Climate disputes – Managing voluntary carbon offsetting risks

This article considers aspects of voluntary carbon offsetting, sets out some of the risks for companies which rely on it and how such issues may be mitigated. While this article focuses on these matters from an English law perspective, similar legal issues arise for companies operating in many other jurisdictions around the world.

What is voluntary carbon offsetting?

In a number of countries (including the UK), certain high emitting industries are subject to caps on the amount of emissions companies can make and can purchase further credits to top up their allowance – these are known as "cap and trade" schemes. However, in addition to such mandatory systems, an increasing number of companies have looked to engage in the voluntary offsetting of their carbon emissions. These schemes principally operate to capture emissions already in the atmosphere or to reduce future emissions and can include a wide range of initiatives, such as the roll-out of clean energy technologies or reforestation and afforestation projects. 

Companies typically use carbon offsetting to mitigate their environmental impact and as part of demonstrating their ESG credentials and commitment to sustainability. In recent years, offsetting schemes have become an increasingly popular mechanism for companies to try to meet their net-zero targets. A diverse range of companies, spanning from banks and professional service companies to airlines, have invested in such schemes to date. The increase in interest is due to a number of factors, including customer demand and demonstrable levels of ESG compliance being needed to attract investment or finance as well as the increase in mandatory reporting obligations in many jurisdictions in relation to such compliance. In the UK, for example, this includes by regulators such as the Financial Conduct Authority pursuant to obligations under the Companies Act (see here for further analysis).

One way that companies can seek to offset their emissions is by purchasing voluntary carbon emission reduction credits (VCRs). These VCRs are said to represent how many tonnes of greenhouse gases are being removed from the atmosphere (removal credits), or, in many cases, how many tonnes have been prevented from being emitted in the first place because of the scheme (avoidance credits).  The underlying projects can be nature-based (such as forest-related offset projects) or science-based projects (where CO2 is sequestered more permanently using various technologies). 

VCRs are usually registered with an independent third party, which verifies and tracks the VCRs and allows them to be traded. Companies can buy or sell VCRs in the voluntary carbon market either directly from a carbon offsetting project or by engaging with a broker or an intermediary. Once a VCR has been purchased, the buyer must "retire" it in order to claim the relevant emission reduction.

How accurate are the carbon reductions? 

At present, voluntary carbon offsetting is not subject to any standardised governmental or regulatory oversight. While there are a number of different standards for certifying VCRs (two of the most commonly used being VERRA's Verified Carbon Standard and the Gold Standard) in recent years there have been suggestions that certain carbon emissions reduction projects may have exaggerated the verifiable levels of emissions reduction. 

Determining the exact amount of carbon emissions reduced or avoided by a project can involve intricate calculations. Factors such as baseline emissions, additionality (ie, the emissions that would have occurred without the project), and leakage (ie, emissions displaced elsewhere) may contribute to the complexity. The monitoring techniques employed by different carbon offsetting projects to determine the level of emissions reduction vary substantially (perhaps unsurprisingly given the lack of standardised regulation). Such issues can make it difficult for third parties to verify the claimed reductions independently. All these factors contribute to concerns by some about the effectiveness of certain carbon offsetting projects in cancelling out or reducing emissions. 

Legal risks 

In this context it is apparent that companies relying on VCRs to balance their emissions face potential legal risks related not only to their use, but also the promotion to investors and consumers of the effect of their use. Indeed, any contract with a provider or broker of VCRs may give rise to disputes if, for example, there is disagreement between the parties as to the "value" of the VCRs, the information to be provided to the customer under the contract or the allocation of funds between stakeholders.

In particular, it is possible that companies who promote their use of VCRs to offset emissions may be subject to allegations of greenwashing and the risk of reputational damage as a result. A previous article in this series addressed in broad terms the types of potential greenwashing claims which may arise in different jurisdictions, many of which could potentially arise in connection with the use of VCRs.   

Managing the risks 

There are several practical considerations for companies to bear in mind to avoid some of the legal risks described above. 

Companies should give careful thought to the claims they are making about their environmental efforts and credentials and whether these claims can be objectively assessed and supported by evidence. This might involve engaging third parties to conduct due diligence in relation to particular carbon offsetting projects, especially where such projects are located in an unfamiliar jurisdiction or sector. This may help to prevent accusations of greenwashing and misleading consumers and stakeholders. 

Relatedly, when engaging with a carbon offsetting project, it is important to verify the credentials of the project developers and investigate any relevant standard setters. Companies should look for standard setters who employ reputable global standards aligned with recognised international frameworks for emissions reduction. 

Companies may also want to consider the availability and suitability of insurance products which may provide coverage in the event that carbon credits purchased are impaired in some way.

In addition to these practical considerations, there are steps companies can take to seek to mitigate the risks posed by carbon offsetting schemes from a legal perspective. 

First, when entering into a carbon offsetting agreement, companies should ensure they are contractually entitled to frequent and specific/comprehensive updates regarding the project in which they have invested. This will provide them with the best opportunity to understand the nature of the project and its impact in terms of carbon reduction. In addition, it is important to ensure that the mechanism used to retire any credits is clearly drafted in the agreement. 

Second, if the scheme involves using the funds paid for VCRs for different purposes, it may be important to enshrine that in the contract (especially if, for example, the credits are being resold by a third party broker which is taking commission, or if any particular proportion of revenues is anticipated to be passed to local communities). 

Third, companies should consider carefully what contractual warranties and termination rights are required to ensure they have sufficient recourse to damages and/or termination if it transpires that they may not be able to rely on the value of the emissions reductions promised to them in the way originally envisaged.

Fourth, companies should give some thought to the appropriate dispute resolution mechanism in any carbon offsetting contract. In particular, they should consider the type of expertise that might be necessary to solve the specific dispute, the forum in which such a dispute should be resolved (bearing in mind both confidentiality concerns and the potential intersection with regulatory issues) and what kind of governing law might be suitable.