Special Series Part 5: How to find "commercially reasonable" valuation in power contract terminations.
Contract termination should be easy. Consult the applicable master agreement, calculate the close-out amount, and send or receive a check. If only it were so. The well-publicized demise of key players in the energy industry has led to many counterparties failing to perform on their contractual obligations.
In the course of calculating settlement amounts, it has become apparent that many sections of the governing agreements, particularly those sections dealing with termination and settlement calculation, are maddeningly vague and unclear. Disputes and litigation have resulted, with many cases yet to be resolved.
Whereas the contractual language that defines an "event of default" is often clear (although even this seemingly straightforward topic can be subject to interpretation and dispute), the guidelines regarding the calculation of a "settlement amount" following an event of default often are not. The language within the majority of master agreements used in electricity trading remains murky and open to interpretation. Phrases such as "commercially reasonable valuation" or "settlement amount must be determined in good faith" are commonplace in electricity trading master agreements but are not clearly defined. In the absence of clear guidelines or standard industry practice, the settlement process often turns out to be litigious, protracted, and costly.