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	England and Wales High Court (Commercial Court) Decisions
You are here: BAILII >> Databases >> England and Wales High Court (Commercial Court) Decisions >> INEOS Manufacturing Scotland Ltd. v Grangemouth Chp Ltd & Anor [2011] EWHC 163 (Comm) (11 February 2011) URL: http://www.bailii.org/ew/cases/EWHC/Comm/2011/163.html Cite as: [2011] EWHC 163 (Comm), [2011] Env LR 23

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IN THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
COMMERCIAL COURT

		Royal Courts of Justice Strand, London, WC2A 2LL
		11/02/2011

The Honourable Mr Justice David Steel :

Introduction

1. This action involves a substantial claim relating to EU CO₂ emissions allowances. It arises in the following way. The Claimant ('IMSL') is responsible for sourcing electricity and steam for use at the Grangemouth petrochemical facility and refinery in Scotland. The First Defendant ('GCHPL') is a special purpose vehicle created for the purposes of the Grangemouth CHP Project ('the CHP Project').
2. The CHP Project involved the construction of a Combined Heat and Power ('CHP') plant at the Grangemouth Site ('the CHP Plant') and the supply of electricity and steam to IMSL. The Second Defendant ('Fortum O&M') is a provider of operation and maintenance and asset management services to power plants including CHP plants.
3. A number of agreements were entered into on 25 November 1998 in order to give effect to the CHP Project. The focus of the dispute is to be found in one of these agreements. This was an Electricity Supply Agreement ('ESA') between IMSL (formerly 'BP') and GCHPL, in which GCHPL agreed to deliver a supply of energy to IMSL for a 15-year period from 27 April 2001.
4. Clause 3.4 of the ESA provides:

"3.4 CO₂ Credits

GCHPL agrees that all CO₂ Emissions Credits accruing to it from time to time shall be held by it for and on behalf of BP and that: -

3.4.1 GCHPL shall forthwith co-operate with BP and execute and deliver such documents and make such other arrangements and take such other actions (including obtaining all Clearances) as BP shall reasonably request for ensuring that BP obtains the benefit of all CO₂ Emissions Credits.

3.4.2 No payment will be made by BP to GCHPL in respect of such CO₂ Emissions Credits.

3.4.3 BP will be free to exploit any CO₂ Emissions Credits as it in its absolute discretion thinks fit.

3.4.4 GCHPL shall not utilise for its own benefit nor transfer any CO₂ Emissions Credits to any person other than BP."

5. The term 'CO₂ Emissions Credits' is defined as "all the CO₂ emissions credits or entitlements (or other similar entitlements, rights or benefits in respect of CO₂ of whatsoever nature) accruing to GCHPL in respect of the CHP Plant."
6. These provisions have given rise to short but difficult issues of construction in particular in relation to the meaning of the word "entitlement", the identity of the person to whom any entitlements were "accruing" and the scope of any obligation to ensure that IMSL obtained the "benefit" of such entitlements. There are also issues in regard to the construction of certain exemption and limitation clauses.
7. The source of any such entitlements is said to be an EU scheme for greenhouse gas emission allowance trading. This was established by Directive 2003/87/EC ('the Directive') and the scheme was implemented in the UK with effect from 1 January 2005 by The Greenhouse Gas Emissions Trading Scheme Regulations 2003, which came into force on 31 December 2003 (the '2003 Regulations'). The 2003 Regulations have since been replaced by a new set of regulations which came into force on 21 April 2005 (the '2005 Regulations'). However there is no material difference between the two sets of Regulations for the purposes of the issues in this action.
8. The 2003 and 2005 Regulations ('the Regulations') both require the "operators" of relevant installations, of which the CHP Plant is one, to apply for a greenhouse gas emissions permit ('GGE Permit'), and the holders of such permits are then issued free of charge a particular quantity of transferable allowances in accordance with a National Allocation Plan. The operators are required to surrender allowances equal to the total emissions of the installation in each calendar year within four months of the end of the year.
9. The Regulations define operator as 'in relation to an installation the person who has control over its operation'. The Department for the Environment, Food and Rural Affairs ('DEFRA'), the Environment Agency and the Scottish Environment Protection Agency ('SEPA') have issued guidance in relation to the meaning of operator under the Regulations ('the Guidance').
10. In this connection another of the agreements is pertinent namely an O&M Agreement between GCHPL and Fortum O&M whereby Fortum O&M agreed to provide operation and maintenance services to GCHPL in relation to the CHP Plant. This has been replaced by an Amended O&M Agreement between the same parties.
11. In respect of the CHP Plant, Fortum O&M is the entity to which a GGE Permit and allowances have been issued by the relevant authority, SEPA, and which has duly surrendered the appropriate number of allowances after each year.
12. IMSL claims that the allowances issued in respect of the CHP Plant are 'CO2 Emissions Credits accruing to [GCHPL]' within the meaning of clause 3.4 of the ESA, either because they are allowances within the meaning and definition of 'CO2 Emissions Credits' which accrue to GCHPL in respect of the CHP Plant, or because they are within the meaning and definition of 'CO2 Emissions Credits' and should have been issued to GCHPL as operator of the CHP Plant but are being incorrectly issued to Fortum O&M.
13. IMSL claims that GCHPL is obliged by clause 3.4.1 of the ESA to take all such action as IMSL reasonably requests to ensure that IMSL obtains the benefit of all the allowances that have already been issued in respect of the CHP Plant as well as the benefit of all the allowances that will be issued in respect of the plant for future years over the remaining term of the ESA, and that GCHPL has wrongfully refused to do so.
14. GCHPL's position is that the allowances are not "Emissions Credits" as defined but even if they are they do not accrue to GCHPL. Further it is said that the relevant allowances are properly allocated and issued to Fortum O&M as the operator of the CHP Plant and that GCHPL is not in breach in failing to ensure that IMSL obtained the benefit of the allowances.
15. The financial implications of the dispute are significant. The issue of quantum has now been settled subject to liability. The original claim was in the region of €152 million. It is now agreed that the value of the allowances already issued amounts to €68 million. As regards future allowances, the parties have agreed not to attempt to value them as of today but to make arrangements, again subject to liability, for the transfer of any allowances that may accrue.

