A recent lawsuit filed by the Trump Administration’s Department of Justice seeks to block a six-year-old agreement between California and Québec that “links” their respective cap-and-trade programs.

The lawsuit, filed yesterday in the Eastern District of California, asks that the court declare unconstitutional California’s agreement with Québec which provides for the trading of cap-and-trade compliance instruments across the two jurisdictions. The Complaint boils down to a claim that the agreement unconstitutionally interferes with foreign policy and the federal government’s “full and exclusive responsibility to conduct this nation’s foreign affairs.” California Air Resources Board (CARB) chair Mary Nichols—one of the numerous defendants named by the Complaint—has already responded, calling the lawsuit “another baseless attempt to undermine California’s efforts to protect public health and fight climate change.”

If successful, the lawsuit has the potential to remove an important element of California’s cap-and-trade program, and more broadly, could upset the myriad other agreements California maintains with foreign partners across the globe. It will also provide a relatively rare instance where a federal court is asked to decide on the appropriateness, if any, of state-level involvement with foreign nations and sub-national entities.

Cap-and-Trade and the Agreement with Québec

California’s cap-and-trade program is the State’s primary (but not only) policy initiative for battling climate change. In effect since 2012, the program sets an economy-wide limit on GHG emissions that ratchets down over time. Regulated industry is required to remit compliance instruments (allowances and offset credits) equal to their emissions. Some of these compliance instruments are provided for free, others must be purchased and are available at quarterly auctions jointly held by California and Québec. The foundational statute for this program, AB 32, provides that CARB will “consult with other states, and the federal government, and other nations to identify the most effective strategies and methods to reduce greenhouse gases, manage greenhouse gas control programs, and to facilitate the development of integrated and cost-effective regional, national, and international greenhouse gas reduction programs.” (Cal. Health & Safety Code § 38564.) Quite clearly, the California legislature had an international scope in mind from the start.

Québec’s program operates similar to California’s, and pursuant to the agreement between the two, compliance instruments issued by either jurisdiction can be used for compliance with either program. This allows for auctions with participants from both jurisdictions taking part. California’s and Québec’s programs have been linked since 2014 via an express written agreement, and the linkage is incorporated into California’s cap-and-trade regulation. (17 Cal. Code. Regs. § 95943(a)(1).) 

The agreement between California and Québec, entitled “Concerning the Harmonization and Integration of Cap-and-Trade Programs for Reducing Greenhouse Gas Emissions,” was entered in 2013. In 2017, California and Québec entered into another similar agreement, replacing the 2013 agreement and this time including Ontario, which sought to harmonize the cap-and-trade programs across the three jurisdictions. Ontario later withdrew from the compact. While portrayed by the Complaint as a unitary instrument, the agreement addresses numerous issues related to (among other things):

• Ensuring consistency across the two regulatory programs.
• Developing offset protocols.
• Mutual recognition of compliance instruments.
• Facilitating trade of compliance instruments across jurisdictions.
• Holding joint auctions.
• Maintaining a joint registry for purposes of managing and auctioning compliance instruments.

Both the 2013 and 2017 agreements focus exclusively on cap-and-trade programs administered by the three sub-national governments and compliance instruments generated by, and solely relating to, those programs. The agreements do not address the management or implementation of any federal policies adopted by the United States or Canada, and the only “trade” governed by the agreements relates to compliance instruments generated by regulatory bodies in California and the Canadian provinces. The agreements also preserve each jurisdiction’s regulatory autonomy, with the 2017 agreement expressly providing that it “does not modify any existing statutes or regulations nor does it require or commit the Parties . . . to create any new statutes or regulations.”

The Lawsuit

DOJ’s Complaint alleges four causes of action, all of which surround the Constitution’s vesting of foreign diplomacy exclusively in the federal government:

• The First Cause of Action alleges violation of the Treaty Clause (U.S. Const. Art. I, § 10, cl. 1), which provides (among other things) that “No State shall enter into any Treaty, Alliance, or Confederation.”
• The Second Cause of Action alleges violation of the Compact Clause (U.S. Const. Art. I, § 10, cl. 3), which provides that “No State shall, without the Consent of Congress . . . enter into any Agreement or Compact with another State, or with a foreign Power.”
• The Third Cause of Action alleges violation of the Foreign Affairs Doctrine, which is based on various provisions of the U.S. Constitution and related case law.
• The Fourth Cause of Action alleges violation of the Foreign Commerce Clause (U.S. Const. Art. I, § 8, cl. 3.), which grants Congress the power to “to regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.”

The crux of the Complaint is DOJ’s argument that California’s agreement with Québec frustrates the Executive Branch’s ability to conduct foreign affairs and interferes’ with Congress’ authority over foreign commerce. For relief, DOJ seeks: (1) a declaration that the agreement and relevant portions of California law linking California’s program with Québec are unlawful; and (2) a permanent injunction against any actions pursuant to that agreement or those laws.

Implications

The lawsuit represents the latest battle in the ongoing war between Washington, DC and California over environmental policy. A series of escalating legal actions have pitted the two sovereigns against each other on several issues, such as tailpipe standards for greenhouse gases, California’s preemption waiver under the Clean Air Act, California’s progress on ozone pollution and related highway funding, and the application of the Clean Water Act to salt ponds near San Francisco.

At the same time, the lawsuit is unlikely to undermine California’s cap-and-trade program, which the California Supreme Court upheld in 2017, and would remain legally valid even if DOJ prevails. From a practical perspective, the California program recently weathered the withdrawal of Ontario (which is much larger than Québec in terms of GHG emissions) from the multi-jurisdiction compact with very little impact on the program. While allowance prices may marginally increase within a smaller market, that limited impact is unlikely to alter significantly the operation of the California cap-and-trade program itself. Somewhat ironically, higher allowance prices in both California and Québec resulting from a DOJ victory may even result in a marginal decrease in GHG emissions in both jurisdictions.

Although the California cap-and-trade program is unlikely to suffer a significant setback as a result of the lawsuit, the case is nonetheless significant for its potential to re-shape federal state relations and redefine the limits of state authority on the international stage. California has over 70 international agreements, all of which could theoretically face similar challenges. Similarly, many states routinely engage with foreign nations on matters of trade, seeking to boost their local economies. Further, the suit raises issues regarding federal preemption for other transboundary activity, such as state and local rules on environmental impacts of international pipelines. Regardless of the outcome, the lawsuit will have far-reaching impacts, whether rejecting, constraining, or affirming state authority to operate in this area.

One thing is certain: California is braced to fight the Trump Administration at every turn, and we can expect intense litigation in this case until an ultimate decision is rendered, perhaps by the U.S. Supreme Court.

Beveridge & Diamond’s Air and Climate Change practice group helps private and municipal clients navigate all aspects of carbon markets and climate change initiatives, including state and federal regulatory programs, obligations arising under international agreements, private governance, and sustainability initiatives. For more information, contact the authors.