Energy & Infrastructure Alert
The new coronavirus (“COVID-19”) pandemic has now impacted nearly every business across the world, and poses numerous issues for companies and projects in the energy and infrastructure sectors, as well as their investors and lenders. The Orrick team has been tracking these market developments closely, and set forth below is our current analysis of the state of the market on key COVID-19 issues presently impacting energy and infrastructure companies, projects, and transactions, including the following:
In response to COVID-19, many jurisdictions throughout the U.S. have issued stay-in-place/shelter-in-place or similar orders that may have the effect of limiting business operations to those most essential to support public health and safety as well as community well-being (“SIP Orders”). As of April 1, 2020, states that have issued SIP Orders (broadly defined) include: Alabama, Arizona, Alaska, California, Colorado, Connecticut, Delaware, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Ohio, Oregon, Rhode Island, Texas, Vermont, Washington, West Virginia, and Wisconsin. States with various local SIP Orders in place, but no state-wide SIP Order yet enacted, include: Florida, Georgia, Maine, Mississippi, Missouri, Oklahoma, Pennsylvania, South Carolina, Tennessee, Utah, and Wyoming. Washington, D.C., and the San Francisco Bay Area also have SIP Orders in place. Note further that some states with statewide SIP Orders also have SIP Orders in place at one or more local levels, including both the county and city levels (e.g., California and Texas). At this time, no federal SIP Order has been issued.
Most SIP Orders define or describe what are essential businesses and/or essential/critical infrastructure that must or can remain in operation or otherwise move forward during the effectiveness of the relevant SIP Orders to support public health and safety as well as community well-being. Many state and local SIP Orders (but not all) reference the sixteen critical infrastructure sectors defined by the Department of Homeland Security (“CISA”) in defining what is an essential business or what is essential infrastructure for the purposes of the applicable jurisdiction, and in determining who are essential critical infrastructure workers. On March 28, 2020, the Department of Homeland Security issued guidance to aid identification of essential critical infrastructure workers during COVID-19, including key changes to their descriptions applicable to workers in energy, transportation and logistics, public works and infrastructure support services, communications and information technology, critical manufacturing, and other sectors applicable to E&I clients and their businesses.
The standards in effect in jurisdictions that may impact clients are evolving over time. California’s state SIP Order initially referenced the CISA standards only to replace that standard a few days later with similar but not identical language issued by the State Public Health Officer. A key difference, for example, being that the CISA specifically mentions development (“Workers who maintain, ensure, or restore, or are involved in the development, transportation, fuel procurement, expansion, or operation of the generation, transmission, and distribution of electric power...”) and the now effective California standard does not. New York’s state SIP Order, unique when compared to all other jurisdictions in that a short, ten-point quasi-order was followed by an explanatory order (which included in “essential infrastructure” public and private utilities including but not limited to power generation, fuel supply, and transmission; telecommunications and data centers; airports/airlines; commercial shipping vessels/ports and seaports; transportation infrastructure such as bus, rail, for-hire vehicles, and garages), originally stated essential construction may continue and includes roads, bridges, transit facilities, and utilities; however, on March 27, 2020, the governor modified the order to eliminate most construction as an essential business.
As noted above, most SIP Orders define or describe what are essential businesses and/or critical infrastructure that must or can remain in operation or otherwise move forward during the effectiveness of the relevant SIP Orders to support public health and safety as well as community well-being. In many cases, energy and infrastructure companies are treated as essential businesses thereunder and their projects are treated as essential infrastructure thereunder, though the specifics of the applicable SIP Orders must be carefully analyzed. Importantly, this analysis usually requires an evaluation of various SIP Orders because of the overlapping jurisdictions issuing them (both vertically (e.g., at the state, county, and city levels) and horizontally (e.g., across multiple jurisdictions from residences to workplaces or worksites). Moreover, there are instances where SIP Orders, and their application, are not fully aligned.