Background

16. The refinery at Grangemouth is the only refinery in Scotland. It supplies transport fuels for the whole of Scotland and parts of northern England. It takes crude oil feed from the Forties Pipeline in the North Sea and from imports from deep loch import facilities on the west coast of Scotland. The petrochemical site at Grangemouth has production assets which convert ethylene/propylene to form plastic pellets or ethanol which is exported to the UK and continental Europe.
17. As at 1998, IMSL (then called BP Oil Grangemouth Refineries Limited) was responsible for operating the refinery, for operating the on-site utilities assets so as to generate and distribute steam and power for use by all the BP assets at Grangemouth and for securing any additional power requirements from the grid. In the mid 1990's the BP Group had commenced an investment options study at the Grangemouth Site. This study looked at the various business development plans at the site from an integrated perspective. One of the conclusions of this study was that there was not enough electrical power or steam at the site.
18. The Grangemouth site had an existing power station incorporating seven existing boilers (numbered 9 to 15) used to produce steam and seven existing turbo-alternators used to reduce the boiler steam pressure (to the level required by the refining and petrochemical process plants) and in so doing produce electricity as a by-product. However, this electricity production was not enough to meet the needs of the site, which was therefore importing its additional power requirements from the grid.
19. The BP Group decided that a CHP Plant should be constructed. The CHP Plant would be built in the middle of the existing BP site at Grangemouth meaning that arrangements would be needed to regulate how it would be integrated into the site as a whole. The BP Group did not want to own the CHP Plant itself and thus approached various power companies to see if they would be interested in constructing and owning the CHP Plant. These companies were asked to submit bids. The Invitation Memorandum made it clear that "operations [were] …. to be undertaken by the preferred developer or by a third party O&M contactor with proven experience…".
20. From the beginning, the CHP Project included an "Additional Boiler" namely a new boiler to be installed on a separate part of the Grangemouth site from that used for the CHP Plant. The Additional Boiler was to run in conjunction with 7 other boilers already in operation at the site in November 1998 (i.e numbers 9 to 15). The purpose of the Additional Boiler was to provide back-up to the steam supply from the CHP and otherwise to be an additional source of steam for IMSL.
21. Following review of the bid documents, the potential candidates were narrowed down to two entities: National Power and a consortium between IVO Energy Limited ('IVO Energy') and Mitsubishi Corporation ('Mitsubishi'). In the summer of 1998 BP agreed to enter into an eight week exclusivity period with the IVO-Mitsubishi consortium.
22. Mitsubishi had originally expressed interest in entering into the CHP project alone, but was turned down on the basis that it did not have the necessary operational experience. It then submitted the joint bid with IVO Energy, a company within the IVO group (Imatran Voima OY). This group had considerable experience of the operation and maintenance of plants. The IVO group was subsequently combined with another Finnish group, Neste Oyj, to form a new energy group called Fortum. One of the IVO subsidiaries was IVO Generation Services (UK) Limited (later renamed Fortum O&M).
23. On 11 May 1998, at an early stage in the negotiations, the IVO-Mitsubishi consortium submitted a financial model with a view to demonstrating to the BP Group that its bid was financially viable. It is to be noted in passing that this model did not include any provision for the cost of purchasing emissions allowances let alone the potential revenue from any credits.
24. GCHPL was incorporated as a wholly owned subsidiary within the BP Group in order to obtain the necessary consents for the construction and operation of the CHP plant. The intention was that this company would then be transferred to the successful bidder by way of share sale on completion. GCHPL applied for and obtained a Consent to construct and operate the plant under section 36(1) of the Electricity Act 1989 as well as a consent to burn gas under section 14 of the Energy Act 1976.
25. In November 1998, the share capital of GCHPL was transferred from the BP Group to the IVO-Mitsubishi consortium as the successful bidder for the CHP Project. Several agreements were signed to give effect to the CHP Project, including the ESA between GCHPL and IMSL which is at the heart of this dispute. Since GCHPL was to be the owner, and responsible for the operation of, the CHP Plant, many of the project agreements (including, for example, the ESA, the Steam Supply Agreement ('SSA') and the Gas Supply Agreement ('GSA')) were entered into by GCHPL rather than by either of IVO Energy or Mitsubishi.
26. The agreements concluded to give effect to the CHP Project in addition to the ESA included:

i) A Lease between BP Exploration Operating Company Limited ("BPEOCL") and GCHPL whereby GCHPL leased the land on which it would be constructing the Grangemouth CHP Plant.

ii) There was a separate lease between the same parties relating to an Additional Boiler Area. As already noted GCHPL built the Additional Boiler (sometimes known as Boiler No. 8) in order to provide cover for the breakdown of the CHP and thereby to ensure continuity of supply of steam to IMSL. The Additional Boiler is owned by GCHPL but operated by IMSL with their other seven boilers on an integrated basis.

