Title: Energy Contracting and the Hidden Power of the Force Majeure Clause
Speakers: Brian Fineman and William Droze
William Droze (00:07):
Good morning, Brian.
Brian Fineman (00:08):
Morning, William. How you doing?
William Droze (00:09):
I’m good. How are you? Good to see you.
Brian Fineman (00:11):
Good. So I think today we’re gonna talk about force majeure. I know you’ve been a litigator for 37 years and so you’ve been dealing with this concept your whole career. Can you explain force majeure and why our clients should care about it?
William Droze (00:26):
Force majeure sort of sounds like a French wine or champagne, and it is one of those sleeper items that’s in a contract. Really, if you think about the translation, it means major force. And so it comes into play when you have a situation where a party who has a contractual obligation is unable to perform. And that means that it’s not that it would be harder to perform, but there’s something that literally is stopping you from performing your contractual obligation. And so it becomes usually a nothing buried in a contract until you need it. It’s sort of in that regard like a trusty pocket knife. You want it there with all those attachments whenever it’s available to be used in a contractual situation. In the energy context, you often see that arise where a utility for some reason is unable to provide power to its customers, whether they are residential customers or they are industrial customers.
And what happens, of course, is that people always expect that when you turn on the light switch, the light comes on. Or when you start the machine that’s making equipment, that machine runs. But if there are situations that arise — and I wanna talk with you because you have to draft these things — to give you an example of these major forces, a lot of things that are in these contracts are things like acts of God, strike, war, or insurrection. Sadly, we’ve seen a lot of that kind of thing over the course of the last 10 years — the pandemic, hurricanes, Winter Storm Uri in Texas and the Midwest. And so all of those kinds of things can contribute to a party to a contract being unable to perform and then facing the question of how do I get out of this?
How do I not breach my contract and be liable for — and in some cases, for example with widespread power outages — it can be millions or billions of dollars. There are commercial applications, but in our cases, as you and I work frequently in the energy sector, it’s usually centered around those kinds of issues. But I know that I draft some of these things, but you do them all the time. I then have to live with what is drafted. So from your standpoint as a long-time transactional partner, what are some of the things that you think about when you’re drafting these kinds of clauses to make sure that a client, when facing some future unforeseen circumstance, doesn’t find themselves in a bad situation?
Brian Fineman (03:10):
That’s a great question. Historically, over the past 10 years or so prior to COVID and prior to Winter Storm Uri, it was one of those concepts that sort of buried in the boilerplate. A lot of clients would sort of just look to the lawyers and say, “That’s something you guys handle.” And it’s not always that simple because we need to be able to prepare our clients for the types of events that could be coming. And obviously with COVID and the supply chain issues that have come up over the past several years as a result of that, these things went from theoretical concepts in the contracts to contract provisions that came into dispute between parties.
With the supply chain, for example, one of the things that’s happened is — I’ll give you an example. Construction contractors have an obligation to procure equipment under construction contracts where we’re building power plants. And things that may have had a lead time of several months all of a sudden become delayed indefinitely because they can’t procure equipment. And so there becomes a question of who should bear that risk. Is it the owner of the project? Is it the contractor? And it’s important when you’re drafting these contracts on the front end to be very clear about who’s going to bear the risks of those types of delays. So those things have gone from being theoretical to being actual risks. An additional concept that’s come into play has to do with the way in which our counterparties under contracts are making force majeure claims.
And what we’ve seen, especially with COVID and supply chain issues, is that counterparties are making claims that are sometimes very generic in their nature. I’ll give one example that’s more extreme: we had a counterparty make a claim for force majeure and deliver us newspaper clippings that there was a pandemic going on. And that was their justification for trying to get out of having to perform under a contract. When you are faced with a situation like that, I think it becomes very important to stop and think about how we are going to respond to that. And one of the things that I always advise my clients on is we really should stop and perhaps consult with some of our litigation partners like yourself about how to go into that process of responding to force majeure claims.
