Presented:
The University of Houston Law Foundation
Oil, Gas and Energy Law
May 8-9, 2008
Dallas, Texas
FAILURE TO DELIVER OR RECEIVE NATURAL GAS
INCLUDING ADEQUATE ASSURANCES, COVER AND FORCE MAJEURE
Craig R. Enochs
Craig R. Enochs
cenochs@jw.com
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) 752-4200 phone
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UCC and NAESB REMEDIES
2
I. UCC Provisions
A. Texas Business and Commerce Code
1.
2.
3.
4.
5.
Clarify commercial transaction law
Unify commercial law across jurisdiction
Allow freedom to contract
Fallback
Restore performing party to contractual
position
3
I. UCC Provisions
B.
§1.302 allows parties to vary the UCC
a)
b)
Flexibility of terms
Warning
4
I. UCC Provisions
B.
1.
Breach
Perfect Tender Rule - §2.601; 2.703
a.
b.
Any failure to perform, no matter how minor,
is a breach
Seller can cure if time for performance has
not expired
5
I. UCC Provisions
2. Exception for installment contracts - §2.612
a. Installment contract - any contract requiring the
delivery of goods in separate lots to be
separately accepted.
b. Reject if breach “substantially impairs the value
of the installment and cannot be cured.”
6
I. UCC Provisions
c. If the value of the contract as a whole is not
impaired and seller gives assurances it will cure,
then buyer must accept the non-conforming
installment.
d. Terminate contract if it impairs the value of the
contract as a whole.
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I. UCC Provisions
C. Rights and Remedies
1. Either Party
a. Adequate assurance of performance - §2.609
1) No breach required, only reasonable grounds for insecurity
2) Requesting party may suspend
3) Failure to deliver is a deemed repudiation
4) Reasonableness of demand and assurance requested
determined according to commercial standards
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I. UCC Provisions
b. Anticipatory repudiation - §2.610
1. Requires:
a) an overt communication of intention or action
b) that demonstrates a clear determination not to continue with
performance or
c) renders performance impossible and
d) the failure will substantially impair the value of the contract
9
I. UCC Provisions
2. Remedy
a) Await performance by the repudiating party,
b) Suspend performance, or
c) Resort to any remedy for breach
10
I. UCC Provisions
2. Seller’s remedies
a. Buyer’s Insolvency - §2.702
1) Refuse to deliver additional goods until payment is
received for all goods previously delivered.
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I. UCC Provisions
2) If goods delivered while buyer was insolvent,
reclaim the goods
a)
b)
Reclamation is exclusive remedy
§546(c) of Bankruptcy Code requires
exercise within 10 days of buyer’s
receipt of the goods
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I. UCC Provisions
b. Wrongful rejection, acceptance of goods revoked, failure to make
payment when due, or repudiation - §2.703
1. Withhold delivery - §2.705
2. Resell goods and recover actual and incidental damages §2.706
3. Recover lost profits and incidental damages for non-acceptance
- §2.708
4. Termination of contract - §2.703
13
I. UCC Provisions
3.
Buyer’s remedies - §2.711
a.
Seller’s failure to deliver or Buyer’s
rightful rejection:
1.
2.
3.
Terminate the contract,
Recover the amount paid, and
Collect damages
14
I. UCC Provisions
b.
Seller’s failure to deliver or repudiation:
1. Recover the goods,
2. Obtain specific performance, or
3. Replevy the goods
15
I. UCC Provisions
c. Buyer’s rejection or revocation
1. Exercise an automatic security interest on the
goods in buyer’s control, and
2. Resell the goods as an aggrieved seller
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II.
NAESB Remedies
A. Liquidated Damages - §3.2
1.
If seller fails to deliver or buyer fails to receive
2.
Elect Cover Standard or Spot Standard
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II.
NAESB Remedies
3. Cover Standard
a.Positive difference between contract price and market
price
b.Market price must be reasonable
c. Market price will be adjusted for differences in
transportation costs
d.If unable to cover, then use spot price standard
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II.
NAESB Remedies
4. Spot Standard
a.
Positive difference between
Spot Price and Contract Price
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II.
B.
NAESB Remedies
Adequate Assurances
1.
2.
Either party may demand
Requires reasonable grounds for insecurity
regarding the performance of any obligation
a.
Reasonable grounds include material changes
of a party’s or its guarantor’s credit
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II.
NAESB Remedies
3. Adequate assurances – §10.1
a.
b.
c.
d.
Sufficient security in a form, amount and term
reasonably acceptable to the requesting party
May include cash, letter of credit, prepayment,
security interest or guaranty
Failure to provide within 48 hours but at least
one business day is an Event of Default
Could relate to failure to deliver or receive gas
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II.
4.
NAESB Remedies
Early Termination and Liquidation
a.
b.
c.
d.
Triggered by Event of Default
