Presented:
The University of Texas School of Law
4th Annual Gas and Power Institute
October 20-21, 2005
Houston, Texas
A COMPARISON OF REMEDIES IN THE UCC TO REMEDIES
AVAILABLE UNDER THE NAESB, EEI, CTA AND ISDA
Craig R. Enochs
Amy L. Head
Craig R. Enochs
cenochs@jw.com
Amy L. Head
alhead@jw.com
Jackson Walker L.L.P.
1401 McKinney, Suite 1900
Houston, Texas 77010
(713) 752-4200 phone
I. INTRODUCTION
Article 2 of the Uniform Commercial Code (“the Code” or “U.C.C.” or “Article 2”)
governs the sale between merchants of energy and energy commodities, like the sale of all
goods.1 The U.C.C., in one of its several versions, has been enacted in 49 of the 50 states.2
Accordingly, when evaluating rights and remedies in energy commodity transactions, the
provisions of Article 2 are often the lens through which these energy commodity transactions are
viewed. However, standard form agreements used to document energy commodity transactions
often contain remedies that differ from those promulgated in Article 2.
Since the provisions of Article 2 act merely as default language when a contract is
ambiguous or fails to address a particular topic, a party relying on Article 2 to evaluate its legal
risks may improperly assess its legal rights and remedies in a transaction.3 Looking to Texas law
for the applicable U.C.C. provisions, this paper will summarize the Code’s remedies for breach
of contract, summarize the remedies for breach of contract contained in some of the standard
form agreements used to document certain energy commodity transactions,4 analyze the
differences between the remedies of Article 2 and the standard form agreement remedies, and
evaluate any inadequacies that may exist in these contractual remedies.
II. U.C.C. PROVISIONS
A. GENERAL PROVISIONS
Before beginning an analysis of the specific remedy provisions of the U.C.C., it is
important to acknowledge the general manner in which the Code is applied. First, Section 1.103
of the U.C.C. gives the parties to a contract the ability to vary the terms of the U.C.C. as it
applies to their relationship; this section is particularly important, as it gives the parties the right
to contract around, or out of, the U.C.C.’s contractual remedies provisions.5 While this section
seems fairly straightforward, parties to a contract must realize that there may be instances in
which an issue has been addressed in a contract, but the terms of a contract are determined to be
insufficient to preempt the application of the U.C.C.6 Therefore, if the parties to a contract
believe that its provisions do not adequately protect the risks they face in the specific
circumstances of their transaction, it is imperative that the parties carefully draft their agreement
and include provisions that are sufficiently detailed and specific to preclude application of the
U.C.C.’s default provisions.7
1
TEX. BUS. COM. C. §2.102.
Louisiana, the sole holdout, has enacted much of the Code, but because Louisiana's commercial law is based on
civil law and the Napoleonic Code rather than on common law, Louisiana has failed to adopt Article 2 in its entirety
because it is difficult to harmonize the state’s legal procedures and terminologies with Article 2.
3
See TEX. BUS. COM. C. §§ 1.102; 2.201; 2.204; 2.301.
4
This article analyzes the NAESB (gas), the Master Coal Agreement (coal); the EEI (power), and the ISDA (power
and gas).
5
TEX. BUS. COM. C. §1.103.
6
See id.
7
See id.
2
Page 2
Second, Section 1.106 states that “[t]he remedies provided by this Act shall be liberally
administered to the end that that the aggrieved party may be put in as good a position as if the
other party had fully performed.” Most energy commodity contracts do not contain a provision
analogous to this one, although most such contracts detail the remedies available to each party in
the event of a breach. However, the application of Section 1.106 means that, in the event of any
ambiguity, the U.C.C. remedies provisions may be construed against the breaching party.
B. BREACH
One of the most important characteristics of the U.C.C. is the manner in which it deals
with the breach of a standard contract by the buyer or seller. The Code espouses what is
commonly known as the “perfect tender” rule, which provides that any failure to conform to the
obligations stated in the contract, regardless of how minor the deviation, constitutes a breach of
the contract.8 Under Section 2.601, the seller breaches the contract if its delivery fails in any
respect to conform to the contract. Conformity does not mean substantial performance; it means
complete, perfect performance.9 However, Section 2.508 somewhat relaxes the perfect tender
rule by allowing a seller to cure any improper tender if the time for performance has not yet
expired.10 In the energy context, for example with the delivery of electric power, it would be
impossible to cure imperfect tender (as the amount and type of electricity delivered is delivered;
it generally is incapable of physical rejection by the buyer); however, application of this section
could potentially be used to allow a seller who does not begin delivery on the date specified in
the contract, or who improperly stops and then restarts delivery at some point during the term of
the contract, to cure any defects in performance or delivery.11
It is also important to note that the U.C.C. treats the breach of an installment contract
differently from the breach of other standard types of agreements, which is particularly important
in any discussion of energy contracts, as most all energy contracts fall within the U.C.C.’s
definition of “installment contract.”12 The Code defines an installment contract as one that
requires the delivery of goods in separate lots to be separately accepted, even though the contract
contains a clause stating that “each delivery is a separate contract” or the like.13 Section 2.612
allows the buyer to reject any installment that is non-conforming if the non-conformity
substantially impairs only the value of the single installment and cannot be cured.14 But, if the
non-conformity does not impair the value of the contract as a whole (as discussed below),
8
See TEX. BUS. COM. C. §§2.601; 2.703.
TEX. BUS. COM. C. §2.601; Tex. Imps. v. Allday, 649 S.W.2d 730, 737 (Tex. App.—Tyler 1983, writ ref’d n.r.e);
Printing Ctr., Inc. v. Supermind Publ’g Co., 669 S.W.2d 779, 783 (Tex. App.—Houston [14th Dist.] 1984, no writ).
10
TEX. BUS. COM. C. §2.508.
11
See id.
12
See TEX. BUS. COM. C. §2.612(a).
13
TEX. BUS. COM. C. §2.612, cmt. 3 (stating “[t]his Article rejects any approach which gives clauses such as “each
delivery is a separate contract” their legalistically literal effect. Such contracts nonetheless call for installment
deliveries. Even where a clause speaks of “a separate contract for all purposes,” a commercial reading of the
language under the section on good faith and commercial standards requires that the singleness of the document and
the negotiation, together with the sense of the situation, prevail over any uncommercial and legalistic
interpretation
.”) .
14
TEX. BUS. COM. C. §2.612(a).
9
Page 3
subsection (b) provides that if the seller can give assurances that it will cure the non-conformity
with respect to the installment, the buyer must then accept the non-conforming installment.
Subsection (c) provides that whenever a non-conformity with respect to one or more installments
“substantially impairs the value of the whole contract, there is a breach of the whole.” Whether
the non-conformity in any given installment justifies cancellation of all future transactions
depends “not on whether such non-conformity indicates an intent or likelihood that the future
deliveries will also be defective, but whether the non-conformity substantially impairs the value
of the whole contract.”15 If only the seller's security in regard to future installments is impaired,
he has the right to demand adequate assurances of proper future performance but does not have
the immediate right to cancel the whole contract.16 Defects in installments are cumulative in
effect, which means that acceptance “does not wash out the defect ‘waived.’”17 Subsection (c)
also provides that when the nonconformity impairs the value of the whole contract, if a party
then accepts a non-conforming installment, the contract is reinstated.
C. REMEDIES
1. Available to both parties
The Code permits either party to request and receive assurances of performance when a
breach has not yet occurred if the counter-party’s performance, or continued ability to perform,
has been called into question.18 This section recognizes the commercial reality that a seller needs
to be able to protect against the risk of having to deliver a commodity on credit to an unreliable
buyer, as well as against having to procure goods for that buyer, which could necessitate turning
away other, credit-worthy buyers.19 The same section offers the identical protection to the buyer,
who is not required to wait until the date for performance, when any failure by the seller at that
point may seriously impair the buyer’s business.20 Given the price volatility of energy
commodity markets, this right is an important way to ameliorate the market risk that commodity
prices might change dramatically over short periods of time.
Section 2.609 allows either party to request adequate assurances of performance when the
party has reasonable grounds for insecurity and allows the requesting party to suspend
performance if it does not receive adequate assurances within a reasonable period of time, not to
exceed thirty days, of the request.21 In order to receive such assurances, a party must make a
15
TEX. BUS. COM. C. §2.609, cmt. 6.
Id.
17
Id.
18
TEX. BUS. COM. C. §2.609.
19
TEX. BUS. COM. C. §2.609, cmt. 1.
20
See id.
21
TEX. BUS. COM. C. § 2.609 (stating “(a) A contract for sale imposes an obligation on each party that the other’s
expectation of receiving due performance will not be impaired. When reasonable grounds for insecurity arise with
respect to the performance of either party the other may in writing demand adequate assurance of due performance
and until he receives such assurance may if commercially reasonable suspend any performance for which he has not
already received the agreed return; (b) Between merchants the reasonableness of grounds for insecurity and the
adequacy of any assurance offered shall be determined according to commercial standards; (c) Acceptance of any
improper delivery or payment does not prejudice the aggrieved party’s right to demand adequate assurance of future
performance; (d) After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty
16
Page 4
written request to the other party demanding assurances of future performance and may, if
commercially reasonable, suspend his own performance until he receives such assurances.22
Failure to provide the requested assurance within the thirty-day window is deemed a repudiation
of the contract.23 The reasonableness of a request for assurance, and the adequacy of the
assurance offered, will be determined according to commercial standards.24 Further, the
acceptance by the seller of a partial payment, or by the buyer of nonconforming goods, does not
prejudice the party’s right to receive assurances under this section.25
The Code also addresses anticipatory repudiation by either party and provides that (i)
when a party repudiates the contract and (ii) declares that performance not yet due under the
contract will not be rendered, and that failure to perform will “substantially impair the value of
the contract,” the aggrieved party may either await performance by the repudiating party26 or
resort to any remedy available for breach and suspend performance.27 “Anticipatory repudiation”
is defined as “an overt communication of intention or an action which renders performance
impossible or demonstrates a clear determination not to continue with performance.” To
constitute repudiation, it is not necessary that performance be made literally and utterly
impossible. Repudiation can result from any action that “reasonably indicates a rejection of the
continuing obligation.” However, the Code also allows a party to retract its repudiation until the
next performance is due under the contract.28 Retraction may be made by any method that clearly
indicates to the aggrieved party that the repudiating party intends to perform but must include
any assurance justifiably demanded.29 Retraction reinstates the repudiating party's rights under
the contract but requires the repudiating party to answer to the aggrieved party in damages for
any delay occasioned by the repudiation.30
2. Remedies Available Exclusively to Seller
Article 2 includes several provisions addressing the seller’s remedies in the event of a
breach by the buyer, or prior to a breach, in the event the buyer becomes insolvent. Section
days such assurance of due performance as is adequate under the circumstances of the particular case is a
repudiation of the contract.”).
22
Id.
23
TEX. BUS. COM. C. §2.609(d).
24
TEX. BUS. COM. C. §2.609(b).
25
See id.
26
TEX. BUS. COM. C. §2.610, cmt. 1 (stating that if the performing party awaits performance beyond a
commercially reasonable time, he cannot recover resulting damages which he should have avoided by taking action).
27
TEX. BUS. COM. C. §2.610 (stating that “[w] hen either party repudiates the contract with respect to a performance
not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may
(1) for a commercially reasonable time await performance by the repudiating party; or (2) resort to any remedy for
breach, even though he has notified the repudiating party that he would await the latter's performance and has urged
retraction; and (3) in either case suspend his own performance or proceed in accordance with the provisions of this
chapter on the seller's right to identify goods to the contract notwithstanding breach or to salvage unfinished good.”).
28
TEX. BUS. COM. C. § 2.611(a).
29
TEX. BUS. COM. C. § 2.611(b).
30
TEX. BUS. COM. C. § 2.611(c).
Page 5
2.702 identifies the seller’s remedies upon discovery of the buyer’s insolvency.31 Subsection (a)
provides that when a seller discovers the buyer is insolvent, the seller may refuse to deliver
additional goods unless the buyer pays, in cash, for the current shipment, and makes payment for
all goods previously delivered under the contract.32 Section 2.702(b) allows a seller who
delivered goods on credit to a buyer who was insolvent at the time of delivery to reclaim the
goods within ten days of delivery; if more than ten days have passed since delivery, the seller
may reclaim only if, within the three-month period preceding delivery, the buyer falsely
represented to the seller in writing that the buyer was solvent.33 There are, however, two
limitations on the seller’s right to reclaim delivered goods under subsection (b). First, the
seller’s ability to reclaim is subject to the rights of a buyer in the ordinary course of business,
another good faith purchaser, or a lien creditor.34 Second, the seller’s right of reclamation under
this subsection is exclusive; if the seller reclaims goods under Section 2.702, no other remedy is
available to the seller under Article 2.
Finally, it is important to note that the interplay of Section 2.702 with the provisions of
the Bankruptcy Code has limited the use of the seller’s right of reclamation in the bankruptcy
setting to only those attempts at reclamation made within ten days after delivery.35 In the
bankruptcy context, confusion was caused by the fact that the U.C.C. effectively creates a lien
under state law that conflicts with the provisions of the Bankruptcy Code that strike down
disguised priorities.36 The inclusion of §546(c) in the Bankruptcy Code attempted to alleviate
that confusion by providing that the “rights and powers of the trustee under §§ 544(a), 545, 547
and 549 of this title are subject to any statutory right or common-law right of a seller, in the
ordinary course of such seller's business, of goods to the debtor to reclaim such goods if the
debtor has received such goods while insolvent, but (1) such a seller may not reclaim any such
goods unless such seller demands in writing reclamation of such goods before ten days after
receipt of such goods by the debtor.”37 The courts construing the interrelation of these two
provisions have held that the Bankruptcy Code represents the exclusive remedy available when a
buyer is in bankruptcy, and that unless a seller meets the strict ten-day notice requirement of
Section 546(c), he retains no other common law or statutory right of action.38 When a buyer has
31
TEX. BUS. COM. C. § 2.702 (stating that “(a) Where the seller discovers the buyer to be insolvent he may refuse
delivery except for cash including payment for all goods theretofore delivered under the contract, and stop delivery
under this chapter (Section 2.705); (b) [w]here the seller discovers that the buyer has received goods on credit while
insolvent he may reclaim the goods upon demand made within ten days after the receipt, but if misrepresentation of
solvency has been made to the particular seller in writing within three months before delivery the ten day limitation
does not apply. Except as provided in this subsection the seller may not base a right to reclaim goods on the buyer’s
fraudulent or innocent misrepresentation of solvency or intent to pay; (c) [t]he seller’s right to reclaim under
Subsection (b) is subject to the rights of a buyer in ordinary course or other good faith purchaser or lien creditor
under this chapter (Section 2.403). Successful reclamation of goods excludes all other remedies with respect to
them.”).
32
TEX. BUS. COM. C. §2.702(a).
33
TEX. BUS. COM. C. §2.702(b).
34
TEX. BUS. COM. C. §2.702(c).
35
See id.
36
Id; In re Gibson Distributing Co., Inc.-Permian Basin, 40 B.R. 767 (Bkrtcy. Tex. 1984) (citing Deephouse Equip.
Co., Inc., 22 B.R. 255, 257 (Bkrtcy D. Conn. 1982)).
37
11 U.S.C.A. §546(c).
38
See id.; see also In re Jeanes Mechanical Contractors, Inc., 32 B.R. 657 (Bkrtcy. W.D. Ky. 1983).
Page 6
filed for bankruptcy, the sole remedy for an unpaid vendor is reclamation pursuant to Section
546(c); therefore, reclamation outside of the ten-day period is not permissible when a party has
filed for bankruptcy, although it would appear to be permitted under the U.C.C.
Two additional points regarding the application of Section 2.702 may be particularly
important in the energy context. First, the seller may only exercise its right of reclamation if the
buyer is actually insolvent, which is defined as “having generally ceased to pay debts in the
ordinary course of business other than as a result of a bona fide dispute,” or “being insolvent
within the meaning of the federal bankruptcy law.”39 Second, and more important, is the fact
that Section 2.702 allows a seller to refuse to deliver goods to a buyer who is insolvent without
requiring that the seller also take steps to terminate the contract.
All remedies available under the U.C.C. to a seller in the event of a breach by the buyer
are listed in Section 2.703, which is not used to apply any specific remedy, but merely “gathers
together in one convenient place all of the various remedies open to a seller for any breach by the
buyer.”40 Section 2.703 allows an aggrieved seller to, under certain circumstances, withhold
delivery, stop delivery of goods already in transit, resell the goods and recover damages, recover
damages for non-acceptance, or terminate the contract.41 The remedies of Section 2.703 are
available to the seller when the buyer wrongfully rejects or revokes acceptance of conforming
goods, fails to make a payment due, or repudiates any part of the contract.42 Section 2.705
allows a seller to withhold delivery or stop delivery of goods in transit when the seller discovers
the buyer is insolvent, when the buyer repudiates the contract, or the buyer fails to make any
payment due before delivery.43 The seller may stop delivery until the buyer has received the
goods, the bailee or carrier has acknowledged to the buyer that the bailee or carrier holds the
goods for the buyer, or until any negotiable instrument of title concerning the goods has been
negotiated to the buyer.44 However, where a seller justifiably withholds delivery of goods
because of the buyer’s breach, the buyer remains entitled to restitution of any amount by which
the sum of his payments exceeds the liquidated damages to which the seller is entitled under the
contract, or, if no liquidated damages are specified, twenty percent of the value of the total
performance for which the buyer is obligated. 45
39
TEX. BUS. COM. C. §2.702(a).