Because I think the way in which you respond and the way in which you prepare to respond can really affect the outcome of a dispute over this topic. And so one of the things that I wanted to talk to you about generally is when we find ourselves in that situation where we need to make a claim that a force majeure has occurred, what’s the first step that we should take?
William Droze (06:04):
I joke with clients sometimes that there’s a guy behind those “in case of emergency break glass” moments, and I’m that guy. Usually by the time things get to litigation, they’ve gone horribly wrong. But you make an excellent point, which is there are preparations that can be made before you ever reach the courthouse steps. And some of those preparations not only can prepare you if you have to litigate, but at the same time, they allow you the opportunity to create a negotiation or a leverage strategy that perhaps can keep you out of litigation altogether. One of the things that I’ve worked with your group on is that once there is either a potential for our client to have to declare a force majeure, or our client receives a declaration of force majeure from the other party, that’s the point at which to sit down and really go through the contract to think about what was anticipated by the parties.
Are there business ways to potentially work things out? And then last but not least, if you have to litigate, then be in the best position you can be in to represent the client so they can maximize their situation. Often you run into these situations where these types of stoppages are so dire that it really is a bet-the-company type environment.
And I always think that whenever somebody declares force majeure, there ought to be some kind of sound effect, like the Law & Order sound to tip you off that this is an important moment in the client’s engagement with the other party. But to your specific point about counterparties, one thing to keep in mind — we’ve talked a little bit about these situations where you have equipment stoppages or products can’t flow — but there’s also a financial waterfall. You have to have investors to invest the money to build the plants, and then the plants have to create power and sell that power to industrial and residential customers, and then the customers have to pay for that power. And when you have these major disruptions like Winter Storm Uri, which really was a signature event — and for those unfamiliar with it, it was a horrific ice storm in the Midwest that really affected Texas and its independent grid disproportionately. Sadly, some people lost their lives in that situation.
It was literally the perfect storm. There was ice on wind transmission assets that prevented them from operating. There was ice on gas pipelines that prevented the transmission of gas. There were, of course, the heavier loads where people were trying to heat their homes, and that caused brownouts and issues where they were just not able to deliver power. And it’s certainly tragic on the physical side and the human side. From the financial side, there are also impacts. For example, those residents and industrial users — because of some financial tweaking that was allowed by ERCOT, the financial management grid operator for Texas — they were able to raise rates to compensate for the additional load, which meant homeowners who usually would have a $200 light bill were having bills in the thousands over this period, and magnify that with those customers who are using electricity on an industrial scale.
So you are looking at investors saying, “Where’s my check? We’re due a payment.” And you have the plant saying, “We’re doing our best to generate power. We can’t pay you till we get paid.” And you have customers who are saying, “We don’t have the money” — and even for the industrial customers, it’s a hardship and something that’s way out of the norm. So one of the things I think you find that’s very unique in this situation — because of either a supply chain or an investment chain like I just described — is that you may be having a force majeure declared against you, but then you may have to declare a force majeure against another party. And so as a result of that, you have to be very conscious of whether you’re taking inconsistent positions, because you may want to say, “Well, wait a minute, you could go get this power somewhere else and therefore it’s not a force majeure.” Again, it’s impossibility.
It’s not because it costs more money. If you could do it and it’s reasonable, then you have to go out and get additional funds and procure that performance. But if it’s impossible, like some of those situations were in Uri, then you wanna make sure that you’re not only protecting your client, but making sure that in doing so, you’re not harming an upstream or a downstream relationship.
Brian Fineman (10:48):
Well, I think that brings up a really interesting point because you’re viewing it on the back end after there’s fallout from these events. On the front end, what I always advise clients on is if you are a party that’s in the middle — where you have a contract where you’re procuring or having someone procure on your behalf and then you have to deliver — ideally you’d negotiate both of those contracts at the same time and you’d be reviewing the force majeure provisions in both contracts and syncing them up. That’s the ideal situation. But the practicalities of that are sometimes that it’s just not possible.
