Payments for ecosystem services (PES) contracts are the agreements used in transactions where, broadly speaking, one or more sellers restores, protects, or enhances an ecosystem and the services that the ecosystem provides, in exchange for compensation from one or more buyers. The ecosystem service of interest might be carbon sequestration, water quality or quantity, or biodiversity, among many other things.
This page provides basic background information about contracting for PES, including:
The differences between purchase agreements and services agreements for PES.
Private contracts versus contracts that are signed with a government entity as part of a state-run program.
Key elements that are common to different types of PES agreements.
And special considerations for PES agreements, compared with agreements for other goods or services.
Purchase Agreement versus Services Agreement
Like PES transactions themselves, PES contracts might take a number of different forms. On a basic level, there is an important distinction between a purchase agreement for PES credits, and an agreement covering conservation services.
Using a purchase agreement, the buyer pays for credits that represent improved ecosystem services delivery - measured, for example, in tons of carbon sequestered or hectares of habitat conserved - created by the seller's actions. Validation and verification of credits is very important to ensure that they correspond to real ecosystem services outcomes.
For example, a seller might have a project to plant trees in order to remove carbon from the atmosphere for climate change mitigation purposes. The seller must first establish how much carbon will be stored as a result of project activities, and have the project plan and associated estimates validated by an independent third party. As planted trees mature, an independent third party will verify that carbon sequestration is occurring as planned and will issue a credit, like a verified emission reduction (VER), for each ton of carbon stored in the trees. The seller can then transfer credits to buyers in exchange for payment. Ecosystem services credits can be used to offset the buyer’s own environmental impact in a concrete quantifiable way. They buyer may use offsets to comply with regulations or to claim that its activities have, on net, low or no negative environmental impacts in specific respects.
On the other hand, a PES services agreement is for ecosystem restoration, protection or enhancement services to be performed by the seller. Services might include things like tree planting, habitat protection, or streamside restoration, the key difference from a purchase contract being that third-party validated and verified credits are not required for the seller to receive payment. Rather, payment depends upon the verified provision of labor and/or raw materials by the seller. In other words, it depends on the seller’s inputs, rather than the project’s outputs.
A services contract for PES is best suited for situations where providing certain services is certain or very likely to result in environmental benefits and predictable, regular payments are needed. Otherwise, there is a danger that the buyer will pay yet no environmental improvement will occur.
Participation Contracts in Public PES Programs
PES transactions and contracts may be between private entities or individuals, contracting on a voluntary basis or to satisfy compliance obligations, or may form part of a public program of conservation-based payments. In the context of a government PES program, the agreement that speaks directly to what goods (credits) or services a landholder will provide in return for government payments is likely to be the participation agreement signed between the relevant ministry and the landholder.
While participation agreements may vary widely, depending on the program, and may even be a series of documents rather than a single agreement, they are likely to share certain key characteristics that are different from private contracts. First, they are likely to be standardized, non-negotiable form contracts. They will probably be relatively short and simple, but will refer to much more extensive program guidelines for additional details. Other documents that will be relevant include application and enrollment forms and anything required to be submitted during that process.
Because program guidelines and application documents can supply necessary details, the participation contract itself can be short, simply providing an outline of the basic contours of the transaction.
Key Elements of PES Contracts
While PES contracts will vary widely in their basic structure and terms, depending upon the type of ecosystem service, the circumstances, and the needs and bargaining positions of the parties, PES contracts will share certain basic elements, such as:
Clearly-defined rights and obligations for each party with respect to the PES project;
Allocation of costs and risks between the parties; and
Definition of default and remedies.
First, the contract must define what is being sold – what the relevant ecosystem services are, whether the contract deals in a good or service, what the seller and buyer must do, may do, and may not do in connection with the project and transaction. Typically, the seller’s obligations will be to provide the relevant service or to generate and deliver the relevant good, and to take various measures to mitigate risks associated with the project. The contract may also specify that the seller may not engage in certain land uses or economic activities within the project area. The buyer’s primary obligation is to make payment in a timely way. Payment amounts are likely to be based on (1) the cost to the seller of providing services or creating PES credits, (2) market prices for services or PES credits, if an established market exists for comparable items, and (3) the allocation of risks and costs under the agreement. The buyer may also have the responsibility to set up registry accounts, engage in or contract for measurement, monitoring, reporting, and verification (MMRV), or assist with other aspects of project development or execution.
Second, the contract must allocate diverse costs and risks between the parties. For example, what happens if an "act of God" makes performance under the contract impossible or the project area is seized by the government in eminent domain? Who pays for costs associated with MMRV, registries, and public consultations, among other things? The allocation of risks and costs will have a significant impact on contract price and the relative benefit of the transaction to each party.
Third, the agreement must specify what will be considered to be a default by a party - that is, under what circumstances will a party be considered to have breached the agreement - and what the consequences are in terms of remedies available to the non-breaching party. Default must be defined carefully so that remedies aren't triggered by minor deviations from contract terms. Remedies typically include contract termination and monetary damages, which may be limited to cases of willful violation or gross negligence. The non-defaulting party may be limited to contractual damages, or may retain the right to seek legal redress in court or otherwise.
Special Considerations for PES Agreements
For many reasons, such as the uncertain regulatory frameworks, the newness of the markets, and the unique characteristics of the good or services being provided, there are numerous special considerations for PES contracting, as compared with contracts for other goods or services.
Often, the contract must provide for multiple sellers, or even whole communities as sellers, and may consequently also have to deal with coordination, benefit sharing, and project governance between sellers. Whoever signs on behalf of the group must be duly authorized to do so. Because, ultimately, it is group members and not the representative who are bound by the terms of the agreement, the terms must be agreed via a consultative process and group members must be clearly informed of their contractual rights and obligations. Particularly for larger groups, a pre-identified process for resolving intra-group disputes or enforcing contractual obligations against individual group members may be needed.
Also, whether the contract deals in goods or services, monitoring progress and measurement of the benefits provided will be very important. The contract generally must provide for how, and how often, monitoring and measurement will take place, as well as allocating the costs of monitoring and measurement between the parties. Although technology is improving, these costs can be quite high for PES projects, particularly in remote and rural areas.Similarly, verification is necessary to make sure that the project is generating ecosystem benefits. The contract will generally provide for verification procedures to be used, potentially a process for changing verification procedures, allocation of costs, and provisions for what happens if there is a delay or failure of verification.
Also, PES contracts generally impose long-term obligations, to avoid the danger that an ecosystem is improved today, only to be destroyed tomorrow, next week, or next year. The contract therefore provides for what happens if natural disasters or other unforeseen events disrupt the ecosystem during the project term, and, potentially, for rights and obligations to pass to successors of the sellers and buyers.
In terms of default and remedies, PES contracts involving rural and small scale sellers for whom monetary damages are potentially ruinous face additional challenges. Contract negotiators and drafters may therefore need to think outside the box in terms of providing effective consequences that are not too much of a burden for the sellers in the particular case.
Finally, because of extensive state ownership and regulation of natural resources, the local and national governments are likely to have major roles in PES projects. However, these roles are not yet clearly defined, and there may be problems of overlapping authority or authority gaps. Furthermore, PES law and policy is developing rapidly at international, national, and subnational levels, creating a moving target for PES projects and contracts.
Disclaimer: Materials on this site are meant to highlight issues that should be considered in PES transactions, not to provide a substitute for experienced legal counsel. It will be essential to engage legal counsel in conjunction with any PES transaction to ensure that any agreements reflect the latest developments in the field and comply with current local and national legislation.
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