Electricity and gas loans, swaps and hedges: how to deal with the force majeure fallout from the ERCOT market disaster

Heavy investments in the Texas electric power market have left many lenders and derivatives market participants wondering about the financial implications of February’s storms, widespread blackouts and resulting losses. While the full picture of the financial fallout remains to be seen, one thing has already become clear: Each affected market participant examines their force majeure rights under a plethora of contractual arrangements to determine whether performance can be excused. . Banks should be prepared to take advantage or defend against invoking these provisions, depending on the circumstances.

The force majeure clause of a contract allows a party to suspend performance if it cannot perform due to listed circumstances beyond the control of the parties. Every contract is different and, further complicating matters, financial institutions may have multiple interests in a transaction, some of which could benefit from a force majeure assertion (e.g., a generation project lender) and others who might lose one (eg, a buyer of bank coverage). It is therefore essential to understand which contracts are at issue and what exactly are the relevant force majeure provisions.

Regardless of the agreement, if the relevant contracts include a force majeure clause, the bank must (1) assess whether an event related to weather conditions or network failure is admissible so that performance is excused, and (2) understand what she needs to do to protect her rights. With the sheer volume of force majeure notices expected as a result of events in the ERCOT market, observers expect significant disputes regarding the legitimacy of such notices. Banks need to prepare for it.

Determine the applicable law and the force majeure language of the contract concerned. Beforehand, a bank which examines a claim for force majeure must identify the law applicable to the contract in question. Although the grid outage is a Texas-based event, New York law governs many of the resulting disputes: by New York law, and many loan agreements drafted by banks also include provisions on the choice of New York law.

Force majeure provisions vary widely from contract to contract, as some list qualifying events while others use standard catch-all language. We see various provisions, if any, in the loan of documents. On the derivatives side, most electricity and gas ISDAs incorporate the electricity annex, which replaces the force majeure provisions of the 2002 ISDA framework agreement. See annex on food §6 (b) (iii). Although the Power Schedule uses fairly broad language to define force majeure, it includes exceptions upon which force majeure cannot be based: (1) loss of Buyer’s business; (2) the inability of the purchaser to use or resell economically; (3) loss or failure of Seller’s supply; or (4) the ability of the seller to sell the product at a price higher than the contract price. Identifier. §6 (i) (iv). These exceptions can also be – and often are – amended through annexes to the Electricity Annex. In addition, sophisticated parties often modify standard force majeure provisions in loan documents.

Assess whether the intermediate event is a case of force majeure. Under New York law, the terms of the contract control the applicability of force majeure. The courts interpret these clauses restrictively and did not want to release part of its responsibility unless the intermediate event falls within the scope dictated by the parties. See Belgium v. Mateo Prods., 29 NYS3d 312, 315 (1st Dep’t 2016) (citation omitted); Phibro Energy c. Empresa De Polimeros De Sines Sarl, 720 F. Supp. 312, 318 (SDNY 1989). If the contract does not contain a force majeure clause, the courts will not infer one. See Kel Kim v. Hundred. Markets, 70 NY2d 900, 902-03 (1987).

The fact that a provision names the alleged force majeure event is not sufficient: the party must also demonstrate that the event is the immediate cause of the party’s non-performance – not just a tangential event – and that it has makes reasonable efforts to comply with its obligations. See 22A NY Jur. 2d Contracts §386; 98-48 Queens Blvd v. Parkside Mem’l Chapels, 70 Miscellaneous. 3d 1211 (A) (NY Civ. Ct. 2021).

Striking at the heart of some of the recent claims, the economic conditions that make enforcement financially inadvisable, even if those conditions were the result of force majeure, are unlikely to constitute force majeure. See Wizard vs Clipper Cruise Lines, n ° 06-civ-2074 (GEL), 2007 WL 29232, at * 5 (SDNY January 3, 2007). Indeed, unless otherwise specified in the applicable contract, a case of force majeure must make performance impossible, not simply difficult or financially unfeasible. See 98-48 boul. Queens, 70 Miscellaneous. 3d to 1211 (A); see also Coastal energy production. Co. v. New York State Pub. Serv. How, 551 NYS2d 354, 356 (1990) (performance not excused by “[t]The fact that a contract becomes more and more difficult and expensive to perform ”).

