"I realise that some of my criticisms may be mistaken; but to refuse to criticize judgements for fear of being mistaken is to abandon criticism altogether... If any of my criticisms are found to be correct, the cause is served; and if any are found to be incorrect the very process of finding out my mistakes must lead to the discovery of the right reasons, or better reasons than I have been able to give, and the cause is served just as well."

-Mr. HM Seervai, Preface to the 1st ed., Constitutional Law of India.

Tuesday, June 27, 2017

Force Majeure under Indian Contract Law: Energy Watchdog v CERC (SCI)

Recently, newspapers reported that certain power producers proposed to sell large amount of their stake in the Ultra Mega Power Projects.  The proposal to sell their stakes is a direct outcome of the recent decision of the Supreme Court of India in Energy Watchdog & Ors. v. Central Electricity Regulatory Commission & OrsThe dispute between power producers such as the Tata Power Co. Ltd. (“Tata”) and Adani Power Ltd. (“Adani”) on the one hand and the electricity regulators on the other was adjudicated upon finally by the Supreme Court by ruling in favour of the latter.

Followers of commercial law in India would be well aware of this issue on compensatory tariff allowed by the Central Electricity Regulatory Commission and the appellate proceedings thereon in the case of these power producers. The case has enormous implications on contract law, in general, and the law on force majeure, in particular. The seminal decision also impacts energy and regulatory laws. This post analyses the decision and its possible impact on contract law and the electricity sector in India.

Brief Facts

Mundra Ultra Mega Power Project (“MUMPP”) was conceived to be a huge power project which was to supply power to at least three states- Gujarat, Haryana and Rajasthan through the state power procurers. The tariff for the sale of power was to be determined through a competitive bidding process as per the electricity regulatory laws, which was undertaken. In the competitive bidding process, the bidders had the flexibility to choose escalable or non-escalable tariff (that is, tariff based on an increase in tariff formula). Both Adani and Tata quoted a non-escalable tariff. This was because the only major component that required an escalable tariff was an increase in fuel (coal) price. Since Adani and Tata had long term fuel supply agreements from coal mines in Indonesia at fixed/ predictable prices, there was no need to factor in price escalation.

Accordingly the lowest tariff was arrived at and power producers began to sell power at the said tariff after executing Power Purchase Agreements (PPAs) with the state power procurers. In two-three years after the determination of tariff, there was a massive jolt to the power producers in the form of new regulations passed by the Indonesian Government. The effect of these regulations was that the coal price under the long term fuel supply agreements  was to be benchmarked to the international prices instead of the then prevailing pricing mechanisms. This meant that the price under those agreements had drastically increased, thereby making the tariff at which these price producers sold price to the power procurers totally unviable. It may be recollected that a non-escalable tariff was quoted because of the long term fuel supply agreements.

Proceedings before the CERC and the APTEL

Consequently, Adani filed an application in 2012 with the Central Electricity Regulatory Commission (CERC) under the Electricity Act either to discharge them from performance of the PPA due to frustration of contract or to evolve a mechanism to restore them to the same economic position prior to occurrence of force majeure and/ change in law. The CERC did not accept the prayer of Adani but held in April 2013 that the CERC had the power to redress grievances of power producers considering larger public interest and constituted a committee to look into the difficulties of power producers so as a to find an acceptable solution. A Committee was constituted in August 2013 and the Committee recommended grant of compensatory tariff to Adani in its report. Consequent to the report, the CERC proceeded to grant compensatory tariff in February 2014.

Against this decision, appeals and cross-appeals were filed before the Appellate Tribunal for Electricity (APTEL). A summary of APTEL’s decision on the dispute is worth noting here:

  • Performance of the PPAs was hit by force majeure under the provisions of the Indian Contract Act, 1872 (ICA).
  • Changes in Indonesian law did not come within the purview of “Change of Law” clause in the PPA.
  • The purported power exercised by the Commission in constituting a committee and awarding compensatory tariff was beyond the statutory mandate of the Commission and the terms and conditions of the sale and purchase of power was governed by the PPAs.
  • Where there is an express or implied term of contract on force majeure, the same is covered under Section 31 of the ICA dealing with contingent contracts. Where there is no such term, force majeure is governed by Section 56.
  • In Indian law, under Section 56, as held in Satyabrata Ghose v. Mugneeram Bangur 1954 SCR 310 impossibility is not simply physical or literal impossibility but means impracticability and futility in performance from the perspective of object and purpose of the parties.
  • A more onerous performance method of performance or a mere rise in price would not amount to frustration.
  • Application of the frustration doctrine required a multi-factorial approach and some of the factors that are to be considered are the contract itself, the context, the parties’ knowledge, expectations, assumptions and contemplations, especially as regards risk at the time of contracting which the parties could reasonably foresee.
  • Application of the doctrine is not straightforward since it involves not only the contract but also an inquiry into the “contemplation of the parties”.
  • The “Change of Law” contemplated in the PPA was only of Indian law and which were made by Indian Governmental Instrumentalities or Competent Courts in India.
  • Certain clauses referred to the expression “Indian law” but such an expression nowhere found its place in the clause pertaining to “Change of Law”. Consequently, it would be dangerous to interpret the Change of Law clause merely on the basis of such usage in other parts of the PPA.
  • For these reasons, the contention that since the PPA envisaged import of fuel, Law should also be taken to mean non-Indian law should also be negated.