TEX. BUS. COM. C. §2.703, cmt. 1.
41
TEX. BUS. COM. C. §2.703.
42
TEX. BUS. COM. C. §2.703 (stating that “[w]here the buyer wrongfully rejects or revokes acceptance of goods or
fails to make a payment due on or before delivery or repudiates with respect to a part or the whole, then with respect
to any goods directly affected and, if the breach is of the whole contract (Section 2.612), then also with respect to
the whole undelivered balance, the aggrieved seller may (1) withhold delivery of such goods; (2) stop delivery by
any bailee as hereafter provided (Section 2.705); (3) proceed under the next section respecting goods still
unidentified to the contract; (4) resell and recover damages as hereafter provided (Section 2.706); (5) recover
damages for non-acceptance (Section 2.708) or in a proper case the price (Section 2.709); (6) cancel.”).
43
TEX. BUS. COM. C. §2.705.
44
TEX. BUS. COM. C. §2.705(b).
45
TEX. BUS. COM. C. §2.718 (providing that “(b) Where the seller justifiably withholds delivery of goods because of
the buyer's breach, the buyer is entitled to restitution of any amount by which the sum of his payments exceeds (1)
the amount to which the seller is entitled by virtue of terms liquidating the seller's damages in accordance with
Subsection (a), or (2) in the absence of such terms, twenty percent of the value of the total performance for which
40
Page 7
Section 2.706 allows a seller to resell goods wrongfully rejected by the buyer or the
undelivered balance of any goods identified to the contract.46 When the resale is made in good
faith and in a commercially reasonable manner, the seller may recover the difference between the
resale price and the contract price together with any incidental damages incurred as a result of
the resale, but less expenses saved in consequence of the buyer’s breach.47
If the buyer is unable to stop delivery or is not made whole by the resale of the rejected
goods, the Code also allows the seller to recover damages for the non-acceptance based on the
difference between the market price and the contract price or the profit the seller would have
received had the buyer fully performed (discussed below).48 The Code also allows the seller to
terminate the contract in certain circumstances49
3. RemediesAvailable Exclusively to Buyer
The Code offers several remedies specific to the buyer in the event of a breach by the
seller; however, not all remedies offered by the Code are applicable in the energy context. For
example, Section 2.601 allows a buyer to reject non-conforming goods in whole or in part if the
goods fail in any respect to conform to the terms of the contract.50 Section 2.602 is similar in its
application to Section 2.601, in that it allows a buyer to reject the goods within a reasonable time
after delivery or receipt.51 Both Section 2.601 and 2.602 are largely inapplicable in the energy
industry, as most such contracts presume that acceptance occurs upon delivery.52
Section 2.711 outlines the remedies generally available under Article 2 to a buyer in the
event of a breach by the seller.53 Subsection (a) provides that when the buyer rightfully rejects or
the buyer is obligated under the contract or $500, whichever is smaller. (c) The buyer's right to restitution under
Subsection (b) is subject to offset to the extent that the seller establishes (1) a right to recover damages under the
provisions of this chapter other than Subsection (a), and (2) the amount or value of any benefits received by the
buyer directly or indirectly by reason of the contract. (d) Where a seller has received payment in goods their
reasonable value or the proceeds of their resale shall be treated as payments for the purposes of Subsection (b); but if
the seller has notice of the buyer's breach before reselling goods received in part performance, his resale is subject to
the conditions laid down in this chapter on resale by an aggrieved seller.”).
46
TEX. BUS. COM. C. §2.706(a) (stating that “[u]nder the conditions stated in Section 2.703, on seller’s remedies, the
seller may resell the goods concerned or the undelivered balance thereof. Where the resale is made in good faith and
in a commercially reasonable manner the seller may recover the difference between the resale price and the contract
price together with any incidental damages allowed under the provisions of this chapter (Section 2.710) but less
expenses saved in consequence of the buyer’s breach.”).
47
TEX. BUS. COM. C. §2.706(a).
48
TEX. BUS. COM. C. §§2.708(a); 2.709.
49
TEX. BUS. COM. C. §§2.703; 2.612.
50
TEX. BUS. COM. C. §2.601 (stating “[s]ubject to the provisions of this chapter on breach of installment contracts
(Section 2.612) and unless otherwise agreed under the sections on contractual limitations of remedy (Sections 2.718
and 2.719) if the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may: (1)
reject the whole; or (2) accept the whole; or (3) accept any commercial unit or units and reject the rest.”).
51
TEX. BUS. COM. C. §2.602.
52
See id.
53
TEX. BUS. COM. C. §2.711 (stating “(a) Where the seller fails to make delivery or repudiates or the buyer
rightfully rejects or justifiably revokes acceptance then with respect to any goods involved, and with respect to the
whole if the breach goes to the whole contract, the buyer may cancel and whether or not he has done so may in
Page 8
revokes acceptance, the buyer may terminate the contract, recover the price paid, and either
“cover” and have damages (as discussed below), or have damages for non-delivery.54
Subsection (b) allows the buyer the option of (1) recovering the goods (if the goods have been
identified to the contract),55 (2) obtaining specific performance56, or (3) replevying the goods.57
Subsection (c) offers yet another option by creating an automatic security interest in goods in the
buyer’s possession or control for any payments made on those goods and any expenses incurred
in the receipt, inspection, and transportation of the goods.58 This section allows the buyer to sell
any non-conforming goods in the buyer’s possession and keep the price received.59 However,
Article 2 does not allow a buyer automatically to cancel the entire contract if the seller fails to
deliver only one installment of conforming goods.60 Section 2.711, when read with other
applicable Article 2 provisions, provides for cancellation of the entire contract only when the
seller’s breach “goes to the whole contract,” which requires that the breach must impair the value
of the entire contract.61
If the buyer rightfully rejects any goods delivered, or accepts but then later revokes his
acceptance, Section 2.711 gives the buyer an automatic security interest in the goods in his
possession and allows the buyer to sell the goods to offset the price paid, if any, and for any
expenses reasonably incurred in their inspection, receipt, transportation and storage. This right
could be important to a buyer who fails to evaluate the quality and composition of the energy
addition to recovering so much of the price as has been paid (1) “cover” and have damages under the next section as
to all goods affected whether or not they have been identified to the contract; or (2) recover damages for nondelivery as provided in this chapter; (b) Where the seller fails to deliver or repudiates the buyer may also (1) if the
goods have been identified recover them as provided in this chapter (Section 2.502); or (2) in a proper case obtain
specific performance or replevy the goods as provided in this chapter (Section 2.716); (c) On rightful rejection or
justifiable revocation of acceptance a buyer has a security interest in goods in his possession or control for any
payments made on their price and any expenses reasonably incurred in their inspection, receipt, transportation, care
and custody and may hold such goods and resell them in like manner as an aggrieved seller.”).
54
TEX. BUS. COM. C.§2.711(a).
55
See TEX. BUS. COM. C.§2.502.
56
TEX. BUS. COM. C.§2.716(a) (stating that the buyer’s right to demand specific performance is generally available
only where the goods are unique).
57
See TEX. BUS. COM. C.§ 2.716.
58
See TEX. BUS. COM. C.§2.711(c).
59
Id.
60
TEX. BUS. COM. C.§2.711(a).
61
TEX. BUS. COM. C.§2.612(c). Section 2.612 deals primarily with installment contracts. Under this section, a
breach by either the seller or the buyer may impair either the installment in question, or the contract as a whole.
Whether the non-conformity in any given installment is substantial enough to warrant cancellation of all future
installments depends on the likelihood of whether any future deliveries will also be defective, as well as whether the
non-conformity substantially impairs the value of the whole contract. Substantial impairment may be based on any
number of factors, including the quality of the goods, the time of delivery, etc. Comment 6 to this section
specifically states, however, that where the only impairment is the seller’s security in regard to future installments,
the seller may demand adequate assurances of future performance, but does not have the right to immediately cancel
the contract. But, it is important to note that defects in the performance of either the buyer or the seller are
cumulative in effect. This section also provides that a buyer who accepts a non-conforming installment, or who
does not receive an installment, may withhold his decision as to whether or not to cancel the entire contract pending
a response from the seller as to any request for cure or adjustment. A seller also may withhold delivery of future
shipments pending the receipt of payment for any prior shipments, and withhold his decision regarding cancellation.
Page 9
commodity delivered prior to making payment to the seller or to a buyer requiring to prepare the
seller before the commodity is delivered.
In addition to the remedies available above, Article 2 allows the buyer to terminate the
contract if the buyer receives notification of a material reduction or delay in delivery.62
D. DAMAGES
The Code allows damages for breach by either party to be liquidated in the agreement
between the parties but limits those damages to an amount that is reasonable “in light of the
anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the
inconvenience or non-feasibility of otherwise obtaining an adequate remedy.”63 Any contract
that provides for the payment of an “unreasonable” amount of liquidated damages is void as a
penalty.64
1. Damages Available to Seller
If the contract does not contain a liquidated damages clause, Article 2 allows a seller to
recover actual damages when a buyer wrongfully refuses acceptance of conforming goods or
repudiates the contract.65 The seller’s damages for the buyer’s breach are determined by
calculating the difference between the contract price and the market price.66 However, while the
general goal of Article 2’s provisions relating to damages states that an aggrieved party should
be placed in as good a position as if the other party had fully performed, consequential damages
may not automatically be recovered under Article 2.67 Consequential damages are defined as
those damages that “do not arise within the scope of the immediate buyer-seller transaction, but
rather stem from losses incurred by the non-breaching party in its dealings, often with third
parties which were an approximate result of the breach.”68 Article 2 specifically allows for the
62
TEX. BUS. COM. C. §2.616.
TEX. BUS. COM. C. §2.718.
64
Id.
65
The buyer is allowed to reject non-conforming goods without penalty, but is allowed to repudiate the entire
contract only when there has been a previous breach by the seller, or the seller has clearly manifested an intent to not
perform. At common law, actual damages can be either direct or consequential. Direct damages are the usual and
necessary result of the defendant's wrongful conduct; they flow naturally and necessarily from the wrong. Arthur
Andersen & Co. v. Perry Equip. Corp., 945 S.W.2d 812, 816 (Tex. 1997). Direct damages compensate the plaintiff
for the loss, damage, or injury that is conclusively presumed to have been foreseen by the defendant as a
consequence of his breach of contract or wrongful act. Id. On the other hand, consequential damages result
naturally, but not necessarily, from the defendant's wrongful actions. Id.; Haynes & Boone v. Bowser Bouldin, Ltd.,
896 S.W.2d 179, 182 (Tex. 1995).
66
TEX. BUS. COM. C. §2.708.
67
TEX. BUS. COM. C. §1.106 (stating that consequential damages under the UCC may not be had unless specifically
provided for).
68
USX Corp. v. Union Pacific Res. Co., 753 S.W.2d 845, n.5 (Tex. App.—Fort Worth 1988, no writ). Under the
common law, consequential damages need not be the usual result of the wrong, but must be foreseeable and must be
directly traceable to the wrongful act and result from it. Arthur Andersen, 945 S.W.2d at 816. Article 2 also has
defined direct, incidental and consequential damages. Section 2.714(a) discusses “damages resulting in the ordinary
course of events,” such as direct damages, while subsection (c) provides that incidental and consequential damages
also may be recovered. TEX. BUS. & COMM. CODE. ANN. § 2.714. Section 2.715 defines both incidental and
63
Page 10
recovery of consequential damages by an aggrieved buyer,69 but does not provide for recovery
by a seller of consequential damages.70
The common benefit-of-the-bargain method of calculating a seller’s damages in the event
of a buyer’s non-acceptance or wrongful repudiation is set forth in Section 2.708, which seeks to
restore the injured party to the economic position it would have been in had the contract been
performed.71 Subsection (a) allows a seller to recover the difference between the market price at
the time and place for tender and the unpaid contract price, together with incidental damages but
less expenses saved.72 Texas courts have yet to thoroughly interpret the meaning of “market
price,” as used in Article 2, but the term is generally defined as the “prevailing price at which
something is sold in a specific market.”73 Texas courts have held that when the resale price is
determined by reference to an arm’s length transaction, it is an adequate reflection of market
price.74 Texas courts also have found that the spot price may sometimes be an adequate
representation of Article 2’s “market price” of a commodity.75 The Code does, however,
consequential damages. Section 2.715(a) defines incidental damages as those resulting from the seller's breach,
including expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods
rightfully rejected, plus any commercially reasonable charges, expenses or commissions incurred in connection with
effecting cover and any other reasonable expenses incident to the breach. Section 2.715 defines consequential
damages resulting from the seller’s breach as (1) any loss resulting from general or particular requirements and
needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented
by cover or otherwise; and (2) injury to person or property proximately resulting from any breach of warranty. TEX.
BUS. COM. C. §2.715; see also Wade & Sons, Inc. v. American Standards, Inc., 127 S.W.3d 814, (Tex. App.—San
Antonio 2003) (discussing damages available under Article 2).
69
TEX. BUS. COM. C. §§2.709; 2.710; 2.714(c); 2.715(b); see also USX Corp. v. Union Pacific Res. Co., 753 S.W.2d
845, 856 (Tex. App.—Fort Worth 1988, no writ) (instructing the jury not to include consequential damages in
damage award); Tennessee Gas Pipeline Co. v. Lenape Resources Corp., 870 S.W.2d 286 (Tex. App.—San Antonio
1993, rev’d on other grounds) (holding that an aggrieved seller may not recover consequential damages under the
Uniform Commercial Code).
70
Gray v. West, 608 S.W.2d 771, 781 n.3 (Tex. Civ. App.—Amarillo 1980, writ ref’d n.r.e.) (pointing to Article 2’s
failure to specifically allow the seller to recover consequential damages in the energy context as justification for
denying the recovery of damages under a gas farm-out agreement with a third party, finding that farm-out damages
are consequential damages).
71
TEX. BUS. COM. C. §2.708 (stating “(a) Subject to Subsection (b) and to the provisions of this Chapter with respect
to proof of market price (Section 2.723), the measure of damages for non-acceptance or repudiation by the buyer is
the difference between the market price at the time and place for tender and the unpaid contract price together with
any incidental damages provided in this chapter (Section 2.710), but less expenses saved in consequence of the
buyer’s breach; (b) If the measure of damages provided in Subsection (a) is inadequate to put the seller in as good a
position as performance would have done then the measure of damages is the profit (including reasonable overhead)
which the seller would have made from full performance by the buyer, together with any incidental damages
provided in this chapter (Section 2.710), due allowance for costs reasonably incurred and due credit for payments or
proceeds of resale.”); Sava Gumarska in Kemijska Industria v. Advanced Polymer Sciences, Inc., 128 S.W.3d 304,
n.6 (Tex. App.—Dallas 2004)(finding that the Code’s remedies seek to restore the injured party to the economic
position it would have been in had the contract been performed).
72
TEX. BUS. COM. C. §2.708(a) (stating that the “time and place for tender” is the time and place for delivery of the
goods).
73
Id. (citing BLACK'S LAW DICTIONARY 1207 (7th ed. 1999)).
74
Cook Composites, Inc. v. Westlake Styrene Corp., 15 S.W.3d 124, 138-39 (Tex. App.--Houston [14th Dist.] 2000).
75
Id.
Page 11
specifically provide that the market price is to be determined as of the date the non-breaching
party learned of the breach.76
In the event that the seller is not made whole by the method of calculation set forth in
subsection (a), subsection (b) provides an additional measure of protection to the seller by
allowing a seller to measure damages as the profit, including overhead, that the seller would have
made had the buyer fully performed.77 This section also allows the seller to recover incidental
damages plus all costs reasonably incurred, but provides for an allowance to the buyer for any
payments made or the proceeds of any resale.78 Subsection (b) is particularly useful in cases in
which a buyer repudiates the contract before delivery and the goods are specially manufactured,
so that there is no market available for resale, and in situations in which the contract is
advantageous to the seller, such as when the seller has an above-market contract. In the energy
context, the application of subsection (a) alone would be inadequate. A party bringing suit under
Section 2.708(a) must plead and prove all elements of the section to make a prima facie case for
damages, including the prevailing market price for the commodity.79
Section 2.709 sets forth a seller’s remedies when a buyer fails to pay the purchase price
when it becomes due.80 Subsection (a) allows a seller to recover from a non-paying buyer either
the purchase price of all goods accepted by the buyer, or the price of goods lost or damaged after
risk of loss has passed to the buyer, plus incidental damages. This subsection also provides that
if the seller is unable to resell goods identified to the contract, the seller may recover the price of
such goods under this section if the seller is unable, after making a reasonable effort, to resell the
goods.81 An action for the price under this section is available only if the goods have been
delivered to the buyer.82
76
TEX. BUS. COM. C. §2.723 (providing that “(b) If evidence of a price prevailing at the times or places described in
this chapter is not readily available the price prevailing within any reasonable time before or after the time described
or at any other place which in commercial judgment or under usage of trade would serve as a reasonable substitute
for the one described may be used, making any proper allowance for the cost of transporting the goods to or from
such other place.(c) Evidence of a relevant price prevailing at a time or place other than the one described in this
chapter offered by one party is not admissible unless and until he has given the other party such notice as the court
finds sufficient to prevent unfair surprise.”).