As of April 1, 2020, most jurisdictions that have issued SIP Orders do not require essential employees of essential businesses and/or essential infrastructure to present “travel papers” to validate their exemption from the SIP Orders. However, this is not universally true of all SIP Orders and it is possible that paperwork requirements may change going forward. If paperwork is being provided, it is advisable to clearly track the SIP Orders applicable to such employee(s) and/or contractor(s) as well as to align with similar notices being provided (if any) across the relevant industry, given the evolving nature of these issues. Additionally, most SIP Orders already require that any exempted individual be instructed to comply with social distancing requirements to the extent feasible; some SIP Orders issued more recently are also requiring that companies adopt and post social distancing protocols within a specified deadline. As a matter of practice, even where not expressly required, a number of energy and infrastructure companies are providing such documentation to their essential employees and/or contractors and/or adopting and posting social distancing protocols, either pre-emptively or due to a request from such employees or counterparties to do so.
With COVID-19 now spread throughout the world, most counterparties to commercial contracts that include schedule guarantees or fixed pricing (e.g., PPAs and other offtake agreements, supply contracts, construction contracts, concession agreements), as well as many other types of project contracts, have either sent (or received) some type of force majeure notice or are in the process of evaluating the necessity for such a notice. Moreover, for all new similar contracts currently under negotiation, many counterparties are including or evaluating the need to address COVID-19 events as a special category of force majeure.Whether COVID-19 or its impacts (e.g., quarantine of personnel, shut-down of facilities, imposition of travel bans, and/or supply chain disruptions) constitute force majeure or may give rise to a claim due to change in laws under any particular contract will depend on the specific terms thereof. Additionally, the doctrines of “commercial impracticability,” “frustration of purpose,” and UCC § 2-615 (excuse by failure of presupposed conditions) may in some instances excuse a party’s nonperformance even in the absence of a force majeure clause.
When a counterparty declares force majeure under an agreement, it is critical to evaluate the basis given for such declaration, any potential legal, commercial, and financial consequences, and if such declaration would trigger any notification or other obligations of the client under any other agreements—one example in the project context might be an obligation to notify the project’s financing partners, or, with respect to public companies, whether disclosure is required under applicable securities laws, etc.
Where force majeure is claimed under a contract, it is critical also to evaluate contract termination risk, as many contracts that have express force majeure provisions also allow the contract to be terminated by one or both parties if the force majeure condition delays performance for longer than a set period of time (e.g., 180 days). Additionally, contracts typically require the parties to mitigate the consequences of force majeure events, so the claiming party may need to consider alternative ways to perform its obligations or mitigate the impacts.
Those sending force majeure notices also must consider whether they are required to provide evidence of the specific circumstances that allegedly prevent performance (e.g., the specific impact of COVID-19, not just a general reference to the pandemic), and periodic updates regarding its efforts to resume performance and/or mitigate the impact of nonperformance; and, the recipient of such a notice should consider whether such items should be requested, if not initially proffered. Where appropriate, the parties should consider negotiating a written amendment to the contract to reflect a commercially sensible resolution. Impacted parties also should carefully review any business insurance coverage and evaluate the necessity of obtaining extended coverage relating to COVID-19.
Assuming the facts fit within the scope of the relevant force majeure clause, the second broad question requires an analysis of if—and if so, how—the contractual provision links the force majeure event with performance. Some contracts require that the force majeure describe the impact that the force majeure event must have on contractual performance. Many contracts state that the force majeure event must render performance illegal or impossible, and in such cases, courts have strictly construed those terms to exclude situations where performance has been rendered merely more expensive or significantly more difficult than originally contemplated. On the other hand, some force majeure clauses excuse performance where the event has rendered it “commercially impractical.” Where a force majeure clause is silent on the issue, parties should be aware of the standard used by the courts in their jurisdiction, because while many require that performance be “impossible” for nonperformance to be excused, that is not the standard in all jurisdictions. There must be a causal connection between the COVID-19 triggering circumstances and the party’s claimed inability to perform. In short, each contract’s terms and the unique facts and circumstances must be analyzed under the applicable law.
Note also that force majeure provisions frequently exclude “payment obligations” from their ambit—at the core, force majeure provisions are generally intended to protect suppliers, sellers, or performers from instances where their performance has been rendered physically impossible or impracticable. Thus, as a general matter, if the seller or supplier determines that it can still satisfy its obligations, a buyer will often be unable to invoke a force majeure provision to excuse its payment obligation and/or otherwise prevent the seller from performing (in turn triggering the buyer’s obligation to pay).
