The Sierra Club accuses utilities of trying to snuff out rooftop solar. Attorney Donald Sipe recommends RTO/ISO markets for natural gas.
The unclear language governing termination rights is subject to interpretation and extraordinary financial risk.
How does one determine the value of power contracts under early termination? Given the vagaries of the contracts themselves, the process is neither clear nor standard, and often results in protracted and costly litigation. In a previous article, we had assumed that termination already had occurred (“Mastering the Mastering Agreement ,” May 2005) . But there is an even more basic question: Did the counterparty have the right to terminate in the first place?
Several recent cases have highlighted that termination can be a tricky business and is definitely not as straight forward as it would seem. The cases in-volve not just the valuation of the terminated portfolio but the legality of the terminations themselves. Although the exact details of each case are different, they do share at least one thing in common: the circumstances of each firm prior to termination and the assurances offered factored into the litigations and were central to the disputes. Given the relevant contractual language, this is to be expected.
Whether the applicable contract is the Western Systems Power Pool Agreement (WSPPA), Master Power Purchase and Sale Agreement (MPPSA) or ISDA (International Swaps and Derivatives Association) Agreement, the language governing termination rights is often unclear and subject to interpretation, and relies heavily on the tenets of “good faith,” “discretion,” and “commercially reasonable” behavior.
Although the right to terminate following events such as a failure to pay is often well defined, what is less clear is the right to terminate due to concerns regarding a counterparty’s potential failure to pay. Conventionally, concerns regarding counterparty performance have been addressed by using various forms of adequate assurance. However, the success of adequate assurance as a credit risk-management tool is based upon two prerequisites:
a) Clear contractual definitions governing: a. request of adequate assurance; b. ï»¿provision and form of adequate assurance; and c. acceptance of adequate assurance.
b) Both parties being committed to ensuring contract performance to expiration and standing ready and willing to do so.
Without a clear definition of suitable adequate assurance and rules governing its request and acceptance, any counterparties not committed to contract performance will attempt to game the system, resulting in adequate assurance becoming more a tool of termination as opposed to its conventional use as a tool of performance. Let’s examine each contract and see how complicated this can get.
WSPPA: Leaves Much to Interpretation
The provisions in the WSPPA provide guidance regarding the use of adequate assurance to manage counterparty default risk. Sections 22.1 and 22.2 deal with events of default and remedies for events of default, respectively. Section 27 on “creditworthiness” describes the conditions under which a dissatisfied party (“first party”) may require additional security from their counterparty (“second party”) to protect against a potential default event and what forms that security can take. The WSPPA lists 5 well-defined reasons for requesting additional adequate assurances: