Carbon credits and companies in administration
An unpaid carbon credits liability can form a significant part of a company's overall debt burden; in the case of British Steel, which entered liquidation in May 2019, it was cited as one of the key factors in the company's collapse. In the context of an administration, determining whether a carbon credits liability is an expense of the insolvency process (and thereby payable in priority to all but fixed charge creditors), or a provable debt, can be pivotal in decisions over distribution of assets. There is currently no case law providing guidance on this specific issue, and so the assessment can be a difficult one. This article sets out the key considerations.
The carbon credits regime
The EU Emissions Trading Scheme (ETS), implemented in the UK by the Greenhouse Gas Emissions Trading Scheme Regulations 2012 (GGETS), applies to stationary industrial installations over a certain net heat production threshold, with modified provisions for aviation operators. Around 11,000 installations in Europe are covered by the ETS. Emissions levels of specified gases at each installation are capped, with the cap reducing annually. Each installation must surrender sufficient allowances each year to cover its emissions; broadly, the aim of this 'cap and trade' system is that installations that exceed their emissions cap must purchase credits by trading with installations with surplus allowances, or by participating in auctions. If the ETS is functioning as intended, those who fail to reduce emissions will pay an increasingly high price, to the point at which it becomes cheaper to clean up than to trade.
A failure to surrender adequate allowances to cover total emissions attracts substantial civil penalties from the regulator (for onshore installations in the UK this, usually, will be the Environment Agency). The regulator has no discretion over whether to issue a penalty notice, irrespective of whether a company is in administration. Enforcement of carbon credits liabilities is by way of civil debt recovery proceedings.
Under the terms of the EU withdrawal agreement, the UK will remain in the ETS until at least the end of 2020. In the spring budget statement issued on 11 March, further detail was released on plans to replace or continue with the EU Emissions Trading Scheme. According to the Chancellor, 'the UK will continue to apply an ambitious carbon price from 1 January 2021 to support progress towards reaching net zero. The government will legislate at Finance Bill 2020 to prepare for a UK Emissions Trading System (ETS), which could be linked to the EU ETS. The government will also legislate for a carbon emissions tax as an alternative carbon pricing policy and consult on the design of a tax in spring 2020.'
Borrowing to meet a carbon credits liability
British Steel had its initial appeal for a full government bail-out rebuffed, which the Department for Business, Energy and Industrial Strategy attributed to restrictions imposed by EU state aid rules. Weeks before its collapse into liquidation in May 2019, the company obtained a £120m bridging loan from the UK Government, repayable on commercial terms, to meet its liabilities under the ETS. The company's carbon credits liability related to 2018 emissions and reportedly would, if unpaid, have resulted in a penalty of around £500m, in addition to the £120m headline cost of purchasing allowances. When the loan was announced, the then Business Secretary, Greg Clark, called the arrangement 'unique', saying that it was reached under 'exceptional circumstances'.
Obtaining a bridging loan on the commercial market comes with a number of considerations. Highly-leveraged companies, or those with poor covenant strength, may struggle to attract lenders. Lenders may also be unsatisfied if, as will often be the case, the company is only able to grant them subordinated security. In many cases, then, a company will tip over into administration with the liability outstanding.
Carbon credits and insolvency – the decision in Nortel
The leading decision on the question of contingent debts in company insolvency processes is Re Nortel Companies , relating to the under-funded defined benefit pension scheme of the telecoms group (and, in a conjoined decision, of the Lehman group). The Pension Regulator (PR) had served notice that it intended to issue a financial support direction (FSD) to the Nortel group companies; the FSD would impose an obligation on those companies to provide reasonable monetary support to the pension scheme. Once an FSD had been issued, should a target company fail to comply with it the PR could then issue a contribution notice (CN) to that company, creating a financial liability to provide the pension scheme with the stipulated support.
Considering FSDs and CNs as contingent liabilities, the Supreme Court concluded that the liability created by them flowed from and was adjunctive to a liability (the pension scheme deficit) that pre-dated the administration, and would therefore create a debt provable in the administration rather than an expense. The liability was not the result of some step taken by the administrators in the course of their appointment, and nor did the mere fact that a debt arose during the course of the administration automatically render it an expense.
Applying Nortel to a carbon credits liability
Like the pension CN/FSD regime, the incurrence of a carbon credits liability is twofold. First, the company incurs a primary liability by failing to surrender carbon credits to meet its excess emissions. The regulator then issues a penalty notice, which creates an additional liability to pay the civil penalty.
Whether or not either or both of these liabilities are provable debts will depend on a number of factors, most notably the time at which they arose. Where they arise pre-administration, they will clearly be provable debts. However, where either liability arises during the administration, the point is more arguable, as non-payment may then be considered a 'step taken' by the administrators which renders the liabilities expenses of the administration. This is a complex point that requires careful analysis and advice.
Whether pre- or post-appointment, administrators should establish the date on which the obligation to surrender carbon credits arises, and the date of any penalty notice issued by the regulator. It should also assess, with the input of the company's management, whether the amounts claimed by the regulator are correct. Grounds for appealing a carbon credits civil penalty are restricted to challenging an error in the calculation of that penalty; where there has been a substantial error in calculation, an appeal should be considered.
It should be emphasised that the treatment of carbon credits liabilities in administration or liquidation has not been tested in the courts; analysis of the position therefore needs to be carried out on a case-by-case basis, with input from regulatory counsel where necessary.
Michelmores' Banking, Restructuring and Insolvency group advises officeholders on the full range of administration and liquidation issues, including carbon credits liabilities, with input from expert colleagues in our Energy team where required.