77
TEX. BUS. COM. C. §2.708(b).
78
Id.
79
Cook Composites,at 138-39.
80
TEX. BUS. COM. C. §2.709 (stating “(a) When the buyer fails to pay the price as it becomes due the seller may
recover, together with any incidental damages under the next section, the price (1) of goods accepted or of
conforming goods lost or damaged within a commercially reasonable time after risk of their loss has passed to the
buyer; and (2) of goods identified to the contract if the seller is unable after reasonable effort to resell them at a
reasonable price or the circumstances reasonably indicate that such effort will be unavailing; (b) Where the seller
sues for the price he must hold for the buyer any goods which have been identified to the contract and are still in his
control except that if resale becomes possible he may resell them at any time prior to collection of the judgment.
The net proceeds of any such resale must be credited to the buyer and payment of the judgment entitles him to any
goods not resold; (c) After the buyer has wrongfully rejected or revoked acceptance of the goods or has failed to
make a payment due or has repudiated (Section 2.610), a seller who is held not entitled to the price under this
section shall nevertheless be awarded damages for non-acceptance under the preceding section.”).
81
Id; TEX. BUS. COM. C. §2.501(a) (stating that goods “identified to the contract” are those that have been set aside,
identified, or purchased for the contract at issue).
82
Nobs Chemical, U.S.A., Inc. v. Koppers Co., Inc., 616 F.2d 212, 215 (5th Cir. (Tex.) 1980).
Page 12
Section 2.709(b) requires a seller bringing an action under this section that has attempted,
but was unable, to sell goods identified to the contract, to hold the goods still in his possession
for the buyer. If possible, the seller may sell the goods at any time before he collects a judgment
from the buyer but must credit the buyer for the amount received.83 In addition, if the buyer pays
the judgment in full, the buyer is entitled to receive all goods held by the seller.84
Overall, Section 2.709 provides a fairly powerful remedy for sellers who have delivered
goods to a non-paying buyer. However, this remedy is available only after the price becomes
due; a seller may not bring an action for the price before that time even if it is apparent that the
buyer will not pay as required by the contract.85 Courts have held that the “crucial inquiry” with
regard to the issue of whether payment has “become due” is simply whether acceptance, without
a valid subsequent revocation of acceptance, has occurred.86 Acceptance of goods is defined
under section 2.606, and occurs when the buyer fails to make an effective rejection or does “any
act inconsistent with the seller's ownership.”87 The requirements of subsection (b) have been
held to supplant any common-law duty of the seller to mitigate damages for goods delivered and
accepted.88
Section 2.710 allows an aggrieved seller to recover incidental damages, including all
reasonable expenses incurred in connection with the return or resale of the goods, resulting from
any breach by the buyer.89 This section does not allow a seller to recover consequential
damages, which are damages that do not arise within the scope of the immediate buyer-seller
transaction, but rather stem from losses incurred by the non-breaching party in its dealings with
third parties that were an approximate result of the breach. 90
2. DamagesAvailable to Buyer
Section 2.712 is Article 2’s primary avenue of recourse for a buyer who attempts to
minimize the damages suffered as a result of the seller’s breach by obtaining substitute goods or
commodities.91 This section provides for the “cover standard” of calculating damages in the
83
TEX. BUS. COM. C. §2.709(b).
Id.
85
See Custom Controls Co. v. Ranger Ins., 652 S.W.2d 449, 453 (Tex. App. – Houston [1st Dist.] 1983) (finding that
an action for the price was not available to a seller when the goods were destroyed by fire, because the prerequisites
of manufacture, sale, and delivery had not been met).
86
See TEX. BUS. COM. C. §2.709 cmt. 5 (indicating that a valid revocation of acceptance "means that there has been
a default by the seller which bars his rights under this section"); see also Bacchus Industries, Inc. v. Frontier
Mechanical Contractors, 36 S.W.3d 579, 584 (Tex. App.--El Paso 2000) (discussing the application of §2.709).
87
TEX. BUS. COM. C. §2.606; Bacchus Indus., Inc., at 584.
88
F & P Builders v. Lowe's of Texas, Inc., 786 S.W.2d 502 (Tex. App.—Dallas 1990).
89
TEX. BUS. COM. C. §2.710 (stating that “[i] ncidental damages to an aggrieved seller include any commercially
reasonable charges, expenses or commissions incurred in stopping delivery, in the transportation, care and custody
of goods after the buyer’s breach, in connection with return or resale of the goods or otherwise resulting from the
breach.”).
90
Tennessee Gas Pipeline, at 302; USX Corp. v. Union Pacific Resources Co., 753 S.W.2d 845, 856 (Tex. App.-Fort Worth 1988).
91
TEX. BUS. COM. C. §2.712 (stating “(a) After a breach within the preceding section the buyer may ‘cover’ by
making in good faith and without unreasonable delay any reasonable purchase of or contract to purchase goods in
84
Page 13
event of any breach by the seller.92 The primary purpose of Section 2.712 is to provide the buyer
with a remedy that enables him to obtain the goods or commodities he needs, thus allowing him
to continue to run his business regardless of whether the seller performs under the contract. In
comparison to the seller’s remedies, this remedy is the buyer’s equivalent of the seller’s right to
resell.93
Subsection (a) provides that upon the seller’s breach, the buyer may effect “cover” by
promptly purchasing substitute goods on commercially reasonable terms.94 Texas law requires
that in order to be entitled to “cover” damages under this section, a plaintiff must plead and
prove that the goods or commodity were either not delivered at all or were non-conforming in
such a way that the value of the non-conforming or undelivered products was substantially
impaired.95
This subsection has generated substantial litigation regarding whether the “cover”
obtained by the buyer was “reasonable” within the meaning of the statute.96 Texas courts have
held that the test of proper cover is whether at the time and place the buyer acted in good faith
and in a reasonable manner.97 Courts also require that the type of substitute goods acquired by
the buyer must be a reasonable substitute for the undelivered or non-conforming goods.98 The
crucial time for determining the reasonableness of cover is the time at which the buyer learns of
the breach; therefore, “it is immaterial that hindsight may later prove that the method of cover
used was not the cheapest or most effective.”99 Courts have also held that the buyer must act to
procure substitute goods “without unreasonable delay.”100 However, the requirement that the
buyer cover “without unreasonable delay” does not act as a strict limit on the time the buyer may
substitution for those due from the seller; (b) The buyer may recover from the seller as damages the difference
between the cost of cover and the contract price together with any incidental or consequential damages as hereinafter
defined (Section 2.715), but less expenses saved in consequence of the seller’s breach; (c) Failure of the buyer to
effect cover within this section does not bar him from any other remedy”); see also Aztec Corp. v. Tubular Steel,
Inc., 758 S.W.2d 793, 799-800 (Tex. App. -- Houston [14th Dist.] 1988) (stating that “[d]amages may exceed the
price paid upon findings by the jury of cost of cover exceeding contract price and by findings of incidental or
consequential damages”).
92
TEX. BUS. COM. C. §2.712; Manon v. Tejas Toyota, Inc., 162 S.W.3d 743, 747 (Tex. App.-- Houston [14th Dist.]
2005).
93
TEX. BUS. COM. C. §2.712, cmt. 1.
94
TEX. BUS. COM. C. §2.712(a).
95
Manon v. Tejas Toyota, Inc., 162 S.W.3d 743, 747 (Tex. App.--Houston [14th Dist.] 2005, no pet.) (finding that in
order for the value of a good to be “substantially impaired,” the good or commodity must not be capable of its
intended use by the party).
96
See, e.g., id.; Equitable Res. Marketing Co. v. U.S. Gas Transp., Inc., 2001 WL 533808 (Tex. App. – Dallas
2001).
97
Aquamarine Associates v. Burton Shipyard, Inc., 645 S.W.2d 477, 480 (Tex. App. 9 Dist., 1982) (citing Teenan v.
Jurek, 215 N.W.2d 698, 702 (Minn. Sup. 1977)).
98
Mueller v. McGill, 870 S.W.2d 673, 675 (Tex. App.—Houston [1st Dist.] 1994) (discussing whether a 1986
automobile was a reasonable substitute for a 1985 automobile).
99
TEX. BUS. COM. C. §2.712, cmt. 2; §2.713, cmt. 1 (discussing the buyer’s damages for non-delivery or repudiation
in the event that the buyer does not choose to cover, and stating that “the crucial time is the time at which the buyer
learns of the breach”); see also Jon-T Farms, Inc. v. Goodpasture, Inc., 554 S.W.2d 743, 749-50 (Tex. Civ. App.
1977, rev’d on other grounds) (discussing the time at which the buyer discovers the breach).
100
Mueller, at 675-76; Aquamarine, at 480.
Page 14
take “to examine the situation and available remedies, and determine the best method of
effecting cover.”101
Article 2 presumes that the cost of cover will approximate the market price of the
undelivered goods.102 Therefore, the U.C.C. presumes that the “cover” procured by the buyer,
and the price paid for it, is proper. The burden, therefore, is on the seller to show otherwise;
however, the presumption of propriety and reasonableness arises only when the buyer proves that
it has complied with the requirements of Section 2.712.103 This burden does not, however,
require the buyer to show the market price at the time of the breach, unless the reasonableness of
the price paid for the substitute goods is called into question.
Section 2.712(b) provides that if the buyer is able to purchase substitute goods, the buyer
may then recover from the seller the difference between the cost of cover and the contract price,
together with any incidental or consequential damages, but less expenses saved in consequence
of the seller’s breach. Subsection (c) provides that the buyer may “cover” at its option; the
wronged buyer may “cover” as a means of minimizing damages, but his failure to effect cover
does not bar him from any other remedy. Neither this Section 2.712(c), nor any other Code
provision, actually requires the buyer to purchase or attempt to purchase substitute goods in the
event of a breach by the seller; the buyer may elect not to cover and still sue the seller for
damages, including any consequential damages incurred as a result of the breach. However, the
buyer’s recovery of consequential damages will be limited to those damages that could not have
been prevented had substitute goods been obtained.104 Therefore, the buyer is always free to
choose between damages based on the difference between the contract price and the cost of
cover under Section 2.712, and damages for non-delivery under Section 2.713, which consist of
the difference between the market price at the time when the buyer learns of the breach and the
contract price.105
Section 2.713 outlines the buyer’s primary recourse against the seller in cases in which
the buyer does not cover and obtain substitute goods.106 Subsection (a) provides that the buyer’s
measure of damages when the buyer does not cover is the difference between the market price at
the time the buyer learned of the breach and the contract price, plus any incidental and
consequential damages, but less any expenses saved as a result of the breach.107 Subsection (b)
requires that, in the event of complete non-delivery, the market price be determined as of the
101
TEX. BUS. COM. C. §2.712, cmt. 2.
Kiser v. Lemco Indus., Inc., 536 S.W.2d 585, 589 (Tex. Civ. App.—Amarillo 1976, no writ).
103
Id.
104
TEX. BUS. COM. C. §2.712, cmt. 3.
105
TEX. BUS. COM. C. §2.712, cmt. 3
106
TEX. BUS. COM. C. §2.713 (stating “(a) Subject to the provisions of this chapter with respect to proof of market
price (Section 2.723), the measure of damages for non-delivery or repudiation by the seller is the difference between
the market price at the time when the buyer learned of the breach and the contract price together with any incidental
and consequential damages provided in this chapter (Section 2.715), but less expenses saved in consequence of the
seller’s breach; (b) Market price is to be determined as of the place for tender or, in cases of rejection after arrival or
revocation of acceptance, as of the place of arrival; (c) Evidence of a relevant price prevailing at a time or place
other than the one described in this chapter offered by one party is not admissible unless and until he has given to
the other party such notice as the court finds sufficient to prevent unfair surprise.”).
107
TEX. BUS. COM. C. §2.713(a).
102
Page 15
place for tender or, in the event that non-conforming goods are delivered, as of the place of
arrival.108
As discussed above, Article 2 assumes that the cover obtained, and the amount paid for it,
is proper; therefore, under Section 2.713, “[t]he general baseline… uses as a yardstick the market
in which the buyer would have obtained cover had he sought that relief.”109 The market price to
be used in calculating damages under this section is the price for goods of the same kind and in
the same branch of trade.110 However, determining the applicable market price is not as simple
as it may appear at first glance; parties’ attempts to determine the applicable market price has led
to substantial litigation in many industries. Making this determination in the energy industry can
be particularly problematic, because of the volatile nature of commodity prices, and the use of
different internally calculated price curves to determine the market price.
In effort to alleviate the difficulty in determining market price, Article 2 specifically
provides for reference to the market price of a comparable commodity, or, more commonly, of
the same commodity in a comparable market. Section 2.723(b) sets forth the acceptable method
of proving market price in such a situation.111 Where determining the market price at the time of
breach is difficult, the parties may reference the prevailing price for the commodity at any
reasonable time either before or after the breach or at any other commercially reasonable
location.112 Article 2 also specifically contemplates reference to the applicable spot sales price
when no market price is available.113 When the market price is unavailable because of the
scarcity of the good or commodity, opinion evidence regarding the value of the goods or
commodity is admissible.114 In such a situation, a liberal construction of allowable consequential
damages should also result.115
Section 2.714 sets forth the method by which a buyer who has accepted non-conforming
goods may recover damages.116 Generally, this remedy will be applicable only in cases in which
108
TEX. BUS. COM. C. §2.713(b).
TEX. BUS. COM. C. §2.713, cmt. 1.
110
TEX. BUS. COM. C. §2.713, cmt. 2.
111
TEX. BUS. COM. C. §2.723 (stating “(b) If evidence of a price prevailing at the times or places described in this
chapter is not readily available the price prevailing within any reasonable time before or after the time described or
at any other place which in commercial judgment or under usage of trade would serve as a reasonable substitute for
the one described may be used, making any proper allowance for the cost of transporting the goods to or from such
other place”).
112
TEX. BUS. COM. C. §2.723(b).
113
TEX. BUS. COM. C. §2.713, cmt. 3.
114
TEX. BUS. COM. C. §2.713, cmt. 3.
115
TEX. BUS. COM. C. §2.713, cmt. 3.
116
TEX. BUS. COM. C. §2.713 (stating “(a) Where the buyer has accepted goods and given notification he may
recover as damages for any non-conformity of tender the loss resulting in the ordinary course of events from the
seller’s breach as determined in any manner which is reasonable; (b) The measure of damages for breach of
warranty is the difference at the time and place of acceptance between the value of the goods accepted and the value
they would have had if they had been as warranted, unless special circumstances show proximate damages of a
different amount; (c) In a proper case any incidental and consequential damages under the next section may also be
recovered.”).
109
Page 16
the time for revocation of acceptance has passed.117 However, the remedy of Section 2.714 is
available not only in the event of a breach of warranty by the seller (i.e. the delivery of nonconforming goods), but also in the event of any failure of the seller to perform his obligations
under the contract.118 This section is somewhat unique, as it provides that the buyer may recover
in damages any loss resulting in the ordinary course of events from the seller’s breach, “as
determined in any manner which is reasonable.”119 A buyer who elects to pursue a remedy under
this subsection (a) must, however, strictly comply with its notice requirements.120 This section
also offers an additional remedy for a buyer who may still owe part of the purchase price.121
Further, subsection (b) describes the usual measure of damages for a breach of warranty
by the seller, which is measured as the difference at the time and place of acceptance between the
value of the goods accepted and the value the goods would have had if they had been as
warranted.122 This subsection does, however, contemplate that special circumstances may
warrant a recovery by the buyer of an amount of damages different from that calculated under
the usual method outlined in subsection (b).
Section 2.715 describes the method of calculating incidental and consequential damages
available under Sections 2.712, 2.713, and 2.714.123 This section is intended to reimburse the
buyer who incurs reasonable expenses in connection with rightfully rejected goods or in
connection with effecting cover where the seller breached by delivering non-conforming goods,
or none at all.124 Article 2 defines incidental damages resulting from the seller’s breach as those
expenses reasonably incurred in the inspection, receipt, transportation, care and custody of goods
rightfully rejected, together with any commercially reasonable expenses incurred in effecting
117
See TEX. BUS. COM. C. §2.714, cmt. 1.
TEX. BUS. COM. C.§2.714, cmt. 2.
119
TEX. BUS. COM. C. §2.714(a).
120
The notice requirements under this subsection reference §2.607. Section 2.607 requires that when a buyer has
initially accepted goods, the buyer must notify the seller of the breach within a reasonable time after the buyer
discovers, or should have discovered, the breach; failure to give such notice will bar the buyer from recovering
under any remedy. Section 2.607 also states that a buyer cannot later reject goods if, at the time of acceptance, the
buyer had knowledge of the non-conformity, unless the buyer accepted on the reasonable assumption that the nonconformity would seasonably be cured.
121
The primary remedy for a buyer who still owes is under §2.717, which allows the buyer to deduct all or any part
of damages resulting from any breach of the contract from any part of the price still due under the same contract.
See also §2.714, cmt. 1 (stating that the ability of a buyer to deduct damages from the price owed is an additional
remedy for a buyer who still owes part of the purchase price).
122
TEX. BUS. COM. C. §2.714(b).
123
TEX. BUS. COM. C. §2.715 (stating that “(a) Incidental damages resulting from the seller’s breach include
expenses reasonably incurred in the inspection, receipt, transportation and care and custody of good rightfully
rejected, any commercially reasonable charges, expenses or commissions in connection with effecting cover and any
other reasonable expense incident to the delay or other breach; (b) Consequential damages resulting from the seller’s
breach include: (1) any loss resulting from general or particular requirements and needs of which the seller at the
time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (2)
injury to person or property proximately resulting from any breach of warranty.”)
