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The legality of passing on carbon tax costs

The carbon tax is coming, and lawyers are warning that businesses must actively review their contractual rights and obligations around the passing on of carbon costs so they’re not left with an unacceptable share of the cost burden when the legislation kicks in.

According to CPB Lawyers senior associate Julian Mellick, businesses that assume their ability to pass on the costs of the carbon tax is protected by standard ‘change in law’ clauses in existing contracts, could be in for a surprise.

“’Change in law’ clauses allow prices to be adjusted where there’s been a major regulatory change. But they are unlikely to be very helpful on the carbon tax because they typically require the change to be ‘not reasonably anticipated’, which is hardly the case since these reforms have been expected for some time.”

Mellick warns the clauses often only cover situations where reforms require payment of a particular fee or charge. While the large carbon emitters liable for the tax fall into this category, other businesses saddled with higher input costs “would be left out in the cold.”

Going forward, all businesses should consider whether to incorporate specific carbon pass-through clauses into their new contracts, Mellick urges.

“When tailoring a carbon pass-through clause, companies should consider the scope of the costs that may be passed on, such as whether both direct and indirect costs are covered as well as any incidental compliance costs. There should also be transparency, equity and accountability around how those costs are calculated.”

Given the legislation will move to a fluctuating market price in 2015, the contract should also include a process for assessing the carbon cost pass-through mechanism every couple of years to ensure it’s operating as intended.

In the case of existing long term contracts, Mellick recommends that businesses consider negotiating amendments to deal specifically with how the costs and risks of the carbon tax should be allocated between the parties.

“Dominant parties may seek to rely on the muscle of their market power to negotiate amendments in their favour. But even so, businesses should still question whether it’s in their longer term interests to insist their suppliers and contractors take on 100 per cent of the risk.”

According to Mellick, the elements of a first-rate carbon pass-through clause include:

  • Ensure there is an appropriate allocation of the risks and costs associated with the carbon tax/price between contracting parties;
  • Consider the scope of costs that can be passed through such as whether direct and indirect costs are covered and how any fines or penalties are to be dealt with;
  • Include incentives for suppliers to minimise their carbon costs through the adoption of emission reduction strategies or acquisition of well-priced permits;
  • Ensure there is transparency, equity and accountability in how the pass-through costs are determined;
  • Provide for a periodic evaluation of the carbon costs pass-through mechanism over the contract term; and
  • Incorporate a cost-effective and efficient dispute resolution process to sort out any disagreements.

For more information about energy, renewables and resources, please see the website of CBP Lawyers or contact Julian Mellick at jcm@cbp.com.au