Standard Events of Default exclude delivery-related
defaults
Could add in Special Provisions
1)
Usually done if molecules are more important
than Dollars
Allows liquidation of all transactions and two-way
payment of mark-to-market value
22
III. UCC Compared to NAESB
UCC
Failure to Deliver -
(1) Recover liquidated, incidental and consequential damages;
(2) No requirement to attempt to affect cover;
(3) Obtain specific performance;
(4) Replevy;
(5) Terminate
Failure to Receive -
(1) Recover liquidated and incidental damages;
(2) Suspend deliveries;
(3) Terminate
Adequate Assurance - (1) Demand adequate assurances;
(2) Suspend performance pending receipt of such assurances;
(3) Assurances must be received within a reasonable time not to exceed 30 days
Events of Default -
(1) If buyer is insolvent, seller may suspend delivery until payment is received and reclaim
goods already delivered;
(2) Suspend deliveries;
(3) Recover liquidated, incidental and consequential damages;
(4) Reject an installment;
(5) Terminate the contract if the breach goes to the whole of the contract
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III. UCC Compared to NAESB
NAESB
Failure to Deliver -
(1) Recover liquidated damages using the “spot price standard,” the “cover
price standard,” or “alternative damages”;
(2) Must use commercially reasonable efforts to effect cover
Failure to Receive -
(1) Recover liquidated damages using the “spot price standard,” the “cover
price standard,” or alternative damages;
(2) Must use commercially reasonable efforts to effect cover
Adequate Assurance – (1) Demand adequate assurances, which must be received
within 48 hours of demand
Events of Default -
(1) Suspend performance;
(2) Recover liquidated damages;
(3) Terminate all transactions;
(4) Net and setoff all amounts owed between the parties under the NAESB,
or under all agreements between the parties
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III. UCC Compared to NAESB
A. Remedies may be inadequate under NAESB
1. Lacks rights of replevy or specific performance
2. Buyer may need the commodity more than cash
damages
a. Ex. LDC – gas deliveries
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III. UCC Compared to NAESB
B.
UCC may have remedies that are inferior to the
NAESB, and does not recognize industry practices
1.
Ex. Time period for delivering adequate
assurance
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III. UCC Compared to NAESB
C.
1.
2.
3.
Summary
Differences exist
NAESBs are customized and flexible
Certain transactions may require remedies
not offered by the NAESB
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IV. Force Majeure
A.
UCC - §2.615
1.
Seller’s delay in delivery or non-delivery is
excused if:
a.
b.
it is impracticable because of an occurrence,
the non-occurrence of which was a basic
assumption of the contract when made, or
it is in compliance with a governmental
regulation or order
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IV. Force Majeure
2.
Seller must:
a.
Allocate remaining deliveries in a fair
and reasonable manner
b.
Notify buyer of delay, non-delivery
and/or reallocation
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IV. Force Majeure
3.
Any claimed contingencies giving rise to
impracticability should be analyzed in light of
the provision’s underlying reason and
purpose
a.
The UCC does not list specific events
30
IV. Force Majeure
4.
Governmental order does not have to
be valid, but seller must have a good
faith belief in its validity
a.
Must interfere in a manner beyond the
risk seller assumed in the contract
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IV. Force Majeure
5.
Buyer may, upon notice to seller, and with
respect to the deliveries not provided:
a.
Terminate and discharge any unexecuted
portion
b.
Modify the contract by agreeing to take the
modified quantity
1)
Failure to modify within a reasonable
time causes the contract to lapse
32
IV. Force Majeure
6.
Buyer’s rights under 2.616 cannot be waived
by contract unless seller has assumed a
greater obligation
33
IV. Force Majeure
B.NAESB - §11
1.
Failures caused by Force Majeure are excused
a.
b.
2.
Either party
Some payments are excluded
Force Majeure is any cause not reasonably within
the control of the party claiming suspension.
a.
NAESB lists sample Force Majeure events
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IV. Force Majeure
3.
Both parties have a duty to avoid the adverse impact
of the Force Majeure and to resolve the event
causing the Force Majeure
4.
Exclusions:
a.
b.
c.
Claiming party fails to remedy with reasonable dispatch
Economic hardship including better alternative prices in
the market
Loss or failure of seller’s supply unless caused by a
Force Majeure
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IV. Force Majeure
5.
Notice must be provided as soon as
reasonably possible
6.
Obligations to deliver or receive gas are
excused
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Force Majeure Provisions in Energy
Trading Contracts: Recent
Developments
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Force Majeure Provisions in Energy Trading
Contracts