124
TEX. BUS. COM. C. §2.715, cmt. 1.
118
Page 17
cover. The buyer’s incidental damages also may include any other reasonable expenses incident
to any delay or other breach by the seller.125
Section 2.715(b) allows the buyer to recover consequential damages resulting from the
seller’s breach. However, the standard “tacit agreement” test is rejected by Article 2 in this
section. The general common-law approach to consequential damages made the breaching party
liable for all such damages of which he knew or had reason to know of prior to the breach. The
approach taken by Article 2 in this section limits the buyer’s recovery of consequential damages
to only those damages the buyer could not reasonably have prevented through effecting cover or
otherwise.126 In order to charge the seller with knowledge sufficient to enable the buyer to
recover consequential damages, any particular needs of a buyer must generally be made known
to the seller, while general needs must rarely be made explicitly known in order to charge the
seller with knowledge.127 The burden of proving the extent of the loss incurred as consequential
damages is on the buyer, but loss may be determined in any manner that is considered reasonable
under the circumstances.128
III. CONTRACTUAL RIGHTS AND REMEDIES
A. NAESB BASE CONTRACT FOR SALE AND PURCHASE OF NATURAL GAS
The North American Energy Standards Board Base Contract for Sale and Purchase of
Natural Gas (the “NAESB”) is the master agreement most commonly used to document natural
gas transactions. The NAESB provides specific remedies for a failure to deliver or receive gas
and upon the occurrence of Events of Default. The NAESB also contains specific provisions
granting the parties the right to demand adequate assurances of performance and provides a
remedy to the demanding party if the other party fails to comply with a proper request for
assurances.
1. Failure to deliver or receive gas
Section 3.2 of the NAESB provides for liquidated damages in the event the seller fails to
deliver, or the buyer fails to receive, quantities of gas agreed to in a transaction. The NAESB
requires the parties to elect to use either the “cover standard” or the “spot price standard” for
calculating liquidated damages.129 Once a remedy is selected, that remedy becomes the
exclusive remedy in the event of a breach of an obligation to deliver or receive gas.130
125
TEX. BUS. COM. C. §2.715(a).
TEX. BUS. COM. C. §2.715, cmt. 2.
127
TEX. BUS. COM. C. §2.715, cmt. 3.
128
TEX. BUS. COM. C. §2.715, cmt. 4.
129
NAESB §3.2.
130
See NAESB §3.2; see also §2.17 (stating that “Firm” shall mean that either party may interrupt its performance
without liability only to the extent that such performance is prevented by reasons of Force Majeure; provided
however that during Force Majeure interruptions, the party invoking Force Majeure may be responsible for any
Imbalance Charges as set forth in Section 4.3 related to its interruption after the nomination is made to the
Transporter and until the change in deliveries and/or receipts is confirmed by the Transporter”).
126
Page 18
The “Cover Standard” is defined by the NAESB to require the non-breaching party to use
commercially reasonable efforts to either obtain gas or an alternate fuel, or sell gas, at a price
that is reasonable for the delivery point or production area.131 The price paid or received by the
non-breaching party attempting to effect cover in this manner is the price that will be used to
calculate any payment due under Section 3.2. Under this “Cover Standard,” the reasonableness
of the price received or paid for gas may be affected by several factors, including (1) the amount
of notice provided by the nonperforming party; (2) the immediacy of the buyer’s consumption
needs or the seller’s sales requirements; (3) the quantities involved; and (4) the anticipated length
of failure by the breaching party.132
Section 3.2 sets forth the “Cover Standard” for calculating damages.133 Under this
section, if the seller fails to deliver the gas as required by the contract, the seller must pay to the
buyer the difference between the purchase price paid by the buyer utilizing the Cover Standard
and the Contract Price.134 Similarly, if the buyer fails to receive the gas as required by the
contract, the seller is entitled to the difference between the Contract Price and the price received
by the seller utilizing the Cover Standard.135 The damages calculated pursuant to this method
will, in both instances, be adjusted for commercially reasonable differences in transportation
costs to or from the delivery points, and for the percentage of the contracted-for quantity gas
actually taken by the buyer or delivered by the seller.136
131
NAESB §2.9 (providing that “Cover Standard shall mean that if there is an unexcused failure to take or deliver
any quantity of Gas pursuant to this Contract, then the performing party shall use commercially reasonable efforts to
(i) if Buyer is the performing party, obtain Gas (or an alternate fuel if elected by Buyer and Gas is not available), or
(ii) if Seller is the performing party, sell Gas, in either case, at a price reasonable for the delivery or production area,
as applicable, consistent with: the amount of notice provided by the nonperforming party; the immediacy of the
Buyer’s Gas consumption needs or Seller’s Gas sales requirements, as applicable; the quantities involved; and the
anticipated length of failure by the nonperforming party”).
132
NAESB §2.10.
133
NAESB §3.2 (defining “Cover Standard” as “[t]he sole and exclusive remedy of the parties in the event of a
breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach
by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the positive difference, if any, between
the purchase price paid by buyer utilizing the Cover Standard and the Contract Price, adjusted for commercially
reasonable differences in transportation costs to or from the Delivery Point(s), multiplied by the difference between
the Contract Quantity and the quantity actually delivered by Seller for such Day(s); or (ii) in the event of a breach by
Buyer on any Day(s), payment by Buyer to Seller in the amount equal to the positive difference, if any, between the
Contract Price and the price received by Seller utilizing the Cover Standard for the resale of such Gas, adjusted for
commercially reasonable differences in transportation costs to or from the Delivery Point(s) multiplied by the
difference between the Contract Quantity and the quantity actually taken by Buyer for such Day(s); or (iii) in the
event that Buyer has used commercially reasonable efforts to replace the Gas or Seller has used commercially
reasonable efforts to sell the Gas to a third party, and no such replacement or sale is available, then the sole and
exclusive remedy of the performing party shall be any unfavorable difference between the Contract Price and the
Spot Price, adjusted for such transportation to the applicable Deliver Point, multiplied by the difference between the
Contract Quantity and the quantity actually delivered by Seller and received by Buyer for such Day(s). Imbalance
Charges shall not be recovered under this Section 3.2, but Seller and/or Buyer shall be responsible for Imbalance
Charges, if any, as provided in Section 4.3. The amount of such unfavorable difference shall be payable five
Business Days after presentation of the performing party’s invoice, which shall set forth the basis upon which such
amount was calculated.”).
134
Id.
135
NAESB §3.2.
136
NAESB §3.2.
Page 19
The “Spot Price Standard,” offered as an alternative to the Cover Standard, sets forth a
materially different method of calculating damages.137 If a party fails to take or receive gas as
required by a transaction, the non-performing party must pay to the performing party the
difference between the Contract Price and the Spot Price. “Spot Price” is defined as the price
listed in the publication indicated on the Base Contract for the geographic location in closest
proximity to the delivery points for the relevant days.138 Additionally, both standards provide
that all charges assessed using either standard must be paid five business days after the
presentation of the performing party’s invoice setting forth the basis upon which such amount
was calculated.139
The NAESB allows the parties to elect an alternative measure of damages if they are
unsatisfied with the option offered by either the Cover Standard or the Spot Price Standard.
“Alternative Damages” are defined as any measure or amount of damages agreed upon by the
parties in a Transaction Confirmation.140 Alternative Damages may be used only when the
parties have expressly agreed to their use in a written transaction confirmation executed by both
parties.141
The NAESB requires the parties to make “commercially reasonable efforts” to buy or sell
gas before the aggrieved party will be entitled to damages for any failure to take or deliver.142
The NAESB also requires that the performing party’s efforts to obtain “cover” in this respect be
“commercially reasonable.” In addition to the “commercially reasonable” requirement, the
NAESB allows the non-breaching party, when assessing the reasonableness of the price of cover,
to take into account not only the time and place for tender, but also the amount of notice
provided by the nonperforming party, the immediacy of the buyer’s consumption needs or the
137
NAESB §3.2 (defining “Spot Price Standard” as “[t]he sole and exclusive remedy of the parties in the event of a
breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach
by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the difference between the Contract
Quantity and the actual quantity delivered by Seller and received by buyer for such Day(s), multiplied by the
positive difference, if any, obtained by subtracting the Contract Price from the Spot Price; or (ii) in the event of a
breach by Buyer on any Day(s), payment by Buyer to Seller in an amount equal to the difference between the
Contract Quantity and the actual quantity delivered by Seller and received by Buyer for such Day(s), multiplied by
the positive difference, if any, obtained by subtracting the applicable Spot Price from the Contract Price. Imbalance
Charges shall not be recovered under this Section 3.2, but Seller and/or Buyer shall be responsible for imbalance
Charges, if any, as provided in Section 4.3. The amount of such unfavorable difference shall be payable five
Business Days after presentation of the performing party’s invoice, which shall set forth the basis upon which such
amount was calculated.”).
138
NAESB §2.26. This section refers to the “price listed in the publication indicated on the Base Contract;” thus, if
the parties choose the Spot Price Standard for calculating damages, the parties must then select a reliable market
publication that will allow them to determine the spot price on any given day. This section also provides that if
there is no single spot price published for a particular location on a particular day, but there is a published range of
prices, then the spot price will be the average of the highest and lowest prices listed. If there is no range of prices
published, then the spot price will be the average of (1) the price for the first day for which a price or range of prices
is published that next precedes the day(s) of the breach, and (2) the price for the first day for which a price or range
of prices is published after the day of the breach.
139
NAESB §3.2.
140
NAESB §2.1.
141
NAESB §3.3.
142
NAESB §3.2.
Page 20
seller’s sales requirements, the quantities involved, and the anticipated length of failure by the
nonperforming party.143 Notably, both the Cover Standard and the Spot Price Standard expressly
address the payment of imbalance charges and provide that such charges will be paid by the
party whose act or omission caused such charges to be imposed.144 The NAESB also requires
that any amount owed for failure to deliver or accept must be paid within five business days after
receipt of an invoice detailing the manner in which any damages were calculated.
These remedy elections differ in scope from those offered in the U.C.C. First, unlike the
NAESB, the U.C.C. applies the “perfect tender” rule, which labels any failure by either party to
deliver or receive goods in perfect conformity with the terms of the contract as a “breach.”145
Under the U.C.C., any breach gives the non-breaching party the right to exercise certain
remedies, and, in certain circumstances, terminate the contract. The NAESB, like most energy
commodity contracts, does not apply the “perfect tender” rule, but instead lists certain Events of
Default, the occurrence of which gives the performing party the right to suspend its performance
and/or terminate the contract. Not every failure to comply with the obligations of the contract
constitutes an Event of Default. Most notably, perhaps, is that the failure to deliver or receive
the quantity of a commodity identified by the contract does not constitute an Event of Default
under the NAESB; the NAESB simply sets forth a method of calculating the payment that must
be made to the performing party in the event the counterparty fails to delver or receive the
requisite amount of gas. Under the U.C.C., upon a failure by the buyer to receive gas, the seller
may be entitled to suspend further deliveries, resell the gas not received by buyer and recover
costs and incidental damages associated with the resale, and, if the rejection goes to the whole
contract, terminate the contract.146 Upon the failure by the seller to deliver gas, the buyer may be
entitled to cancel the contract if the seller’s failure goes to the whole contract, and/or cover
damages or specific performance of seller’s obligations.147 The NAESB requires both seller and
buyer to sacrifice the opportunity to exercise powerful remedies in exchange for the certainty
that their liability will be limited to cover damages and costs.
The NAESB also requires the parties to make “commercially reasonable efforts” to buy
or sell gas before the aggrieved party will be entitled to damages for any failure to take or
deliver; the Code, however, does not require the non-breaching party to attempt to mitigate its
damages before being entitled to exercise any remedy. The Code merely limits the nonbreaching party’s recovery of consequential damages in the event the party fails to cover.148
143
NAESB §2.9.
NAESB §4.3 (providing that “[t]he parties shall use commercially reasonable efforts to avoid the imposition of
Imbalance Charges. If Buyer or Seller receives an invoice from a Transporter that includes imbalance charges, the
parties shall determine the validity as well as the cause of such Imbalance Charges. If the Imbalance Charges were
incurred as a result of Buyer’s receipt of quantities of Gas greater than or less than the Scheduled Gas, then Buyer
shall pay for such Imbalance Charges or reimburse Seller for such Imbalance charges paid by Seller. If the
Imbalance Charges were incurred as a result of Seller’s deliver of quantities of Gas greater than or less than the
Scheduled Gas, then Seller shall pay for such Imbalance Charges or reimburse buyer for such Imbalance Charges
paid by Buyer”).
145
Tex. Bus. Com. C. §2.601; 2.703.
146
See infra [fill in reference to final section numbers]; TEX. BUS. COM. C. §§2.609; 2.612; 2.703.
147
See infra [fill in reference to final section numbers]; TEX. BUS. COM. C. §§2.612; 2.711; 2.716.
148
See Tex. Bus. Com. C. §2.712(c).
144
Page 21
2. Events of Default
The NAESB sets forth specific acts and omissions of either a party or a party’s guarantor
that constitute Events of Default, including (1) failing to give adequate assurance of performance
within 48 hours after a request; (2) failing to pay any amount due on or before the second day
following written notice that such payment is due; (3) making an assignment or any general
arrangement for the benefit of creditors; (4) filing a petition in bankruptcy; and (5) being unable
to pay debts as they become due.149 As discussed above, neither the seller’s failure to comply
with its delivery obligations nor the buyer’s failure to receive the amount of gas contracted for
constitutes an Event of Default.150
Upon the occurrence of an Event of Default, the non-defaulting party may withhold or
suspend deliveries or payments upon notice to the defaulting party.151 If any Event of Default
has occurred and is continuing, the non-breaching party may designate an Early Termination
Date, and liquidate and terminate all transactions under the contract upon notice to the defaulting
party.152 The NAESB prohibits the non-breaching party from terminating less than all
transactions existing under the agreement between the parties.153
If an Event of Default occurs, and the non-breaching party elects to declare an early
termination date instead of merely suspending its own performance, the parties may choose
whether early termination damages will be applied.154 If the parties have elected early
termination damages, the non-defaulting party will determine the amount owed by each party
with respect to all gas delivered and received on or before the early termination date and the
market value of each terminated transaction. The non-defaulting party will then liquidate and
accelerate each terminated transaction at its market value. If the market value155 exceeds the
contract value,156 a termination payment will be owed to the buyer; if the contract value exceeds
the market value, a payment will be owed to the seller.157 The amount calculated using this
formula will be discounted to present value in a commercially reasonable manner.158
149
NAESB §10.2.
See id.
151
NAESB §10.2.
152
NAESB §10.3.
153
NAESB §10.3.
154
NAESB §10.3.1.
155
Market value means the amount of gas remaining to be delivered or purchased under a transaction multiplied by
the market price for a similar transaction at the Delivery Point determined by the non-defaulting party in a
commercially reasonable manner. To ascertain the Market Value, the non-defaulting party may consider, among
other valuations, any or all of the settlement prices of NYMEX Gas futures contracts, quotations frm leading dealers
in energy swap contracts or physical gas trading markets, similar sales or purchases and any other bona fide thirdparty offers, all adjusted for the length of the term and differences in transportation costs.
156
Contract value means the amount of Gas remaining to be delivered or purchased under a transaction multiplied
by the contract price.
157
NAESB §10.3.1.
158
NAESB §10.3.1.
150
Page 22
If early termination damages do not apply, as of the early termination date, the nondefaulting party will determine in good faith and in a commercially reasonable manner the
amount owed by each party with respect to all gas delivered and received between the parties in
the terminated transactions on or before the early termination date for which payment has not yet
been made, and the only payment owed between the parties will be this amount.159 The NAESB
also allows the parties to select whether they want the netting and set-off provisions to apply to
other agreements existing between the parties or just to the NAESB itself.160
The occurrence of an events of default under the NAESB results in damages very similar
to what the parties would receive under the U.C.C. in the event of a breach. While the NAESB
adds specificity as to how the damages will be calculated and remedies enforced, the end result
following an Event of Default will be substantially similar under the NAESB and UCC.
However, there are some distinctions to be made. First, while the NAESB would likely
be considered an installment contract under the U.C.C., parties to the NAESB are not required to
determine whether a breach “impairs the value of the contract as a whole” in order to determine
whether they may terminate the contract; if an act or omission listed as an Event of Default in the
NAESB occurs, the non-breaching party may terminate the contract, with no further analysis
required.161
Also, under the U.C.C., the mere occurrence of a breach gives the performing party the
right to terminate the contract.162 Under the NAESB, an Event of Default must “have occurred
and be continuing” in order to allow the non-breaching party the right to terminate; cure by the
defaulting party will eliminate the performing party’s right to terminate. In addition, the NAESB
allows a non-breaching party to suspend its performance only when terminating and liquidating
the contract in its entirety upon the occurrence of an Event of Default. The Code, however,
allows the parties to exercise certain remedies, such as refusing to deliver goods to a buyer who
is insolvent, without requiring termination of the contract.163
The NAESB also allows the parties to choose whether certain Early Termination
Damages will be applied if an Event of Default occurs, and the non-breaching party elects to
terminate all outstanding transactions; no such damages are available under the Code.164 Unlike
the NAESB, the Code also does not provide a mechanism by which any amounts calculated may
be discounted to present value.165 The NAESB allows the parties to net and set-off the amounts
owed between different transactions existing between the parties, and even between agreements
other than the NAESB. There is no right of netting and setoff recognized under the U.C.C.