Lastly, since project owners may be on both sides of the force majeure issues, it is important that such parties consider all potential implications of the positions they are taking. A project owner that is part of a chain of agreements may need to declare force majeure in response to a supplier’s declaration in order to avoid being in breach itself. Additionally, if the project owner is negotiating multiple project documents for a project, it is crucial to review the force majeure provisions in the relevant offtake agreement and the relevant construction agreement side by side to ensure that the owner is protected from potential risks (e.g., an EPC contractor declares force majeure, but the project owner client cannot declare force majeure under the PPA, or the PPA offtaker can terminate the PPA, but the project owner client is still on the hook for EPC payments, etc.).
A SIP Order or other COVID-19-related order or law may qualify as a change in law under a relevant commercial contract; as such, the applicable SIP Order could excuse one or both parties’ performance obligations or provide the basis for scheduled relief or compensation claims. However, whether a particular SIP Order or other COVID-19-related order or law would be a change in law depends on how the parties have defined the term “change in law” and the wording of the relevant contractual clauses.
While the specifics of the relevant contract are important, in general, change in law claims may entitle a contractor or equipment supplier to modify the schedule or cost terms of the contract through a change order; while there are likely to be mitigation requirements for change in law claims (such as for force majeure claims), often such entitlements would include any increased costs resulting therefrom, whereas force majeure provisions often contemplate that each party bears its own costs (if not entirely, then at least up to a set limit); as such, contractors may be incentivized to make a change in law claim in order to obtain both cost and schedule relief. Project owners will want to understand the specifics of each applicable SIP Order at the state, county and city level to understand the exemptions that apply to such orders. Some SIP Orders include exemptions for federally critical infrastructure and construction, which may limit a contractor’s ability to claim relief for a change in law.
With more and more counties and states in the U.S. having SIP Orders in place, we expect that energy and infrastructure project owners may receive claims of change in law-related delay/cost increase notices by impacted parties.
Often, contracts permitting change in law relief will have exceptions, such as requiring the change in law result in a “material change,” or result in a “significant adverse impact” or similar language.
Where a change in law relief entitlement exists and an exemption is not applicable, the recipient of a change in law relief request should, before negotiating the delay/cost relief with the requesting party, (i) consider all applicable SIP Orders (noting that more than one may apply simultaneously) and (ii) carefully identify all the work or obligations that the client needs the other party to perform by the time required in the applicable agreement. In the amendment resolving the delay or cost increase due to the change in law, consider including language to deter the other party from claiming another change in law on similar grounds (as the COVID-19 situation is evolving quickly and SIP Orders are being issued and updated on a regular basis)
The parties should also consider cross-contract defaults and obligations, and should examine other related project documents to determine if there are obligations triggered to deliver any notices under other agreements because of the receipt of a change in law notice. It should be considered whether granting certain delay relief would jeopardize any obligations under another project document, or if granting cost relief is financially feasible (e.g., delay relief for an EPC contractor could lead to a delay of the COD date under the relevant PPA).
A SIP Order or other COVID-19-related order or law or the impacts of COVID-19 generally may under certain circumstances qualify as a material adverse change (“MAC”) or a material adverse effect (“MAE”) under relevant acquisition and/or finance documentation, and as such could form the basis for a counterparty to refuse to close or fund a transaction, or declare a contract default or breach. Since the advent of COVID-19, there have been some instances of parties claiming the occurrence of a MAC/MAE in the transactions that have signed pre-COVID-19 but not yet closed; but this does not appear to be commonplace to date.When a party claims that the MAC/MAE clauses are triggered, in addition to how the relevant agreement has been drafted, a court will look at the factual situation, such as the actual impact on the business and the industries of the seller or borrower, as the case may be (materiality, sustainability, duration, etc.) and the geopolitical responses, etc. Historically, courts have been reluctant to find the existence of a MAC in the M&A context. Although there have been very few MAE litigations in the financing context, in those few cases, courts have also been cautious about declaring a MAE. Furthermore, the overriding focus of courts when evaluating claims/allegations that a MAC/MAE has occurred is whether a MAC/MAE has had a “long[-]term and durational” impact on the relevant business. Whether the durational aspect will be satisfied is a highly fact-specific question. Accordingly, the decision to invoke the MAC/MAE should be made after careful consideration of the actual facts and in consultation with litigation counsel. Additionally, before claiming that a MAC/MAE exists due to COVID-19, consider any possibility that the other party could challenge the client’s assertion via any carve-outs to the definition of MAC/MAE. One carve-out that is often seen is if the material adverse effects do not disproportionately adversely affect the target’s (or borrower’s) business relative to other businesses in the same industry, then such effects are excluded from MAC/MAE. Therefore, the analysis may hinge on whether there is any uniqueness in connection with the material adverse effects that impact a particular business (which may not be easy to evidence as the current COVID-19 pandemic likely has an impact in some way on every industry).