iii) A Site Interface Agreement (the 'SIA') between BPEOCL and GCHPL which concerned arrangements for "mutual co-operation and satisfactory co-existence at the Grangemouth Site" and "a framework for managing the interfaces of the respective operations in an open and co-operative manner". In particular it gave BPEOCL certain rights over the O&M Agreements and in relation to the appointment or replacement of the "operator".

iv) A Participation Agreement between BPEOCL, GCHPL, IVO Energy, IVO and Mitsubishi whereby BPEOCL was granted "certain approval rights and certain rights in relation to the transfer of Ownership Interests in [GCHPL]". In particular it gave BPEOCL a right to appoint a "BP Director" to the GCHPL board and an ability to influence GCHPL's activities in certain key respects such as health and safety and security.

v) A Deed of Guarantee by IVO and Mitsubishi in favour of IMSL and BPEOCL, whereby IVO and Mitsubishi guaranteed certain obligations of GCHPL under the CHP Project Agreements, including the obligation of GCHPL to pay liquidated damages to IMSL for breach of GCHPL's obligation to supply electricity under the ESA.

vi) The GSA between BP Gas Marketing Limited ('BPGML') and GCHPL by which, among other things, BPGML agreed to sell natural gas to GCHPL for combustion in the Grangemouth CHP plant in order to produce electricity and steam.

vii) The SSA between GCHPL and IMSL whereby GCHPL agreed to supply and IMSL agreed to receive a "baseload supply of steam" produced by the CHP Plant and the Additional Boiler "for on-sale to parties on the Grangemouth Site" for a 15 year period.

viii) The O&M Agreement between GCHPL and Fortum O&M whereby Fortum O&M agreed to provide operation and maintenance services to GCHPL in relation to the Grangemouth CHP Plant with GCHPL being authorized to have access.

27. In March 1998 the Chancellor of the Exchequer asked Lord Marshall to lead a Task Force on the subject of "whether, and if so, how best to use economic instruments to improve the industrial and commercial use of energy and help reduce emissions of greenhouse gases." Lord Marshall's report, entitled "Economic Instruments and the Business Use of Energy", was published on 3 November 1998 (i.e. some three weeks before the ESA and the other agreements mentioned above).
28. The report concluded:

i) There was a role for economic instruments in helping improve business use of energy and reducing greenhouse gas emissions as part of a package of measures.

ii) There were two leading options: first, a system of tradable emissions permits and secondly, various tax mechanisms.

iii) As regards a system of tradable emissions permits, it was probably not sensible for practical reasons for the Government to introduce a fully fledged, statutory scheme domestically in the UK immediately. However, the Government was advised to step up its consultations so as to resolve the issues involved in designing a trading scheme and, as a first step, seriously to consider a dry-run pilot with interested players as soon as possible.

iv) As regards tax, there was probably a role for tax designed in a way that would protect the competitive position of British industry. In relation to CHP, any tax should be designed so as to take into account the environmental benefit of CHP. The most feasible solution was to tax fuel inputs but to provide that no tax would be due on electricity outputs. At least some of the revenues generated by any tax should be channeled into schemes aimed at promoting energy efficiency and reducing greenhouse gas emissions directly. This might include tax relief or credits for firms making energy saving investments, including in CHP.

v) In the section headed "Trading" Lord Marshall referred to the successful sulphur trading scheme operating in the US as showing that the theoretical advantages of a trading scheme could, in the right circumstances, be realised in practice. Annex B of the Report provided a more detailed description of the US sulphur trading scheme (called the "US Acid Rain Programme") which had commenced in 1995. According to this description, the scheme involved trading sulphur dioxide "allowances", each allowance being worth one tonne of sulphur dioxide. A fixed number of allowances were allocated to each participant for each year. Allowances could be traded, or unused allowances banked for future use.

29. It was thus common ground that at the time of the execution of the ESA there was a well-advertised prospect that at some future date a scheme would be introduced in the UK that would use an economic instrument to improve the industrial and commercial use of energy and to help reduce emissions of greenhouse gases. The precise details of any such scheme had yet to be worked out, but the leading options identified by Lord Marshall were a system of tradable emissions permits or one or more tax mechanisms.
30. As already noted, GCHPL agreed by the ESA to deliver and IMSL agreed to receive a "baseload supply of active energy for on-sale to parties principally on the Grangemouth Site" for a 15 year period. Following completion of the ESA and the other project agreements, GCHPL constructed the CHP Plant. Operations at the plant commenced in April 2001 (although there is a dispute between the parties as to whether GCHPL or Fortum O&M has been in control over the operations since they commenced).
31. During the course of 2002, GCHPL raised the possibility of amending the O&M agreement. By this time IVO Energy had bought out Mitsubishi's interest in GCHPL, with the result that both owner and operator were wholly owned by IVO Energy. The Fortum Group decided to restructure and streamline its operations in light of this change and in light of a desire to make all of its assets in the UK and Republic of Ireland more efficient. In particular, GCHPL concluded that the CHP Plant no longer needed a separate general manager (working for GCHPL) and operations manager (working for Fortum O&M). The restructuring was approved at GCHPL board meetings on 2 September 2002 and 5 December 2002, which were attended by Mr Grant, then the BP representative on the board of GCHPL.
32. On 13 October 2003 Directive 2003/87/EC introduced a scheme in respect of CO2 emissions from combustion installations with a rated thermal input exceeding 20 MW, which included the Grangemouth CHP plant. This Community scheme was implemented in the UK with effect from 1 January 2005 by the 2003 and 2005 Regulations.
33. In summary, the 2003/2005 Regulations provide as follows:

a) "Operators" of relevant installations are required to apply for GGE Permits.

