With the profitability of companies across the power industry at risk from extreme weather events, weather-related clauses appear in many different types of power-project-related contracts. Often they are an afterthought, not heavily negotiated, and are part of one provision or another that the parties wholly expect will never be triggered. In some instances, however, they are heavily negotiated, integral parts of an agreement, and in crafting the language of such provisions each party to an agreement is working to gain some perceived commercial advantage.
As with most provisions in a power-project contract, the potential risks associated with adverse weather conditions and their impacts are one of many risks to be allocated by and between the contracting parties. Some contracts, such as construction contracts, allocate weather-related risks and other “acts of God” to allow for extensions of time, but typically not money damages; in other contracts, such as merger and acquisition (M&A) or financing agreements, an extreme weather event occurring between signing and closing may provide a buyer, seller, or financing party with an opportunity to terminate a proposed transaction or claim a breach for which damages might be due. Some of these risks can be mitigated through insurance or related products. Nevertheless, the key to settling the allocation of risk is careful contract drafting, thereby reducing the likelihood of future disputes. This article explores the potential impact of extreme or unforeseen weather events on certain types of power-project contracts, the provisions therein, and the parties thereto.
For contractual provisions to be implicated by an extreme weather event, the agreement in question must first define what will constitute an extreme weather event. Most often, impacts of extreme weather events qualify as a force majeure. Consequently, what qualifies for such treatment will typically be found within the definition of force majeure itself.
Exactly what will qualify as “extreme” or “unforeseen” weather events will differ based upon the type of agreement and can be defined using exhaustive lists, carefully tailored limits, or negative inferences. Of course, the details of what would be included in an exhaustive list will vary based on the geographic location of the project or type of power project. For example, it would hardly make sense to include a tsunami as a potential extreme weather event if one were contracting with a construction company to build a wind-power project in Iowa, but for a developer negotiating financing for the construction of a gas-fired combined cycle facility in California, it would be understandable to have a tsunami considered a force majeure event.
The following is an example of a force majeure provision with an “exhaustive list” style definition for extreme weather events or acts of God taken from an Engineering, Procurement, and Construction Agreement for an infrastructure project to be located on the West Coast of the United States:
Force Majeure Event . . . means any act, event or circumstance or any combination of acts, events or circumstances which . . . prevents, hinders or delays the affected Party in its performance of all (or part) of its obligations under this Contract . . . without limiting the generality of the foregoing, a Force Majeure Event may include any of the following . . . an Act of God, including drought, fire, earthquake, tsunami, volcanic eruption, landslide, flood, hurricane, lightning strike, cyclone, tornado, typhoon or other natural disasters . . . any act, event or circumstance of a nature analogous to any of the foregoing.
Carefully tailored limits typically attempt to evaluate and quantify the expected weather for a given region and then define “extreme” or “unforeseen” weather as any event that is outside some measure above or below what is expected.
Quantifying “extreme” or “unforeseen” weather events can be very difficult to accomplish in a way that is meaningful or useful. The official commentary to the 2007 American Institute of Architects (AIA) A201 (which is a general conditions form intended to be used as one of the contract documents forming a construction contract and which sets forth standard terms and conditions to be used as a basis from which to negotiate) suggests looking to historical data accumulated by NOAA for determining what constitutes “normal weather” for a region, but more thought needs to be given to the issue in contract drafting. For example, if a region’s average expected monthly rainfall was eight inches and an agreement provided that it would be a force majeure event if the rainfall in any month exceeded 125 percent of the average expected amount, it would be understandable if a party claimed a force majeure following a two-day weather event that produced 11 inches of rain and flooded a project site, as opposed to a scenario in which 2.6 inches of rain fell in each week of a month (which, despite qualifying as a force majeure, may well not have any practical impact on schedule or cost). Finally, some agreements define a weather related force majeure event by stating that it is anything that is not typical or expected. For example:
Notwithstanding anything to the contrary, the following shall not constitute Force Majeure Events except and to the extent that they result directly from a Force Majeure Event . . . delays resulting from weather conditions that could reasonably be expected to occur in the geographic region in which the Project is located.
