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Texas Supreme Court Holds that Wind Energy Generators Owe Damages for Failure to Meet Minimum Generation Requirements Due to Curtailment, but Amount of Damages is Unclear

April 2, 2014

 

The Texas Supreme Court recently issued a decision that partially resolves a case involving damages alleged to have been suffered a decade ago by the purchaser under three contracts for sales of electric energy and associated renewable energy credits from wind farms located in West Texas. On March 21, 2014, the Texas Supreme Court held that the wind farms owe damages to the purchaser as a result of their unexcused failure to deliver guaranteed minimum amounts of production required under the contracts. But the Court remanded the case for further consideration of the amount of the damages owed because the Court found that the liquidated damages provisions in the contracts were unenforceable as a penalty.[1]

The case involves the right of Luminant Energy Company, L.L.C. (“Luminant”), as the purchaser under the three wind energy power purchase agreements (“PPAs”), to collect liquidated damages from three wind farms owned by NextEra Energy Resources, LLC (“NextEra”). The liquidated damages arose as a result of the wind farms’ failure to meet their minimum annual generation requirements under the PPAs. The wind farms’ failure, in turn, arose, in part, from curtailments ordered by the Electric Reliability Council of Texas (“ERCOT”) during 2002 to 2006 at times when there was insufficient capacity on the electric transmission network to accommodate energy that could have been generated by the wind farms. One lesson drawn from the case is the importance for wind energy generators to ensure that there is adequate and timely transmission capacity to handle their production, since curtailments resulting from inadequate transmission capacity can not only reduce the revenues received by the generators but can also expose the generators to damages for failure to meet minimum generation requirements. The case also shows the importance of including contractual provisions that clearly allocate among the parties the risk of curtailment and that provide for liquidated damages that represent reasonable estimates of actual damages.

Background

Three wind farms (FPL Energy Pecos Wind I, L.P., FPL Energy Pecos Wind II, L.P., and Indian Mesa Wind Farm, L.P., all of which are now affiliates of NextEra) entered into PPAs in 2000 with TXU Electric Company, which subsequently assigned them to Luminant’s predecessor, TXU Portfolio Management Company, L.P. For various reasons, including ERCOT-ordered curtailments, the wind farms failed to generate and deliver sufficient energy and associated renewable energy credits (“RECs”) to meet their annual minimum generation requirements under the PPAs in the 2002 to 2006 time period. Luminant sued the wind farms for breach of contract and sought recovery of liquidated damages under the PPAs. The wind farms counterclaimed, arguing that Luminant breached its obligation under the PPAs to ensure that there was sufficient transmission capacity to allow the wind farms to generate and deliver as much energy as the facilities could produce based on the amount of available wind.

Following a trial in 2007, the district court found that neither party owed damages to the other.[2] In 2010, the Court of Appeals upheld the district court’s finding that no damages were due to the wind farms but, reversing the district court, held that the wind farms owed damages to Luminant.[3] In particular, the Court of Appeals rejected the wind farms’ argument that Luminant breached its obligation to provide for transmission of energy from the wind farms beyond the delivery point by failing to ensure that there was adequate transmission capacity. The Court of Appeals also rejected the wind farms’ argument that the liquidated-damages requirements were unenforceable penalty provisions.

The Supreme Court upheld the Court of Appeals on the parties’ obligations under the PPAs, holding that Luminant had an obligation to provide transmission only after delivery of energy to the transmission grid. The problem, here, however, was that the wind farms were prevented by the ERCOT curtailment orders from generating and delivering energy to the transmission grid. The Supreme Court held that the obligation to deliver energy to the transmission grid at the delivery point, including making all interconnection arrangements so that energy could reach the delivery point, was an obligation of the wind farms. Moreover, even though the lack of adequate transmission capacity, which led to the ERCOT curtailment orders, was considered under the PPAs to be an uncontrollable force, the PPAs specified that the wind farms’ obligation to deliver the annual guaranteed amounts of production was not excused by uncontrollable force. Accordingly, the Supreme Court held that the wind farms were obligated to meet the annual production guarantee amounts or to pay liquidated damages, notwithstanding the uncontrollable force caused by the ERCOT curtailment instructions.

