The IBA’s response to the war in Ukraine  

Energy: Companies and governments consider legal remedies as crisis set to deepen

Neil Hodge Friday 26 August 2022

Europe’s current energy crisis is set to worsen as winter approaches, according to most analyses. Energy shortages combined with severe price hikes for gas and electricity threaten industrial slowdowns and factory shutdowns. Recession in Europe’s top economies –Germany, in particular – appears likely.

European countries are sourcing alternate supplies of energy and reducing their reliance on Russia. But in the immediate short term, governments and companies will need to prepare for a financial hit.

John Zadkovich, a partner at Penningtons Manches Cooper, says there are several ways governments can alleviate the current and future energy crises. Perhaps the most dramatic, he says, would be for policymakers to consider expediting approval processes and reducing bureaucracy for energy projects.

He also believes governments should encourage foreign investment in the sector through incentives, while abandoning disincentives such as ‘windfall’ taxes and nationalising infrastructure.

‘The energy market has long lead times’, says Zadkovich. ‘For example, the time between discovering a specific ore and/or fossil fuel to producing it is often just shy of ten years. Equally, most renewable projects also have long lead times, often five to ten years before they are commercially viable. While talk of increasing renewable power is laudable, it needs to be remembered that renewable energy is dependent on the mining sector as metals are material to energy projects whether at the generation, transmission or storage stage.’

Dr Mattias Lang, Secretary-Treasurer of the IBA Energy, Environment, Natural Resources and Infrastructure Law Section and a partner at Bird & Bird in Germany, explains there are numerous ways in which governments can ease the pressure on soaring energy prices. For example, they might reduce specific taxes, such as those related to fuel. Another option is to provide money through direct payments or tax breaks, with an example being Germany's Energy Cost Reduction Program, which enables companies particularly affected by high energy costs to apply to a special agency for a subsidy towards their natural gas and electricity.

Governments can help energy companies through the granting of state aid in certain circumstances. The EU’s Temporary Crisis Framework, for instance, enables EU Member States to grant limited amounts of aid to compensate for the extra costs arising out of high energy prices.

The effect of high energy prices on a company is material, especially where local laws and/or listing rules compel them to not trade whilst insolvent and not to mislead markets as to the company’s true financial state

John Zadkovich
Partner, Penningtons Manches Cooper

In February the European Commission introduced new Guidelines on State aid for climate, environmental protection and energy to enable EU Member States to more easily provide subsidies for climate and renewable energy projects.

Member States may also grant aid to make good the damage caused by the exceptional occurrences under Article 107(2)(b) of the Treaty on the Functioning of the European Union – provided the aid is directly linked to the exceptional occurrence, is proportionate, and causes no conflict with EU State aid rules.

While some companies may be able to hedge against energy price hikes, Zadkovich says it’s more likely that businesses will simply look to rationalise, including, for example, by passing the costs to customers through price increases.

However, he adds, contractual terms with customers or suppliers may not allow such flexibility and a business will be stuck with the original terms agreed. Moreover, an ill-informed attempt to renegotiate a contract – especially deploying some form of brinksmanship – may constitute a repudiatory breach, he warns.

Depending on the governing law of the contract, parties may have some redress, albeit limited, says Zadkovich. Some civil codes provide that a ‘change of circumstances’ – in essence, an ‘unforeseeable’ event that causes an excessive burden on a party through no fault of their own – enables a party to apply to renegotiate the terms of the contract, apply to a court to renegotiate the terms of the contract, or terminate the contract.

Determining whether the changed circumstances are actually unforeseeable may be difficult to prove, though, especially when volatility in commodity prices, for example, is common.

Other legal options may prove more useful. Parties in the process of acquiring assets that are affected by energy/commodity prices can include in an acquisition agreement a condition precedent to the effect that there has been no material adverse change in the value of the acquisition target, commodities or change of law for the period between executing the acquisition agreement and completion.

Zadkovich says companies in the oil and gas sector may be well-versed in price review clauses, which are common in many modern supply agreements. ‘Given such agreements contemplate 15–20-year terms and prices obviously change during that period, the price review clause contains an agreed formula by which the price of the commodity can be changed by reference to market prices or some other agreed price objective’, he explains.

The trigger for such reviews depends on the contract, but they could be set at milestones, objective events and/or a change in market conditions, adds Zadkovich.

He warns that some companies may ‘deem it is more efficient to breach their contract than comply with it’.

There’s a risk too that executives could be held personally liable for failing to inform the market or regulators about the financial impact energy price rises might have on the business, or if supply is disrupted. ‘The effect of high energy prices on a company is material, especially where local laws and/or listing rules compel them to not trade whilst insolvent and not to mislead markets as to the company’s true financial state’, says Zadkovich.

In a post-Covid world, typical ‘boilerplate’ force majeure clauses no longer provide the level of protection for events once easily classed as unforeseen.

Instead, Zadkovich advises companies to ‘pay careful attention to the terms of their existing contracts and don’t assume their counterparties will simply “get it”’. He adds that companies should ‘study the contract for any ability to review and/or renegotiate terms due to adverse energy related prices’.

Sarah Fitts, Co-Chair of the IBA Power Law Committee and a partner at ArentFox Schiff in New York, says ‘energy supply and pricing has always been a risk for companies that are heavy energy and resource consumers, such as some manufacturers, but it has just become more volatile as a result of Russia’s actions’.

‘The likelihood that energy prices in Europe would substantially increase by autumn has been discussed since before March 2022, so the risk of significant energy price hikes has been foreseeable for at least six months’, adds Fitts. Smart companies, then, will need to plan to become more energy-efficient or find alternative sources of supply.

Fitts explains that due to this foreseeability, contractual force majeure provisions and business interruption insurance policies may be more difficult to invoke, for example, if there are production slowdowns, especially if they were drafted or obtained after the Ukraine conflict began. ‘The precise drafting of the provisions and the facts of the situation will determine whether coverage is actually available’, she says.

Image credit: Paolese/AdobeStock.com

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