b) "Operator" is defined as "the person who has control over [an installation's] operation".

c) The operators are obliged to submit reports of their emissions verified by an authorised third party.

d) The GGE Permit contains an obligation on the holder of the GGE Permit to surrender allowances equal to the total emissions of the installation in each calendar year.

e) The GGE Permit holder is issued free of charge with a particular quantity of allowances in accordance with a National Allocation Plan. 1 allowance is equivalent to 1 tonne of CO2. The allocations are issued in proportion to (albeit somewhat less than) historic emissions from the relevant installation.

f) Allowances are transferable between persons within the Community (and, in certain circumstances, between persons within the Community and persons in third countries). The allowances are also (i) freely tradable in the market with a market price that fluctuates with the level of supply/demand and (ii) fungible in that, at any given time, each allowance is worth the same as each other allowance at that time, irrespective of the installation of origin.

g) Operators who emit more CO2 than they have allowances to surrender must obtain allowances on the market at the market price.

h) Compliance with the scheme is secured by imposing sanctions on operators, including criminal sanctions in respect of false or misleading statements for various purposes such as obtaining a GGE permit.

34. In July 2003 DEFRA / the Scottish Executive asked GCHPL to confirm whether or not the CHP Plant would be covered by the Community scheme. GCHPL replied that it would be, although possibly merely as part of BP's Grangemouth installation. DEFRA/the Scottish Executive sent a further request for data in September 2003 as part of the National Allocation Plan Data Requirements for the implementation of the Community scheme. GCHPL responded to this data request on 23 September 2003. In this response, GCHPL was identified as the "operator" of the CHP Plant and stated that "Grangemouth CHP Ltd owns and operates a CHP station generating steam and electricity". This effect of this response was that, when the draft of the National Allocation Plan was published on 19 January 2004, it identified GCHPL as the entity entitled to the relevant allocation of allowances.
35. On 8 January 2004 GCHPL submitted an application to the SEPA for a GGE Permit. This application (which is dated 12 January 2004) identified Fortum O&M as the operator. In due course this led to the grant of a GGE permit to Fortum O&M on 26 March 2004. As well as submitting the GGE Permit application to SEPA in the name of Fortum O&M, GCHPL also wrote to DEFRA on 12 March 2004 noting that the operator of the CHP Plant was Fortum O&M and not GCHPL as was stated in the draft NAP. Fortum O&M was also identified as the operator of the CHP Plant in the NAP data form submitted to DEFRA on 13 April 2004.
36. In fact, DEFRA continued to identify GCHPL as the operator of the CHP Plant in the next draft of the NAP (which was published following consultation on the January 2004 draft NAP) and in the list of installation level allocations of allowances. GCHPL complained to DEFRA about its approach in a letter dated 4 June 2004 and in an email dated 17 June 2004. Ultimately, DEFRA confirmed that it would match the NAP installation list with the names in installation permits. The effect of this was that Fortum O&M was included as operator in the final NAP.
37. Although Fortum O&M has become the holder of the GGE Permit in respect of the CHP Plant, it may be of note that GCHPL (and not Fortum O&M) is or was the holder of other licences/consents in respect of the CHP Plant. Indeed, as described above, GCHPL was incorporated prior to completion in November 1998 for the purpose of acquiring the licences/consents that would immediately be required. In particular:

i) GCHPL is the holder of the Generation Licence under section 6(1) of the Electricity Act 1989. Under section 4(1)(a) of the Electricity Act 1989 a person who "generates electricity for the purpose of giving a supply to any premises" is guilty of an offence unless he is authorised to do so by a licence. Section 6(1)(a) entitles the Gas and Electricity Markets Authority to grant such a licence. The Generation Licence became effective on 18 May 2000.

ii) GCHPL is the holder of the Consent to construct and operate the Grangemouth CHP Plant under section 36(1) of the Electricity Act 1989. Under this provision, a generating station shall not be "constructed, extended or operated except in accordance with a consent granted by the Secretary of State". Under section 36(6) a person who without reasonable excuse contravenes the provisions of section 36 is liable on summary conviction to a fine. GCHPL's application for this Consent expressly sought consent under section 36 of the Electricity Act 1989 for "operation of the new CHP plant including the supply of steam from the site and the transfer of treated water to and from the site". The Consent itself "grants consent to the construction and operation by [GCHPL] of a combined heat and power plant ('the development') at BP Grangemouth, Stirlingshire".

38. GCHPL was also the holder of the IPC permit in respect of the CHP plant. Under section 6 of the Environmental Protection Act 1990 no person shall carry on a prescribed process except under an authorisation granted by the enforcing authority. But the IPC Permit regime has now been replaced by the Pollution Prevention and Control ('PPC') Permits regime which is governed by the PPC (Scotland) Regulations 2000. Under paragraph 6(1) of the PPC Regulations, no person shall operate an installation from a prescribed date unless authorised by a PPC Permit. Under paragraph 7(3) a permit cannot be granted to a person who does not have control over the operation of the installation. On 4 July 2006 GCHPL applied for the PPC Permit in respect of the CHP Plant. However, on 15 September 2006 GCHPL notified SEPA that, so far as it was concerned, its "sister company, Fortum O&M" was the correct applicant and the PPC Permit has now been issued to Fortum O&M.

Do the allowances fall within the contractual definition of CO₂ Emissions Credits?