The APTEL remanded the matter back to the Commission to determine the impact of force majeure so as to grant compensatory tariff to the power producers. The Commission arrived at a compensatory tariff in December 2016. 

Judgement of the Supreme Court

Appeals were filed to the Supreme Court. The Supreme Court held against the power producers on the force majeure as well as the change of law arguments. 

Summary of the judgement of the Supreme Court on contentions relating to force majeure is given below:
  • The doctrine of frustration is inapplicable to the present case as the fundamental basis of the PPA remains unaltered, the PPA nowhere states that coal is to be procured only from Indonesia at a particular price, and the fuel supply agreement is only a part of the PPA to establish that fuel supply is available and is in order. When the power producers quoted the tariff, they very well knew the existence of the risk of increased prices of Indonesian coal and knowingly took it by quoting a non-escalable tariff. However, mere fact that they quoted non-escalable tariff does not mean that they would be disentitled from raising a plea of frustration if they were otherwise entitled to under law.
  • Force majeure clauses are to be narrowly construed. On a construction of the force majeure clause in the PPA, “Hindrance” could mean an event wholly or partly preventing performance.
    But mere rise in prices is not hindrance, whole or part. Clause 12.4 specifically excluded rise in fuel cost or agreement becoming onerous to perform from the purview of force majeure. 
  • Since Clause 12.4 specifically excluded rise in fuel cost from force majeure, since the fundamental basis of the contract was never dislodged and since alternative modes of performance were available even though at a higher price, there was no force majeure. Further, since there was a specific clause addressing force majeure, Section 56 did not have any application.
Another argument taken up by the power producers was that the change in Indonesian regulations fell within the scope of the “change of law” clause in the PPA and that they were entitled to relief under the said clause. Among other things, the PPA defined “Law” to mean “all laws including Electricity Laws in force in India… and any statute…. Or any interpretation of any of them by an Indian Governmental Instrumentality... and shall include all applicable rules… by an Indian Governmental Instrumentality…” Article 13.2 of the PPA provided that in case a party was affected by Change of Law, such party was entitled to be restored through Monthly Tariff Payments to the same economic position as if such change had not occurred. The Court dismissed the argument of the power producers and the following is a summary of the judgement on this aspect:

On facts, the court also noted that there was a Change of Law insofar as a change in India law was concerned. During the currency of the PPAs, the Ministry of Power issued a Notification in 2013, which was reflected in the Revised Tariff Policy of 2016. The Court held that if these notifications resulted in affecting Indian coal procurement, the Change of Law clause would be applicable. But change in Indonesian law affecting coal supply or prices would not amount of “Change of Law” for PPA purposes.

The Court ultimately set aside the decisions of the APTEL and the Commission and remanded the matter back to the Commission on the minor issue as to determination of effect on Change of Indian law on the power producers.

The decision of the Supreme Court clarifying the law on the issue is of fundamental importance on several counts. First, the judgement constitutes an important restatement on the law of force majeure. Second, special word about RF Nariman, J. Since assuming judgeship, he has passed several judgements clarifying and restating various aspects of commercial law thereby rendering clarity and updating various contract law concepts to the present times and breathing in fresh air to the 145 year old Indian Contract Act, 1872. Third, in the context of regulatory law, the decision offers clarity in the extent to which a tribunal/ court can go in balancing the competing interests of protecting consumers on the one hand and preserving the efficacy of the industry sought to be regulated on the other. Balancing the competing aims of preserving the efficacy of the industry by upholding the legitimate interests of the regulated on the one hand and protecting consumer interests on the other is the fundamental challenge in regulatory law. This case affords considerable clarity in the extent to which a regulator of a tribunal could or could not rewrite contractual terms between the regulator and the regulated.

The decision calls for an off-the-cuff remark. One of the arguments of the power producers was that Section 56 ICA operated de hors the force majeure clause in PPA. It may be recollected from the above analysis that the court negatived this contention. It would have been great if RF Nariman, J. referred to the concept of default rules to explain away how Section 56 operated as a default rule and how the PPA clause on force majeure eclipsed Section 56 and occupied its field instead. Even so, the effect of RF Nariman, J’s analysis remains the same.

One last remark. The decision of the Supreme Court has received considerable criticisms from the power industry. A direct result of the judgement has been that both Adani and Tata have asked the State power procurers to take control of the power projects (see here). Adani seems to have discontinued power supply from its power plant (see here). Experts also argue that the once-power surplus state of Gujarat could be facing the risk of power scarcity (See here). There is a strong argument that the power producers are to be protected considering that they had invested in public goods which was meant for consumption of the economy and that in case of failure to protect such investors, economy, and ultimately, the consumers will suffer. From the other end of the spectrum it has been argued that the power producers attempted to engage in crony capitalism by entering into unviable contracts knowing fully well that they could later demand renegotiation of the PPAs (see here). The reality, perhaps, lies somewhere in between.

Power producers have suggested two alternatives for the current arrangement. The first one is that they would forego their security deposits under the PPA and that fresh bids should be called from power generators. The second alternative is that the state power procurers should import coal directly and that the power producers would offer their power generation capacity (see here). It will be interesting how this issue would be resolved. For now, the Centre has taken a stand that the issue is for the power producers and the State power procurers to resolve but it doubtable if the stance is correct considering that the problem pertains to the nation as a whole.