The PPAs specified that the liquidated damages for the wind farms’ failure to meet the guaranteed annual production amounts were based on deficiency payments, as set forth in the regulations of the Public Utility Commission of Texas, that utilities are required to pay in the event that they fail to generate or otherwise acquire required amounts of RECs. The Supreme Court held that these liquidated damage provisions were intended to compensate Luminant for its losses associated with not receiving the guaranteed amount of RECs, and that Luminant could seek common law remedies for the wind farms’ failure to deliver the required amounts of energy. But the Supreme Court found that Luminant likely did not have an obligation to make any deficiency payments in connection with a REC shortfall and, therefore, that the liquidated damage calculations did not represent a reasonable estimate of Luminant’s actual damages for failure to receive the guaranteed annual amount of RECs. This rendered the liquidated damages provisions to be unenforceable as a penalty. Accordingly, the Supreme Court reversed the Court of Appeals on the liquidated damages provision and remanded the case to the Court of Appeals to determine the damages due.

Implications

This case highlights the risks that wind energy developers face when significant transmission system upgrades are needed before the transmission grid can accommodate the full generation from their facilities. Curtailments resulting from inadequate transmission capacity can cause these developers to not only suffer reduced revenues due to an inability to generate and deliver energy and RECs (and the loss of related production tax credits) but also to pay liquidated damages to their purchasers if they are unable to meet their annual minimum generation requirements.

The results in this case depended very much on the language of the particular PPAs, so it is important for wind energy developers and their investors to look carefully at the PPAs to ensure that they clearly and appropriately allocate the risk of congestion between the wind farms and their off-takers. Had the wind farms in this case been able to obtain stronger protections in their contracts, the result might have been more favorable to the wind farms. That may not have been an option for them under the circumstances, however, given the relative negotiating power of the parties. It also is critical for the off-takers to ensure that the liquidated damage calculations in their PPAs reasonably approximate actual damages that the off-takers will suffer for non-performance by the wind farms; otherwise they risk a finding that the provisions are not enforceable.

The case also emphasizes how important it is for wind farms to ensure through the interconnection process that the transmission system will be sufficiently robust to receive most of the generation the wind farms are capable of producing so that they will not be subject to frequent curtailment orders. It appears that the wind farms in this case had arranged for sufficient transmission capacity to be constructed eventually but that delays in completion of the transmission upgrades, and urgency to begin production in order to qualify for production tax credits, caused the temporary insufficiency in transmission capacity.

The transmission situation in much of Texas has changed for the better since these wind farms were built, particularly with the construction of Competitive Renewable Energy Zone (“CREZ”) projects to deliver wind energy from West Texas and the Panhandle area to areas of the state with high demand for electric energy. But with many wind farms being constructed to interconnect to CREZ, it is still necessary to consider the possibility of congestion and to obtain credible studies from wind consultants forecasting the potential for congestion and curtailment orders in the future. These forecasts should take into account other projects planned that will be using the same transmission lines, as well as plans for expanding the capacity of those transmission lines. Such studies can enable the wind farms, and their investors, to quantify these risks and to carefully review how these risks are allocated among the various parties to the transaction under the PPA and other contracts when evaluating these deals.

[1] FPL Energy, LLC v. TXU Portfolio Mgmt. Co., 57 Tex. Sup. Ct. J. 325 (Tex. 2013) (the case was issued in 2014 but was mistakenly dated 2013).
[2] TXU Portfolio Mgmt. Co. v. FPL Energy Pecos Wind I, LP, No. 04-10314-F (116th Jud. Dist. Ct. Tex. Aug. 27, 2008) (final judgment).
[2] TXU Portfolio Mgmt. Co. v. FPL Energy, LLC, 328 S.W.3d 580 (Tex. App. Dallas 2010).

For more information, please contact Hugh E. Hilliard at +1 202 383 5109 or hhilliard@omm.com; or Junaid Chida at +1 212 326 2031 or jchida@omm.com.



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