39. It was IMSL's submission that the allowances allocated in regard to the CHP Plant fell squarely within the broad definition of CO₂ Emissions Credits contained in clause 1.1 of the ESA as set out above. In very brief summary the contentions were as follows:

i) The ordinary meaning of an entitlement was a right or title to something. It was being used in its broadest sense having regard to the use of the words "all", "other similar entitlements, rights or benefits" of "whatsoever nature".

ii) Such a wide definition is consistent with the fact that no scheme relating to CO₂ emissions was in place at the time of the ESA although Lord Marshall's report heralded the likely use of a tax credit scheme on the one hand or a "cap and trade" scheme in the form of a system of tradable permits or allowances on the other.

iii) An allowance is manifestly a CO₂ emissions "entitlement" because it is an entitlement to emit one tonne of CO₂ even if it is not a credit in the sense of having been earned for reducing emissions.

iv) Any suggestion that the definition only covered instruments constituting a reward or benefit for reducing emissions would render the word "entitlement" redundant and mere surplusage.

v) Contemporary industry publications demonstrate that the terms "entitlement", "permit" and "allowance" were used interchangeably.

40. It was GCHPL's submission that the allowances allocated in regard to the CHP Plant fell outside the definition of CO₂ Emissions Credits. Again, in very brief summary the contentions were as follows:

i) Whilst an allowance could be included in the phrase "credits or entitlements" as a matter of ordinary language, viewed in its context an allowance is simply an authorisation to emit CO₂ whilst an entitlement must constitute a reward or incentive to reduce emissions.

ii) Any other construction would give rise to the absurd consequence that GCHPL would be obliged to sign away the very allowances needed to perform the ESA leaving GCHPL having to buy replacement allowances on the market.

iii) Various provisions in the ESA demonstrated that the parties were endeavouring to maintain a careful commercial balance in the event of changes to the financial assumptions underlying the ESA. It was therefore improbable that clause 3.4 was intended to result in an upset to that commercial balance.

iv) Given the published information on tax credit schemes and cap and trade schemes at the time of the execution of the ESA, the failure of the parties to make any reference to "permits" or "allowances" in the definition gives rise to a strong pointer that it did not encompass the allowances.

Discussion

41. The approach to the construction exercise is not of course in issue. In ICS v West Bromwich Building Society [1998] 1 WLR 896 Lord Hoffmann summarised the task as follows:

"(1)      Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.

(2)      The background was famously referred to by Lord Wilberforce as the "matrix of fact," but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3)      The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action for rectification. The law makes this distinction for reasons of practical policy and, in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life. The boundaries of this exception are in some respects unclear. But this is not the occasion on which to explore them.

(4)      The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax: see Mannai Investments Co. Ltd. v. Eagle Star Life Assurance Co. Ltd. [1997] AC 749 http://www.bailii.org/uk/cases/UKHL/1997/19.html

(5)      The "rule" that words should be given their "natural and ordinary meaning" reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had."

42. The starting point is the fact, as is common ground, that the ordinary and natural meaning of an "entitlement" may well be wide enough to include allowances under the Regulation all the more so when the definition is expressed as encompassing "all" CO₂ emission entitlements "of whatsoever nature". But it is also common ground (and if not, I so hold) that the allowances are not "credits" certainly in the sense used by the industry in this field because that would necessitate some allocation on the credit side of an account. In contrast, an operator who receives an allowance in proportion to (but less than) historic emissions which he then surrenders derives no net benefit.
43. Thus the question arises whether the parties intended that emission credits should include instruments which are not credits at all. At first blush that seems unlikely but the point is hardly determinative. Perhaps the point does no more than give some credence to the proposition that "entitlement" may simply be being used as synonymous with credit. But it emphasises the need to consider the commercial implications of such a construction with particular rigour.
44. I recognise that it is important for the court to be careful not to substitute its own judgment of the commerciality of an apparent agreement for that of the parties. But if a particular construction giving effect to the ordinary and natural meaning of the words appears to flout business common sense it is open to the court to prefer an alternative construction: Antaios Compania Naviera SA v Salen Rederierna AB [1985] A.C. 191.
45. The competing considerations were recently outlined by Patten LJ in Kookmin Bank v Rainy Sky SA [2010] EWCA Civ 582 at paras 41-42:

"Another example is the contractual provisions considered by the House of Lords in Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101 which, if given their natural meaning, produced a result which Lord Hoffmann described as arbitrary and irrational. But, read in its context, the dictum in The Antaios provides no support for the re-formulation by the court of contractual provisions which are relatively clear in their meaning simply because they balance the interests and obligations of the parties in a way which the judge considers to be one-sided or unfair. The starting point has to be that commercial parties can look after themselves and are sufficiently organised and well advised as to be able to ensure that the contractual documents which they sign accurately reflect their intentions.

In this case (as in most others) the Court is not privy to the negotiations between the parties or to the commercial and other pressures which may have dictated the balance of interests which the contract strikes. Unless the most natural meaning of the words produces a result which is so extreme as to suggest that it was unintended the Court has no alternative but to give effect to its terms. To do otherwise would be to risk imposing obligations on one or other party which they were never willing to assume and in circumstances which amount to no more than guesswork on the part of the Court."

