venture or other agreement);
  • the ability of the subsidiary to request a transfer to it of the liability for the permits to achieve the same end; and
  • to support any possible oppression of minority shareholders in a subsidiary where the subsidiary is not wholly-owned but takes on the cost of the permits, oppression remedies akin to those in the Corporations Law.

Consideration was given to whether change of law clauses in agreements (which provide that there can be a price increase or other amendment to an agreement if there is a change in law) would assist in being able to pass on the cost of permits. A concern was raised that, if a subsidiary voluntarily chose to ask for a transfer of the permits, this may not trigger a change of law clause and, as a result, the subsidiary could not pass on the cost.

If the same position is to be reflected in the next round of proposed legislation, companies could consider:

  • how the liability to acquire, and the ability to trade and transfer, permits, would operate within the group;
  • where the parent would be liable to hold the permits, but its subsidiary is the party to a joint venture or other agreement, how the subsidiary could recover the costs and how it could increase costs or otherwise recover the exposure that the parent has borne; and
  • how any compensation payable under a carbon pricing structure is received and to be retained.

Operating agreements: If, under an Operation and Maintenance Agreement, the operator is responsible for obtaining any necessary licences, permits and other authorisations required to undertake the project, does that agreement:

  • clearly identify whose responsibility it would be to obtain any carbon permits (and at whose cost) and to ensure compliance with the relevant laws associated with a carbon price;
  • if permits are required under the legislation to be held by the operator, include provision for them to be transferred if the agreement comes to an end and does it deal with the transfer value of the permits;
  • include obligations for the operator to provide evidence that the legal requirements and obligations anticipated in relation to a carbon price are being met; or
  • deal with who makes decisions about trading the permits and the upside and downside of such trading?

Joint venture arrangements: The issues under "parent-trap" above are relevant, but other issues arise, such as:

  • Which of the joint venturers has "operational control" of the emitting facilities?
  • Is there a requirement for the joint venture participants to agree to share any carbon price liability equivalent to their interests in the joint venture arrangement to avoid liability sitting with the majority interest?
  • Is there the necessary freedom of transfer of the permits and should the joint venture end, how would the permits be dealt with?
  • How would any upside (or downside) on the trading of the permits be dealt with?

Existing trading contracts: If a company has existing long-term or recurring customer contracts, do they contemplate and make provision for increasing the price of the goods or services the subject of the contract, as a result of an additional cost such as a carbon price? If not, to what extent can the contracts be varied unilaterally to pass on such a cost?

Transactional issues

If part of a company's strategy involves looking at target businesses or companies to acquire, or divesting of interests, issues could arise in relation to the preliminary due diligence in relation to such a transaction and/or the transaction documents reflecting any proposed deal.

Due diligence: When undertaking a due diligence exercise prior to acquiring or investing in a company or business, consideration could be given to asking broad questions such as:

  • How would a carbon price affect the viability and profitability of the business?
  • To what extent has the business factored in the possible effects of a carbon price, both financially, and in connection with their trading relationships?
  • How will the carbon price affect any of the terms of their existing contracts and will it be possible to pass on additional costs arising as a result of a carbon price or otherwise amend those contracts to deal with the ramifications for the business of a carbon price?
  • What plans are there to seek to use offsets as a mechanism to reduce the permit exposure and how likely are those plans to be successful?

Sale and purchase agreements: When negotiating a sale/purchase agreement, consider:

  • Who will bear the cost of a carbon price if it affects the value of the company or business?
  • Where there is to be a subsequent adjustment to the purchase price based on post-completion trading results, who bears the effect on those results of the imposition of a carbon price?
  • How will fluctuations in the value of the permits – when the fixed permit price moves to a market-driven price – be dealt with, who wears the downside and who benefits from any upside?

If a carbon price becomes a reality there will be specifics that will need to be addressed. The above issues are a hint of what will need to be considered.

In the meantime, it would be worthwhile for companies to consider how a carbon price could impact their business, having regard to the above issues, and consider whether it is appropriate as a result to take steps to guard against the impacts should it eventuate.

As noted at the beginning of this article, documents can be drafted (and changes may be able to be made to documents) to address the effects of a carbon price without adversely impacting the documents should the legislation not come into being.

Of course, it is not just legal issues that need to be considered; accounting and tax issues should also be considered to identify opportunities of dealing now with the possible impact of a carbon price on existing deals and deals that are likely to close (and commercial arrangements that are likely to be put in place) before the introduction of a carbon price.

This article first appeared in CMI Review, Issue 2, 2011

 

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.