Post - Blog
Energy contracts: Come Hell or High Water - or come Covid-19
- 4 years ago (2020-06-13)
- Junior Isles
By Julia Kalinina Belcher, Deborah Ruff and Charles H. Golsong of Pillsbury Winthrop Shaw Pittman LLP
EP Shanghai 2024
As the spectre of COVID-19 remains worldwide, endangering the public’s health and bringing unprecedented business interruption, energy professionals should review their existing contracts to evaluate their obligations and actively consider the impact that the COVID-19 pandemic may have on existing and future negotiations of energy contracts, including the use of “hell or high water” clauses.
So-called “hell or high water” (“HOHW”) clauses, aptly named after the common expression used to assure that something will be done despite seemingly insurmountable difficulties—i.e., it must be done “come hell or high water”—typically provide that the party’s obligation to perform under the contract is absolute and unconditional and that the costs of any interruption must be borne by the party obligated to perform.
HOHW provisions are most often used in equipment leases or charters (such as aircraft leases and marine vessel charters), as well as project finance and merger and acquisition agreements. For instance, a HOHW clause may require a lessee of an aircraft to pay for the rentals “come hell or high water” (and yes, some HOHW clauses actually use that phrase). HOHW clauses also have a role to play in the energy sector.
In energy contracts, the HOHW clause would mandate a party’s obligation to perform regardless of the difficulties, thereby shifting the loss to the contractual counterpart, much in the same way as “take or pay” contracts provide an unconditional obligation on the offtaker to pay for a product even if not taking delivery.
In the wake of this pandemic and unprecedented monetary losses, and the likely absence of insurance cover, rather than relying on the traditional force majeure and change of circumstances clauses to allocate risks, parties to energy contracts (whether upstream, midstream or downstream) may find their counterparts seeking to negotiate new provisions to allocate risks. While the strength of their bargaining position will certainly play a role, even parties with lesser bargaining power should consider the options available to them to mitigate the risks associated with pandemics and other extraordinary situations that result in undue economic hardships.
Those seeking to include a HOHW clause in their contract should take heed of the clause’s limitations. Your clause should be well drafted and “watertight”, as one US court cautioned. (1)
Others may seek to bolster “take or pay” obligations by supplementing them with a HOHW provision, for example by disapplying contractual provisions which mitigate those obligations – such as the option for the offtaker under the contract to vary the amounts of electricity to be supplied during a particular period or elect the port at which delivery of gas or oil should take place – and/or by including wording to the effect that force majeure events will not entitle the offtaker temporarily to suspend payment for any goods or services not taken.
Government orders restricting physical activity, such as the “shelter-in-place” orders that remain in effect in many countries, states, and localities, could cause complication, as courts in both the UK and the US may decline to enforce HOHW provisions that are against public policy, such as those that would require one to violate the law or that interfere with public welfare or safety. Indeed, courts would likely be reluctant to compel activities where they would violate a “lockdown” order or other similar government directive.
Further, courts in the UK and the US may also decline to enforce a HOHW clause where agreement to the provision was based on fraudulent inducement or fraudulent misrepresentation. Courts also recognise unconscionability as a defence, although for most parties to energy contracts, this defence likely would not apply in jurisdictions where there is a presumption that unconscionability does not apply to contracts between sophisticated business entities.
It also remains to be seen whether the common law doctrine of frustration could be relied on to displace HOHW provisions, both in the energy sector and beyond. It remains to be seen how arguments as to frustration in light of the COVID-19 pandemic will be determined by the courts, as much will turn on the length of the impossibility of performance versus the length of the contractual term. ( 2)
To be sure, any well-advised party will likely resist the inclusion of HOHW clauses or at least seek to water them down so as to excuse performance—for example, on the occurrence of certain force majeure events (including epidemics or pandemics) or where government policy or laws render performance difficult or impossible (such as when a lockdown is imposed).
Parties seeking to negotiate or enforce HOHW clauses should proceed with caution and carefully consider their anticipated context. Although the current uncertain climate is less than ideal for negotiating a contract, some parties will inevitably start to look back at the drafting table and hope to get terms drawn up, ready to hit the ground running when measures are lifted. Energy professionals should be ready – come hell or high water – for how negotiations have changed in response to this pandemic.
Footnote
1. See Blue Ridge Bank, Inc. v. City of Fairmont , 240 W. Va. 123, 129–30 (2017) (Doctrinally, “[t]he hell or high water clause is not . . . watertight”).
2. See the Hong Kong case of Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754 which arose out of the SARS epidemic, and in which the Hong Kong District Court held that a 10-day isolation order did not frustrate a two-year property lease.