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A new environment
The Equator Principles are designed to help control and monitor the impact of environmental damage caused by large-scale project financing. Paul Watchman and Charles July consider the practicalities of implementing green principles
The Equator Principles (EP) provide a voluntary framework for assessing environmental and social issues in project financing. Based on International Finance Corporation (IFC) and World Bank safeguards, they are applied by banks and financial institutions when deciding whether to provide finance to projects costing $50m (£28m) or more.
By the beginning of January 2006, the EP had been adopted by almost 40 banks (Equator banks), representing about 80% of project finance funds worldwide. In practice, the EP’s influence is even greater as Equator banks also apply the principles when co-financing with other banks or when taking part in syndication of other banks’ projects.
The EP are, without doubt, a huge step forward for responsible banking. The Equator banks undertake “only to provide loans directly to projects”, which have been categorised and screened appropriately, with a comprehensive Environmental Impact Assessment (EIA) report necessary for those deemed particularly complex or risky. That said, there are a number of legal and practical issues that still need to be addressed.
How can Equator banks be held accountable for failing to apply the EP or failing to apply them consistently? There is no legal redress against the Equator banks for failure to comply with the EP and no dispute resolution mechanism for dissatisfied third parties. While the project sponsor may create a complaints mechanism or an external expert review panel to handle complaints, these bodies may not be regarded as particularly objective or effective as a means of legal redress.
So local communities and non-govern-mental organisations (NGOs) must turn to the law courts (perhaps in several jurisdictions), with obvious potential for long delay in the construction stages of the project.
It is unlikely that the Equator banks owe third parties a common law or contractual duty of care in applying the EP and they are not discharging public law functions. More likely targets are sovereign governments or the Export Credit Agencies (ECAs) and regulators who carry out EIAs or issue construction and operating permits.
Equator banks may, at least in theory, attract legal liability, for example where the lenders exercise their powers to take over and manage the project. Alternatively, lenders may be at risk of prosecution for environmental damage, if they can be shown to be “knowingly permitting” pollution. This requires both proof of knowledge, perhaps obtained through reports supplied under the environmental management plan (EMP); and also power to prevent
pollution, possibly granted under the loan covenants. In practice, this risk can be easily avoided by having a good information handling system; however, it is a potential pitfall.
How do third parties obtain information on how the Equator banks apply the EP? NGOs feel that there is a lack of transparency as to how the Equator banks implement projects in accordance with the EP. Unlike the IFC or the European Bank for Reconstruction or Development (EPRD), the Equator banks are not empowered to publish derogations from their policies or the EP. While some Equator banks have begun to provide general information about the total value of deals, they do not usually provide details of individual projects. Banks are bound by strict rules of confidentiality, which prevent Equator banks from disclosing information about their clients’ projects. In some jurisdictions, the penalties for unauthorised disclosure may even include criminal sanctions.
A third party may obtain more information by focusing on the multinational lenders and the ECAs, which often co-finance major projects.
These institutions’ practices favour disclosure except in respect of commercial confidentiality, state security and highly sensitive information and they may have duties to provide information under international or national freedom of information laws.
So, what legal standards should be applied by the Equator banks in implementing the EP? One of the main issues is which legal norms are to be applied to the project. The host country or countries’ environment and human rights laws may be much less onerous than World Bank or IFC safeguard policies. Equally, a host country may not have any, or may have only limited, legal requirements in relation to an EIA. Finally, a host country may not have ratified important public international law treaties or documents, such as the International Labour Organisation conventions on child labour and slavery.
The decision as to which laws or standards should apply always involves a balance, but there is little merit in Equator banks applying lower standards to projects in jurisdictions where the legal requirements for EIA are rudimentary or even non-existent. Indeed, the lack of legal redress, disregard for due process and human rights, the vulnerability of local communities and potential difficulties with enforcing such standards, would suggest that the standards applied by the Equator banks should be more stringent.
Can Equator banks rely on the objectivity of the due diligence carried out by or on behalf of the sponsor? Selection of reputable professional advisers by the project sponsors is vital to the credibility of the project. Another advantage is the avoidance of costs or delay to a project if the Equator banks can be confident in the quality of the advisers.
Equator banks, though, have no contractual relationship with the sponsor’s advisers and it is unusual at present to include a provision allowing the Equator banks to rely on the work or reports of the sponsor’s advisers. Finance providers cannot be expected to rely on sponsors’ experts against whom they have no legal recourse, even if there were no issues as to the objectivity of such advisers.
In practice, the financiers usually appoint their own technical people to review the advisers’ work. An alternative and less costly solution could be the joint appointment by sponsors’ advisers with express provision that the financiers should be able to rely their outputs. Provided the terms of the appointment are appropriately drawn, this will give advisers pause for thought, as well as provide Equator banks with a long-stop means of legal redress in cases of professional negligence or failure to discharge the terms of the contract of appointment.
The EP have put environmental and social issues centre stage. Project sponsors must adapt to this new reality if they are to find financing at reasonable rates. A New Year’s resolution for project sponsors would be to talk to lenders, including the Equator banks, and potential objectors in the local and NGO communities earlier in the project lifecycle. An equally valuable move would be to engage professional advisers who clearly understand the EIA and how the relevant national laws, transnational laws and public international laws can enhance the prospects of constructing projects which are fit for sustainable development in the 21st century.
At $20bn (£11.3bn), Sakhalin II, the largest integrated oil and gas project in the world, may prove the litmus test for the EP and how they work in practice.
Paul Watchman and Charles July are partners at Freshfields Bruckhaus Deringer.
Author: Legal week
Source: Legal Week
Start Date: 02/02/2006
End Date: 09/02/2006

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