Short-changed on CfDs?

Change in law provisions under the contracts for difference regime may expose generators to unmanageable risk, warns Elisabeth Blunsdon.

It is not possible to identify a standard change of law clause used in power purchase agreements (PPAs), but there is a broadly accepted principle that a change in law (which includes changes in industry codes and multi-party agreements) will allow the PPA contract parties to review, and amend, a PPA where a change in law causes either party to be unable to perform its obligations or where a party is materially adversely affected.
The electricity industry has developed this principle over many years (see box), largely because the industry itself is subject to ongoing changes – whether in industry rules, such as the balancing and settlement code and grid code, or more substantial structural changes such as that which occurred when the Pool made way for the bilateral market under the New Electricity Trading Arrangements (Neta).
So having established a well understood and generally accepted change in law regime, the feed-in tariff contract for difference (CfD) that is being developed under Electricity Market Reform (EMR) presents a rather different approach. For a start, the change in law provisions in the draft CfD published this summer run to more than 20 pages and warrant their own section in the CfD. The average change in law provision in a PPA is considerably shorter.
So what does it say? First, change in law is broken down into various different categories. These are: foreseeable; discriminatory; specific; and other changes in law. Generally speaking, change in law includes not only changes in statute, but also changes to statutory instruments, industry codes, licences and authorisations and regulatory guidance. However, the type of change in law will determine whether or not any compensation is permissible.
Generators take the risk of all “foreseeable changes in law” (the term is defined, at great length, in the draft CfD). They also take what could be called “general” changes in law, namely those that apply to everyone or to the energy sector as a whole. Where generators may be able to claim compensation is where there is a “qualifying” change in law. This means a change in law that is either specific or discriminatory, where such discrimination is without objective justification.
If a qualifying change in law occurs, the generator or the CfD counterparty may be entitled to compensation.
As one might expect, there are detailed processes that must be gone through and a complex set of provisions setting out how compensation is to be calculated. If the parties cannot agree compensation, the dispute resolution procedure in the CfD applies.
It is envisaged that compensation will usually be made (to whichever party is appropriate) by an adjustment to the strike price – although the CfD counterparty does have a discretion to pay a lump sum instead.
This approach is far more prescriptive than that normally seen in a PPA. And while the usual PPA approach described in the box is quite vague, it is that very vagueness that allows a wide range of circumstances to be covered and dealt with. The CfD mechanism, while much longer, is arguably narrower, which is logical from the viewpoint that consumers ultimately pay for the support provided under the CfD regime. However, the CfD change in law provisions may not protect generators sufficiently. Compensation by way of adjustment to the strike price would not help a generator that could no longer generate, and there is insufficient flexibility to cater for a change in law that did not change costs or revenues, as defined, but nonetheless adversely affected the risk profile of one of the parties.
Further, CfDs do not make provision for power offtake, so generators will still need to enter into a PPA to sell their electrical output. The Department of Energy and Climate Change is developing a standard form PPA for use alongside the CfD, which may mirror the terms of the CfD in this area (time will tell), but there is no obligation to use the document and, crucially, the risk profile of power offtakers is highly unlikely to be aligned with that of the CfD counterparty. There is an obvious risk of change in law provisions being misaligned between the CfD and the PPA, which could leave generators exposed to risk they cannot manage.
Elisabeth Blunsdon is of counsel at Hogan Lovells LLP

Change of law provision in PPAs

When Neta was introduced, there was some discussion as to whether it would “frustrate” existing PPAs (which were actually financial instruments in the form of contracts for difference, as physical delivery was to the Pool, not the contract counterparty). The legal doctrine of frustration allows a contract to be set aside when performance becomes impossible due to the occurrence of an unforeseen event post formation of the contract. The obvious possibility that a contract party could use such an argument as an excuse to get out of a bad bargain means the doctrine is very rarely successfully applied in the courts.
 Doubtless back in 2001 the drivers behind raising the argument in relation to Neta implementation were economic, and in the end it was accepted that, as a rule, Neta would not constitute frustration of PPAs. However, the upshot was that PPAs started to contain change of law provisions that expressly contemplated changes in law that rendered performance impossible. This further expanded to include changes in law that have a materially adverse effect on one (or both) parties.
As a result of such a change in law, the parties are required to meet to discuss, and where possible agree, amendments to make performance possible and “preserve the original economic balance of the parties”. Hence, any future claim of frustration could be avoided, and the parties have a mechanism to deal with the change in circumstances.
Many change in law provisions provide for expert determination in the event that amendments cannot be agreed, albeit that the extent that an expert can impose contract amendments is usually heavily negotiated, particularly if a project is bank financed.