And so you may have one contract in place already and then you’re negotiating the second contract. And when you do that, I think it’s critical that the clients talk to their lawyers about, “Hey, I’ve already got this contract in place. Please review these provisions because I wanna make sure that I have back-to-back protection.” And that’s how lawyers talk about it — back-to-backing risk. And so we always try to make sure that we’ve done a deep dive on that topic and really walk through with our clients where they’re exposed. Are they comfortable with that? Is that something they can live with? Because ultimately there are certain things when you’re defining what force majeure is in a contract and you’re agreeing with your counterparties on who’s gonna bear what risk.
There are some things — like war, insurrection, and other things — which are commonly just deemed to be a force majeure as long as it’s not reasonably foreseeable and they’ve done what they can to mitigate. Those are two key preconditions to any force majeure.
A lot of the things that have to do with economic impacts and supply chain and procurement and the types of things that we’ve been seeing a lot of recently are really things that parties negotiate — it’s a commercial risk allocation decision. And what goes into deciding who’s gonna bear the risk of that particular condition really comes down to how are people being compensated under the contract. Are they being paid to take that risk? That’s critical. But I think what it underscores is that force majeure is not simply an issue for the lawyers. The commercial teams with your clients need to get involved and understand these risks so that they can prepare for them and make sure that it’s being accounted for in the overall risk allocation that goes into making a decision whether to sign an agreement or not.
William Droze (13:13):
You make a very good point because you’ve talked about counterparties, but there are also third parties and optics. And that would be the other thing. We wanna always make sure that our client’s legal position is protected, but everybody has an online presence these days.
Brian Fineman (13:27):
Right.
William Droze (13:27):
Everyone is subject to social media. And just to give you an example, one of the things we handled during the pandemic was we had a commercial client who had a product that required liquid oxygen in order to make it have all of the elements that it is typically required to have. Well, guess what? Liquid oxygen was being diverted to hospitals to make sure people were living longer and surviving COVID. So you don’t wanna be the person that is saying, “I don’t care. You’re contractually bound to deliver me this liquid oxygen,” because that’s not exactly the company look that you want to have.
And fortunately, we had a client that was very invested in making sure that the human component was superseding everything else. And so force majeure was a valid way for them to be able to tell their upstream customers, “We just can’t provide this product to you right now because there is a pandemic out there and people are dying if they don’t get liquid oxygen.” And so all of these things kind of come back to — not only is there a legal component, there’s a business component, and there’s a good stewardship of your resources and your company that factors into everything.
Brian Fineman (14:40):
That’s a great point. And I think where that ties into the situation where you receive a force majeure claim from somebody — receive a letter, or you need to make a claim — I think it’s critical to sit down and have all the stakeholders in your organization along with your attorneys there to decide what’s the message we’re going to send in responding to a claim. Because I think it’s critical for the optics, but also for consistency, because you may be having to make this same argument with more than one counterparty. And so you wanna think about not just the impacts in that particular contract, but in similarly situated contracts where the issue maybe has arisen or is about to arise.
William Droze (15:27):
I couldn’t agree more. One of the things, of course, if you’re making the force majeure claim, the evidence you have to show — again — is impossibility. And how do you do that? You go to the business people who deal in this arena as subject matter experts every day and say, “Can you procure this power from any other source? Can we get this pipeline up and running?” And one of the things that you typically have to do — as part of the great things that you guys draft — is when you declare force majeure, you have to give the other side some idea as to how they can expect that performance to begin again.
Brian Fineman (16:00):
Right.
William Droze (16:00):
And otherwise you might give them some termination right — they need to go elsewhere if you just can’t perform ever again. Your plant burns down. It’s not just a temporary force majeure. So you wanna consult with those subject matter experts and say, “What can we do? Is there any alternative source? And once this problem resolves itself, when can we start performing under the contract again?” And the lawyers don’t know that. We have to rely on the client subject matter experts to help us. So it really is a team effort when you’re approaching these issues, not only from the standpoint of how do we deal with the other side, but also how do we make the claim if we’re gonna do that?