In some instances, however, weather clauses are found in a separate, standalone section of an agreement. In contrast to a force majeure provision, which requires some negative impact to have occurred before contract remedies are implicated, when negotiating an agreement with a stand-alone weather clause, parties are cautioned to include language indicating that the weather in question not only must occur but must also cause some negative impact with respect to the power project in question.
Another set of provisions frequently used in power-project contracts, those related to “Prudent Industry Practice,” may be implicated by extreme weather events and should be considered not only at the time an agreement is being negotiated, but also revisited throughout the life of an agreement as well, particularly in those instances where an agreement’s term is longer than a few months, such as off-take, operations, service, and warranty agreements typical of large generation projects. “Prudent Industry Practice” can be defined in using an overarching industry description, such as the following definition taken from an Operations and Maintenance Agreement for a fossil-fuel-fired power plant:
“Prudent Industry Practices” means those practices, methods, techniques, specifications and standards of safety and performance that are commonly used from time to time by electric generation stations as good, safe and prudent engineering and operating practices would dictate in connection with the operation, maintenance, repair and use of electric generating and other equipment, facilities and improvements of such electrical generation stations, with commensurate standards of safety, performance, dependability, efficiency and economy, consistent with applicable law, Governmental Authorizations and applicable Contractual Obligations.
In the alternative, “Prudent Industry Practices” can be defined using more project-specific definitions, such as the following definition taken from an Operations and Maintenance Agreement for a wind farm:
Prudent Wind Power Practices” means those practices, methods, standards and acts (including the practices, methods, standards and acts engaged in or approved by a significant portion of the wind power industry for facilities of the type and size similar to the Project in the United States) that, at a particular time, in the exercise of reasonable care and judgment in light of the facts known at the time that the decision was made, would have been expected to accomplish the desired result in a manner consistent with Applicable Law. One might also see “Prudent Construction Industry Practice,” and “Prudent Engineering Standards” used in different agreement models.
These standards can become important because affirmative covenants in power purchase, construction, financing, and other agreements are often qualified by an obligation to comply with some form of “Prudent Industry Practices.” Where a failure to comply with prudent industry practices leads to breach of contractual obligations, there can be significant repercussions for the breaching party.
Some industries have multiple levels of regulations with respect to weather preparedness and safety, including local, state, and federal government-imposed regulations, manufacturer recommendations, and advisory issuances of industry groups. Determining which of these should be considered within the scope of “prudent industry practice” and which are merely suggestions can be the subject of expensive and protracted dispute resolution following an extreme weather event that has caused some significant negative impact.
In the first week of February 2011, an Arctic cold front descended on the Southwest United States, including parts of Texas, Arizona, and New Mexico, bringing with it temperatures that were, on average, twenty degrees below normal and sustained twenty to thirty mile per hour winds that produced severe wind chill factors. Report on Outages and Curtailments During the Southwest Cold Weather Event of February 1–5, 2011—Causes and Recommendations, August 2011 prepared by the staffs of the Federal Energy Regulatory Commission and the North American Electric Reliability Corporation (FERC/NERC Staff Report). According the FERC/NERC Staff Report, nearly 1.3 million retail electric customers in the Southwest were entirely without service, and a total of 4.4 million retail electric customers were negatively impacted between February 1–5. There were also significant problems with natural gas service in the region. The cold weather resulted in cumulative production declines from the Southwest’s five natural gas basins of nearly 14.8 Bcf. This reduced production aggravated the region’s electric generation issues and resulted in the curtailment of natural gas service to more than 50,000 customers.
This extreme cold weather was not unprecedented in the region. In fact, the Southwest has experienced six similar extreme cold weather events over the past thirty years. In 1989 and again in 2003, these extreme cold weather events led to widespread blackouts and natural gas curtailments. Following the 1989 outages, the Public Utility Commission of Texas (PUCT) issued a number of recommendations intended to improve winterization of generating units, but these recommendations were not mandatory, and many of the generating units that experienced outages in 1989 and 2003 failed again in 2011 (See FERC/NERC Staff Report, p. 10).
On one hand, it is not hard to imagine a party claiming that it was not “prudent” for these generators to ignore the recommendations of the PUCT. But given the widespread electric outages in Texas in February 2011, it is clear that for most generators, not following the PUCT’s winterizing advice would have been among “those practices, methods, techniques, specifications and standards of safety and performance that are commonly used from time to time by electric generation stations as good, safe and prudent engineering and operating practices.”
