International safeguards

By Tariq A. Khan, Houston, Texas, USA

Long-term international agreements are often worth tens or hundreds of millions of dollars. Are power companies doing enough to protect these contracts?

Globalization has led to a proliferation of long-term international agreements such as build-own-operate (BOO) agreements. Multinational companies are at risk of a counterparty using its national laws to gain unfair negotiating leverage or to terminate a BOO agreement or other long-term international agreement without adequate compensation. These agreements are often worth tens if not hundreds of millions of dollars, and are certainly worth safeguarding.

Several nations, including Italy and some Latin American countries, have enacted laws that allow parties to an agreement to terminate that agreement when commercial impracticability arises due to unforeseeable change in the marketplace. The general intent of these termination laws is to protect a party from having to perform under extremely onerous fiscal circumstances that were outside the realm of foreseeability at the time of contracting. They are not intended to protect parties from poor negotiating or from failing to take historical price trends into account.

Sometimes these termination laws are vague about the process for termination and about termination value. Their imprecise nature allows one party to an agreement to threaten the other with termination as a negotiating ploy if the long-term agreement does not contain terms and conditions that define if, when and how renegotiation or termination may occur. Though the threatening party may ultimately lose, the process of fighting such an undefined threat can sour the relationship and future prospects with that counterparty.

Some countries in Latin America have enacted termination laws
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If the counterparty happens to be a government or government agency, the fight over the agreement can delay expansion in that country. Preventing or minimizing damages from such disputes can have significant positive financial and relational results.

Careful due diligence

One way to prevent damage related to termination laws for long-term agreements is to become familiar with the law of the governing jurisdiction. Legal research should include at least laws that terminate or modify a contract for impracticability or for unforeseeable circumstances.

Local counsel should not only find the law, but also should research cases that apply the law. These cases will indicate how the law has been interpreted in the past. Some civil law jurisdictions require that the national supreme court render three similar written opinions before the holding can be considered precedent.

If there is no established precedent, local counsel should indicate the succession of sources that would be used to analyse a termination law case. Counsel should then prepare a comparative law analysis of the termination law. The governing jurisdiction’s foreign investment, corporation, commercial, and dispute regulation laws and regulations, and laws and regulations of the specific business sector should also be analysed.

Companies should employ local counsel to find the termination law and research cases that apply the law
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Another way to prevent or minimize damage related to termination laws is to carefully draft several clauses in the long-term agreement. The main argument advanced by a counterparty regarding termination will often be that, given the circumstances, the price is too high or too low.

Price clause

The price clause in a long-term agreement will often contain several factors in a price formula, with one or more factors linked to a particular index. Safeguards should be incorporated to govern the amount of fluctuation allowed in the price. Normal fluctuations in price formula factors may cause a party to pay more than it would like or to get paid less than it would like. Without safeguards, there is little financial downside for a counterparty to seek termination because if it loses a termination law case, the contract still stands. If it wins or gets financial relief through forced renegotiation, it benefits.

Newspapers in El Salvador reported that CEL, the government agency responsible for the electric sector, sought to use El Salvador’s termination law. CEL claimed that it should be able to terminate its power purchase agreement with Nejapa Power Company, a subsidiary of The Coastal Corporation, without compensation because of unforeseeable changes in the world economy. An unnecessary arbitration followed.

CEL had disregarded the historical fluctuation in oil prices in helping to set the electricity price. CEL claimed in the Salvadoran press that the rapid increase in fuel price caused CEL to seek a solution to its increasing electricity cost, and it resorted to the rarely used termination law.

Price safeguards can include:

  • Setting an explicit agreed range of fluctuation around the price formula in which renegotiation or termination will not be allowed. This will help prevent arbitrary use of termination laws within the specified range. It may also be useful to cite historical fluctuation of the various factors as support for foreseeability.
  • Specifying that if the termination law is to be invoked, the price must stay outside the specified range for a minimum period.
  • Specifying that a change in law that leads to a change in price of a given percentage of the total price should be borne by one party, or by both according to a given formula.

Termination clause

Another important clause is the right to terminate. This clause should refer to the termination law and clarify the terms, standards and processes for termination. Included here should be the trigger for termination, a pre-termination negotiation process, the dispute resolution process, a definition of termination value, and other important terms.

The trigger should be finite and well defined. Termination value will usually best be expressed as a formula, with flexibility for calculation of the contract alone, the contract plus the underlying assets, or just the underlying assets.

Dispute resolution

In an international setting, the dispute resolution process can be binding arbitration in a neutral forum or litigation in a neutral forum. Either one should occur after negotiation of a specified type and duration. This negotiation process should contain parameters for if, when and how renegotiation of price should occur.

If arbitration is selected, special care should be given in the dispute resolution process to choice of governing law, situs, the selection of arbitrators and their number. Careful thought should be given to the notion that discovery rules are different in most jurisdictions. Discovery standards may need to be specified.

It may be useful to carefully file all correspondence with the counterparty and to obtain yearly annual reports in case of difficulty in obtaining such information later. It would also be helpful to keep records of any public statements by the other party regarding the agreement. Having negotiation drafts and correspondence on file is often invaluable in establishing the intent and mindset of the parties at the time of executing the agreement.

Thought should also be given to include a put of the contract alone, the contract plus the underlying assets, or just the underlying assets upon the termination trigger. Each case should have a well-defined formula so that value can be clearly determined and the scope of each case is understood.

In the case of a power generator that deals with a government entity, the ability of the power generator to put the plant at market value to the government could act as a deterrent to the government entity’s improper use of a termination law.

Important definitions

Commercial impracticability should be defined, as should foreseeability and other important terms in the termination law. Methods for dealing with commercial impracticability should be specified. Force majeure should exclude an inability to pay.

Another way to minimize damages related to termination laws is to obtain guarantees for performance, both of the performance of the contract by the counterparty and for payment for the construction of the underlying assets needed to perform the contract. These guarantees should be coordinated with the right to put, if any.

Win-win relationships

A win-win relationship with the counterparty does much to prevent or smooth out conflict and maintains a spirit of cooperation. For example, if a wholesale power customer was unable to pay for electricity at the long-term agreement rate, both sides could enter the spot market as long as spot prices stayed within an agreed range. Then, if economic conditions changed, the original terms would apply and the contract would continue as before. Otherwise, the contract would terminate at the contract value, with the generator having a right to put the plant if that had been previously negotiated.

Another example would be to trigger a renegotiation period if the price stayed outside a given range for a specified period. This renegotiation could flow into a carefully drafted dispute resolution. This would allow the parties to adjust the agreement in a mutually agreed way but would also prevent delay and abusive tactics.

The above safeguards can be applied to existing long-term agreements through renegotiation with private parties. Both sides benefit from the provisions if they are properly written, so both sides have a significant incentive to execute an amendment. Government entities are reluctant to amend contracts, especially those awarded through a bid process. Some of the above safeguards can be introduced into agreements with government as clarifications. There may be no specificity about the above topics, and the clarification may be accepted. The stakes are often high enough to make the attempt worthwhile.

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