3. Adequate assurance of performance
159
NAESB §10.3.1.
NAESB §10.3.2
161
TEX. BUS. COM. C. §2.612.
162
See TEX. BUS. COM. C. §2.712(c).
163
See TEX. BUS. COM. C. §2.702.
164
NAESB §10.3.1.
165
NAESB §10.3.1.
160
Page 23
The NAESB allows either party to demand adequate assurance of performance if the
party has reasonable grounds for insecurity regarding the performance of any obligation by the
other party, whether or not the obligation is then due.166 A “reasonable” ground for insecurity
specifically includes the occurrence of a material change in the creditworthiness of the party.167
The NAESB describes an “adequate assurance of performance” as sufficient security in a form,
amount, and term reasonably acceptable to the requesting party, which may include a letter of
credit, a prepayment, a security interest, or a performance bond or parental guarantee.168 Failure
to provide properly requested assurance within 48 hours of the request constitutes an Event of
Default.169
The NAESB’s adequate assurance rights are both more limited and more strict than those
provided in the UCC. The principal differences between the NAESB’s adequate assurances
provision and the equivalent provision in the UCC are (i) the UCC permits the demanding party
to suspend performance during the period between the date the demand is delivered to the other
party and the earlier of the date the assurance is posted or the period for delivering assurance
expires, while the NAESB does not allow the suspension of performance by the demanding
party; and (ii) the NAESB requires the delivery of adequate assurance within forty-eight hours of
the demand, which is substantially different than the U.C.C. that provides a thirty-day window in
which assurance must be posted.170 The cure period allowed by the NAESB is much shorter than
that allowed by the U.C.C., and so offers more protection to a party who reasonably requests
such assurances.171
Unlike the Code, the NAESB does not address anticipatory repudiation by either party,
although any failure to perform any obligation relating to Credit Support will constitute an Event
of Default.172 Under the NAESB, however, insolvency by either party is an Event of Default,
which gives the non-defaulting party the right to immediately withhold and/or suspend deliveries
or payments upon giving notice to the defaulting party, or terminate and liquidate all
transactions.173 There is, however, no right to reclaim under the NAESB. Furthermore, the
nature of the commodity sold under the NAESB makes stopping delivery or reclamation not
feasible in most cases.
The NAESB also specifically addresses imbalance charges and provides that they will be
paid by the party who caused such charges.174 The NAESB also specifically requires the buyer,
166
NAESB §10.1.
Id.
168
NAESB §10.1.
169
NAESB §10.2.
170
TEX. BUS. COM. C. §2.609.
171
The seller may only exercise these rights if the buyer is actually insolvent. ‘Insolvent’ is defined as “having
generally ceased to pay debts in the ordinary course of business other than as a result of a bona fide dispute,” or
“being insolvent within the meaning of the federal bankruptcy law.” TEX. BUS. COM. C. §1.201(23)(a).
172
NAESB §10.2.
173
NAESB §10.2(iv).
174
NAESB §4.3 (providing that “[t]he parties shall use commercially reasonable efforts to avoid the imposition of
Imbalance Charges. If Buyer or Seller receives an invoice from a Transporter that includes imbalance charges, the
parties shall determine the validity as well as the cause of such Imbalance Charges. If the Imbalance Charges were
167
Page 24
in the event of a breach by the seller, to obtain an alternate fuel if buyer is capable of utilizing the
alternate fuel, or if gas is not available.175 Also of note is the fact that the NAESB allows the
parties to elect to use “alternative damages,” which are any measure or amount of damages
agreed upon by the parties in a Transaction Confirmation. Alternative Damages may be used
only when the parties have expressly agreed to their use in a written transaction confirmation
executed by both parties.176
B. MASTER COAL PURCHASE AND SALE AGREEMENT
The Master Coal Purchase and Sale Agreement (the “Master Agreement”) is commonly
used in the purchase and sale of coal in North America. 177
1. Failure to deliver or receive coal
Like the NAESB, the Master Agreement does not adhere to the perfect tender rule and
thus does not label every failure to deliver or receive in perfect conformity with the terms of a
transaction as a “breach.” A failure to deliver or receive coal as specified in the applicable
transaction does not constitute a breach or an event of default; the Master Agreement provides a
specific method for calculating damages if the seller or buyer fails in its delivery or receipt
obligations prior to the non-defaulting party’s early termination of a transaction due to the
occurrence of an event of default under Section 8.1.178 If the seller fails to deliver, the seller
must pay to the buyer the difference between the lowest reasonable market price at which buyer
is able, or would have been able at the time of the breach, to purchase coal of comparable quality
minus the contract price on an SO2 adjusted basis.179 If buyer fails or refuses delivery of
conforming coal, the buyer must pay to the seller the difference between the contract price, and
the highest reasonable market price at which seller is able or would be able to sell the coal at the
time of the breach.180 The Master Agreement requires the non-defaulting party to make
“commercially reasonable” efforts to mitigate its damages when making a claim for a failure to
deliver or receive.181 If the parties agree in writing, the non-defaulting party may schedule
deliveries or receipts in order to discharge the defaulting party’s obligation to pay damages.182
Furthermore, section 8.4(a) allows for the payment of alternative damages using any method
specified by the parties and agreed to in writing.
incurred as a result of Buyer’s receipt of quantities of Gas greater than or less than the Scheduled Gas, then Buyer
shall pay for such Imbalance Charges or reimburse Seller for such Imbalance charges paid by Seller. If the
Imbalance Charges were incurred as a result of Seller’s deliver of quantities of Gas greater than or less than the
Scheduled Gas, then Seller shall pay for such Imbalance Charges or reimburse buyer for such Imbalance Charges
paid by Buyer.”).
175
NAESB §2.9.
176
NAESB §3.3.
177
NAESB §2.9.
178
Master Agreement §8.4.
179
Master Agreement §8.4(b).
180
Master Agreement §8.4(c).
181
Master Agreement §8.4(d).
182
Master Agreement §8.4(a).
Page 25
Section 5.2 of the Master Agreement allows a buyer to reject any non-conforming
shipment of coal that falls within the Rejection Limits identified in each transaction by giving
notice to the seller within twenty-four hours of the time the buyer receives an analysis indicating
that the coal is non-conforming; however, the delivery of non-conforming coal constitutes an
Event of Default only if the failure occurs on more than one occasion within a specific time
period.183 If a seller delivers non-conforming coal, and the delivery does not constitute an Event
of Default, the seller must remove any non-conforming coal rejected by the buyer from the
buyer’s place of business at seller’s expense and replace the non-conforming coal within a
reasonable period of time if the buyer notifies seller of a desire to receive replacement coal
within 48 hours.184
Upon giving the required notice to the seller, the buyer may either reject the shipment at
the delivery point or while the coal is in route (but prior to unloading the coal from the
transporter’s equipment), or accept the non-conforming coal and adjust the contract price by
using the very specific formula set forth in Section 5.2.185 Under Section 5.2, if the buyer
accepts the non-conforming coal, the buyer may adjust the contract price of all non-conforming
shipments by 12.5 percent of the FOB Mine Price if the FOB Mine Price is greater than $8.00
per ton, or 25 percent of the FOB Mine Price if the FOB Mine Price is equal to or less than $8.00
per ton. Notably, the Master Agreement specifically states that the buyer’s failure to provide
notice of the rejection to the seller within the requisite 24-hour time period does not act as a bar
to the buyer’s ability to recover a penalty adjustment calculated under the formula set forth
183
See Master Agreement §4.4. The seller, who is identified as the Sampling Person, designates a certified lab,
known as the Analysis Person, to perform the requisite analysis of each shipment of coal. The Analysis Person
determines whether the coal is falls within the Rejection Limits specified in the confirmation. “Rejection Limits”
may differ between loads; the Rejection Limits for each load as identified by the seller in a written confirmation that
is delivered to the buyer after an oral transaction is made. Master Agreement §1.2. Section 5.2 of the Master
Agreement identifies the Buyer’s Rejection Rights, and states “[u]nless otherwise specified in the relevant
Confirmation, if any Shipment of Coal triggers any of the Rejection Limits specified in the Confirmation for a
Transaction (a “Non-Conforming Shipment”), Buyer shall have the option, exercisable by notice to Seller within
twenty-four hours of Buyer’s receipt of the Sampling Person’s short proximate analysis and additional analysis, if
any, of the Coal provided pursuant to Article 4.4, of either (i) rejecting such Non-Conforming Shipment at the
Delivery Point or in route, but prior to unloading from Transporter’s equipment or (ii) accepting any NonConforming Shipment with a Contract Price adjustment equal to (1) 12.5% of the FOB Mine Price if such FOB
Mine Price is greater than $8.00 per ton or (2) 25% of the FOB Mine Price if such FOB Mine Price is equal to or
less than $8.00 per ton. If Buyer fails timely to exercise its rejection rights under this Article 5.2 as to a Shipment,
Buyer shall be deemed to have waived such rights to reject with respect to that Shipment only. Buyer’s failure to
timely exercise such notice does not however, constitute a waiver of its right to any penalty adjustment provided for
herein or in the relevant confirmation with respect to such Non-Conforming Shipment. If Buyer timely rejects the
Non-Conforming Shipment, Seller shall be responsible for promptly transporting the rejected Coal to an alternative
destination determined by Seller and, if applicable, promptly unloading such coal and shall reimburse Buyer for all
reasonable costs and expenses associated with the transportation, storage, handling and removal for the NonConforming Shipment. Seller shall, at Buyer’s election, replace the rejected coal within a reasonable period of time,
provided that Buyer gives written notice to Seller of its desire for replacement coal within forty-eight hours after
rejection for the Non-Conforming Shipment.”
184
Master Agreement §5.2.
185
Master Agreement §5.2.
Page 26
above; however, it appears that the buyer’s failure to provide notice of rejection within the 24hour time period does waive the buyer’s right to reject the shipment entirely.186
Additionally, section 3.5 allows the seller the right to give timely notice to the buyer, and
provide coal from a source other than that identified in the confirmation, without those actions
constituting an Event of Default; while the buyer must approve the substitution, the approval
may not be unreasonably withheld, provided, however, that the seller will be responsible for any
increased costs associated with the substitution.187
This general standard for calculating liquidated damages in the event of a failure to
deliver or receive coal by the buyer or seller is closely analogous to the “cover standard” adopted
by the U.C.C. However, unlike the Code, the Master Coal Agreement requires that the nondefaulting party use commercially reasonable efforts to mitigate its damages when making a
claim for a failure to deliver or receive.188
The Master Agreement requires the buyer to give notice of the rejection within 24 hours
after receipt of the sample analysis; the requirement that the buyer act within 24 hours of
receiving notice that a shipment is non-conforming is different from Article 2’s requirement that
the buyer reject and cover only without “unreasonable delay.”189 The Master Agreement
additionally allows a buyer to reject non-conforming coal while it is in route or at the delivery
point, but requires the rejection to take place before the coal is unloaded from the transporter’s
equipment.190 Article 2 imposes no such time limitations on the buyer’s right to reject nonconforming goods. The Master Agreement also requires the seller to remove any nonconforming coal from buyer’s place of business at seller’s expense, and replace the nonconforming coal within a reasonable period of time if the buyer notifies seller of a desire to
receive replacement coal within 48 hours.191 While Article 2 allows for the recovery of
additional transportation costs by the non-breaching party, it does not directly impose the
responsibility for transporting the non-conforming goods to an alternate location on the
defaulting party, as is the case under the Master Agreement.192 Article 2 does provide for the
recovery by the buyer of all costs associated with the receipt, storage, care and transportation of
any goods delivered but later rightfully rejected by the buyer; however, Article 2 does not require
the seller to remove the goods from the delivery location and replace the rejected goods with
conforming goods within such a strict time period.193
186
Master Agreement §5.2.
Master Agreement §3.5 (stating “[u]nless otherwise restricted by the subject Confirmation, Seller shall, by giving
timely notice as provided in Section 3.2 above, have the option, subject to Buyer’s approval, not to be unreasonably
withheld, to provide the Coal from any alternate source Seller may select. Any such substituted Coal must comply
with all Specifications for the Coal to be replaced and be otherwise acceptable to Buyer.”).
188
Master Agreement §§8.3; 8.4(d).
189
TEX. BUX. COMM. C. §2.712(a).
190
TEX. BUS. COM. C. §2.602.
191
Master Agreement §5.2
192
TEX. BUS. COM. C. §2.712; 2.715.
193
TEX. BUX. COMM. C. §2.715.
187
Page 27
Section 3.3(d) addresses charges or penalties incurred as a result of a party’s failure to
timely and appropriately load or unload coal.194 Under this subsection, unless the failure to
properly load or unload is a result of Force Majeure, the party whose failure incurred the charges
must either pay the charges or penalties directly, or reimburse the other party who paid the
charges. No such provision is made in Article 2.
Another important distinction between Article 2 and the Master Agreement is the Master
Agreement’s inclusion of a very specific formula for calculating damages upon the delivery of
non-conforming coal, which is based on the FOB mine price per ton.195 Use of Article 2’s cover
standard for calculating damages would result in a substantially different amount of damages
owed than that calculated using the formula set forth in the Master Agreement.
2. Events of Default
Section 8.1 identifies Events of Default that may apply to either party, which include (1)
the failure to pay when due any required payment if such failure is not remedied within three
business days after receiving written notice thereof; (2) the failure to comply with any “material
obligations” under a transaction, if the failure is not remedied within 10 business days after
written notice thereof; (3) being subject to a bankruptcy proceeding; (4) the failure of a party’s
guarantor, if any, to perform any covenant in its guaranty, such as allowing the guaranty to
expire; and (5) any representation or warranty made by a party is untrue in any material respect
when made.196
The Master Agreement also includes a separate section setting forth the specific
circumstances in which the buyer may declare an Event of Default with respect to a specific
transaction.197 If there are three non-conforming shipments within any three-month period, or if
194
Master Agreement § 3.3(d) (stating “[i]f a Party involved in a Transaction is charged for any increased
transportation charges, penalties, or other costs, including demurrage, attributable to the other Party’s failure to
timely and appropriately load or unload the Coal in accordance with the terms of the Transaction or the timing and
tonnage requirements of the Transportation Specification, and if such failure is not due to Force Majeure, failure of
the other party or the other Party’s railcars or transportation carrier, such failing Party shall promptly reimburse the
other for such actual charges, if such charges are usual and customary, after written notice thereof.”)
195
Master Agreement §5.2(ii).
196
Master Agreement §8.1. Notably, the term “material obligations” is not defined by the Master Agreement.
197
Master Agreement §5.3 (stating “[i]f there are three (3) Non-Conforming Shipments, whether rejected or not,
under a Transaction in any three (3) month period or if two (2) out of four (4) consecutive Shipments under a
Transaction (with respect to barge coal the preceding test shall be determined by one (1) or more rejectable barges
being loaded in each of two days of sequential Shipments under a given Transaction whether or not there are any
intervening days without Shipments) are Non-Conforming Shipments, or should Seller fail to meet one or more
Schedule 2 Periodic Performance Quality Limits as set forth in a Schedule 2 to a Confirmation, as the case may be,
then Buyer may upon notice to Seller suspend the receipt of future Shipments (except Shipments already loaded or
in transit to Buyer) under such Transaction. A waiver by Buyer of the suspension right for any one period shall not
constitute a waiver for subsequent periods. If Seller, within ten days of its receipt of such notice, provides
reasonable assurances in writing to Buyer that Future Shipments under the Transaction will conform to the
Specifications and Buyer has accepted such assurances ) such acceptance not to be unreasonably withheld),
Shipments shall resume and any tonnage deficiency shall be made upon within the Term at Buyer’s option. If (i)
Seller fails to provide such acceptable assurances within such ten day period, or (ii) after such assurances are
provided and for a period of three months thereafter, any Shipments of Coal trigger any of Buyer’s rejection rights
under Article 5.2 for the Rejection Limit parameter for which there was a prior suspension under such Transaction
Page 28
two out of four consecutive shipments under a single transaction are non-conforming, the buyer
may give notice to the seller and suspend the receipt of all future shipments, except those already
loaded or in transit.198 Upon receipt of notice, the seller is then allowed ten days in which to
provide assurances of performance acceptable to buyer and cure the Event of Default.199 If the
seller either fails to deliver the assurances of performance, or delivers any non-conforming
shipments within the three-month period following the request for assurances of performance,
the buyer may declare that an Event of Default has occurred with respect to the transaction.200
If an Event of Default occurs with respect to either party, the non-defaulting party may,
during the continuance of an Event of Default, either suspend its own performance, (including all
payment obligations). until the Event of Default is cured or accelerate and liquidate the Parties’
obligations under the Master Agreement and all transactions by deciding on and notifying the
defaulting party of an early termination date and suspending performance of its obligations under
the Master Agreement until the default is cured.201 If an early termination date is established, the
non-defaulting party will net and offset all outstanding amounts owed between the parties for all
terminated transactions; the Master Agreement does not allow parties the option to net and setoff
amounts owed between the parties pursuant to agreements other than the Master Agreement.202
However, unlike the NAESB, in most situations, the Master Agreement allows the nondefaulting party the option to terminate all transactions under the Master Agreement, or only the
transaction that gave rise to the Event of Default.203
The Master Agreement does provide a ten-day cure period, in which the seller may cut
off the buyer’s right to terminate the contract by providing adequate assurances of performance
to the buyer that all future shipments will conform to the requirements of the contract.204 Upon
receipt of notice, the seller is then allowed ten days in which to provide assurances of
performance acceptable to buyer, and cure the Event of Default. If the seller either fails to
deliver the assurances of performance, or delivers any non-conforming shipments within the
three-month period following the request for assurances of performance, the buyer may declare
that an Event of Default has occurred with respect to the transaction.205
or should Seller fail to meet one or more Schedule 2 Periodic Performance Quality Limits as set forth in a Schedule
2 to a Confirmation, as the case may be, then such failure shall constitute an Event of Default (as hereinafter
defined) with respect to such Transaction.”).