The FERC/NERC Staff Report made a number of recommendations aimed at avoiding such widespread outages and curtailments in the event of similarly severe cold weather impacting the Southwest again. How these recommendations will impact the profitability or operations of generators and gas companies that undertake to voluntarily comply remains to be seen, but once again these are simply recommendations and do not have the force of law. At some point, however, if industry participants have repeatedly ignored the advice of industry organizations with respect to extreme weather preparedness, and other companies with which they have contracted are injured as a result of a failure to have followed Prudent Industry Practice, it could lead to significant liability.
This liability could arise in the context of M&A, financing, or power or fuel supply transactions. In M&A transactions involving generation assets, there is often a period between signing and closing during which a seller will covenant to “use commercially reasonable efforts to operate and maintain the facility in the ordinary course in accordance with Prudent Industry Practices.” Consider whether or not a potential purchaser would be able to terminate a purchase and sale agreement for an infrastructure asset that suffered significant damage from an extreme weather event where the seller had ignored recommendations that, if followed, could have prevented or mitigated such damages.
In financing transactions involving infrastructure assets, there is typically a covenant that provides that
so long as any obligation of any Loan Party under any Loan Document shall remain unpaid or any Lender shall have any commitment hereunder, the Borrower will . . . maintain, preserve and protect (and, as necessary, repair), all of its properties and equipment that of the [collateral project] in good working order and condition, ordinary wear and tear excepted, and in accordance with Prudent Industry Practices . . .
It is not difficult to imagine a lender taking an aggressive stance if its collateral were damaged in an extreme weather event and the revenues intended to pay the loan in question would not be available for an extended period of time.
Construction contracts typically contain strict milestone deadlines leading to the completion of the project in question and stiff penalties for missing these deadlines without excuse. Construction contracts typically do not excuse all weather-related impacts to the project and the project schedule but instead focus on unforeseeable weather events. Unforeseeable weather delays could result from a single extreme weather event, such as a hurricane or severe blizzard, or could occur from the cumulative impact of a prolonged unexpected weather pattern, such as unusually heavy rains that cause flooding.
When planning construction of a large power project, some measure of weather-related impact is typically expected, most often in the form of a delay, and can, in some circumstances, be priced into the contract. The party bearing the risk of weather-related delays varies from contract to contract depending on the relative negotiating strength of the parties (often based on whether the project developer has a looming deadline for the completion of the project and if financing contingencies or other penalties hinge on completion by a date certain) such that the risk of any such delay can be allocated to one party or the other or split between the parties.
Contracts may require that when adverse weather impacts the contractor’s ability to perform one type of work, the contractor must divert resources to the performance of other work. For example, if high winds prevent the use of cranes, additional manpower could be assigned to perform ground level work. In most instances, this is beneficial, as it keeps a project progressing, but it can also adversely impact the contractor’s performance by requiring out-of-sequence work, out-of-sequence material deliveries, or a loss of project momentum.
In most contracts, adverse weather delays are generally not, by themselves, compensable. Rather, such delays may entitle a contractor to an extension of time, unless the project developer requests that the contractor accelerate its work to avoid anticipated adverse weather (e.g., an impending rainy season or an oncoming winter) or to make up for lost time as a result of weather-related delays, in which case contractors are typically entitled to compensation. However, if a contractor is required to have large equipment such as cranes on the job site (which may result in significant additional costs when delays occur), the contractor will often try negotiating the contracts to allow for compensation for otherwise noncompensable delays.
It is also important to remember, however, that the occurrence of adverse weather by itself may not have any impact on a project. Only where the project’s schedule or cost is adversely impacted by severe weather will weather related clauses be implicated. The official commentary to the 2007 AIA A201 provides an excellent example, stating that four days of unusual rain could render a job site impassable or unworkable for seven days, but if the work in question is being performed inside and no heavy equipment needs to be transported to the site, it may have no impact at all.
Often times, builder’s risk insurance can be purchased to mitigate financial losses resulting from physical loss or damage to property during the course of a construction project. This type of insurance is usually written as an “all risk” basis that covers damage stemming from any cause that has not been expressly excluded. Builder’s risk insurance protects the developer’s insurable interest in any materials, equipment, or other items to be used in the project, which in the context of power projects can easily amount to millions of dollars.