Dearth of case law
Recent Texas cases:

Tejas Power Corp. v. Amerada Hess Corp., 1999 WL 605550
(Tex. App.—Houston [14th Dist.] 1999, no pet.)(not designated for
publication).

Apache Corporation v. Virginia Power Energy Marketing, Inc., et
al., Case No. 2005-76899 (157th Dist., Harris Cty., decided
August 16, 2007).
38
The Tejas Case: Basic Facts

Transaction – Tejas purchased 10,500,000 Btu of
gas per day in February 1996.

Feb. 2 – 5, 1996: Cold weather caused gas wells
to freeze, Hess could not deliver contract
quantities.

Tejas covered by withdrawing gas from storage
with a market value of $186,447.75.
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The Tejas Case: Basic Facts

Tejas offset and withheld payment of
$186,447.75.

Hess objected to the offset, Tejas sued for (1)
breach of contract, and (2) declaratory judgment
that Hess’ Force Majeure claim was improper.

Trial Court held that:
1) Tejas suffered no damages,
2) Amerada was excused by Force Majeure, and
3) Tejas’ withholding of funds was improper.
40
The Tejas Case:
Court of Appeals Analysis
 Argument 1: Hess could have supplied
more gas if it had apportioned gas evenly
among customers:
Court Rejects:
 Tex. Bus. Comm. Code § 2.615: if force majeure
affects only part of seller’s performance, seller can
allocate deliveries in a fair and reasonable manner.
 Uncontroverted expert testimony at trial court level that
Hess acted reasonably.
41
The Tejas Case:
Court of Appeals Analysis
 Argument 2: Hess required to exercise due
diligence to overcome force majeure event
(i.e., the obligation to purchase gas on spot
market to replace Force Majeure volumes)

Court Rejects:
 Plain reading of Force Majeure clause
 Tejas’ position would render Force Majeure
meaningless for a seller
42
The Tejas Case:
Court of Appeals Holding

Hess was entitled to benefits of Force Majeure
under base contract and did not act
unreasonably.

Tejas’ withholding of offset for its cover
damages during the Force Majeure was
improper.
43
The Tejas Case:
Comments
Conclusion that Hess suffered no
damages
2. “Fair and reasonable” is subjective
3. Tejas is not precedent
1.
44
The Apache Case:
Basic Facts

Apache and VPEM entered into a NAESB.
Dominion Resources issued a guaranty for VPEM.

August 2005: 3 Firm Transactions at fixed prices at
the Tennessee 500 Pool (“L500 Pool”) and Transco
Zone 3 Pool (“Station 65 Pool”).
45
The Apache Case:
Basic Facts

Aug. 29 – Sept. 29, 2005: Apache sent four (4)
notices of Force Majeure due to Hurricanes Katrina
and Rita.

VPEM covered by buying gas at different delivery
points at spot prices through an anonymous online
exchange. VPEM eventually learned that it was
buying replacement gas from Apache.
46
The Apache Case:
Basic Facts

Replacement spot price transactions with Apache did not
use the L500 or Station 65 Pools as delivery points.

VPEM argued Apache was not entitled to Force Majeure,
and offset $2,253,350.69 from its payments to Apache
for the replacement, spot price transactions.

Apache demanded payment from VPEM and DRI—both
refused.
47
The Apache Case:
Claims
 Apache filed Motion for Partial Summary
Judgment:
 Wrongful withholding of over $2.2 Million because Force
Majeure was proper
 Dominion breached guaranty by failing to pay on behalf of
VPEM.
48
The Apache Case:
Claims
 Argument 1: Apache should have delivered gas at
alternative delivery points:
 Court Rejected VPEM’s Argument:
 Apache’s obligation was to make “reasonable efforts to
resume performance”
- “performance” means the delivery of gas at the Delivery Points
in the contract.
 VPEM’s interpretation of “reasonable efforts” renders the
Force Majeure clause meaningless, since Apache could
always deliver gas to VPEM somewhere (Citing Tejas).
49
The Apache Case:
Claims
 Argument 2: Apache should have found other gas supplies to
deliver to the agreed-upon Delivery Points
 Court rejected VPEM’s argument:
 Tejas expressly rejects this idea
 Section 11.3 of the contract expressly relieves Apache from
delivery obligations for “failure of gas supply” caused by
Force Majeure.
50
The Apache Case:
Court’s Analysis and Holding
 HOLDING: Court granted Apache’s Motion for Partial
Summary Judgment:
 Apache properly invoked Force Majeure, VPEM’s withholding
was improper and Dominion breached its guaranty to Apache.
51
The Apache Case:
Comments

Court analyzed Apache independently

Unclear if gas ever flowed from platforms
52
Apache and Tejas

Both cases appear to involve NAESBs
 Tejas and Apache focused on whether a party’s source of gas
was disrupted by a Force Majeure—even though the NAESB
does not generally require gas to come from a specific source.
 NAESB: Confirmation generally does not specify a source from
which Seller must deliver Gas under the Contract—only the
specified Delivery Point for such Gas.
53