46. With those strictures very much in mind I turn to the commercial implications of IMSL's construction of the scope of Emissions Credit. As I understand it, it is accepted by IMSL that its construction would in fact have the consequence of depriving GCHPL of the very permits that are needed to perform the contract. In short, GCHPL must measure the CO₂ emissions and then purchase permits on the market to cover them, while at the same time providing IMSL free of charge with the very permits allocated to it for that purpose.
47. It may well be that in a literal sense GCHPL can perform the contract by this means but in my judgment it is indeed commercially absurd to make the lawful operation of the plant dependent on handing over the free allowances and at the same time requiring purchase of the substitutes. Furthermore, there is the added problem that any substitute entitlements purchased by GCHPL would still be on this basis Emissions Credits. In the result these in turn may need to be accorded to the benefit of IMSL in an infinite regression.
48. As indicated, in further support of its construction, GCHPL relied on various provisions in the ESA which were said to be directed to maintaining a balance between costs and revenues so as to keep pace with changes in the financial assumptions on which the project was predicated throughout the 15 year term. The contract contemplated an "emissions" scheme. Given the efficiency of a CHP plant, it was improbable that any significant reduction in CO₂ emissions could be achieved. Thus the provision of credits was unlikely to impact on the balance of account. Any bonus accruing in respect of the CHP project would both be modest and legitimately to be allocated to the owner/constructor of the plant.
49. But a cap and trade scheme was likely to give rise to valuable permits and allowances. Whilst the scale of the impact on GCHPL's profitability could not be foreseen, it was obvious that permits would potentially attract significant market value so as to render GCHPL's operations uneconomic if they had to be bought in.
50. In contrast, the provisions of clause 7 of the ESA do indeed demonstrate an aim to balance costs and revenue over the full term of the contract despite foreseeable and unforeseeable changes in such matters as tax rates, costs of gas, price of electricity and so on. I agree that this is a significant indicator that the parties did not intend that clause 3.4 should have the meaning contended for by IMSL.
51. The most striking is clause 7.5 which provides for adjustments to the Contract Price in the event of a 'Relevant Change' in applicable legislation, so that, in broad terms, additional capital expenditure costs were allocated as between the parties as follows:

a) up to £1 million were for GCHPL's account and did not increase the Contract Price;

b) over £1 million and less than £3 million resulted in an adjustment to the Contract Price so GCHPL would be no worse off; and

c) more than £3 million resulted in the terms of the ESA being subject to renegotiation and, potentially, termination at GCHPL's election.

52. GCHPL also prays in aid the terminology used in the industry in November 1998 as reinforcing the proposition that, given the parties' presumed background knowledge of the various emission schemes being contemplated, they did not intend to include "permits" and "allowances" within clause 3.4 even if such might otherwise fall within the term "entitlements".
53. There is no suggestion that some special industry meaning of the words "permit" and "allowances" can be relied upon, not least because the terms were not used. In any event, it is accepted that the various terms were not used in any conventional let alone habitual way. There are indeed instances of the words being used interchangeably. That said, I accept the proposition that in the industry there was a practice of contrasting schemes affording tax credits (or other rewards) in respect of reduction of emissions as constituting "credits" and emissions trading schemes as constituting "permits" and "allowances". The trading scheme with which the parties were concerned fell within the latter category. Indeed, as already noted the tradable instruments allocated to an operator were defined as allowances.
54. Of particular note was the internal emissions trading scheme introduced in 1998 by BP (the then owner of IMSL):

i) In the wake of the Kyoto Conference meeting, BP's Group Chief Executive gave a speech at Chatham House on 6 February 1998 in which he discussed the mechanism available to governments to grapple with CO2 emission. In the speech he expressed enthusiasm for the US sulphur emission scheme introduced in 1995 whereby tradable "permits" and/or "allowances" were issued in contrast to tax incentives.

ii) As promised in that speech BP introduced its own internal emissions trading scheme in September 1998. The tradable instrument was a permit, otherwise categorised as an "allowance". The initial outcome was described in a speech by BP's Deputy Chief Executive on 27 November 1998 as follows:

"And I can tell you today that our first trade has just taken place. Between two UK business units. One of our developing fields, Foinavon, has bought 100 permits - which represents 10,000 tons of carbon dioxide - from the Forties Pipeline System."

He went on to contrast such a scheme with tax credit or reduction schemes.

iii) Lord Marshall's report was published in November 1998 shortly before the signature of the CHP Project Agreements. Although there was not an entirely consistent use of terminology, his analysis of emission trading schemes contemplated purchase or sale of "rights" to emit pollution in the form of "permits" or "allowances" in contrast to tax credits awarded for reducing emissions.

55. This background affords emphasis to the absence of any reference to permits or allowances in the ESA. This in turn gives support to the conclusion that a reasonable person would conclude that clause 3.4 was not intended to include allowances issued under the regulations.
56. If this be right, it follows, as the Claimant points out, that the word "entitlements" is largely surplusage as it is to all intents and purposes being used synonymously with "credits". But an argument of construction based on redundancy is of limited weight:

"At different stages of his judicial career Lord Hoffmann, whose contributions to the law of interpretation of contracts, as in so many other areas, has been as remarkable for their perception of analysis as for their elegance of expression, has made illuminating observations on the topic of redundancy. At first instance, in Norwich Union Life Insurance Society v British Railways Board [1987] 2 EGLR 137, 138D he referred to the "torrential drafting" of leasehold repairing covenants. In the Court of Appeal in Arbuthnott v Fagan [1995] CLC 1396, 1404D-E, discussing Lloyds' agency agreements, he stated that "little weight should be given to an argument based on redundancy", which he said was "a common consequence of a determination to make sure that one has obliterated the conceptual target". And, as Lord Hoffmann in Beauford Developments (NI) Ltd v Gilbert-Ash (NI) Ltd [1999] AC 266, 274B-D, when discussing a JCT Standard Form, he described "the argument from redundancy" as "seldom … entirely secure", because of "a lawyer's desire to make sure that every conceivable point has been covered". These remarks apply, in my view, with as much force to contractual warranties in sales of companies and businesses, perhaps particularly when it comes to the reliability of accounts." Macquarie Internationale Investments Ltd v Glencore UK Ltd [2010] EWCA Civ 697, para 83.