Generally, tolling parties, other off-takers, and construction companies, in an attempt to provide certainty with respect to potential losses, additional potential costs, or both, will want to be as specific as possible when defining the limits of extreme weather and will want almost anything outside of the expected average for a region or project site to be treated as extreme. In contrast, project sponsors and owners generally prefer that construction, off-take, and other such agreements remain silent with respect to what might qualify as “extreme weather,” preferring to wait until such events occur so that they can be analyzed with hindsight and in context of the damages asserted by their counterparties. To the extent owners and sponsors are willing to define such events, they typically attempt to define them in terms of events that are highly unlikely to occur.
If the party being asked to accept weather-related risk can find a relatively inexpensive way to mitigate that risk, it might be in a position to roll the cost into its contract price and either be prepared if there is a weather-related loss or delay or use its willingness to accept these risks as part of a strategy to negotiate a better bargain with respect to some other issue it deems to be of equal or greater importance.
Whether it is determining how to price weather insurance and weather derivatives or how to quantify “severe” or “extreme” weather in an agreement, the parties involved will invariably look to historical data to predict future conditions. How then should past extreme events factor into those considerations? For example, a weather option purchased in 2012 that is keyed to rainfall in the Midwest United States, if based on the previous five- or ten-year average, would have a significantly higher strike point when compared to a similar option that might be purchased in 2013, following this year’s historic drought.
Additionally, and perhaps more significantly, the power industry does not appear to have reached a consensus with respect to climate change and how to factor its potential impact into weather-related clauses. For short- to mid-term contracts, such as an engineering, procurement, and construction agreements, climate change may not be a significant issue, but for longer-term agreements like power purchase, tolling, and other off-take agreements, trying to plan for the unknown and unknowable may be more than parties are willing to undertake, particularly when one party is in a position where climate change might positively impact its position vis-à-vis its counterparty.
Dispute resolution following a severe or extreme weather event that has negatively impacted a party or project is more likely in those circumstances in which a contract failed to adequately define what would constitute an extreme weather event. Sometimes the result hinges on a judge’s or arbitrator’s interpretation of the weather data presented at trial and, not surprisingly, sometimes it is the language of the affected agreement that leads to a determination of damages being due to one party or the other. Three examples of “severe weather litigation,” the courts’ determinations, and rationale are described below.
In Roger Johnson Construction Co. v. Bossier City, 330 So. 2d 338 (La. Ct. App. 1976), Bossier City withheld funds from Roger Johnson Construction Co. (RJC), claiming liquidated damages because a construction project was not completed within the 200-day period agreed to by the parties. RJC brought suit claiming that the delays it experienced were acceptable because the contract excused such delay when due to “unforeseeable cause beyond the control and without the fault or negligence of the contractor, including, but not restricted to acts of God . . . and severe weather.” As the contract contained no definition of severe weather, the court set out to determine the meaning of this phrase with respect to the contract. The court first looked to the local office of the National Weather Service, which used the term “severe weather” to mean thunderstorms or tornadoes, and determined that the parties had meant something more project-specific and that the
usage intended by the parties herein involved implies bad weather which by reason of atmospheric conditions such weather is not reasonably fit or proper to permit the performance of the undertaking contemplated.
Rodger, 330 So. 2d at 340.
Noting that the project site only experienced rain totaling 2.82 inches above average over the eight-month construction period, the court determined that a lack of sufficient personnel and not “severe weather” was the cause of the delays and found that Bossier City was entitled to the liquidated damages it claimed.
In McDevitt & Street Co. v. Marriott Corp., 716 F. Supp. 906 (E.D. VA. 1989), Marriott withheld more than $450,000 from a construction contract based on McDevitt’s inability to complete a hotel within 330 days from a designated date, as provided for in a contract between the parties. Here, the contract in question placed the risk of anticipatable weather conditions on the contractor, indicating that extensions of time shall only be authorized for delays caused by: “adverse weather conditions not reasonably anticipated, or by any other causes beyond the control of the Contractor” and further included a provision that “Contractor shall not allow reasonably foreseeable weather conditions to impede the progress of the Work.” McDevitt, 716 F. Supp. at 913.
