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Bulletin | Covid-19

Independent Power Producers, COVID-19 and Contractual Issues

Fasken
Reading Time 8 minute read
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Energy Bulletin

The COVID-19 crisis reminds us of the crucial role of independent power producers at a time in our lives when, more than ever, we need to secure the availability of power. In Quebec, for example, energy production, transmission and distribution have been recognized as priority  services to be provided and maintained by the Government.[1] The same is true for example for Ontario[2] and New York State[3].

Yet, even though these services are a priority, power producers and the entire power industry in the value chain have and will have to deal with many operational, legal and financial uncertainties.

Operational uncertainties

Gas-fired power plants are directly affected, in particular due to the more complex and time-consuming supply of natural gas. The solar photovoltaic industry is also affected, in particular due to the suspension of several production units in China (which have since gradually resumed) and an increase in prices due to challenges that each of the players in the value chain will have to meet. The wind industry has seen many of its workers repatriated to their country of origin following the halt of certain power plant projects under construction. The collapse in oil prices has also led to a drop in the cost of delivering electricity to the domestic market and thus a drop in the import of certain products, as we have seen in China, for example, with a drop in its coal imports from Australia.

Given that electricity demand is an important indicator of economic activity, the drop in consumption in many countries does not bode well for global energy markets and, incidentally, for independent power producers.

Legal uncertainties

The COVID-19 crisis affects all stakeholders in the electricity sector. The notion of force majeure, an unforeseeable event beyond the reasonable control of the party invoking it, is on everyone's lips, but this notion and its consequences must be provided for in the contract or in the law applicable to the contract in question. Below are some examples of situations that may be considered an event of force majeure, dependent of course on the assessment of the circumstances on a case-by-case basis.

Power purchase agreements (PPAs)

What type of force majeure should be invoked; by whom should it be invoked and for what purpose? In the case of power plant projects under construction, can the project company invoke COVID-19 to justify an absence of workers on site and, more generally, the total disruption of the value chain without any risk? In the case of projects in operation in developing countries, assuming that the procurement risk is borne by the producer, how can such procurement and the supply of energy continue to be financed when independent power producers have no certainty that they will receive adequate payment from their customers, who claim that their own users are unable to pay their electricity bills? In theory, such a situation could lead to a suspension of payments by independent power producers. In practice, the reality should be quite different, provided that one knows where the leverage with the contracting party or parties is, be it contractual, operational or even political.

Construction (EPC) and operation and maintenance (O&M) contracts

As in the case of PPAs, the unavailability of workers on site and the closure of certain industrial equipment production units have a significant impact on both the costs associated with the project and the ability to perform scheduled or unscheduled maintenance, with the risk of altering the performance of the plant in the short or medium term.

Delays in the granting of permits, authorizations or licences

The closure of the competent authorities or agencies, and thus the unavailability of civil servants, undeniably leads to delays in the appraisal and issuance of permits, licences and authorizations, which will push back the actual commissioning date of power plants.

Transmission system connection contracts and electricity distribution contracts

 Here again, the unavailability of workers and equipment will lead to delays in the connection of power plants to the transmission system and the electricity distribution processes, particularly for new projects that connect to the system.

Project financing

The lack of revenue for operating power producers and the unavailability of some power plants, if no precautions are taken, may lead to independent producers being unable to repay the debt they have incurred to finance their energy assets.

Financial uncertainties

In addition to the operational and legal uncertainties arising from COVID-19, there are a number of events of default in financing documents that must be analyzed with the utmost rigour. These events of default may also be considered as such in relation to all stakeholders, such as construction companies, customers, operators, insurers, etc. The following are some examples of events of default that should be assessed in light of the current COVID-19 situation.

Delays in project delivery

The absence of industrial commissioning of the plant prior to an agreed date often constitutes an event of default. Delays due to a lack of equipment supply and unavailability of employees are also likely to constitute an event of default.

Failure to repay debt and steps to avoid suspension of payments

 Operating independent producers will be in default only if the payment due in respect of principal and interest is not made on the scheduled date of payment. This being said, these producers will likely be required under the terms of their financing to provide regular updates on cash flow which will identify potential events of default prior to actual default occurring. In any event, producers must weigh the impact of the COVID-19 crisis on their financial commitments to determine whether an event of default could arise from it. In addition to avoiding an event of default, one can also try to limit the risks of receivership or compulsory liquidation by exploring all measures to protect independent power producers from their creditors and, in particular, their bank creditor(s). Early communication with lenders is key to potentially avoiding an actual event of default and potentially triggering cross default clauses in other facilities.

