Risk allocation and mitigation in long term infrastructure contracts
How do deal with change in circumstances in case of suprise future events.
Long-term Infrastructure Contracts
A power purchase agreement or PPA is a contract for setting up a generating plant with a commitment to supply power for 25 years. Owing to the length of these contracts, these contracts are exposed to various subsequent events, which may have an unpredictable impact.1
A PPA signed on the basis of tariff discovered during competitive bidding2 does not have the adaptability that a PPA signed without bidding does3. All such contracts need carefully worded clauses to deal with not-envisaged future eventualities to provide scope for re-negotiation. Such clauses make the contract dynamic to changes in circumstances and more particularly to re-establish the contractual equilibrium of the transaction.
In this post, I do an analysis of various renegotiation and adaptation clauses that could potentially allow changes in the contract. I also look at the existing legal doctrines and their adequacy in dealing with the pressure of renegotiation.
Incomplete Contracts
The traditional position under English Common law is that contracts are absolute. Parties are required to perform the contract however burdensome it may have become and however much the circumstances change. Generally, there is no duty upon the parties to revisit or renegotiate the terms of the contract nor do Courts have the power to modify the terms of the Contract should a fundamental change in the very basis of the contract take place/ disputes arise.
Common law jurisprudence, therefore has leaned against readjustments of contracts or price. Courts of law have time and again held that force majeure must be treated at par with frustration of contract, i.e., impossibility. As such, commercial impracticability, economic equilibrium and hardship have not necessarily found their way to grant relief, especially when the “liability/fault” for the causal event cannot be pinned on any particular party.
It is notable that civil law countries are more realistic towards unforeseen and uncontrollable adverse events.
K.M. Schmidt in his writings on Incomplete contracts and privatization4, notes that contracts in reality are typically incomplete. The view on foresight or lack thereof, has also been appreciated by J. Tirole as he writes that the drafters of the contract are limited by foresight and/or transactions costs that prevent the contracts that are drafted from providing for all possible future contingencies. This limitation of contract drafting becomes aggravated in cases of long term contracts wherein it is not possible to take into account all possible contingencies.5
The reasons for incomplete contracts are:-
Unforeseen Contingencies: Parties cannot or fail to define ex-ante the contingencies that may occur or actions that may be feasible later on. So, they must content themselves with signing a contract which does not explicitly mention these contingencies.
Cost of writing contracts: Event if a person could foresee all contingencies, they might be so numerous that it would be too costly to describe them in a contract.
Asymmetric Information between the parties to the contract. i.e. parties to the contract do not share the same level of information amongst themselves.
In the context of adjudication of disputes arising out of incomplete contracts, the word “contract” ought to be considered to have two distinct facets (i) something that is actually written and signed, and (ii) something that the parties have in mind as they engage in their relationship.
Common law Courts, however fail to endorse this view and have recognized frustration of contract only in those events where relief arises from contractual obligations/ liability.
Frustration and Force Majeure
Frustration applies when the event is so fundamental as to alter the contract itself. In common law, a contract may be discharged or set aside on the ground of frustration where an unforeseen event renders the contract impossible to fulfil. Frustration does not need to be provided for in the contract.
Force Majeure on the other hand is a creature of the contract by which either party is entitled to cancel the contract or is excused from performance of the contract, in whole or in part, or is entitled to suspend performance or to claim an extension of time for performance, upon the happening of a specified event or events beyond his control. Such clauses may assume a variety of forms depending on the negotiation between the parties.
Interesting the term “the usual force majeure clauses to apply” has been held void for uncertainty.
The concept of force majeure in English law is wider than that of “Act of God” or vis- major, and have been expanded to include human acts as well.6 In fact you will see contracts will provisions that delineate natural and non-natural force majeure events separately.
Force Majeure clauses in present day serve as an effective as a risk management option, offering protection to contracting parties in the event of extraordinary circumstances. For these clauses to be invoked, allowing parties to suspend or terminate contractual obligations, three key criteria must be met:
The event must be unforeseeable, meaning it couldn't have been reasonably anticipated when the contract was formed.
It must be external to the parties involved, occurring outside their control or influence.
The situation must be severe enough to make it impossible, not just difficult or inconvenient, for the affected party to fulfill their contractual duties.
The onset of Covid 19 leading to disruption of supply chains qualified as a Force Majeure event under various contracts.
These provisions allow parties to navigate unforeseen, severe disruptions without being held liable for non-performance, provided the situation meets the specified criteria.
Commercial impracticability
In common law, judicial approach to commercial impracticality is conservative. Courts in India and UK have consistently held that mere commercial difficulty or economic hardship does not constitute a valid reason for discharging a contract7. This stance is rooted in several key legal principles and precedents:
Pacta Sunt Servanda - meaning agreements must be kept. Courts are reluctant to interfere with contractual obligations that parties have willingly entered into, even if circumstances change.
