Can Governments Rip Up Power Purchase Agreements? Only at a Steep Price

"You make up your mind, you choose the chance you take ... Now you can't walk away from the price you pay." - Bruce Springsteen

Bruce probably was not thinking about power purchase agreements when he wrote his hit ballad. But the themes of choices and consequences are relevant to recent events in the Canadian electricity sector.

Contracts between power generators and central agencies have come under attack in Alberta and Ontario, and potential investors in the power sector are watching closely. After all, a so-called "power purchase agreement" is the instrument that provides certainty that someone will purchase the electricity that a generator produces over, let's say, a 20-year period. That certainty allows the generator to finance the development of the power plant, wind farm or solar facility.

Potential investors in places like Russia, China and Venezuela know that when they enter into contracts with the government or related agencies, they need to price in significant political risk. Those countries ranked, respectively, 81^st, 94^th and 138^th (out of 144 countries) in Forbes 2015 rankings of Best Countries for Business. Canada ranked 7^th. Important criteria included rule of law, property rights and contract enforcement. In other words, part of the reason Canada is highly-ranked is because of contract certainty.

Lawrence Solomon, Executive Director of Energy Probe, recently argued in the National Post that the Ontario government should address the high cost of hydro by "ripping up" renewable energy contracts ("Yes, Ontario's Liberals can cancel their terrible renewable power contracts-and they should do it now", September 15). This would be done by adopting legislation to declare those contracts null and void.

In Alberta, the provincial NDP government has brought an action to prevent certain utilities and generators (Transcanada, Enmax and AltaGas) from exercising their rights under power purchase agreements signed by a previous Conservative government. The contracts allowed the generators to terminate them in certain circumstances. The utilities signalled their intention to terminate the agreements after the province introduced cap and trade legislation that would have increased costs of coal generation. In effect, the province is arguing that, despite what the contract says, the generators should bear the risk of those increased costs. It is worth noting that when the contracts were executed (and approved by the regulator), Alberta faced an acute shortage of generation and blackouts were a real possibility.

The NDP says that the clause allowing the generators to terminate the contracts was inserted "at the last minute" and was sought by companies like Enron. Even a first-year contract law student would recognize these arguments as highly suspect. In fact, they are not really legal arguments at all. The government decision has the potential to worsen the uncertain business climate in Alberta.

In the case of Ontario's contracts, Mr. Solomon cites the case of Trillium Power Wind Corp., who sued the provincial government when they said they were prevented from proceeding with an offshore wind project. This case is used to support his argument that the government can terminate the contracts with impunity. The court held that it was "plain and obvious" and "beyond all reasonable doubt" that Trillium could not succeed in arguing breach of contract. The court continued:

Proponents who choose to participate in discretionary government programs, such as Ontario's renewable energy program, do so primarily at their own risk. Governments may alter the policies that underlie a program, and may even alter or cancel such programs, in a manner that may be fully lawful and immune from civil suit.

Sounds like the court is saying that the government has the right to terminate power purchase agreements, right? Only one problem: the Trillium case wasn't about a power purchase agreement and actually stands for the exact opposite of what Mr. Solomon is arguing. Trillium had merely applied for a power purchase agreement when the government postponed the offshore wind component of the program. What the court was actually saying was that Trillium's rights only would have vested once they entered into a contract, not before. The government was free to stop the project precisely because a contract had not yet been entered into. (The case has subsequently been appealed by Trillium on the issue of whether the government committed a tort of "misfeasance," but this is separate from the contract issue.)

The notion that "a contract is a contract" was reinforced by a recent Quebec Court of Appeal decision that represents the latest round of an ongoing dispute between the Province of Newfoundland & Labrador and Hydro-Quebec. In the 1970s and 1980s, Newfoundland twice unsuccessfully challenged Hydro-Quebec's rights under a 65-year(!) power purchase agreement signed in 1969 under which Hydro-Quebec bought electricity from Churchill Falls (Labrador) Corporation Limited (owned by Newfoundland) at what had become a bargain-basement price. In both instances the Supreme Court of Canada ruled against Newfoundland, and upheld the validity of the contract.

In the recent case, Churchill Falls argued that the contract was unfair, and should be renegotiated between the parties, as it permitted Hydro-Quebec to earn large profits that were unforeseeable at the time the contract was signed. On August 1, the court released its decision, which was consistent with previous findings. The court held that the parties had chosen, freely and voluntarily, not to vary the price of electricity in the contract. Even though they were fully cognizant that this price could fluctuate over the life of the contract, there was no duty to renegotiate as a result of Hydro-Quebec's increased profits, whether on the basis of good faith or unforeseen circumstances.

One more thing: power purchase agreements in Ontario generally contain a provision that specifically contemplates what happens if the government takes steps to terminate the contract. It's called the "discriminatory action" clause. It says in effect that, in the event of such governmental action, the generator is to be kept whole. Thus, under one possible calculation, a contract termination would result in a payment to the generator of the net present value of up to twenty years of electricity generation (less mitigated expenses). According to the Auditor General, the decision to halt construction of just two gas plants in Mississauga and Oakville cost hundreds of millions. The costs of "ripping up" Ontario's existing renewable energy contracts would be staggering.

Once a contract has been entered into in a country where the rule of law is respected, it's expensive to break it. And it should be. That's the price you pay.

*This article was published by the Financial Post on October 6, 2016.