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
company.
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.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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