198
Master Agreement §5.3
199
Master Agreement §5.3
200
Master Agreement §5.3.
201
Master Agreement §8.2.
202
Master Agreement §8.3. It is important to note that if a non-breaching party declares an Early Termination Date,
that party may, in its sole discretion, choose to terminate all Transactions between the parties, or terminate only the
transactions giving rise to the Event of Default. Master Agreement §8.2.
203
Master Agreement §8.2. Allowing the non-defaulting party the option to terminate all transactions or only the
transaction that gave rise to the Event of Default if the triggering “Event of Default” is one described in Sections
8.1(a)(i), (ii), or (iv)-(x).
204
Master Agreement §5.3.
205
Master Agreement §5.3.
Page 29
The Master Agreement also allows the parties the right to net and setoff all obligations
owing between the parties, whether for a particular transaction, or for all transactions under the
Master Agreement.206
Additionally, the Master Agreement includes an arbitration provision, requiring all
disputes under the agreement to be submitted to binding arbitration.
Events of Default under the Master Agreement differ from the Code in several ways.
First, the Master Agreement offers a substantial improvement in the enforceability of oral
transactions than that offered by the Code. The Master Agreement expressly recognizes the
validity and enforceability of oral transactions, an option not offered by the Code, which requires
a writing for all transactions over $500.00. Second, the Master Agreement allows a failure to
deliver by the seller to constitute an Event of Default only if the failure occurs on more than one
occasion, and within the time period specified in the contract. This leniency clearly is not
mirrored by the Code, which labels any failure by the seller to make perfect tender a breach.207
Third, the Master Agreement sets forth very specific circumstances in which the buyer
can rightfully suspend future shipments of coal, except those shipments already loaded or in
transit.208 The Master Coal Agreement varies from both the NAESB and the U.C.C., as it does
not allow the seller the right to refuse delivery if the buyer is insolvent; the seller may only
suspend its performance if the buyer becomes subject to a bankruptcy proceeding. Mere
insolvency, as defined by the U.C.C., is insufficient to allow the seller to suspend its
performance under the Master Agreement. This provision does not correspond with Article 2,
which allows a seller to stop delivery of goods in the possession of a carrier when he discovers
the buyer to be insolvent.209 Furthermore, the seller has no right to reclaim under the Master
Coal Agreement, as it would under the Code.
Further, unlike the Code, the Master Coal Agreement provides that the failure of a party’s
guarantor to perform any obligation under its guaranty, such as allowing the guaranty to expire,
will constitute an Event of Default.210 While a guaranty clearly is related to the underlying
agreement (here, the Master Coal Agreement) such that a breach of any obligations in the
guaranty could rationally be imputed to the underlying agreement, the Code does not specifically
provide that the breach of a party’s obligations under a separate agreement such as a guaranty
automatically will constitute a default under the main agreement between the parties. The Code
certainly does not label any failure by a third party to perform its obligations under a separate
agreement as a breach of a party’s obligations under the main agreement. Furthermore, the
Master Coal Agreement allows the parties to select a provision that makes the parent’s or
guarantor’s default on any indebtedness to third parties that results in such indebtedness being
206
Master Agreement §§6.2; 8.3.
TEX. BUS. & COM. C. §§2.601; 2.703.
208
Master Agreement §5.3.
209
TEX. BUS COMM. C. §2.705.
210
Master Agreement §8.1(iv).
207
Page 30
accelerated or being capable of becoming accelerated as an Event of Default.211 There is no
analogous mechanism in the Code.
Additionally, the Master Coal Agreement sets forth very specific circumstances in which
the buyer can rightfully suspend future shipments of coal.212 While Article 2 does allow a buyer
to refuse future shipments, the buyer is only allowed to do so under Article 2 when exercising
termination rights.213 The Master Coal Agreement, however, provides a ten-day cure period, in
which the seller may cut off the buyer’s right to terminate the contract by providing adequate
assurances of performance to the buyer that all future shipments will conform to the
requirements of the contract.214 Article 2 also provides a mechanism by which the nonbreaching party may request assurances of performance, but the time period for cure is 30 days,
rather than the ten allowed by the Master Coal Agreement.215
The Master Coal Agreement’s arbitration provision also is not found in the remedies
provided by the Code.
3. Adequate Assurances of Performance
The Master Coal Agreement addresses adequate assurances of performance in several
sections. First, in section 5.3, a seller who delivers non-conforming coal may cut off the buyer’s
right to terminate the contract by providing adequate assurances of performance to the buyer that
all future shipments will conform to the requirements of the contract. Upon receipt of notice, the
seller is then allowed ten days in which to provide assurances of performance acceptable to
buyer. If the seller either fails to deliver the assurances of performance, or delivers any nonconforming shipments within the three-month period following the request for assurances of
performance, the buyer may declare that an Event of Default has occurred with respect to the
transaction.
Performance assurances also are addressed under Section 6.5, which allows the parties
the option of allowing a party to request a performance assurance in an amount equal to the early
termination payment that would be owed to the requesting party in the event of a default if the
outstanding balance owed by the counterparty exceeds a certain threshold level. Additionally,
under Section 6.6, a party is allowed to retain any interest received on cash collateral provided by
the counterparty as a performance assurance until the non-performing party satisfies its
obligations under the Master Coal Agreement.
C. EEI MASTER POWER PURCHASE & SALE AGREEMENT
The fact that Article 2 governs the sale of electric energy creates interesting problems for
lawyers and industry professionals alike, because electric energy has properties vastly different
211
Master Agreement §8.1(vii).
Master Agreement §5.3.
213
TEX. BUS. COMM. C. §2.
214
Master Agreement §5.3.
215
TEX. BUS. COMM. C. §2.609.
212
Page 31
from other energy commodities and most of the other things considered to be “goods.”216
Electricity, unlike other goods, cannot be stored, and the system for delivering electricity is
structured in a way that ensures that even if the seller fails to put the required electricity onto the
grid, the end user will usually still receive the product. Despite these unique characteristics,
damages in wholesale electricity contracts are similar to those found in contracts for other
wholesale commodities.
The EEI Master Agreement (the “EEI”) is a form contract for the sale of electric power
drafted by the Edison Electric Institute and the National Energy Marketers Association. The
Agreement is comprised essentially of three parts: (1) the Cover Sheet, which is specific to each
party, and identifies the parties to the Agreement and sets forth the specifics regarding delivery,
credit, payment, and collection; (2) the General Terms and Conditions, which generally are not
renegotiated between the parties and form the substance of the parties’ agreement; and (3) the
Confirmation Letter, which is used to confirm individual transactions made by telephone
between the parties. The provisions addressing breach and damages discussed below are
included in the General Terms and Conditions section and therefore are common to every EEI
contract, unless specifically altered by the contracting parties.
The EEI contains liquidated damages provisions that apply in the event of a failure to
deliver or receive electricity and specific remedies for use upon the occurrence of an Event of
Default. It also contains multiple provisions addressing the parties’ credit risks, including
adequate assurances, threshold margining, and credit rating downgrades.
1. Failure to deliver or receive electricity.
Article 4 of the EEI addresses remedies for any failure to deliver or receive electricity.
Despite the fact that any failure on the part of the seller to deliver electricity onto the grid will
not affect whether the buyer receives power, the EEI includes a provision addressing the method
of calculating damages in just such a situation because although a purchaser will usually still
receive electricity from the grid in the event the seller fails to deliver the contract quantities,
damages are necessary to compensate the buyer for either the cost of obtaining alternative
supplies or for the costs imposed by the grid operator for buyer’s consumption of power in
excess of the quantities delivered to the grid for buyer’s use. 217
Section 4.1 provides for the buyer’s recovery of the difference between the Contract Price
and the Replacement Price in the event of a breach by the seller.218 The Contract Price is defined
216
TEX. BUS. COMM. C. §2.102.
EEI §4.1.
218
EEI §4.1 (addressing a failure by the seller to perform its delivery obligations under the contract, stating “[i]f
Seller fails to schedule and/or deliver all or part of the Product pursuant to a Transaction, and such failure is not
excused under the terms of the Product or by Buyer’s failure to perform, then Seller shall pay Buyer, on the date
payment would otherwise be due in respect of the month in which the failure occurred or, if “Accelerated Payment
of Damages” is specified on the Cover Sheet, within five (5) Business Days of invoice receipt, an amount for such
deficiency equal to the positive difference, if any, obtained by subtracting the Contract Price from the Replacement
Price. The invoice for such amount shall include a written statement explaining in reasonable detail the calculation
of such amount.”).
217
Page 32
as the price to be paid by the buyer to the seller for the purchase of the product,219 while the
Replacement Cost is generally defined as the price the buyer pays for substitute power.220
Section 4.2 addresses a breach by the buyer and provides that if a buyer fails to schedule
or receive any portion of the product under a transaction, the seller is entitled to a payment based
on the difference between the Sales Price and the Contract Price.221 The Sales Price is generally
defined as the price at which the seller is able to resell the commodity, plus any costs reasonably
incurred in reselling the product, and any additional transmission charges reasonably incurred.222
This section also allows the seller the option to use the market price at the delivery point for the
calculation of damages.223
Both sections 4.1 and 4.2 require that the amount calculated under each section must be
paid either on the date payment would otherwise be due had the failure to take or deliver not
occurred, or, if the parties have selected “Accelerated Payment of Damages” on the Cover Sheet,
within five business days of receiving an invoice.224
219
EEI §1.10 (stating that the ‘Contract Price’ means “the price in $U.S. (unless otherwise provided for) to be paid
by Buyer to Seller for the purchase of the Product, as specified in the Transaction”).
220
EEI §1.51 (stating that the Replacement Price “means the price at which Buyer, acting in a commercially
reasonable manner, purchases at the Delivery Point a replacement for any Product specified in a Transaction but not
delivered by the Seller, plus (i) costs reasonably incurred by Buyer in purchasing such substitute product and (ii)
additional transmission charges, if any, reasonably incurred by Buyer to the Delivery Point, or at Buyer’s option, the
market price at the Delivery Point for such Product not delivered as determined by Buyer in a commercially
reasonable manner; provided, however, in no event shall such price include any penalties, ratcheted demand or
similar charges, nor shall Buyer be required to utilize or change its utilization of its owned or controlled assets or
market positions to minimize Seller’s liability. For the purposes of this definition, Buyer shall be considered to have
purchased replacement Product to the extent that Buyer shall have entered into one or more arrangements in a
commercially reasonable manner whereby Buyer repurchases its obligation to sell and deliver the Product to another
party at the Delivery Point.”).
221
EEI §4.2 (addressing a failure by the buyer, stating “[i]f Buyer fails to schedule and/or receive all or part of the
Product pursuant to a Transaction, and such failure is not excused under the terms of the Product or by Seller’s
failure to perform, then Buyer shall pay Seller, on the date payment would otherwise be due in respect of the month
in which the failure occurred or, if “Accelerated Payment of Damages” is specified on the Cover Sheet, within five
(5) Business Days of invoice receipt, an amount for such deficiency equal to the positive difference, if any, obtained
by subtracting the Sales Price from the Contract Price. The invoice for such amount shall include a written
statement explaining in reasonable detail the calculation of such amount.”).
222
EEI §1.53 (defining ‘Sales Price’ as “[t]he price at which Seller, acting in a commercially reasonable manner,
resells at the Delivery Point any Product not received by Buyer, deducting from such proceeds any (1) costs
reasonably incurred by Seller in reselling such Product and (ii) additional transmission charges, if any, reasonably
incurred by Seller in delivering such Product to the third party purchasers, or at Seller’s option, the market price at
the Delivery Point for such product not received as determined by Seller in a commercially reasonable manner;
provided, however, in no event shall such price include any penalties, ratcheted demand or similar charges, nor shall
Seller be required to utilize or change its utilization of its owned or controlled assets, including contractual assets, or
market positions to minimize Buyer’s liability. For purposes of this definition, Seller shall be considered to have
resold such Product to the extent Seller shall have entered into one or more arrangements in a commercially
reasonable manner whereby Seller repurchases its obligation to purchase and receive the Product from another party
at the Delivery Point.”).
223
EEI §1.53.
224
EEI §4.2.
Page 33
The EEI also provides for the seller’s recovery of incidental damages or costs reasonably
incurred in reselling the product, including any additional transmission charges.225 The EEI
requires the seller to act in a “commercially reasonable manner” when reselling any product
received by the buyer.226
The damages contained in the EEI for a failure to deliver or receive electricity are similar
to the remedies in the NAESB and accordingly differ from the U.C.C. in a similar fashion. By
agreeing to use the EEI instead of relying on the provisions of the U.C.C., the seller sacrifices the
right to suspend further deliveries and, if the failure goes to the whole contract, cancel the
contract.227 Likewise, by using the EEI and not the U.C.C., the buyer sacrifices the right to
demand specific performance or, if the failure goes to the whole contract, cancel the contract.228
As in the case of the NAESB, the EEI does not adhere to the “perfect tender” rule
espoused by the U.C.C., but instead discusses the payment of liquidated damages in the event of
a failure to deliver on receive, and the failure of a party to perform as an Event of Default rather
than as a “breach.” Unlike the U.C.C., the Events of Default enumerated by the EEI include the
acts or omissions of certain specifically-identified third parties including a party’s guarantor, and
events of cross-default with respect to such third parties. Like the NAESB, a party’s failure to
deliver or receive product is specifically exempted from this list of Events of Default.229
Despite this difference in the way they approach the issue, the EEI and Article 2 both
address a failure to deliver or receive using the cover standard. The EEI provides that the seller’s
measure of damages is the difference between the Contract Price and the Replacement Price, and
the buyer’s measure of damages is the difference between the Contract Price and the Sales Price.
These measures of damages are identical to the standards for breach identified in Article 2.230
Both the EEI and Article 2 require the parties to act in a “commercially reasonable manner”
when reselling any product received by the buyer.231
Any damages payment for the failure by a buyer or seller to deliver or receive must be
paid on the date payment would otherwise be due, or within five business days of receipt of
invoice.232 While the U.C.C. clearly contemplates timely payment of all amounts owed, the
specific time period for repayment set forth by the EEI is not mirrored by the Code.233
Any “failure to schedule” all or part of the product pursuant to a transaction constitutes a
failure by the seller or buyer to fulfill its delivery or receipt obligations.234 Article 2 allows a
225
EEI §1.53.
EEI §1.53.
227
TEX. BUS. COM. C. §2.612.
228
TEX. BUS. COM. C. §2.612.
229
EEI §5.1(c).
230
TEX. BUS. COM. C. §2.712.
231
TEX. BUS. COM. C. §2.712.
232
EEI §§4.1; 4.2
233
EEI §4.2.
234
EEI §4.1; 4.2.
226
Page 34
seller to recover damages for “non-acceptance or repudiation by the buyer”.235 It is unclear
whether a “failure to schedule” would be considered “non-acceptance or repudiation” under
Article 2. While it seems likely that courts would interpret the Code provision in conformity
with the manner in which the commodity is treated generally in the industry, it may be prudent to
address this in contracts to avoid any uncertainty as to this issue.
2. Events of Default.
a.
Events of Default under the EEI
The Events of Default specifically enumerated in the EEI include the occurrence of any
of the following (1) a party fails to make any payment when due and such failure is not remedied
within three business days after the non-breaching party receives notice of the delinquency; (2) a
party fails to perform any material obligation under the agreement; (3) a party becomes bankrupt;
(4) any representation or warranty made by a party is false or misleading in any material respect
when made; or (5) a party fails to satisfy the creditworthiness/collateral requirements agreed to in
the contract.236 Additionally, certain acts or omissions of a party’s guarantor or another third
party identified in the EEI may constitute an Event of Default under the agreement, as may the
occurrence and continuation of an event of cross-default under a different contract.237 However,
a party’s failure to deliver or receive electricity is specifically exempted from the penalties of
Article 5 and does not constitute an event of default.238
When an Event of Default occurs and is continuing, the non-defaulting party may
withhold payments, suspend its performance, and/or designate an early termination date, thereby
accelerating all amounts owing between the parties.239 Effective on the Early Termination Date
the non-defaulting party may terminate and liquidate all transactions between the parties.240 It is
important to note that under the EEI, it is not enough that the Event of Default has occurred; it
must be continuing in order for the non-breaching party to declare an Event of Default and
terminate all transactions.241 The EEI also offers the parties the option to elect whether to net
and setoff any amounts owing pursuant to other agreements between the parties or other
agreements between the parties and their affiliates.242 Any payments owed between the parties
must be paid within two business days of receipt of the invoice enumerating the final settlement
amount owed following termination, liquidation and setoff.243
The U.C.C. gives a seller certain rights upon discovering that the buyer is insolvent, such
as refusing to deliver additional goods, or reclaiming previously delivered goods.244 Under the
235
TEX. BUS. COM. C. §2.708.