57. I accordingly conclude that GCHPL is correct in its submission that the allowances fell outside the definition of CO₂ Emissions Credits.

Do the allowances accrue to GCHPL?

58. Having concluded that clause 3.4 did not encompass allowances issued under the Regulations, the claim must fail. But in case I am wrong, it is desirable to consider briefly the further question as to whether such allowances "accrued" to GCHPL (or would have accrued if GCHPL had not been in breach in failing to apply for the GGE Permit in place of Fortum O&M).
59. The key to this issue is the identity of the "operator" of the CHP Plant given that a GGE Permit is in effect a licence to operate and emit carbon dioxide at an installation covered by the emissions trading scheme. It was part of IMSL's case that the arrangements between GCHPL and Fortum O&M were to the effect that all benefits and burdens relating to the CHP Plant would be passed through to GCHPL and thus the fact that the allowances were issued to Fortum O&M did not gainsay that they nonetheless accrued to GCHPL. In my judgment it is not arguable that income from operation of the site could encompass allowances issued to Fortum O&M as "operator" and then surrendered to match emissions. There is no other basis on which the allowances could be said to accrue to GCHPL unless it was or could be designated as the operator.
60. The Directive defines an operator as "any person who operates or controls an installation, or, where this is provided for in national legislation, to whom decisive economic power over the technical functioning of the installation has been delegated." The Regulations state that "operator" means "the person who has control over its operation". In this respect, it is clear from the evidence (and indeed common ground) that all day to day operations are carried out by Fortum O&M. In this context there is considerable guidance issued by both DEFRA and the Environment Agency as to the identity of the "operator".
61. In its Guidance Note 1 issued in December 2003, DEFRA emphasised the obligation on an operator to monitor, report and account for emission of carbon dioxide. By way of further elaboration, the task of identifying the operator was described as follows:

"The ETS Regulations define "operator" as the person who has control over the operation of that installation. It is a question of fact in each case who has control over the operation of the installation but the operator must demonstrably have the authority and ability to ensure that the permit is complied with.

A pragmatic approach may be adopted to assess whether an operator has the authority or ability. This may be achieved by assessing the ability of the operator/proposed operator against the following factors – does the person:

Manage site operations through having day to day control of plant operation including the manner and rate of operation;

Ensure that permit conditions that will be imposed or that apply will be effectively complied with;

Hire and fire key staff;

Make investment decisions; and

Ensure that operations are shut down in an emergency."

62. The Environment Agency's guidance issued at the same time was more elaborate but to similar effect:

"3. WHAT DOES CONTROL MEAN?

3.1 The central issue is whether the applicant is able to exercise control over the operation of the installation. An Operator must also have the authority and ability to ensure that the permit is complied with.

3.2 A potential applicant should consider the following factors (this list is not exclusive and other relevant factors may be taken into account).

Does the Operator/proposed Operator have the authority and ability to:

manage site operations through having day-to-day control of plant operation including the manner and rate of operation;

ensure that permit conditions are effectively complied with;

Control, monitor and report emissions of carbon dioxide;

Be responsible for trading in Allowances so that at the end of a reporting period they can balance allowances against reported emissions.

3.3 The Operator might normally be expected to be the owner of the technical unit in which the activity is carried on. There may be some circumstances in which actual control of some or all of the schedule 1 activities is not in the hands of the owner (being contracted out, for example). In such cases, it would be the person with actual control who is "the operator" and who should make the application.

3.4 Operations are often contracted out (particularly heat and power plants) and there is a wide range of possible arrangements from a plant that is wholly owned and operated by the contractor at one extreme to another extreme where the contractor only provides maintenance. In the former case the contractor should apply, in the latter the client should apply. There may also be complex leasing arrangements between client, contractor and in some cases third parties which the client and contractor will need to take account of in deciding who is best described as "the Operator".

3.5 An applicant may argue that it is the Operator of an installation because it has entered into a contract with a contractor such that the Applicant Company retains control through the contract over all of the operations. Whilst each case should be considered on its merits, the Regulators consider such arrangements might undermine the intention of the Greenhouse Gas Emissions Trading Scheme Regulations that the permit holder should be in actual control of operations at an installation. The Regulators would have no way of knowing whether any such contracts remained in place and considers that they cannot monitor such commercial arrangements between operating companies and contractors. In most cases where a company has contracted out the operation of an installation the contractor rather than the contractee will be the Operator. An exception would be where the contractor provides the majority of the staff and perhaps equipment for the installation, but the contractee retains the senior staff providing primary management and operational responsibility, and thus maintains control.

3.6 ….

3.7 Where the Greenhouse Gas Emissions Trading Scheme Regulations installation is also permitted under Part 1 of the Environment Protection Act 1990 or under the PPC Regulations 2000 then the Operator identified in those permits would normally also be the Operator under the Greenhouse Gas Emissions Trading Scheme Regulations."

