Beyond COVID-19: Crisis response or road to recovery?
Crisis response or road to recovery?
The spread of COVID-19 (coronavirus) has caused mass production shutdowns and issues along the supply chain across multiple industry sectors, particularly in China where the virus originated, but wider disruptions are now being experienced as other jurisdictions take steps to contain or delay the spread of the virus.
The impact on the power and renewables sector is likely to be considerable, particularly as the virus spreads globally. For projects under construction, delays in the delivery of key components – which are either in transit or simply not being produced as manufacturing plants are closed – will hamper construction programmes and could increase construction costs as parties look to source parts elsewhere. Renewables projects are particularly vulnerable with China being a significant producer of solar photovoltaic panels and turbines. Contractors reliant on an international workforce will also be impacted as travel restrictions or quarantine measures are imposed and lead to local labour shortages.
For projects which are commissioned, generators may be forced to shut down or reduce capacity where their workforce is subject to quarantine measures and cannot get to site. At the same time, they may also be facing significant reductions in demand in affected areas as the energy requirements of major users (e.g. manufacturing plants) reduce, leading to cash flow issues.
Projects in the procurement phase are particularly vulnerable to the impacts of COVID-19, which is likely to increase prices due to supply shortages, impacting profitability. In addition, the ability of parties to participate in a tender process may be impaired, particularly if contractors cannot get to the site in order to assess the risks properly to bid competitively. We have also seen projects being placed under pressure to use more expensive supplies from markets such as the US or Europe in order to avoid the delays of using Chinese suppliers. However, as the COVID-19 pandemic gains a foothold in more global markets, this argument will become less relevant. Where agreements are as yet unsigned, parties may seek to provide a special regime to deal with COVID-19 within their agreement. For projects with debt finance, lenders are likely to be wary of committing funds unless the implications of COVID-19 can be properly assessed, quantified and mitigated.
With further disruption expected, the knock-on effect will be delays in the progress of construction work and parties risk missing key milestone dates. This may result in project developers facing penalties or, in some cases, losing tax incentives, tariffs or other revenue sources. In the renewables sector in the US, for example, renewable energy developers may lose important tax credits as a result of delays to construction (see our briefing Coronavirus: Effect on US wind and solar projects).
Parties may seek to pass liability for economic losses down to construction contractors. Whether claims will be successful will turn on the provisions of the agreement, including any regime for delay liquidated damages and any applicable exclusion clauses. For further consideration of the implications under construction contracts in the UK, see our briefing: COVID-19 and the UK construction sector: Issues to consider.
Project developers will also need to consider the implications of delays under their funding arrangements, particularly whether these constitute a default or trigger a restriction on utilisations. For further information on the implications under project finance loan agreements, see our briefing COVID-19 and its impact on project finance transactions.
Construction contractors and impacted developers will consider whether they can claim force majeure (FM) as a result of COVID-19-induced disruptions. In English law, there is no general principle of FM and therefore, protection will be limited to that set out in any contractual FM clause. Not all contracts offer the same type of protection: some excuse a party from non-performance, while others offer a mechanism to adjust the commercial terms or even terminate the contract. The generator will need to manage competing claims and will seek to avoid being caught between a claim for FM relief by a contractor, which cannot be claimed by the generator under the offtake arrangements. To achieve this, the definitions and relief must be consistent.
To be successful in claiming FM, the unperformed obligation must be on the critical path of the construction programme. Projects in the early stages of construction or pre-financial close may have to absorb a lot of the float (or contingency) in the programme before being entitled to an extension of time. This increases the construction risk in the execution of the project at the outset. For detailed consideration of force majeure under English law, see our briefing: Force majeure/hardship clauses and frustration in English law contracts amid COVID-19.
For projects located in emerging markets, power purchase agreements may include a concept of political FM which are connected to the government or political risk of the investment country. This is contrasted with other FM, which has arisen from events such as natural disasters. The FM regime and relief available will differ depending on the category of FM which applies. In other liberalised power markets, change in law provisions may apply, which seek to preserve the economic balance of risk and reward under the agreement.
Parties will therefore need to keep the contractual consequences of COVID-19 under review if governments move to legislative actions to contain the outbreak. A generator may find itself in the position of serving multiple notices, in order to ensure that its ability to claim relief and/or compensation is preserved as circumstances change.
Parties will also typically be required to mitigate the consequences of FM. For example in the UK, renewable power generators building out projects under the contract for difference (CFD) regime, are expressly required to use reasonable endeavours to mitigate the effects of the FM event. Developers will also need to mitigate their losses in any damages claimed under English contract law. What constitutes appropriate mitigation will depend on the terms of the agreement and circumstances of the case. Developers may have to source components from other, unaffected suppliers, even where that requires additional expenditure, putting carefully managed budgets with limited contingency to the test.
At all levels of the industry, participants should be taking a proactive approach to discussions and carrying out an urgent review of FM, change in law, material adverse change and other protections in their key contracts. Such measures will be key to maintaining an ongoing commercial relationship into the future.
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