The contractor argued that during a thirty-six-day period of January 24–February 28 there had been nineteen days of measurable precipitation, twelve of which involved snow, but that the average in the same period for the twenty years prior was only 11.6 days of measurable precipitation of which only 2.1 involved measurable snowfall. Ultimately, the court accepted the position of Marriott, offered through an expert witness and based on a review of NOAA records, that the weather conditions encountered by McDevitt January 24–March 24 could have been reasonably anticipated, noting that the total level of precipitation during the period in question “was 13% below normal when compared to the previous 5 years, and 29% below normal compared to the past twenty-four year average.” McDevitt, 716 F. Supp. at 912. The court determined that “the central issue therefore, is whether the time delays were the direct result of adverse weather conditions not reasonably anticipated” and in finding for Marriott determined that McDevin had not demonstrated the levels of precipitation for the time period could not have been reasonably anticipated.
The recent case of SNC-Lavalin America, Inc. v. Alliant Techsystems, Inc., No. 7:10CV00540, 2011 U.S. Dist. LEXIS 118312, at *1 (W.D. VA. Oct. 13, 2011), provides a cautionary tale with respect to drafting weather-related contract clauses. In SNC, the parties had entered into an Engineering Procurement and Construction Agreement which provided the contractor with 642 days to complete the work, in the absence of any time extensions. The Contractor did not meet the deadline and filed a lawsuit seeking reimbursement for, among other things
additional costs incurred as a result of “unusually severe winter weather” and acceleration costs incurred as a result of the denial of SNC’s weather-related request for an extension of time.
SNC-Lavalin, 2011 U.S. Dist. LEXIS 118312, at *13.
In this instance the contract included two important provisions, one related to extensions of the 642-day deadline, which provided that change to the “Contract Time” may be permitted if “unusually severe weather” impacts the timely completion of the work, and another related to changes in the “Contract Price” but which was silent with respect to the impacts of weather. The court granted partial summary judgment to the project sponsor, determining that
[b]ecause severe weather is expressly omitted from [the contract price section] . . . the court concludes that [contractor] is barred from recovering the costs that incurred during the period of severe weather, including the costs of additional items that became necessary for [contractor] to perform as a result of the weather and any costs associated with lost productivity during that time.
SNC-Lavalin, 2011 U.S. Dist. LEXIS 118312, at *13.
The court, however, allowed contractor’s breach of contract claim with respect to acceleration costs resulting from the sponsor’s denial of contractor’s weather-related extension request, and following a jury trial, the contractor was awarded $332,800 in damages for acceleration costs, which was far less than it had originally sought.
As illustrated by these three cases, the party taking on the risk of extreme weather and its negative impacts is accepting the potential for greatly increased costs or losses, which will impact the pricing of contracts. To mitigate these risks, contractors or sponsors might look to weather insurance and weather derivatives, as the evolution and proliferation of these products has made them more transparent, more broadly acceptable, and more accessible. In fact, over the past decade, the use of weather insurance and weather derivatives has grown considerably. Historically, weather derivatives were used in connection with low-risk, high-probability events, such as a colder than expected summer or warmer than expected winter, whereas weather insurance policies are customized and typically cover high-risk, low-probability events, such as damages caused by a flood or hurricane. More recently, however, the Chicago Mercantile Exchange has introduced weather derivatives for events such as hurricanes, frost, snow, and rain.
There are, however, no bright-line rules for weather-related provisions in power industry contracts. Therefore, parties negotiating and drafting agreements that may be implicated by adverse weather need to carefully consider the kinds of weather to which the project in question may be vulnerable, the likelihood of such weather, the potential impact of such weather, and if they are in a position to accept those risks, negotiate those risks away, or mitigate them through the use of weather insurance or weather derivatives. Additionally, industry participants should appreciate that there are significant differences in the potential weather-related risks based on the type of contract or power project, the length of the contract, and, with longer-term contracts in particular, the future unpredictability of climate change and its impact on weather. Finally, parties drafting agreements with clauses that can be impacted by extreme weather events are cautioned to carefully draft even seemingly innocuous provisions so that the language throughout the agreement accurately reflects their intentions.