The implications of the energy crisis for in-house lawyers

Neil HodgeThursday 2 December 2021

The crisis in the energy sector has seen some manufacturers temporarily cease production and created significant consequences for many companies’ supply chains. In-House Perspective examines what the crisis means for in-house lawyers dealing with issues such as risk management and competition rules.

Major markets around the globe have had to contend with the energy crises caused – and exacerbated by – the pandemic. This has forced companies to reassess their supply chains, inventories and production schedules, while governments have needed to consider whether they might need to intervene – and, if so, to what extent.

China – itself in the midst of an energy crisis caused by flooding in early autumn 2021 and Covid-related disruption – has doubled its imports of liquified natural gas to compensate for the lack of domestic coal production. It has also rationed electricity in some areas, threatening manufacturing production in the process.

India is also rationing consumers’ power supply. In October it was reported that more than half of India’s 135 coal-fired power plants, which supply about 70 per cent of the country’s electricity, were in danger of running out of fuel.

Europe, too, is feeling the strain of demand outstripping supply. Global coal shortages in Germany forced the temporary closure of a power plant at the beginning of October, while Russia has cut the amount of gas it’s supplying to the EU, further threatening German manufacturing production.

Simultaneously, Middle Eastern markets such as Qatar have switched their supplies away from Europe to East Asian countries because they are prepared to pay more.

Consequences for companies

At the beginning of October, European chemical and steel companies warned that soaring gas prices threatened the region’s economy, hitting products such as fertiliser, paper and plastics in particular. Although most large companies had long-term supply contracts in place, executives warned that a sustained increase in energy prices would lead to higher manufacturing costs.

Petr Cingr, Chief Executive of SKW Stickstoffwerke Piesteritz, Germany’s biggest ammonia producer, said bleakly that ‘it no longer makes economic sense to produce at these levels’ after the company was forced, in late October, to reduce output by one-fifth to offset rising prices.

In September, Austrian chemicals group Borealis and Norway’s Yara International also reduced production of ammonia. In Italy, Giovanni Arvedi, Founder and President of steelmaker Arvedi Group, said rising energy costs ‘makes it even more urgent to standardise prices to achieve a freer and a more competitive market’.

While some regions – such as North and Latin America – have so far avoided any energy or fuel crises on their own doorsteps, they’re not immune to the problems. US and LatAm companies depend on China and India for everything from cheap apparel to semiconductors, and also rely heavily on European supply chains to source parts and European customers to sell their products to. As such, the problems having an impact elsewhere will test their supply chains too – and their financial viability if such economic disruption continues.

Navigating competition in a crisis

EU Member States have been discussing whether the bloc should make moves to suspend the enforcement of competition law while the energy crisis lingers on. There has been precedent. Early on during the Covid-19 pandemic, competition rules were relaxed to allow the continued movement of foodstuffs, healthcare products and medicines.

So far, however, the European Commission has resisted making such a move in respect of the energy sector. But it has allowed states – rather than companies – to work together and combine their collective muscle to improve energy purchasing to protect consumers and businesses. Other measures deployed include reducing tax and encouraging the adoption of renewable power purchase agreements.

The UK has exercised the kind of flexibility some EU Member States would favour. In September a petrol shortage – caused by a lack of tankers to transport the fuel rather than a lack of supply – forced the UK government to announce plans for a temporary visa scheme to allow 5,000 heavy goods vehicle drivers to come to Britain to alleviate the crisis. It also relaxed competition rules among petrol companies, in order to secure enough fuel supplies.

The government was also forced to suspend competition law to enable carbon dioxide producers to continue operating after a drop in production – caused when rising energy prices forced plants to close down – threatened fresh food deliveries. In September it provided financial support to one of the sector’s largest players – CF Fertilisers, which supplies around 60 per cent of the UK’s CO2 – after the rise in wholesale gas prices forced the company to halt its operations temporarily. The ‘limited’ financial assistance could cost the UK taxpayer tens of millions of pounds, George Eustice, the UK’s Secretary of State for Environment, Food and Rural Affairs, conceded.

While the EU and UK have the powers to override competition rules, companies and their in-house counsel should perhaps not bank on governments taking such steps quickly. ‘While such derogations from existing competition law are not new, they are rare,’ says Alexandra von Westernhagen, an EU and competition partner at UK firm Keystone Law. She adds that such measures are used only to ‘temporarily suspend’ the application of competition law to a specific industry sector to enable it to cooperate or share information with competitors to sustain supply.

Kyriakos Fountoukakos, Vice-Chair of the IBA Antitrust Section and EMEA Regional Head of Practice for Competition, Regulation and Trade at Herbert Smith Freehills in Brussels, advises companies and in-house lawyers to ‘always think carefully about the detail of any government agreement or guidance to relax competition rules’.