EEI §5.1.
237
EEI §5.1(g);(h).
238
EEI §5.1(c).
239
EEI §5.2.
240
Id.
241
Id.
242
EEI §5.3.
243
EEI §5.4.
244
TEX. BUS. COM. C. §2.702.
236
Page 35
EEI, however, bankruptcy or failure to meet creditworthiness requirements by either party is an
Event of Default, and is not treated differently than the occurrence of any other Event of Default.
b.
Damages
Paralleling the NAESB, the Events of Default under the EEI result in damages similar to
those that would be realized under the U.C.C., but the EEI offers greater specificity as to what
constitutes an Event of Default and the method for calculating damages. One important
difference from the NAESB and the U.C.C. is the EEI’s right of parties under the EEI to suspend
performance under any or all transactions upon any event which, with the delivery of notice or
the passage of time, would constitute an Event of Default.245 Thus, although the buyer sacrifices
the U.C.C. right to demand specific performance when entering into an EEI, it and the seller gain
a valuable suspension right that may enable it to cease doing business with an unreliable
counterparty or a counterparty spiraling downward into insolvency.
c.
Right to terminate
Unlike the Code, under the EEI it is not enough that an Event of Default has occurred; it
must have occurred and be continuing in order for the non-breaching party to declare an Early
Termination Date and terminate all transactions, as the performing party’s right to terminate is
eliminated upon cure by the non-performing party.246
Article 2 requires that in order for a party to have the right to terminate the contract as a
whole, the breach must “impair the value of the whole contract.”247 The EEI clarifies this
ambiguous standard, requiring only that an Event of Default must have occurred and be
continuing for termination to occur.
An additional difference is that when a party declares an early termination date under the
EEI, it must terminate all transactions between the parties. In contrast, there is no requirement in
the Code thata party terminate all transactions following a breach.
Section 2.616 allows the buyer to terminate the contract if the buyer receives notification
of a material reduction or delay in delivery; but no such right is recognized by the EEI. Like
most energy contracts, the EEI allows termination by the buyer only if an Event of Default has
occurred and, in most cases, termination would not be allowed because a delay or reduction in
delivery does not constitute an Event of Default.
d.
Payment of damages following termination
The EEI specifies the timing of payments in greater detail than does the U.C.C., requiring
any payments owed between the parties upon declaration of an early termination date to be paid
245
EEI §5.7.
EEI §5.2.
247
TEX. BUS. COM. C. §2.612.
246
Page 36
within two business days of receipt of the invoice.248 The U.C.C. does not specify the time
frame by which payment of damages must be made following termination.
Like Article 2, the EEI provides for the seller’s recovery of incidental damages, or costs
reasonably incurred in reselling the product. However, the EEI also provides for the recovery of
any additional transmission charges incurred. It is unclear whether a seller would be able to
recover additional transmission charges under the Code, as such charges are not specifically
enumerated.
e.
Setoff
If the parties terminate all outstanding transactions, the EEI allows the parties to net and
setoff the amounts owed between them pursuant to other agreements in addition to the EEI, if
that option is selected by the parties.249 There is no right of netting and setoff recognized under
the Code.
f.
Suspension
The U.C.C. allows a seller to stop delivery of goods in transit when the seller discovers
the buyer is insolvent, the buyer repudiates the contract, or the buyer fails to make any payment
due before delivery.250 Under the EEI there is no right to suspend performance immediately
upon learning of the buyer’s insolvency; and performance may be suspended only when the nonbreaching party takes steps to terminate the contract by declaring an Event of Default, or when a
Potential Event of Default has occurred and is continuing. Potential Events of Default are
defined as events which, with notice or passage of time or both, would constitute an actual Event
of Default.251 The EEI provides that when a Potential Event of Default has occurred and is
continuing, the non-defaulting party may give written notice thereof to the defaulting party and
suspend performance under any or all transactions for 10 business days per transaction before the
suspension must end or the contract must be terminated.252
3. Credit protection.
Unlike the NAESB, Master Coal Agreement and U.C.C., the EEI contains multiple
methods of mitigating credit risk.
a.
Adequate assurance of performance.
The EEI allows a party to demand assurances of performance if the party has reasonable
grounds to believe that the counterparty’s creditworthiness or performance has become
248
EEI §5.4.
EEI §5.6.
250
TEX. BUS. COM. C. §2.703.
251
EEI §1.46.
252
EEI §5.6. This section allows the suspension to continue for up to ten (10) NERC Business Days, which are any
days except a Saturday, a Sunday or a holiday defined by the North Americn Electric Reliability Council or any
successor organization. EEI §1.31.
249
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unsatisfactory.253 If the performance assurance is not delivered in an amount reasonably
acceptable to the requesting party within three business days after receipt of the request therefor,
then an Event of Default will be deemed to have occurred.254 Under the U.C.C., a party must
deliver adequate assurance within a commercially reasonable time period, not to exceed thirty
days. The cure period allowed by the EEI is much shorter than that allowed by the U.C.C., and
therefore, like the NAESB, it offers more protection to a party who properly requests such
assurances than is found in the U.C.C.
Other than the difference in time periods for delivering the assurance and the ability to
elect on the EEI Cover Sheet whether or not to use adequate assurances, the U.C.C., NAESB and
EEI are substantially similar in their treatment of the right to demand adequate assurances of
performance.
b.
Threshold margining.
The EEI goes beyond the subjective adequate assurance provisions of the U.C.C. and
NAESB by adding an objective method of determining when and the amount of collateral that
must be exchanged by the parties.255 Under threshold margining the parties measure their
respective mark-to-market exposure under the EEI, subtract from that figure the collateral
threshold of the other party, and the party with the subsequent net positive exposure may demand
collateral from the other party equal to such amount. In the event collateral is not delivered
within three business days of the date of the demand therefor, such failure will constitute an
Event of Default.256
c.
Credit rating downgrade.
One risk that exists when relying on rights to demand adequate assurance of performance
is that the party from which collateral is demanded may dispute whether reasonable grounds
exist for demanding the assurance, leaving the demanding party in the difficult position of
choosing between continuing to perform under the contract without collateral or terminating the
contract on grounds that the other party failed to deliver performance assurance when required
and risk being sued for wrongful termination of the contract. The EEI addresses this risk by
offering the parties the option to elect the applicability of downgrade event, under which the
occurrence of a credit rating downgrade below the minimum level listed on the Cover Sheet for a
party triggers the right of the other party to request collateral in an amount determined by the
requesting party in a commercially reasonable manner.
d.
Objective versus subjective collateral triggers
These credit support options offer three approaches to addressing credit risk instead of
the single approach offered by the U.C.C. and NAESB. These methods utilize different
combinations of subjective and objective rights for the party demanding credit assurance. The
253
EEI §8.1(b).
EEI §8.1.
255
EEI 8.1(c)
256
Id.
254
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adequate assurance right contains a subjective trigger and a subjective calculation of the amount
of collateral that must be delivered. The collateral threshold contains an objective trigger and the
amount of collateral to be delivered is based on objective mathematical calculations. The
downgrade event option contains an objective trigger but a subjective method of calculating the
amount of collateral to be delivered.
D. ISDA MASTER AGREEMENT
The International Swaps and Derivatives Association drafted the ISDA Master
Agreement (the “ISDA”) for use in documenting swap and derivative transactions. Although
derivatives are not goods and therefore would not fall under the scope of Article 2 of the U.C.C.,
the ISDA is so commonly used in energy commodity transactions and negotiated in tandem with
other energy commodity master agreements that it is useful to compare the ISDA to the NAESB,
Master Coal Agreement and EEI as well as the U.C.C. The ISDA, like the NAESB, Master Coal
Agreement and EEI; is a Master Agreement that the parties agree will govern the terms of any
subsequent transactions the parties may enter into. The Schedule to the Master Agreement is the
part of the ISDA that is customized by the parties for the particulars of their transactions. The
Schedule includes the names of the parties, any Credit Support Providers or Specified Parties
(discussed below), plus certain credit and payment obligations.
1. Events of Default.
Section 5 addresses Events of Default and Termination Events with respect to either party
or with respect to any Credit Support Provider of either party. The ISDA, like the NAESB,
Master Coal Agreement, and EEI, differs from the Code in that the acts or omissions of a third
party, the Credit Support Provider or a Specified Entity, may constitute an Event of Default or
Termination Event.257 Both the “Credit Support Providers” and the “Specified Entities” are
identified by the parties in the Schedule.
Section 5(a) defines Events of Default as the occurrence of any of the following acts or
omissions by a party, a Credit Support Provider, or a Specified entity: (1) any failure to make
any payment when due,258(2) any failure to comply with or perform any agreement or obligation
or any repudiation or rejection of the Master Agreement or any Transaction or Confirmation,259
257
ISDA §5(a).
ISDA §5(a)(1): “Failure by the party to make, when due, any payment under this Agreement or delivery under
Section 2(a)(i) or 9(h)(i)(2) or (4) required to be made by it if such failure is not remedied on or before the first
Local Business Day in the case of any such payment or the first Local Delivery Day in the case of any such deliver
after, in each case, notice of such failure is given to the party.”
259
ISDA §5(a)(ii): “(1) Failure by the party to comply with or perform any agreement or obligation (other than an
obligation to make any payment under this Agreement or delivery under Section 2(a)(i) or 9(h)(i)(2) or (4) or to give
notice of a T under Section 4(a)(i), 4(a)(iii) or 4(d)) to be complied with or performed by the party in accordance
with this Agreement if such failure is not remedied within 30 days after notice of such failure is given to the party;
or (2) the party disaffirms, disclaims, repudiates or rejects, in whole or in part, or challenges the validity of, this
Master Agreement, any Confirmation executed and delivered by that party or any Transaction evidenced by such a
Confirmation (or such action is taken by any person or entity appointed or empowered to operate it or act on its
behalf).”\
258
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(3) any Credit Support Default;260 (5) the making or repeating of any material
misrepresentation;261 (6) any default under a specified transaction;262 (7) any event of CrossDefault;263 (8) bankruptcy;264 or (9) any merger, if the new entity fails to assume all the
obligations of the original party to the contract.265
260
ISDA §5(a)(iii) (stating that “(1) Failure by the party or any Credit Support Provider of such party to comply with
or perform any agreement or obligation to be complied with or performed by it in accordance with any Credit
Support Document if such failure is continuing after any applicable grace period has elapsed; (2) the expiration or
termination of such Credit Support Document or the failing or ceasing of such Credit Support Provider to the other
party pursuant to any such Credit Support Document, to be in full force and effect for the purpose of this Agreement
(in each case other than in accordance with its terms) prior to the satisfaction of all obligations of such party under
each Transaction to which such Credit Support Document relates without the written consent of the other party; or
(3) the party or such Credit Support Provider disaffirms, disclaims, repudiates or rejects, in whole or in part, or
challenges the validity of, such Credit Support Document (or such action is taken by any person or entity appointed
or empowered to operate it or act on its behalf)”).
261
ISDA §5(a)(iv) (stating that “[a] representation (other than a representation under Section 3(e) or 3(f) made or
repeated or deemed to have been made or repeated by the party or any Credit Support Provider of such party to this
Agreement or any Credit Support Document proves to have been incorrect or misleading in any material respect
when made or repeated or deemed to have been made or repeated.”).
262
ISDA §5(a)(v) (stating “[t]he party, any Credit Support Provider of such party or any applicable Specified Entity
of such party: - (1) defaults (other than by failing to make a delivery) under a Specified Transaction or any credit
support arrangement relating to a Specified Transacting and, after giving effect to any applicable notice requirement
or grace period, such default results in a liquidation of, an acceleration of obligations under, or an early termination
of, that Specified Transaction; (2) defaults, after giving effect to any applicable notice requirement or grace period,
in making any payment due on the last payment or exchange date of, or any payment on early termination of, a
Specified Transaction (or, if there is no applicable notice requirement or grace period, such default continues for at
least one Local Business Day); (3) defaults in making any delivery due under (including any delivery due on the last
delivery or exchange date of a Specified Transaction or any credit support arrangement relating to a Specified
Transaction and, after giving effect to any applicable notice requirement or grace period, such default results in a
liquidation of, an acceleration of obligations under, or an early termination of, all transactions outstanding under the
documentation applicable to that Specified Transaction; or (4) disaffirms, disclaims, repudiates or rejects, in whole
or in party, or challenges the validity of, a Specified Transaction or any credit support arrangement relating to a
Specified Transaction that is, in either case, confirmed or evidenced by a document or other confirming evidence
executed and delivered by that party, Credit Support Provider or Specified Entity (or such action is taken by any
person or entity appointed or empowered to operate it or act on its behalf)”).
263
ISDA §5(a)(vi) (stating “[i]f ‘Cross-Default’ is specified in the Schedule as applying to the party, the occurrence
or existence of: - (1) a default, event of default or other similar condition or event (however described) in respect of
such party, any Credit Support Provider of such party or any applicable Specified Entity of such party under one or
more agreements or instruments relating to Specified Indebtedness of any of them (individually or collectively)
where the aggregate principal amount of such agreements or instruments, either alone or together with the amount, if
any, referred to in clause (2) below, is not less than the applicable Threshold Amount (as specified in the Schedule)
which has resulted in such Specified Indebtedness becoming, or becoming capable at such time of being declared,
due and payable under such agreements or instruments before it would otherwise have been due and payable; or (2)
a default by such party, such Credit Support Provider or such Specified Entity (individually or collectively) in
making one or more payments under such agreements or instruments on the due date for payment (after giving effect
to any applicable notice requirement or grace period) in an aggregate amount, either alone or together with the
amount, if any, referred to in clause (1) above, of not less than the applicable Threshold Amount”).
264
ISDA §5(a)(vii).
265
ISDA §5(a)(viii) (stating that “[t] he party or any Credit Support Provider of such party consolidates or
amalgamates with, or merges with or into, or transfers all or substantially all its assets to, another entity and, at the
time of such consolidation, amalgamation, merger or transfer: (1) the resulting, surviving or transferee entity fails to
assume all the obligations of such party or such Credit Support Provider under this Agreement or any Credit Support
Document to which it or its predecessor was a party by operation of law or pursuant to an agreement reasonably
Page 40
If an Event of Default has occurred and is then continuing, the non-defaulting party may
give notice to the defaulting party specifying the applicable Event of Default and designate a
date as an Early Termination Date in respect to all outstanding Transactions.266 When an Early
Termination Date is designated, the termination will occur on the Early Termination Date
regardless of whether the default has been cured prior to that date.267 Upon the designation of an
Early Termination Date no further payments or deliveries will be made by either party; each
party will calculate the amounts owed between the parties, and each party will provide a
statement to the other party showing the calculations made, specifying the amount payable, and
giving details of the account into which the payment should be made.268
a.
Cure periods
In order for a failure to pay or deliver not to be considered an Event of Default under
Section 5(a), the failure must be remedied by the first Local Business Day or the first Local
Delivery Day, whichever is applicable, after notice of the failure is given to the non-performing
party.269 Failure to comply with any other agreement or obligation must be remedied within
thirty days after notice is given in order to avoid constituting an Event of Default. The ISDA
provides no cure period for any rejection or repudiation of the Master Agreement, or a
Transaction or Confirmation. Further, all Credit Support Defaults will constitute an Event of
Default unless cured by the time any grace period identified in the applicable Credit Support
Document(s) has elapsed.
b.
Events of Default and Termination Events
Under Section 5(b), Termination Events are distinct from Events of Default, and include:
(1) any transaction or portion thereof becomes unlawful or illegal;270 (2) the occurrence of an
satisfactory to the other party to this Agreement; or (2) the benefits of any Credit Support Document fail to extend
(without the consent of the other party) to the performance by such resulting, surviving or transferee entity of its
obligations under this Agreement.”).
266
If at any time an Event of Default with respect to a party (the "Defaulting Party") has occurred and is then
continuing, the other party (the "Non-defaulting Party") may, by not more than 20 days notice to the Defaulting
Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an
Early Termination Date in respect of all outstanding Transactions. If, however, "Automatic Early Termination" is
specified in the Schedule as applying to a party, then an Early Termination Date in respect of all outstanding
Transactions will occur immediately upon the occurrence with respect to such party of an Event of Default specified
in Section 5(a)(vii)(l), (3), (5), (6) or, to the extent analogous thereto, (8) and as of the time immediately preceding
the institution of the relevant proceeding or the presentation of the relevant petition upon the occurrence with respect
to such party of an Event of Default specified in Section 5(a)(vii)(4) or, to the extent analogous thereto, (8).
267
ISDA §6(c)(i).
268
ISDA §6(c)(ii).
269
ISDA §5(a)(i).
270
ISDA §5(b) (i) (addressing illegality, and stating that “[d]ue to the adoption of, or any change in, any applicable
law after the date on which a Transaction is entered into, or due to the promulgation of, or any change in, the
interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law after
such date, it becomes unlawful (other than as a result of a breach by the party of Section 4(b)) for such party (which
will be the Affected Party): (1) to perform any absolute or contingent obligation to make a payment or delivery, or to
receive a payment or delivery in respect of such Transaction or to comply with any other material provision of this
Agreement relating to such Transaction; or (2) to perform, or for any Credit Support Provider of such party to
Page 41
event of force majeure;271 (3) a tax event;272 (4) a tax event upon merger;273 (5) a credit event
upon merger;274 or (6) an additional termination event, if one is specified by the parties.275
perform, any contingent or other obligation which the party (or such Credit Support Provider) has under any Credit
Support Document relating to such Transaction.”).
