The jurisdictional questions involving Article 37 of the Registry Regulation cause that under the same factual circumstances in one potential case the Seller may be established to be in good faith and in the other it won’t. This may have a direct influence on the determination on the Seller liability under IETMA.
In an answer to the Question 11 of the document ‘FAQ’s on the International Emissions Trading Master Agreement’ of 16 April 2012 the organisation IETA explains an important issue regarding the treatment of the stolen allowances in the EU ETS under the new framework of International Emissions Trading Master Agreement (IETMA).
IETMA is generally designed for the third trading period, it contains, however, also specifically formulated provisions enabling traders transition between Phases 2 and 3.
It’s good that IETA has decided to clarify IETMA provisions in that regard (see clauses 5.3.1. – 5.3.4 of the Schedule 4 EU ETS System Schedule), since they may appear ambiguous to some extent.
In the above FAQ’s on the International Emissions Trading Master Agreement’ of 16 April 2012 IETA summarises its point presented in IETMA in the following manner:
1. The existing No Encumbrances representation has been replaced by an No Encumbrances Obligation, and stolen allowances are dealt with as a separate category of breach of this obligation.
2. If a Seller did not acquire the stolen allowances in good faith, it will always be liable to the Buyer for its breach of the No Encumbrances Obligation. If, however, the Seller did acquire the stolen allowances in good faith, liability will depend on whether the Buyer has a claim brought against it
(a) by the original victim of the theft or
(b) by any other person to whom the Buyer has sold or transferred the stolen allowances.
In the case of (a), the Buyer is required to use best endeavours to defend a claim by the original victim, i.e. the Buyer must utilise any available defence (including Article 37 of the Registries Regulation) and cannot agree to settle a claim. It is only if the Buyer is unsuccessful in such defence that it can pass liability to the Seller.
In the case of (b), the Buyer is subject to a lesser test to use all reasonable endeavours to mitigate its losses. It is only if the Buyer can satisfy this test that it can pass liability to the Seller.
IETA indicates that the purpose of this new wording of IETMA (when compared with ETMA v 3.0) is to address the issue of stolen allowances in a manner consistent with the Registries Regulation by providing clear rules for and discouraging initiation of claims, thereby restoring confidence in the carbon market.
The above stance according to IETA is supported by the fact that EFET has adopted the same wording in their documentation for Phase 3 of the EU ETS. IETA reserves, however, that the above FAQ answer is a high level explanation of some key concepts and refers the audience to the very text of IETMA and the EU ETS schedule for a more precise definition.
So we have here the one of the first practical applications of the key provision of the new the Registry Regulation, i.e. Article 37.
The significance of the said rule has been underlined in numerous articles (see for instance: The protection of the good faith acquirer of emission allowances and finality of transactions in the new Registry Regulation – do they cause traders feel more comfortable? or Legal complications with the recovery of the stolen allowances).
It was also pointed out that judicial disputes regarding settlements between the parties evoked by the stolen allowances being the subject of the transaction are rather complicated (see: Transfer of EUAs as a proof of ownership).
Let’s recall that pursuant to the clause 5.3 of the International Emissions Trading Master Agreement Version 1.0 of 16 April 2012 (titled “No Encumbrances”) the delivering party is under the obligation to transfer to the receiving party the CO2 allowances free and clear of all liens, security interests, claims and encumbrances or any interest in or to them by any person ((the "No Encumbrances Obligation").
The consequences of a breach by a party of obligations in question is governed by IETMA by the terms specified in the relevant so-called ‘Executed System Schedule’ – additional part of the agreement specific for each particular cap-and-trade scheme, whether EU ETS, Californian or Australian (the second and third mentioned ‘Executed System Schedules’ are at present under preparation by IETA).
We’ll see how the new rules will work in practice. The first preliminary observation is, however, the fact that the determination on the good faith of the Seller (a key determination for establishing the liability of the Seller) made in the potential judicial proceedings between the above mentioned parties (the Buyer and the original victim of the theft or the Buyer and any other person to whom the Buyer has sold or transferred the stolen allowances) can diverge from the one made in eventual judicial dispute between the Seller and Buyer under the IETMA framework.
Article 37(4) of the Registry Regulation:
A purchaser and holder of an allowance or Kyoto unit acting in good faith shall acquire title to an allowance or Kyoto unit free of any defects in the title of the transferor.
This is because the jurisdiction governing the process of establishment for the good faith issue in the latter judicial dispute is subject to the choice made by IETMA parties (by default English) and the jurisdiction competent for determining the said point under the framework of the Article 37(4) of the Registry Regulation is the national law of the relevant registry (i.e. any of the 27 Member States in which the parties have holding accounts). The national law of the relevant registry will in that regard have an overriding competence which mustn’t be changed by the free election of the parties to the IETMA agreement.
In conclusion, the IETA intention indicated in the said FAQ document “to provide clear rules” in that regard is praiseworthy, nevertheless the potential judicial disputes regarding stolen allowances may still remain complicated.