Illegality of CO2 emissions trading was recognized

A consumer who had made a deal with a CO₂ emissions trading company claimed damages against the company and its employee who had solicited the consumer on the ground that the sales scheme was fraudulent and that the consumer had been induced to pay money in the name of margin money.

The court construed that the CO₂ emissions trading constituted gambling which was illegal and against the public order and morals, and recognized joint tort liability of the CO₂ emissions trading company, the CEO and the employee concerned. The court ordered them to pay 17,050,000 yen including legal fees.

The judgment serves as a reference because the court judged that the CO₂ emissions trading was against the public order and morals, and did not employ the principle of profit and loss offset. (Judgment by the Tokyo District Court on December 4, 2014; Published on Page 132 of Sakimonotorihiki Saibanreishu No.72)

Summary of the case

Plaintiff:

X (consumer)

Defendants:

Y1 (CO₂ emissions trading company), Y2 (Y1's CEO), Y3 (Y1's employee who solicited and served X)

X, a woman then aged 77, started CO₂ emissions trading with Y1 in October 2012 after being induced to do so by Y3. X paid 15,500,000 yen of margin in total between October 15, 2012 and May 17, 2013 and received 1,921,500 yen in total in the name of dividends.

In the CO₂ emissions trading, CO₂ emissions are sold and purchased through margin trading. In margin trading, a contract signatory deposits part of the total price for a financial product under contract. It is a kind of derivatives, which is highly leveraged¹ and risky as in the case of commodity futures trading. Under the Financial Instruments and Exchange Act and the Commodity Derivatives Act, which regulate derivatives, the coverage shall be designated by Cabinet Order. Neither of the acts covers CO₂ emissions. In Japan, some companies take advantage of holes in the laws and offer fraudulent sales related to CO₂ emissions.

European and some other foreign exchanges are authorized to trade CO₂ emissions. In Japan, there are roughly two types of fraudulent sales schemes related to CO₂ emissions trading: one scheme is to purport to act as an agent between customers and foreign exchanges; another scheme is to highlight that foreign exchanges are authorized to trade CO₂ emissions and to disguise as a reliable business in the form of negotiation transaction. A negotiation transaction is also called an over-the-counter transaction, where a broker and a customer transact on a one-to-one basis. (In case of transaction on exchange, on the other hand, customers entrust trading to brokers and numerous brokers participate in transactions at an exchange.)

In the above case, the court recognized the trading between Y1 and customers as negotiation transactions by way of settlement on balance². In such trading, what matters is the way of pricing. The court construed that Y1 set a trade rate merely based on a rate set by ECX (European Climate Exchange).

X filed a suit against Y1-3 and claimed damages to cover 15,500,000 yen of payment and 1,550,000 yen of legal fees, alleging that the sales scheme was fraudulent and that X had been induced to pay money in the name of margin money.

Incidentally, Y2 had solicited customers as an employee of Y1 since Y1's inception to August 20, 2013 and afterwards served as Y1's CEO. Y3 solicited X as Y1's employee.

1. ¹ Buying more than the margin.
2. ² Settlement is made only by the difference between a selling or buying price and a price at the time of reverse transaction, without exchanging actual objects such as currency and securities.

Reason

The court recognized illegality of the CO₂ emissions trading based on the following.

1.Illegality of the trading

The above consumer entered into a private contract for CO₂ emissions trading by way of settlement on balance based on a trade rate set by Y1. The balance between a buying price and a selling price is the difference between a selling or buying price of CO₂ emissions and a price thereof at the time of reverse transaction calculated at the euro-yen exchange rate. If so, neither Y1 nor X can predict or control the price of CO₂ emissions offered by Y1 and the exchange rate to be used as a reference for the euro-yen exchange rate. In this trading, gaining or losing depends on incidental factors. Therefore, it should be said that the trading falls under the category of gambling which is illegal and goes against the public order and morals. There was no allegation or proof to negate illegality of the trading as gambling.

Moreover, it was highly possible that a trade rate, an index for settlement on balance, was decided by Y1 unilaterally and arbitrarily and that X's profit or loss was determined based on a trade rate set by Y1. If so, it should be said that Y1 conducted a fraudulent trading business while hiding conflict of interest and disadvantages for customers.

2.Liability of Y1-3

The court construed that inducing customers to do illegal gambling or the trading which was fraudulent constituted a tort, and judged liability of Y1-3 as follows.

"Considering Y1's business scale and status, it is reasonable to recognize that all of Y1's executive officers and employees systematically conspired to solicit customers to start trading. Even if Y2 did not directly solicited X, Y2 as Y1's CEO and joint tort-feasor should be liable for damages incurred by X due to Y3's solicitation."

3.Profit and loss offset

The court stated as follows referring to the reference precedent 1.

"It should be said that the money paid by Y1 to X in the name of dividends was considered to have arisen from performance for illegal causes³. It is impermissible to deduct the amount from the compensation for damage under the principle of profit and loss offset."

1. ³ Payment arisen from performance for illegal causes. Article 708 of the Civil Code states that a person who has tendered performance of an obligation for an illegal cause may not demand the return of the thing tendered.

Explanation

There are some preceding judgments which recognized illegality of CO₂ emissions trading. In the reference precedent 2, the court construed that it was highly possible that the CO₂ emissions trading company earned profits at the expense of customers in the form of negotiation transaction where company's interest and customers' interest conflict. If a trade rate is arbitrarily decided by a company, the conflict of interest is obviously larger and the trading is more risky for customers. Accordingly, the court deemed such trading illegal.

The court also recognized the CO₂ emissions trading as gambling⁴ which is illegal and against the public order and morals.

The judgment that the trading constitutes gambling is similar to a series of court decisions on Loco London precious metals trading⁵, one of which is listed as the reference precedent 3. The gold price index used for the Loco London precious metals trading corresponds to the CO₂ emissions price index used for the CO₂ emissions trading. The two businesses have much in common in illegality.

The above judgment did not apply the rule of comparative negligence or the principle of profit and loss offset. The court referred to the reference precedent 1 and stated, "Y1's business was actually fraudulent and illegal, and obviously constituted an unethical conduct. Y1 made customers believe that the CO₂ emissions trading was normal and paid them money in the name of dividends. It should be said that the payment of dividends was nothing but a way to cheat customers and to avoid detection of the fraudulent conduct. If so, it should be said that the money paid by Y1 to X in the name of dividends arose from performance for illegal causes. It is impermissible to deduct the money from the amount of damages under the rule of comparative negligence or the principle of profit and loss offset."

In the reference precedent 4, the court recognized liability of Y1's sales persons, which is related to the above case.

1. ⁴ Gambling is a criminal offense in Japan. Transactions not permitted under finance-related laws are not legal.
2. ⁵ Trading by way of settlement on balance based on the Loco London gold price and the dollar-yen exchange rate. Refer to the reference precedent 3.

Reference precedents

1. Judgment by the Supreme Court on June 24, 2008
   (the court's website)
2. Judgment by the Tokyo High Court on April 11, 2013
   (Page 361 of Sakimonotorihiki Saibanreishu No.68)
3. Judgment by the Tokyo High Court on October 30, 2008
   (Page 377 of Sakimonotorihiki Saibanreishu No.53, illegality of Loco London precious metals trading)
4. Judgment by the Tokyo District Court on December 26, 2016
   (Page 76 of Sakimonotorihiki Saibanreishu No.95)