Brian Fineman (16:39):
I think that’s right. And I think ultimately each situation is unique. And one of the things that’s important for folks to understand is that the particular facts and circumstances in play in your particular situation are going to have a huge impact on how you pursue a force majeure claim or how you respond to a force majeure claim. And you can’t presume that because you’ve handled it a certain way in the past, you can handle it the same way here. And so I think a good general rule of thumb is: don’t presume anything when you receive a force majeure claim. In fact, I think you need to look at it very critically, make sure that your lawyers are looking at it with you as well, and that nobody gets out ahead of their skis, so to speak, and responds to the other side either through writing a response or even sending emails.
So I think you really wanna take a pause when you receive a notice of force majeure.
William Droze (17:37):
I think you’re right. And in an urgent situation like that, there’s a desire to shoot first and aim later. And that’s the exact wrong approach to take. It is an emergency, but your point is very well taken that that is the perfect opportunity to involve counsel because there are no cookie-cutter force majeures. As you just pointed out, it is entirely fact dependent. And where I think we can add value is — even though the facts may all be different — we’ve seen these claims over significant time periods. We’ve seen them negotiated. We’ve seen them litigated. And where we can add value, I think, is helping clients understand how their unique circumstances can best be dealt with in that particular window — which, again, could be a bet-the-company type situation economically or legally — and we can help them with those kinds of issues.
Brian Fineman (18:33):
I think that’s a great point.
William Droze (18:34):
So Brian, as you think about force majeure issues, where do you see the major value add that from a transactional standpoint you can help clients, being in the best position they could be in if they face these situations?
Brian Fineman (18:48):
Absolutely. So as a transactional lawyer who’s negotiating the deals upfront, I think the real value add is in pausing when you get to the force majeure provisions in a contract and having that discussion about who’s gonna bear the risk for a potential force majeure. Nobody could’ve seen COVID coming realistically. And so there’s going to be another event in the future. How do we best prepare our clients for that? It’s understanding the buckets of risk that come along with force majeure — it could be procurement risk, or the risk of unusually severe weather when it comes to construction contracts, or other topics like that. And I like to have the conversations with my clients about how much of that risk are you pricing into this deal, and having them pause and really think through that.
Because I think when they start to think about what assumptions they’re building into doing a deal, that may lead them to the answer on who should bear the risk from their point of view. And that affects how we draft the contract, how we present the contract to our counterparties, and ultimately how that risk should be allocated and therefore how that contract should read. On the flip side of things, as a litigator, where do you see the value add?
William Droze (20:07):
Ironically, one of the first things I try and do is to help my clients avoid litigation if possible. Sort of talking about some of the things and why our interactions on the very early part of these types of force majeure issues can make a major difference in whether people are looking at one to two years of prolonged litigation in a state or federal court. And the litigation world is a totally artificial world. Some clients are used to it, some are not, and have fortunately never had to darken a courthouse doorstep. But if they do, we wanna be prepared so that they can understand what that looks like, because that factors into whether or not you want a negotiated resolution or you wanna actually go to the mat on something. Because if you’re looking at litigation, you’re looking at prolonged delay, business distraction, depositions of corporate officers, going through electronic discovery and pulling out emails and documents, and then potentially going through motions, and worst case scenario, sometimes it goes to a full trial and even an appeal that can proceed after a trial is completed.
So it’s a long and uncertain process at times that we could help clients navigate successfully because we do this all the time. But we do our best to solve the problem on the front end, but are prepared to deal with the back end. So it’s the old hope for the best and prepare for the worst.
Brian Fineman (21:38):
And I’ve seen you in action, William, and I think you do an excellent job in the dispute resolution process trying to get the parties to a mutual agreement that’s acceptable so that you don’t end up in court. I think there’s real value there.
William Droze (21:54):
Well, the best weapon for me is the great job you guys do in drafting great force majeure provisions on the front end.
Brian Fineman (22:01):
Well, I appreciate that. Good talking to you today.
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