When a court reviews a contract specifically designed to offset risk and provide certainty in the midst of price changes, it is likely to stick to its practice of strictly interpreting the terms that excuse performance. The courts have reiterated that “the purpose of contract law is to allocate risks that could affect performance and that performance should only be excused in extreme circumstances.” Kel Kim, 70 NY2d at 902. Although no court has yet interpreted the annex’s force majeure provision on electricity, a party hoping to succeed in a force majeure claim submitted to the annex on the electricity must be ready to demonstrate how the alleged force majeure event falls within the scope of the provision, apart from the exceptions listed.

Protect your rights. Contracts often provide detailed instructions for asserting a force majeure event, including, but not limited to, providing proper notice and pursuing other means of enforcement. Failure to comply with these requirements may result in the failure of an otherwise valid force majeure claim. In some cases, a party who resists a force majeure claim also has their own notification requirements.

Notice provisions vary by contract, but often specify a method of service, timeframes, and required details. While courts disapprove of interpreting a notice provision as essential to the claim, they may require strict adherence to provisions that detail the consequences of inadequate notice. See Toyomenka Pac. Petroleum v. Hess Oil Virgin Islands, 771 F. Supp. 63 (SDNY 1991) (citation omitted); A m. Manufacturers Mut. Ins. Co. v. Payton Lane Nursing Home, 2010 WL 144426, * 15 (EDNY January 11, 2010).

Other obligations may include the requirement to seek another means of performance or to make “reasonable efforts” to overcome the alleged force majeure event. See 98-48 boul. Queens, 70 Miscellaneous. 3d to 1211 (A). Failure to comply with these contractual obligations may result in an otherwise valid claim of force majeure.

Consider other performance excuses. Force majeure is rarely the only doctrine a party can rely on. A party involved in a “sale of goods” contract may invoke commercial impossibility, under which a seller can be excused for his non-delivery if “performance as agreed has been rendered impracticable by the occurrence of a unforeseen “and” the non-occurrence of [that contingency] was a basic assumption on which the contract was made. NY UCC §2-615. However, a party may find it difficult to meet these elements when the contract in question is designed to spread risk in the event of a contingency, especially where a party has arguably agreed to accept abnormal cost increases (such as a hedging contract). Moreover, this defense cannot excuse the execution of electricity contracts, because UCC only applies to “goods” and New York law does not consider electricity to be “good” (unlike to certain other states). United States v. Consol. Edison Co. of New York, 590 F. Supp. 266, 269 (SDNY 1984).

The State of New York recognizes, however, two potentially applicable common law doctrines: the impossibility, when an unforeseen event beyond the control of the party destroys the object of the contract or makes performance “objectively impossible”, and the frustration of purpose, when a change in circumstance, usually complete destruction of an element at the center of the contract, renders the contract worthless. See Kel Kim, 70 NY2d to 902; Beardslee versus inflection energy, 904 F. Supp. 2d 213, 221 (NDNY 2012), confirmed, 798 F.3d 90 (2d Cir. 2015). Such as force majeure, “when the impossibility or difficulty of performance is caused only by financial difficulties or economic difficulties, even to the extent of insolvency or bankruptcy, the performance of a contract is not excused. 407 E. 61st Garage c. Savoy Fifth Ave., 23 NY2d 275, 281 (1968); see also Health-Chem v. Baker, 915 F.2d 805, 810 (2d Cir. 1990) (considering that a subsequent price modification making performance “more expensive” is insufficient).

Force majeure claims are here to stay. In the wake of the global pandemic and more recently the fallout from the ERCOT market, it is clear that force majeure claims are here to stay, along with the need for sophisticated parties to mount an appropriate response. As market players rush to adapt to these changes and litigation ensues, sound and experienced advice can help banks minimize tail risks and improve their chances of a successful outcome.

Leslie Thorne is a partner and co-chair of Haynes and Boone’s litigation practice group in New York, where she advises on complex commercial litigation matters. Avery burrell is associated in the group.

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