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Legal Aspects of Joint Implementation Projects under the Kyoto Protocol in Ukraine
Implementation and use of Joint Implementation Projects under the Kyoto Protocol (JI Projects) offer numerous investment opportunities and benefits attractive to investors, owners and developers of such projects focusing on reducing greenhouse gases (GHG). In the course of carbon trading projects all the parties involved may face uncertainties and irregularities regarding applicable Ukrainian regulations.
In this article we provide a brief overview of certain legal aspects of JI Projects in Ukraine, in particular general regulation, execution and implementation of Emissions Reduction Purchase Agreements (ERPAs), and remedies available in JI Projects.
Legal framework of JI Projects in Ukraine JI mechanism background
The Kyoto Protocol adopted at the Third Session of the Conference of the Parties of December 1997 (the Kyoto Protocol) came into effect in February 2005. Under the Protocol, industrialized countries commit themselves to reducing greenhouse gas emissions until 2012. The Protocol introduced three market-based mechanisms to achieve the agreed targets: Assigned Commitments Trade, Clean Development Mechanism, and Joint Implementation (JI). For projects in Ukraine JI mechanism can be used. Article 6 of the Kyoto Protocol provides for the opportunity to transfer or acquire emission reduction units (ERU) resulting from projects aimed at reducing anthropogenic emissions by sources or enhancing anthropogenic removals by sinks of GHG in any sector of the economy. For this mechanism to be used, a specifically defined JI procedure should be followed to demonstrate the additional effect of GHG emission reductions.
Regulation of JI projects
Generally, there is the option of implementing JI projects through Track I or Track II depending on whether the involved parties are in full or partial compliance with certain criteria. Track I procedure is based on implementation of a party’s own national rules for selection of JI projects and estimation of emission reductions. Track II is based on an international procedure supervised by the Joint Implementation Supervisory Committee (JISC). In Ukraine JI Projects can use both Track 1 and Track 2. Track 1 projects are subject to registration by the National Environmental Investment Agency of Ukraine (NEIA), which is the designated state authority for national approval of JI Projects. Track 2 project requires registration by JISC as well as international determination and verification. Ukrainian legal framework regulations in this field are based on the following documents:
— Procedure for JI Projects Development, Consideration, Approval and Implementation by the Resolution of the Cabinet of Ministers of Ukraine (the Cabinet) of 22 February 2006, No.206;
— Requirements to JI Projects Documents by NEIA Orders of 25 June 2008, No.32 and No.33;
— Procedure for Implementation of JI Projects under National Procedure by NEIA Order of 18 December 2008, No.79.
The JI registration procedure includes a number of stages, including project proposal submission to the NEIA, issuance of the Letter of Endorsement by the NEIA approving development of project design documentation (PDD), submission of the PDD for determination to an independent accredited authority, issuance of a Letter of Approval by the NEIA, registration of the project by the NEIA (and JISC, if Track 2 is used), annual reporting by the project owner, verification by the independent accredited authority, crediting ERUs by the NEIA in the account of the seller in Ukraine's National Registry, and transfer of units to the buyer's account.
Execution of purchase agreements on emission reductions
ERPA is a vital document for all the participants of JI Projects. This document ensures that all of the work on search for investments, project development and other preliminary matters actually result in receipt of revenue from ERUs generated. However, in case of signing unfavorable ERPAs their parties (the Parties) take on unnecessary risks and may not receive a sufficiently high level of income. Basically, ERPA covers a transaction providing for the transfer of carbon credits between parties under the Kyoto Protocol. There is no unified master agreement prescribed by the Kyoto Protocol rules and regulations. However, recommended standards for ERPAs are outlined by the International Emissions Trading Association.
Notably, these standards were developed by the latter for Clean Development Mechanism under the Kyoto Protocol, but are often used for JI projects as rather similar.
ERPA issues under Ukrainian law
Ukrainian law does not specifically regulate the contracts under the Kyoto Protocol, including JI projects. It appears that ERPA will be subject to the general provisions of Ukrainian law regarding commercial contracts between Ukrainian and foreign parties. Apparently, under applicable Ukrainian law, ERPA is qualified as a plain “foreign economic contract”, and JI projects' investor (JI Investor) constitutes a foreign party to such a contract.
The choice of a foreign law as a governing law of a "foreign economic contract" is permitted by Ukrainian law. Obviously, foreign law as the governing law of ERPA is more suitable for a JI investor in such a new area as emission reductions trading under the Kyoto Protocol. However, ERPA drafted according to Western standards may pose certain problems from the perspective of Ukrainian law. For example, based on Westerntype contracts legal practice, it appears that the "Warranties and Representations" sections thereof are almost unenforceable under Ukrainian law due to some fundamental differences in law systems. According to Ukrainian law, a party is liable for breach of its contractual obligation. Such an obligation is defined by law as a legal relation, pursuant to which one party (debtor) is to act for the benefit of the other party (creditor) or withhold from acting. Such acting is defined by law as the transfer of property, provision of works or services, monetary payment, etc. A breach of a contractual obligation triggers civil liability enforceable in a Ukrainian court. Representation and warranties should be considered as the Party's unilateral factual statement, rather than a contractual obligation. An incorrectness of unilateral factual statement would normally not create grounds for a lawsuit under a contract. In view of the aforementioned the inclusion of representations and warranties in ERPA is not prohibited by law. However, respective provisions may not qualify as obligations and could not be enforceable against the breaching party if a lawsuit is brought under Ukrainian law.
