Wednesday, April 12, 2017

Supreme Court on Force Majeure Clauses in Power Purchase Agreements

[Other posts related to this topic are available here and here.]
In 2013, we had discussed an order of the Central Electricity Regulatory Commission (CERC) in a matter involving Adani Power. The brief facts of the case, as discussed therein, are as follows:

Adani Power had entered into separate PPAs with Gujarat Urja Vikas Nigam Limited and two Haryana utilities under which Adani Power had agreed to supply power to these state utilities. Under these arrangements, and the bidding process that preceded them, Adani Power was to assume responsibility to tie up the fuel linkage. Due to issues in procuring fuel from domestic sources, Adani Power established arrangements with entities in Indonesia for supply of coal at reasonable prices. However, in 2010, the Indonesian Government issued a set of regulations stipulating that holders of mining permits in Indonesia will be permitted to sell coal only benchmark prices accepted in the international markets. These Indonesian regulations had a significant impact on export prices of coal from Indonesia, which were higher than the contracted prices, due to which it became unviable for Adani Power to supply power at agreed prices to the state utilities in Gujarat and Haryana. Since this was unforeseen, Adani Power approached the CERC for relief.

Among various issues, an important one related to whether the situation faced by Adani Power fell within the scope of force majeure or “change in law” under the relevant power purchase agreements (PPAs) thereby requiring relief to be provided to the power producers. As discussed in that post, the CERC interpreted the force majeure and “change in law” provisions narrowly and denied relief on that count. However, the CERC found that it possessed inherent powers under legislation to award compensation to Adani Power, and sought to grant compensatory tariff.

An appeal was preferred against the CERC order to the Appellate Tribunal for Electricity. While maintaining that Adani Power must be granted relief, the Appellate Tribunal differed from the CERC as to the grounds. The Appellate Tribunal found that the principle of force majeure applied, and held that the CERC could not exercise its general power to grant compensatory tariff. Finally, the matter was taken up on appeal by the Supreme Court. While there was some controversy surrounding the extent to which the arguments pertaining to force majeure could be considered by the Supreme Court, in the end it held that issues relating force majeure and “change in law” can be argued “in all its plenitude to support an order quantifying compensatory tariff”.

While the Supreme Court considered a few issues, including the scope of the CERC’s powers under the Electricity Act, 2003, its ruling ultimately boiled down to the interpretation of the clauses in the PPA relating to force majeure and “change in law”. After adopting a narrow interpretation, the Court found that neither of these protections would be available in the case of Adani Power. Given the importance of these clauses, this post is limited to a discussion of those rather than the broader issues under the Electricity Act.

The Supreme Court began by considering the scope of force majeure clauses under the Contract Act, 1872. It bifurcated them into force majeure situations expressly or impliedly dealt with by the contracts, in which case section 32 (contingent contracts) would be invoked, whereas in cases where force majeure situations are not so addressed in contracts section 56 (frustration of contracts) would apply. Based on this premise, the fundamental question before the court was whether the change in price of coal to be procured by Adani Power was sufficient to constitute a force majeure situation so as to grant it relief under the PPA.

The Court analysed several Indian and English decisions which suggest that a force majeure situation is one that strikes at the heart of the contract and makes it impossible for a party to comply with its terms. Placing reliance on a leading Supreme Court case, the judgment notes:

The law in India has been laid down in the seminal decision of Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310. The second paragraph of Section 56 has been adverted to, and it was stated that this is exhaustive of the law as it stands in India. What was held was that the word “impossible” has not been used in the Section in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose of the parties. If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do. It was further held that where the Court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be dealt with under Section 32 of the Act. If, however, frustration is to take place de hors the contract, it will be governed by Section 56.

It was found that parties to a contract always carry risks of uncertainty (such as “a wholly abnormal rise or fall in prices”), and that is not by itself a justification for parties to claim excuse. Merely because the performance becomes onerous upon one of the parties, it cannot amount to a discharge of the contractual obligation. Hence, interpreting the frustration doctrine narrowly, the court found that where there are alternative modes of performance it cannot amount to a frustrating event. The Court noted:

It is clear from the above that the doctrine of frustration cannot apply to
these cases as the fundamental basis of the PPAs remains unaltered. Nowhere
do the PPAs state that coal is to be procured only from Indonesia at a particular
price. In fact, it is clear on a reading of the PPA as a whole that the price
payable for the supply of coal is entirely for the person who sets up the power
plant to bear. … It is clear that an unexpected rise in the price of coal will not
absolve the generating companies from performing their part of the contract for
the very good reason that when they submitted their bids, this was a risk they
knowingly took. We are of the view that the mere fact that the bid may be
non-escalable does not mean that the respondents are precluded from raising the plea of frustration, if otherwise it is available in law and can be pleaded by
them. But the fact that a non-escalable tariff has been paid for, for example, in
the Adani case, is a factor which may be taken into account only to show that
the risk of supplying electricity at the tariff indicated was upon the generating

Based on these fundamental principles, the Court interpreted the force majeure clauses of the PPAs, and applied a narrow construction. It was found that “neither was the fundamental basis of the contract dislodged nor was any frustrating event, except for a rise in the price of coal” in existence. Hence, the contract as a whole was not frustrated. Since the express provisions of the PPA dealt with force majeure situations, which did not apply to the present case, the court did not find the need to delve into the broader principles of section 56.

When it came to protection available for “change in law”, the Supreme Court found, after interpreting the provisions of the PPA, that the reference to “law” was limited to Indian law, and did not encompass changes in foreign law such as the present one (i.e. change to Indonesian law).

For these reasons, the Supreme Court set aside the judgment of the Appellate Tribunal and asked the CERC to go into the matter afresh considering the Supreme Court’s decision.

The Supreme Court’s decision addresses some of the concerns raised in our previous post under the section “Analysis”. First, it bolsters the principle of sanctity of contracts, as it refused to interfere in the contractual understanding between the parties. Any situation that prevents performance of a contract must be such that it affects the fundamental nature of the contractual relationship, and the Supreme Court found that this (i.e., a price rise) was not such a situation. In the absence of any specific provision in the PPA that transfers price risk of coal to the power purchaser, it is to be borne by the producer. Secondly, it also addresses the moral hazard problems as it would prevent excessive risk-taking by the power producers. The only method by which such risks can be allocated between the parties is through express contracting, and this decision would suggest that courts and regulators would be unwilling to interfere to protect any of the parties. Ultimately, this might mean that such contracts may have to be even more carefully drafted and negotiated.

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