Government action

In international project financing, particularly involving developing countries, loan agreements often include, as an event of default, the granting of delays or moratoria for the payment of sums guaranteed by the State and due under a power purchase agreement. Despite the fact that many developing countries have applied for assistance, including from the International Monetary Fund, project companies will have their work cut out juggling  the relationships with clients, the State as a guarantor and lenders to avoid acceleration of loan repayment and paralyzing the operation of power plants, which, of course, are key strategic assets for local communities. The success or failure of a project will depend on all stakeholders making a united effort of solidarity at this time; anticipating and avoiding potential abuses of power will entail the project company developing a global strategy and adequately communicating this with all stakeholders. 

Conclusions and recommendations

In light of the difficulties and issues outlined above, we set out below some conclusions and practical recommendations:

  • In respect of the contractual relations between the parties, the COVID-19 crisis allows us, without a doubt, to appreciate the contracting parties' good faith. Indeed, it is crucial to fully understand the notion of force majeure and to determine how and by whom it can be invoked. The credibility of the person invoking force majeure and its consequences will be assessed rigorously, with the risk, in the event of abuse, of seeing that person's good faith and reputation significantly altered during and after the COVID-19 crisis.
  • Force majeure is not a one-way concept, because those who invoke it can put their contracting parties in a difficult position vis-à-vis their own contractual counterparties. Weighing up the reciprocal consequences of invoking force majeure, and communicating clearly throughout the process, is key to maintaining a harmonic business relationship and will encourage solidarity amongst the stakeholders that will help avoid tragic situations, especially when small and medium-sized businesses are involved.
  • Scrupulously examine financing contracts  to determine the notices and notifications to be given, events of default and possible waivers, and work with the borrower's contracting parties (notably insurers) and the lenders to find long-term and mutually beneficial solutions to preserve the energy assets, avoid acceleration of repayments and, as to the extent possible, limit loss of profits.
  • Carefully analyze clauses relating to changes in the applicable legislation, regulations, orders, directives or codes and assess their relevance in relation to force majeure clauses. In reality, clauses relating to changes in laws may prove to be more appropriate than force majeure clauses, so these clauses should be carefully examined; cross-analyzing force majeure clauses with those relating to changes in laws could produce interesting results.
  • If this has not already been done in previous crises, perform an exercise that is crucial for the future and consists in analyzing the "lessons learned" from the COVID-19 crisis by modelling them so that they can be disseminated internally and response scenarios can be considered for the next crisis. One lesson COVID -19 has taught us all is that you never know when a crisis will hit. The way we draft contracts today will have to change substantially. A "COVID" clause will probably have to be included and will likely be analyzed as a real operational risk for operators, the legal consequences of which will have to be carefully written into contracts.
  • All things considered, the situation created by COVID-19 should strengthen rather than weaken the ties between the contracting parties. Each party will remember the "other's" conduct during this period and trust will either have been built or have disappeared entirely. We are likely to see a large number of companies disappear and stronger business relations being built with partners who are able to put aside "unbridled selfishness" in favour of the joint solidarity effort required to limit the negative effects of the COVID‑19 crisis.
  • No one will emerge from this crisis unscathed, whether upstream, such as the operating companies and the various market players, or downstream, such as end customers and energy consumers. As part of a more comprehensive analysis, we need to question our consumption patterns and habits more generally and consider new contractual means and new regulatory standards to be put forward, such as operating methods that comply with strict health standards and warning signals in the event of a repeat of this type of pandemic.
  • More than ever, "To govern means to anticipate." This political motto also applies to businesses. We urgently need to rethink our rules, indicators and cultures to anticipate the effects of the COVID-19 crisis and those of the next crisis.

We are available to assist you with any challenges you may face in relation to the issues outlined above.

 


 


 

[1] O.C. 223-2020, 24 March 2020, item 4.a.

[2] O. Reg. 119/20: Order Under Subsection 7.0.2 (4) - Closure of Places of Non-essential Businesses, item 33.

[3] Executive Order 202.6, para. 2.

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