63. All this was also incorporated by reference in the guidance issued by the SEPA.
64. The Defendants presented a formidable case that Fortum O&M was the operator of the CHP Plant and thus the appropriate applicant for the GGE permit and the appropriate recipient of the allowances:

i) As already noted, it was common ground that Fortum O&M carried out the day to day operations. Such was required under the terms of the O&M Agreement both as originally drafted and as amended.

ii) Importantly from the perspective of the guidance cited above clause 3 of the O&M Agreement expressly included:

a) the management, operation and maintenance of the site;

b) the compliance with permits and licenses;

c) the control, monitoring and reporting of CO2 emissions;

d) the trading in of allowances against emissions;

e) the hiring and firing of key staff; and

f) the shutting down of operations in an emergency.

65. In contrast it is right, as IMSL emphasised, that GCHPL retained a measure of indirect control over some aspects of the operation of the CHP Plant. For instance in the event of a conflict between competing objectives imposed on Fortum O&M which was not resolvable by agreement, GCHPL as owner was entitled to direct which objective should take precedence. As further examples:

i) GCHPL was entitled to require Fortum O&M to replace a person who became subject to disciplinary proceedings or who was perceived as incompetent or negligent.

ii) GCHPL needed to approve Fortum O&M's maintenance programme, budget and strategic plan.

iii) GCHPL was entitled to amend the terms of all the project agreements (subject to the payment of compensation).

66. Of more immediate significance, Clauses 6 and 7 of the O&M Agreement made GCHPL responsible for obtaining the licenses, permits and other consents required by relevant statutory regulations as set out in Schedule 7 although Fortum O&M became responsible for maintaining and renewing them. These included consents under the Electricity Act 1989 and the Environmental Protection Act 1990 and any other consents required by GCHPL to perform its obligation under the agreement.
67. But the reality remains, taking as required a pragmatic approach, that GCHPL is not in any realistic sense the "operator" of the site. Indeed, Fortum O&M was accepted by SEPA as the appropriate applicant for the permit under the PPC regulations. It is an offence under those regulations for a person to operate a relevant installation without an PPC permit, such permit to be granted to the person who has control over the operation of the installation.
68. I have not forgotten that GCHPL held the IPC authorisation under the earlier legislation which again called for authorisation to be granted to the "operator" who carries on a "relevant process". This authorisation was granted before the plant commenced operations. In due course SEPA was notified that Fortum O&M were running the plant as appears to have been SEPA's initial reaction a year earlier. The issue of the identity of the proper person to hold the permit was never resolved. I do not regard the state of play under the preceding pollution regime as being of any material assistance in considering the issue of fact as to the identity of the operator under the new regime.
69. This conclusion is consistent with the position as regards the GGE Permit issued in regard to the Additional Boiler. GCHPL owns the Additional Boiler but does not operate it. Day to day operation is performed by IMSL. Indeed the IMSL personnel were monitoring and controlling the Additional Boiler from the same central control room used by Fortum O&M personnel to run the CHP Plant. In the result IMSL duly held the appropriate permit.
70. In the result, I conclude:

i) Fortum O&M was the operator of the CHP Plant.

ii) As such it was the only legitimate holder of the GGE Permit.

iii) Accordingly, the allowances did not accrue to GCHPL.

71. In the alternative IMSL contends that in the event that the allowances allocated and issued to Fortum O&M did not accrue to GCHPL, then GCHPL was in breach of the ESA in failing to apply for the GGE permit in place of Fortum O&M in circumstances where (i) GCHPL was entitled to apply for such a permit and (ii) if it had done so it would have received it and thus been issued with the allowances.
72. The short answer is, as already determined, GCHPL was not entitled to apply for a GGE Permit because it was not the operator under the regulations. An application in its name would breach the regulations. In any event, the express terms of the ESA relied upon (clause 3.4 and 20.1) do not impose any obligation on GCHPL to ensure that IMSL obtained the benefit of allowances which by definition did not accrue to GCHPL.
73. IMSL allege an implied term to such effect. Such a contention is hopeless whether put forward as necessary or obvious. To the contrary, the ESA remains entirely effective without any such implied term. In any event, absent any obligation arising under the O&M Agreement for transfer of allowances from Fortum O&M to GCHPL, no such implied term can be rendered workable.

Limitations and exclusions

74. Again these issues do not arise if I am right about the scope of clause 3.4. But for completeness' sake I deal with the issue as to whether the Defendants can pray in aid any contractual limitations or exclusions in regard to the claim. Clause 13.4 excludes consequential loss. But IMSL's claim is not a claim for indirect loss: it is made up of the value of the asset (i.e. the allowances) that should have been furnished.
75. As regards limitation clause 13.2 of the ESA limits the liability of a party to £1.5 million per year but not where the claims arise from "Wilful Breach" such being "the wilful and intentional or reckless act or omission constituting a breach of any material obligation" but "excluding any error of judgement, mistake or omission made by any person in the exercise in good faith, of any function authority or discretion conferred pursuant to this Agreement."
76. IMSL contends that it is enough if the act or omission is wilful and intentional or reckless. It is not necessary for the breach to have been intended or the motive of GCHPL's actions. I disagree. This accords inadequate significance to the use of the words "wilful" and "reckless". Even accepting that any breach on the part of GCHPL may be categorised as intentional or deliberate, a wilful act or omission imports, in my judgment, a state of mind constituting recognition of the impact or at least reckless indifference to the outcome. In any event, the failure to obtain the GGE Permit was an omission made in good faith in the belief that GCHPL was not lawfully entitled to apply.

Conclusion

77. In the result, for the reasons set out in paragraphs 39 to 57, the claim fails.