‘Any suspension of competition rules by an antitrust regulator typically specifies that the suspension is limited to a particular time period and a particular set of circumstances, as well as to those activities where cooperation with competitors is absolutely necessary,’ he says.

‘A suspension of the rules does not signify a relaxing of competition rules generally, nor a relaxation in enforcement and monitoring,’ he adds. ‘It is certainly not an invitation for companies to think that all aspects of competition law have been suspended.’

“A suspension of the rules does not signify a relaxing of competition rules generally, nor a relaxation in enforcement and monitoring

Kyriakos Fountoukakos, Vice-Chair, IBA Antitrust Section

To ensure strict compliance, Fountoukakos says companies and their legal functions should check that the scope of the agreement, and the arrangements they put in place with competitors, only last for the period of the crisis. He adds that ‘companies need to check the boundaries’. In some instances, he says, self-assessment will be sufficient but in other circumstances companies may decide to raise questions with the regulator if unsure of any aspect of the government’s agreement or regulator’s announcement.

Urging companies to ‘keep an open dialogue with the regulator,’ Fountoukakos notes that the European Commission is now issuing more guidance on these kinds of issues than ever before. ‘If possible, apply for a “comfort letter” or an exemption decision to gain increased assurance from the regulator as to what practices may be allowable under these exceptional circumstances, and for how long,’ he says.

He suggests that in-house lawyers seek local advice about how regulators in particular countries will react against companies that break the rules, and how receptive they are to offering advice and guidance.

Fountoukakos says that if a company doesn’t get an exemption decision, there’s a possibility the regulator can take action against it. Companies should also be wary of misinterpreting the perimeters of what an antitrust regulator has made allowable for the purposes of satisfying an immediate requirement to deliver certain goods and services.

‘Just because a regulator says sharing sensitive information or cooperating with competitors is justifiable under current circumstances does not mean that other actions not specifically included in any notice or agreement are also permissible,’ says Fountoukakos. ‘Unless they are specifically excluded, assume they still matter.’

He adds that before proceeding with any joint effort with a competitor, companies should identify a ‘legitimate objective’ for the collaboration, and then ensure the activities they’re collaborating on are strictly limited to achieving delivery of those aims. This includes limiting the activities by scope, geography or duration to what’s necessary. ‘Use the principle of “what is the minimum we need to do differently from what we already do to carry out the service under these circumstances”’, says Fountoukakos.

Sylvie Gallage-Alwis, a partner at law firm Signature Litigation in Paris, highlights that while the measures put in place by the EU during the early days of the pandemic were meant to help companies, they also created risks as lockdowns eased, she says, ‘because each national regulator had a different definition of what the end of the pandemic means and when it occurred’.

As a result, ‘it is very important for companies to draft and enter into specific contracts for a limited period. It is also important to ensure that the contract is clear in terms of not allowing one of the companies to create undue stocks of product during the period of lack of enforcement,’ she says.

Gallage-Alwis adds that companies should also retain documents. ‘Contracts and paper trails will be key to protect companies against allegations that they have tried to unduly benefit during a period when competition law was suspended,’ she says.

Dangers on the horizon

Besides the regulatory enforcement of competition rules, there may be other legal threats. In countries where collective redress is more common – the US being a prime example –companies could face class actions from both consumers, as well as from other companies affected by supply disruption, for failure to deliver goods and services as per their contractual obligations.

Better disclosure in annual reports around supply chain risks and disruption is already being encouraged by regulators like the US Securities and Exchange Commission and the UK’s Financial Reporting Council. Companies that downplay, obfuscate, or simply fail to report the level or impact of supply chain risks could risk investor anger and legal action.

The possibility of class actions also exists in Europe, but is perhaps somewhat less likely to gain traction. While consumers could file a claim for breach of contract and/or denial of service in case of a supply chain issue, they’d need to demonstrate a specific damage that’s sufficiently significant to justify court proceedings – and, more specifically, the associated costs.

Claimants would also have to show that they had no alternative choice, for example due to costs or time restraints. ‘If one takes the fuel crisis as an example, a car driver would have to demonstrate that they had no alternative than their car to go to work, or that remote working was not possible,’ says Gallage-Alwis. In the same vein, in the case of a homeowner whose house is set to be renovated but where work is delayed due to key materials not being supplied, the homeowner would need to demonstrate that, as a result, they had to vacate the property for longer. In this case, the homeowner might ask for hotel costs to be covered.

‘My view is therefore that the chance that mass consumer litigation is launched for supply chain issues remains remote as compared to the chance of litigation within the companies of the supply chain,’ says Gallage-Alwis.