For transactions in the negotiation phase, COVID-19 and its impacts are beginning to be addressed directly. For example, if the parties agree as to the importance of the pandemic in the transaction, then COVID-19 should be explicitly referred to in the MAC/MAE clauses (whether to expressly exclude it or to expressly include it), since relying on the general phrasing (even if commonly used in historical practice) in such clauses, may not suffice to ensure the intended treatment. Buyers and financing parties are more likely to want to expressly include the impacts of COVID-19 in the MAC/MAE clauses, which will give them the ability to terminate and walk away from the transaction, decline to fund, etc. On the other side of the table, parties are more likely to want to expressly exclude COVID-19 and its impacts, on the basis that the risk has been broadly publicized and is well known to market participants. A seller/borrower-favorable MAC/MAE definition may try to specifically exclude any occurrence of any “pandemic” or “outbreak.” In recent weeks, a number of publicly filed acquisition agreements have expressly excluded these items, sometimes specifically referencing COVID-19.
As with claims of force majeure and changes in law, a MAC/MAE claim may signal the beginning of a dispute that may ultimately need to be resolved through arbitration or litigation. Therefore, it is important to take all of the usual precautions for a dispute situation, including preserving all relevant records and being careful not to inadvertently make statements or promises that may later form the basis for the other party to claim that the client agreed to waive or forego contractual rights. Where the parties have orally discussed a commercial resolution, be sure to send a written communication to the other party memorializing the discussions and to insist that any amendment to the contract conform to the requirements of the contract’s anti-oral modification clause.
In general, tax equity transactions that were in process in advance of the COVID-19 outbreak have continued to proceed apace. And while there is an expectation of some potential contraction in the tax equity market (as a result of potentially lower overall income levels), it is difficult to assess at the moment. New tax equity transactions have continued to be launched and proceed throughout this period. On the construction and back-leverage front, while we are seeing some increase in margins, many new and existing transactions continue to proceed as before.
In connection with the latest stimulus efforts at the federal level, the solar and wind industry had requested a refundable credit, which would assist in keeping the market liquid in the event tax equity materially contracted. Such was not included in the CARES Act, but the industry remains optimistic there may be relief in a future stimulus bill.
More importantly, developers of wind projects are running into very tight deadlines to complete construction of projects that commenced in 2016; these are required to be completed by the end of 2020 in order to be eligible for production tax credits (under the continuous efforts safe harbor). There was already pressure on this deadline, but COVID-19 has exacerbated the situation even further. In connection with the latest stimulus efforts at the federal level, the wind industry had requested an extension that would allow these projects more time to reach completion, but such extension was not included in the CARES Act; as with the refundable credit request, the industry remains optimistic that this extension will be included in a future stimulus bill.
The impacts of COVID-19 are a developing matter, and the potential impacts thereof, from SIP Orders to stimulus legislation, should be carefully monitored regularly to properly evaluate the feasibility of timelines for current and planned tax equity transactions, and their related projects.
For questions or additional information, please contact Les Sherman or John Donaleski or your Orrick client relationship lawyer. Client alert contributors include Matthew Archer, Spencer Cohen, John Cook, Matthew Gemello, Emin Guseynov, Eli Humphries, Thomas Kidera, Susan Long, Lisa Lupion, Xiaowan Mao, Michael Masri, Bill Molinski, Wolf Pohl, and Kristin Seeger.