However, this is unlikely in the light of the fact that foreign law as usually the governing law in most ERPA contracts. According to the general requirements of Ukrainian law, Annexes to ERPA are to be signed by the parties to be legally in force. The Parties would be well advised to sign and affix the seals of the parties to each annex in the way applicable for the main body of ERPA. Furthermore, all annexes to ERPA, as well as ERPA itself, have to be drafted in the Ukrainian language (optionally, together with a second language version) as nonfulfillment of this requirement may result in the validity of Annexes being challenged.
Disputes Resolution under JI projects
JI projects cover a broad range of activities and, thus, various types of risks arise at each stage of such projects. Such risks may lead to the termination of a JI project due to the breach of obligations under ERPA and/or due to changes in legislation. Therefore, JI investors require efficient instruments for the protection of their rights and interests in the event of disputes arising during JI Projects implementation.
The Kyoto Protocol does not provide JI investors with specific remedies to be pursued against the host state or other parties within the JI mechanism. Therefore, disputes under JI projects are resolved in accordance with general applicable legislation and internationally recognized legal rules. The most common methods of dispute resolution are discussed below.
Ukrainian law entitles JI investors to apply to Ukrainian courts in the event that their rights, liberties and interests are infringed. Obviously, in such cases JI investors shall apply to (i) commercial courts if a dispute arises between the parties or (ii) administrative court if a JI investor's rights are infringed by a government authority during administrative proceedings ("public dispute"). As JI projects are relatively new for Ukraine, there is no solid established court practice with respect to resolving disputes around such projects. Therefore, it appears rather difficult to determine the outcome to be expected from such Ukrainian litigation. Talking about public disputes, it should be noted that applying to administrative courts is almost the only remedy to be pursued against government authorities available to a JI Investor. However, applying to a commercial court in case of disputes between the Parties is not the only way for resolution of such disputes. As a rule, the Parties are able and often choose other instruments such as international arbitration, which are in many respects more efficient and reliable.
Disputes under ERPA may be and often are referred to international commercial arbitration. Arbitration is the leading method for resolving disputes arising from international commercial contracts and other international transactions, and is available to a JI investor if the parties decided to submit disputes to binding resolution by a certain arbitration tribunal. The parties usually include an arbitration clause into the ERPA.
Arbitration cases are heard by institutional or ad hoc tribunals. The most significant institutions for resolving disputes under international commercial contracts are the International Chamber of Commerce (ICC), the International Centre for Dispute Resolution (ICDR), the London Court of International Arbitration (LCIA). A number of arbitral institutions have adopted the UNCITRAL Rules to be used for resolution of such disputes. As to the enforcement of Arbitration awards, Ukraine is a party to the New York Convention on Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958), which is the internationally recognized instrument for the enforcement of international commercial arbitration agreements and awards. Among the advantages of international arbitration as compared to the local courts are avoidance of the uncertainties and local practices associated with litigation in Ukrainian courts, possibility to obtain a quicker, more efficient decision, the relative enforceability of arbitral awards, the commercial expertise of arbitrators, the freedom of Parties to select and design the arbitral procedures, confidentiality and other benefits.
In certain cases a JI investor may, as a foreign investor in Ukraine, apply to the International Centre for Settlement of Investment Disputes (ICSID) in the event of disputes with the state. ICSID was established to provide facilities for conciliation and arbitration of investment disputes between the states (the State) bound by Convention on Settlement of Investment Disputes between States and Nationals and individuals/legal entities of other States (the National). The jurisdiction of the ICSID shall extend to any legal dispute arising directly out of an investment (the Dispute), between the State and the National, which the parties to the dispute consent in writing to submit to the ICSID. As a rule, such consent is given in bilateral investment treaties between States providing for the submission to the ICSID in future disputes. Therefore, if a JI investor is the National of the State having such a bilateral investment treaty with Ukraine, the JI investor would be able to apply to ISCID in the event of a dispute. The number of disputes with Ukraine submitted to the ICSID has risen recently. This trend shows that the ICSID is a rather popular remedy among foreign investors. However, most of the disputes were not settled in favour of investors. As of today, more than eight claims against Ukraine have been filed with the ICSID.
Three such disputes were settled in favour of Ukraine, two disputes were settled by conciliation without compensation to the nationals, and other disputes are still being under the ICSID's consideration.
Summing up, as JI Projects are commonly multilevel projects and involve various types of risks, the method of a JI Investor's rights protection and disputes resolution depends on each individual case. Anyway, it is strongly recommended that Parties agree on the forum of dispute resolution in ERPA in advance.