“The chance that mass consumer litigation is launched for supply chain issues remains remote as compared to the chance of litigation within the companies of the supply chain

Sylvie Gallage-Alwis, Partner, Signature Litigation

The failure to deliver on time in a supply chain arrangement may give rise to a breach of contract, and depending on the contract’s terms, this may give the customer, wherever they are in the supply chain, the right not to pay or at least to delay payment. A domino effect could follow: the supplier who has not been paid will have an immediate cash-flow insolvency crisis which, depending on their circumstances, could be temporary or even terminal.

If the short-term cash flow crisis becomes longer-term, the supplier will then be unable to pay its own liabilities and become cash-flow insolvent. The failure to pay its own bills could lead to services or supplies being withdrawn or suspended, causing huge disruption to its business. This in turn could trigger the supplier’s financial demise and have a knock-on effect on others in the supply chain, resulting in wider financial collapse.

‘The “just-in-time” nature of our supply chains means that a fuel crisis has an immediate impact on those in the chain because they hold very little stock, and so therefore unable to mitigate any temporary delays,’ says Cory Bebb, a partner and licensed insolvency practitioner at UK firm Keystone Law. ‘Whilst just-in-time supply chains save waste and costs, they also leave companies financially exposed when they break down.’

“Whilst just-in-time supply chains save waste and costs, they also leave companies financially exposed when they break down

Cory Bebb, Partner, Keystone Law

Towards better risk management

Some lawyers, however, are not convinced that any disruption caused by the ongoing fuel and energy shortages – and even the pandemic – will result in a sharp spike in lawsuits. Instead, companies will need to improve their risk management practices, rather than look for legal redress.

‘Companies need to tackle supply chain disruption caused by events like the energy and fuel crises as just another risk. These kinds of events are nothing new, though the scale of the problem may be larger than before,’ says Shane Freitag, Chair of the IBA Energy, Environment, Natural Resources and Infrastructure Law Section and National Leader in the Electricity Markets practice at Borden Ladner Gervais, based in Toronto. ‘The same issues that have come to light as a result of the Covid pandemic or the fuel and energy crises have occurred in the past and companies simply need to plan for that,’ he adds.

“The same issues that have come to light as a result of the Covid pandemic or the fuel and energy crises have occurred in the past and companies simply need to plan for that

Shane Freitag, Chair, IBA Energy, Environment, Natural Resources and Infrastructure Law Section

Trying to enforce contracts – however comprehensive and tightly-written – will probably not afford much protection either and will likely be impractical, he adds. ‘Contracts – even if written well – just mean that you are going to get some compensation for a lack of supply but they don’t deal with the immediate problems that companies need to contend with in the meantime, which is replacing that supply at likely a higher cost.’

‘Acting on contractual rights only sends you down a long process,’ adds Freitag. ‘At the end of the day any attempt to recoup money from a supplier might work but it can take a lot of time to resolve.’

He says that pursuing an insurance claim is the same: the costs associated with loss of goods or services might be covered under a policy but it can take a long time to sort out. ‘In the meantime, companies still need to source supply from other suppliers and often draw on working capital to fund these additional expenditures,’ says Freitag.

He believes companies will simply have to accept a certain amount of risk even if they have a contract. Many companies have already reached the same conclusion, with some improving their ‘hedging’ arrangements, organising planned production pauses, passing costs on and even moving parts of production elsewhere where energy costs are lower.

‘Companies will have to go beyond and look at their supply chains and check how they are managed and how resilient they are,’ says Freitag. ‘For example, is the company reliant on one or two key suppliers? Should the company have more inventory to tide it over if the supply chain falters? Making these kinds of checks may take up a significant amount of time but it will provide more assurance in the long-run as contracts are only as good as the supply chain of the companies you are dealing with.’

Gallage-Alwis agrees that ‘there is unfortunately not much that can be done that is effective when there is a supply chain failure and a need to be supplied quickly’. The best solution, she says, is to identify and enter into a contract with another supplier. Following that, a company can ‘request’ compensation for any increase in price that it pays as a result of finding alternative goods/services, as well as for the additional costs of identifying and validating a new supplier. However, such a request could be ignored and may be difficult to enforce, she says.

The energy crisis has highlighted that the global demand for power outstrips the current levels of energy generated from renewables. As such, there is a serious question mark over when gas and fuel prices might stop escalating, plateau and decrease. The impact on many industrial sectors around the world is already evident. Governments may step in and provide temporary relief – either through a relaxation and/or suspension of competition rules, or through other measures such as energy price caps – but smart companies should perhaps not bank on such interventions. Enforcing contracts and ‘flexing muscle’ may help companies in some circumstances, but better risk management is also key.