Narrow Interpretation of Impossibility: Courts typically require absolute impossibility of performance, not just difficulty or unprofitability.
Risk Allocation: Court view commercial impracticality as a foreseeable risk that parties should have accounted for when entering the contract. The assumption is that sophisticated parties can allocate risks through appropriate contractual provisions.
Economic Hardship Not Sufficient: Numerous judgments have established that financial difficulties, market fluctuations, or unexpected costs do not amount to impossibility of performance.
Distinction from Force Majeure: While force majeure clauses (if present in the contract) might offer some relief, commercial impracticality itself is not equated with force majeure events in Indian jurisprudence.
The party seeking discharge bears a heavy burden to prove that performance has become truly impossible, not merely onerous or unprofitable. In rare cases, courts might consider extreme and unforeseen changes in the fundamental basis of the contract. However, these are exceptional circumstances, not general commercial difficulties.
There are notable exceptions but limited in the relief allowed to parties.8 This approach differs from some other legal systems (like certain US states) that recognise the doctrine of commercial impracticability to some extent. The general message which the US Courts convey is that a contracting party may be discharged if, as a result of unexpected supervening events, performance of the contract, though remaining physically possible, has become severely more burdensome for that party9.
Way out?
In light of the conservative approach taken by common law courts regarding commercial impracticality, investors will have to adopt proactive strategies to protect their interests and mitigate potential losses from commercially unviable events.
Some of the options include developing comprehensive force majeure clauses that explicitly cover specific events impacting commercial viability, incorporating well-defined hardship and renegotiation clauses, and implementing automatic price adjustment mechanisms.
Renegotiation has been a feature of the natural resources industry as it reduces the chances of confrontation and deadlock.
Additionally, investors may also consider including step-in rights, exit clauses, and clear risk allocation provisions in their contracts.
Having said that, I do believe that a contract will always stay incomplete. In such a scenario, maintaining open communication channels with regulatory bodies and advocating for frameworks that recognise commercial realities is therefore crucial. These are regulated sectors, after all !
For contracts where tariff is determined by the regulator, there is an option to get tariff revised year after year based on the revenue and expenses. All other change in circumstances are therefore before the regulator.
Competitive Bidding requires bidding parties to commit to a tariff/price at the beginning of the 25 years period.
K.M. Schmidt, Incomplete contracts and privatization, (European Economic Review 40 (1996)) 569-579 at page 571.
J. Tirole, Incomplete Contracts: Where Do We Stand? Econometrica, Vol. 67, No. 4 (Jul., 1999), pp.741-781.
In Lebeaupin vs. Crispin & Co.( [1920] 2 K.B714) McCardic J. reviewed the previous authorities on force majeure. War, strikes, legislative or administrative interference, for eg., an embargo, the refusal of a licence, or seizure, abnormal storm or tempest, flooding which inhibits shipment from river ports, interruption of the supply by rail of raw material, and even the accidental breakdown of machinery can amount to force majeure. Not “bad weather, football matches or a funeral”, a failure of performance due to the provision of insufficient financial resources or to a miscalculation, a rise in cost or expense, the failure by a third party or by the other party to fulfil his contract, or any act, negligence, omission or default on the part of the party seeking to be excused.
Energy Watchdog & Anr. vs. CERC & Ors. 2017 (14) SCC 80, Satyabrata Ghose vs. Mugneeram Bangur & Co. 1954 SCR 310, Alopi Parshad & Sons Ltd. vs. Union of India 1960 (2) SCR 793, Naihati Jute Mills Ltd. vs. Hyaliram Jagannath 1960 (2) SCR 793, Tsakiroglou & Co. Ltd. vs. Noblee Thorl Gmbh 1968 (1) SCR 821, Sea Angel case 2013 (1) Lloyds Law Report 569, Tennants (Lancashire) Ltd. v. G.S. Wilson and Co. 1917 Appeal Cases 495, Peter Dixon & Sons Ltd. vs. Henderson, Craig & Co. Ltd. 1919 (2) KB 778.
Nabha Power Ltd. vs. PSPCL (2018) 11 SCC 508; Union of India vs. D.N. Revri & Co. (1976) 4 SCC 147, Cargill International S.A. & Anr. vs. Bangladesh Sugar and Food Industries Corporation [1998] 1 W.L.R. 461; Satya Jain & Ors. vs. Anis Ahmed Rushdie & Ors. (2013) 8 SCC 131.
In the United States, the case to which the doctrine of discharge by impracticability is usually traced back is Mineral Park Land Co. v. Howard, the court said that “a thing is impossible in legal contemplation when it is not practicable” and it added that, “the defendants were not binding themselves to take what is not there.”