271
ISDA §5(b)(iii) (stating “[a]fter giving effect to any applicable provision, disruption fallback or remedy specified
in, or pursuant to, the relevant Confirmation or elsewhere in this Agreement, by reason of force majeure or act of
state occurring after a Transaction is entered into, on any day: -- (1) the Office through which such party (which will
be the Affected Party) makes and receives payments or deliveries with respect to such Transaction is prevented from
performing any absolute or contingent obligation to make a payment or delivery in respect of such Transaction, from
receiving a payment or delivery in respect of such Transaction or from complying with any other material provision
of this Agreement relating to such Transaction (or would be prevented if such payment, delivery or compliance were
required on that day), or it becomes impossible or impartibly for such Office so to perform, receive or comply (or it
would be impossible or impracticable for such Office so to perform, receive or comply if such payment, delivery or
compliance were required on that day); or (2) such party or any Credit Support Provider of such party (which will be
the Affected Party) is prevented form performing any absolute or contingent obligation to make a payment or
delivery which such party or Credit Support Provider has under any Credit Support document relating to such
Transaction, from receiving a payment or delivery under such Credit Support Document or from complying with
any other material provision of such Credit Support Document ( or would be so prevented if such payment, delivery
or compliance were required on that day), or it becomes impossible or impracticable for such party or Credit Support
Provider so to perform, receive or comply (or it would be impossible or impracticable for such party or Credit
Support Provider so to perform, receive or comply if such payment, delivery or compliance were required on that
day); so long as the force majeure or act of state is beyond the control of such Office, such party or such Credit
Support Provider, as appropriate, and such Office, party or Credit Support Provider could not, after using all
reasonable efforts (which will not require such party or Credit Support Provider to incur a loss, other than
immaterial, incidental expenses), overcome such prevention, impossibility or impracticability.”).
272
ISDA §5(b)(iii) (addressing tax events, and stating that “[d]ue to (x) any action taken by a taxing authority, or
brought in a court of competent jurisdiction, on or after the date on which a Transaction is entered into (regardless of
whether such action is taken or brought with respect to a party to this Agreement) or (y) a Change in Tax Law, the
party (which will be the Affected Party) will or there is a substantial likelihood that it will, on the next succeeding
Scheduled Payment Date (1) be required to pay to the other party an additional amount in respect of an
Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) or (2)
receive a payment from which an amount is required to be deducted or withheld for or on account of a Tax (except
in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) and no additional amount is required to be paid in respect of
such Tax under Section 2(d)(i)(4) (other than by reason of Section 2(d)(i)(4)(A) or (B)).”).
273
ISDA §5(b)(iv) (addressing tax events upon merger, and stating that “[t]he party (the "Burdened Party") on the
next succeeding Scheduled Payment Date will either (1) be required to pay an additional amount in respect of an
Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) or (2)
receive a payment from which an amount has been deducted or withheld for or on account of any Indemnifiable Tax
in respect of which the other party is not required to pay an additional amount (other than by reason of Section
2(d)(i)(4)(A) or (B)), in either case as a result of a party consolidating or amalgamating with, or merging with or
into, or transferring all or substantially all its assets to, another entity (which will be the Affected Party) where such
action does not constitute an event described in Section 5(a)(viii)”).
274
ISDA §5(b)(v) (addressing credit events upon merger, and stating that “[i]f "Credit Event Upon Merger" is
specified in the Schedule as applying to the party, such party ("X"), any Credit Support Provider of X or any
applicable Specified Entity of X consolidates or amalgamates with, or merges with or into, or transfers all or
substantially all its assets to, another entity and such action does not constitute an event described in Section
5(a)(viii) but the creditworthiness of the resulting, surviving or transferee entity is materially weaker than that of X,
such Credit Support Provider or such Specified Entity, as the case may be, immediately prior to such action (and, in
such event, X, or its successor or transferee, as appropriate, will be the Affected Party)”).
275
ISDA §5(b)(vi) (addressing additional termination events, and stating that “[i]f any ‘Additional Termination
Event’ is specified in the Schedule or any Confirmation as applying, the occurrence of such event (and, in such
event, the Affected Party or Affected Parties shall be as specified for such Additional Termination Event in the
Schedule or such Confirmation)”).
Page 42
Because of the distinction made between Termination Events and Events of Default, the ISDA
also includes a section regarding the hierarchy of such events, which addresses the interplay
between Events of Default and Termination Events. 276
Termination Events are treated differently than Events of Default under the ISDA and, in
some cases, differently than other Termination Events. If a Termination Event occurs, the nondefaulting party must give notice to the defaulting party, and may, under very specific
circumstances, declare an Early Termination Date with respect only to those Transactions
affected by the Termination Event.277 The designation of an Early Termination Date because of
the occurrence of a Termination Event creates essentially the same obligations between the
parties as those created when an Early Termination Date is designated as a result of an Event of
Default; however, the payments owed between the parties are calculated using a different
formula than that applicable to Events of Default. The formula varies depending on whether one
276
ISDA §5(c) (stating that “[a]n event or circumstance that constitutes or gives rise to an Illegality or a Force
Majeure Event will not, for so long as that is the case, also constitute or give rise to an Event of Default under
Section 5(a)(i) or 5(a)(ii)(1) or 5(a)(iii)(1) insofar as such event or circumstance relates to the failure to make any
payment or delivery or a failure to comply with any other material provision of this Agreement or a Credit Support
Document, as the case may be. (ii) Except in circumstances contemplated by clause (i) above, if an event or
circumstance which would otherwise constitute or give rise to an illegality or a Force Majeure Event also constitutes
an Event of Default or any other Termination Event, it will be treated as an Event of Default or such other
Termination Event, as the case may be, and will not constitute or give rise to an Illegality or a Force Majeure Event.
(iii) If an event or circumstance which would otherwise constitute or give rise to a Force Majeure Event also
constitutes an Illegality, it will be treated as an Illegality, except as described in clause (ii) above, and not a Force
Majeure Event.”).
277
ISDA §6(b) (stating “(i) If a Termination Event occurs, an Affected Party will, promptly upon becoming aware of
it notify the other party, specifying the nature of that Termination Event and each Affected Transaction and will also
give such other information about that Termination Event as the other party may reasonably require.”); (ii) Transfer
to Avoid Termination Event. If either an Illegality under Section 5(b)(i)(1) or a Tax Event occurs and there is only
one Affected Party, or if a Tax Event Upon Merger occurs and the Burdened Party is the Affected Party, the
Affected Party will, as a condition to its right to designate an Early Termination Date under Section 6(b)(iv), use all
reasonable efforts (which will not require such party to incur a loss, excluding immaterial, incidental expenses) to
transfer within 20 days after it gives notice under Section 6(b)(i) all its rights and obligations under this Agreement
in respect of the Affected Transactions to another of its Offices or Affiliates so that such Termination Event ceases
to exist. If the Affected Party is not able to make such a transfer it will give notice to the other party to that effect
within such 20 day period, whereupon the other party may effect such a transfer within 30 days after the notice is
given under Section 6(b)(i). Any such transfer by a party under this Section 6(b)(ii) will be subject to and
conditional upon the prior written consent of the other party, which consent will not be withheld if such other party's
policies in effect at such time would permit it to enter into transactions with the transferee on the terms proposed.;
(iii) Two Affected Parties. If an Illegality under Section 5(b)(i)(l) or a Tax Event occurs and there are two Affected
Parties, each party will use all reasonable efforts to reach agreement within 30 days after notice thereof is given
under Section 6(b)(i) on action to avoid that Termination Event; (iv) Right to Terminate. If: (1) a transfer under
Section 6(b)(ii) or an agreement under Section 6(b)(iii), as the case may be, has not been effected with respect to all
Affected Transactions within 30 days after an Affected Party gives notice under Section 6(b)(i); or (2) an Illegality
under Section 5(b)(i)(2) a Credit Event Upon Merger or an Additional Termination Event occurs, or a Tax Event
Upon Merger occurs and the Burdened Party is not the Affected Party, either party in the case of an Illegality, the
Burdened Party in the case of a Tax Event Upon Merger, any Affected Party in the case of a Tax Event or an
Additional Termination Event if there is more than one Affected Party, or the party which is not the Affected Party
in the case of a Credit Event Upon Merger or an Additional Termination Event if there is only one Affected Party
may, by not more than 20 days notice to the other party and provided that the relevant Termination Event is then
continuing, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect
of all Affected Transactions.
Page 43
or two parties are effected by the Termination Event. If only one party is affected, the formula
used is the same used upon the occurrence of an Event of Default.278
c.
Damages
If the designation of the Early Termination Date results from an Event of Default, the
damages owed will be the sum of the close-out amounts for all Terminated Transactions, as
determined bythe non-defaulting party, plus any unpaid amounts owed to the non-defaulting
party, minus the unpaid amounts owed to the defaulting party.279 Interest will accrue on all
unpaid and early termination amounts. The date for payment for an Early Termination Date
designated as a result of the occurrence of an Event of Default is the day on which notice of the
amount payable is effective.280
As previously indicated, the designation of an Early Termination Date because of the
occurrence of a Termination Event creates essentially the same obligations between the parties as
those created when an Early Termination Date is designated as a result of an Event of Default,
but the payments owed between the parties are calculated using a different formula than that
applicable to Events of Default. The formula varies depending on whether one or two parties are
278
ISDA §6(e)(ii) (providing that “[i]f the Early Termination Date results from a Termination Event: (1) One
Affected Party. Subject to clause (3) below, if there is one Affected Party, the Early Termini on Amount will be
determined in accordance with Section 6(e)(i), except that references to the Defaulting Party and to the Nondefaulting Party will be deemed to be references to the Affected Party and to the Non-Affected Party, respectively.
(2) Two Affected Parties. Subject to clause (3) below, if there are two Affected Parties, each party will determine an
amount equal to the Termination Currency Equivalent of the sum of the close-out Amount or Close-out Amounts
(whether positive or negative) for each Terminated Transaction nor group of Terminated Transactions, as the case
may be, and the Early Termination Amount will be an amount equal to (A) the sum of (I) one-half of the difference
between the higher amount so determined (by party X) and the lower amount so determined (by party “Y”) and (II)
the Termination Currency Equivalent of the Unpaid Amounts owing to X less (B) the Termination Currency
Equivalent of the Unpaid Amounts owing to Y. If the Early Termination Amount is a positive number, Y will pay it
to X; if it is a negative number, X will pay the absolute value of the Early Termination Amount to Y. (3) MidMarket Events. If that Termination Event is an Illegality or a Force Majeure Event, then the Early Termination
Amount will be determined in accordance with clause (1) or (2) above, as appropriate, except that, for the purpose of
determining a Close-out Amount or Close-out Amounts, the Determining Party will: (A) if obtaining quotations
from one or more third parties (or from any of the Determining Party’s Affiliates), ask each third party or Affiliate
(I) not to take account of the current creditworthiness of the Determining Party or any existing Credit Support
Document and (II) to provide mid-market quotations; and (B) in any other case, use mid-market values without
regard to the creditworthiness of the Determining Party. [ADD SECTIONS (iii) – (v)]
279
ISDA §6(e)(i): “If the Early Termination Date results from an Event of Default, the Early Termination Amount
will be an amount equal to (1) the sum of (A) the Termination Currency Equivalent of the close-out Amount or
close-out Amounts (whether positive or negative) determined by the Non-defaulting Party for each Terminated
Transaction or group of Terminated Transactions, as the case may be, and (B) the Termination Currency Equivalent
of the Unpaid Amounts owing to the Non-defaulting Party less (2) the Termination Currency Equivalent of the
Unpaid Amounts owing to the Defaulting Party. If the Early Termination Amount is a positive number, the
Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay
the absolute value of the Early Termination Amount to the Defaulting Party.”
280
ISDA §6(d)(ii).
Page 44
effected by the Termination Event. If only one party is affected, the formula used is the same
used upon the occurrence of an Event of Default.281
The ISDA also expressly provides that neither party will be liable for consequential,
incidental, punitive, exemplary or indirect damages, lost profits or other business interruption
damages.
d.
Setoff
The ISDA, like the NAESB, Master Coal Agreement and EEI, also provides for the
netting and set off of all amounts owed between the parties pursuant to any agreements, not just
those amounts owed pursuant to the ISDA itself.282
e.
Suspension
Section 5(a)(vii) of the ISDA lists insolvency by the buyer as an Event of Default.
However, in order to have the right to suspend performance upon the buyer’s insolvency, the
seller must first declare an Early Termination Date and give notice of the declaration to the
buyer. Upon the effective designation of the Early Termination Date, the seller may suspend
performance under all outstanding transactions.283 While the U.C.C. provides a right of
reclamation, as previously discussed, the ISDA follows the NAESB and EEI and does not
provide a right of reclamation.
2. Credit Protection.
The ISDA provides the most detailed and flexible credit protection provisions of any of
the energy commodity master agreements. Parties to an ISDA may elect to include the Credit
Support Annex (“CSA”), which contains substantive provisions and a schedule for customizing
281
ISDA §6(e)(ii) (stating that “[i]f the Early Termination Date results from a Termination Event: (1) One Affected
Party. Subject to clause (3) below, if there is one Affected Party, the Early Termini on Amount will be determined
in accordance with Section 6(e)(i), except that references to the Defaulting Party and to the Non-defaulting Party
will be deemed to be references to the Affected Party and to the Non-Affected Party, respectively. (2) Two Affected
Parties. Subject to clause (3) below, if there are two Affected Parties, each party will determine an amount equal to
the Termination Currency Equivalent of the sum of the close-out Amount or Close-out Amounts (whether positive
or negative) for each Terminated Transaction nor group of Terminated Transactions, as the case may be, and the
Early Termination Amount will be an amount equal to (A) the sum of (I) one-half of the difference between the
higher amount so determined (by party X) and the lower amount so determined (by party “Y”) and (II) the
Termination Currency Equivalent of the Unpaid Amounts owing to X less (B) the Termination Currency Equivalent
of the Unpaid Amounts owing to Y. If the Early Termination Amount is a positive number, Y will pay it to X; if it
is a negative number, X will pay the absolute value of the Early Termination Amount to Y. (3) Mid-Market Events.
If that Termination Event is an Illegality or a Force Majeure Event, then the Early Termination Amount will be
determined in accordance with clause (1) or (2) above, as appropriate, except that, for the purpose of determining a
Close-out Amount or Close-out Amounts, the Determining Party will: (A) if obtaining quotations from one or more
third parties (or from any of the Determining Party’s Affiliates), ask each third party or Affiliate (I) not to take
account of the current creditworthiness of the Determining Party or any existing Credit Support Document and (II)
to provide mid-market quotations; and (B) in any other case, use mid-market values without regard to the
creditworthiness of the Determining Party. [ADD SECTIONS (iii) – (v)]
282
ISDA §6(f).
283
EEI §§6(a); 6(c).
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those provisions to the specifics of the parties and their transactions. Although a comprehensive
discussion of the ISDA credit provisions is outside of the scope of this paper, a limited analysis
of some of these rights are discussed below.
a.
Adequate assurances
Unlike the NAESB, Master Coal Agreement and EEI, the ISDA itself makes no provision
for allowing a party to demand assurances of performance if the party has reasonable grounds to
believe that the counterparty’s creditworthiness or performance has become unsatisfactory. This
right is usually viewed as unnecessary and undesirable because of the other credit risk
management tools available under the ISDA, but parties often add the right to demand adequate
assurances of performance when the CSA is not used and therefore no other credit protection
exists for the parties under the ISDA.
b.
Threshold margining
The ISDA contains detailed provisions in the CSA by which the parties establish a matrix
of credit thresholds based on the ratings of the parties or their guarantors which, although
detailed, is structured and functions almost identically to that contained in the EEI. Like the EEI,
the ISDA offers the parties greater credit protection than does the U.C.C. by including threshold
margining and increases the objectivity of the parties’ rights in doing so.
c.
Credit rating downgrade
Another tool offered by the ISDA that mirrors that found in the EEI is the right to
demand collateral upon a credit rating downgrade. The flexibility to include or omit this right in
the standard ISDA gives parties additional comfort that they will be able to demand adequate
assurances and collateralize their risk before the counterparty defaults on its payment
obligations. However, the inclusion of this right also exposes each party to increased risk that
the amount it may be obligated to post to the other party may be determined in a subjective
manner that is greater than the amount that would be owed under purely objective calculations.
IV. CONCLUSION
Energy practitioners often assume that the remedies for breach provided in the master
agreements such as the NAESB, the Master Coal Agreement, the EEI and the ISDA arose from,
and are therefore identical to, the remedies contained in the Uniform Commercial Code.
Practitioners also may assume that those remedies are adequate to protect each party against all
risks it faces in the relevant energy transaction. However, many distinctions exist between the
remedies offered by the Code and those contained in each master agreement. Moreover, the
remedies offered by both the Code and the master agreements may not adequately address the
specific risks faced by the parties in certain situations. Accordingly, the parties should rely on
neither the Code nor the standard provisions of the master agreements for protection. Before any
agreement is executed, the risks faced by each party should be independently evaluated for the
transaction to ensure no differences exist between the expectations of the parties and the
remedies that govern the contract.
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