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Wednesday October 07 General

Technology agreements: A common contract unlocking uncommon environmental value

By Suz Mac Cormac, Partner; Tessa Schwartz, Partner; and Ben Fox, Associate at Morrison & Foerster LLP. 

For decades, royalties and revenue sharing in licensing agreements have been used to reward holders of trademarks, patents, copyrights, and other intellectual property. But while payments from these agreements have historically focused on sales or usage of technology, products, and services that practice or use the IP, some now account for a new kind of value: current or future environmental benefits. Imagine, for example, a company that owns carbon capture and sequestration (CCS) technology. Under a traditional licensing agreement, a prospective licensee might pay for the right to use the technology based on a percentage of sales or revenue derived from the technology.

But what if another contract provision could be added—or a new agreement negotiated—that also provides for a revenue stream arising from the greenhouse gas, or GHG, emissions avoided or removed from the environment by the licensed technology? What if, for example, the licensor could share in the value of a carbon credit, tax benefits or other financial rewards earned by the ultimate emitter due to the licensed technology? Or what if the agreement included a clause that provided milestone payments to the licensor if a certain percentage of the emitter’s GHG emissions were reduced over time? And finally, could those agreements be flexible enough to address increases in the price of a carbon credit and other tax benefits increases over time?

These questions are not theoretical. As counsel to some of the most innovative clean technology companies, we have been helping our clients reimagine the value of their technologies and find a new way to derive new value from them.

If these arrangements prove successful and become standard throughout the industry, they could generate billions in additional revenue for clean technology companies together with billions of tons of carbon removed. More importantly, they could create significant incentives for innovation in an area that desperately needs it.  

A fractured carbon market

To be sure, there are challenges in making these agreements work. For one, there is no U.S. federal standard framework for valuing carbon, such as a national cap-and-trade program or carbon tax. How do you agree with a counterparty on the value of carbon reduction without a transparent and robust carbon market? A lack of a unified price on carbon also challenges the economic viability of many CCS-focused start-up companies.

Despite a lack of federal leadership in this area, U.S. state and regional government initiatives have established GHG compliance markets, most notable among them the Regional Greenhouse Gas Initiative in the Northeast and California’s cap-and-trade program, AB 32. Furthermore, voluntary carbon markets also exist to serve the needs of large emitters seeking to meet internally-imposed GHG reduction goals borne out of a combination of an effective public relations strategy and in anticipation of future regulation and increased carbon value. But these projects are no substitute for a national framework, and substantial federal policy uncertainty remains an obstacle to fully unlocking innovation in this market.

The U.S. federal elections in November 2020 will have enormous consequences for climate change policy. Former Vice President Joe Biden has pledged to work toward net-zero emissions no later than 2050, an ambitious goal (although it may not be enough). Paired with specific compliance policies pricing carbon, such a target could send the price of carbon credits soaring. On the flip side, if President Donald Trump wins his re-election bid, meaningful federal action on climate policy is far less likely—although there is strong support for a carbon tax from a Republican coalition, which would also have a significant impact on the price of carbon credits. 

Marching forward

These challenges notwithstanding, current compliance and voluntary markets are creating room for creativity. Many states, for example, are establishing ambitious goals to limit their GHG emissions. At the same time, major companies are responding to the climate crisis on their own. Microsoft’s recent pledge to remove more carbon than it emits—setting Microsoft on a path to remove by 2050 all the carbon the company has emitted by electrical consumption since it was founded in 1975—is bold and significant. 

Licensing and other agreements that value carbon reduction are possible now. For example, parties can negotiate carbon value by using an agreed-upon metric for adjustment or agree to assess value once regulations have been implemented. Parties may allocate all carbon value benefits to one party or the other. Or they may allocate and share benefits, using revenue sharing principles, or based on contributions or commercial milestones. This can create a source of future revenue.

Until standards are developed, agreements will want to address issues related to the mechanics of measuring, tracking, reporting and trading credits and the parties’ obligations and expenses in connection with such activities. Organizations like the American Carbon Registry and Verified Carbon Standard play important roles in this area: overseeing, registering, and verifying carbon off-set projects. 

It is tempting to wait until a more complete regulatory framework is in place. But companies, especially those with long-term contracts with a significant carbon component, will want to account for carbon issues or risk losing any rights they may have had to extract and maximize value from carbon.

Let’s face it: the law is often last place that most people look to for creativity. But given our vantage point at the intersection of technology and climate science, we see opportunities to capitalize on legal innovation and reward climate change innovators.

We were proud to be part of Climate Week NYC this year as a Silver Sponsor and join the discussion in The Hub Live event Chance of a lifetime? How governments and businesses are achieving a green economic recovery. Watch the event here.

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