Wednesday, April 10, 2013

CERC Order in the Adani Power Case

Last week, the Central Electricity Regulatory Commission (CERC) passed an order relating to Adani Power that has significant implications for the power sector in India. Adani Power, which had entered into power purchase agreements (PPAs) with state utilities in Gujarat and Haryana for sale of power, approached the CERC with a request for relief on account of escalation of imported coal prices due to a change in regulations in Indonesia, where its principal fuel source was located. By a 3:1 majority, the CERC granted temporary relief to Adani Power through a “compensatory tariff” to be paid to it. The majority order is available here, while the dissenting order is here.


Adani Power had entered into separate PPAs with Gujarat Urja Vikas Nigam Limited and two Haryana utilities under which Adani Power had agreed to supply power to these state utilities. Under these arrangements, and the bidding process that preceded them, Adani Power was to assume responsibility to tie up the fuel linkage. Due to issues in procuring fuel from domestic sources, Adani Power established arrangements with entities in Indonesia for supply of coal at reasonable prices. However, in 2010, the Indonesian Government issued a set of regulations stipulating that holders of mining permits in Indonesia will be permitted to sell coal only benchmark prices accepted in the international markets. These Indonesian regulations had a significant impact on export prices of coal from Indonesia, which were higher than the contracted prices, due to which it became unviable for Adani Power to supply power at agreed prices to the state utilities in Gujarat and Haryana. Since this was unforeseen, Adani Power approached the CERC for relief.


After taking on record the submissions of the parties, the CERC identified three broad issues for consideration:

(i)         Whether due to the effect of the Indonesian regulations and the non-availability of domestic coal-linkage, it has become impossible for Adani Power to supply power to the state utilities at the tariff set by the PPAs;

(ii)        Whether the situation faced by Adani Power falls within the scope of force majeure or “change in law” in the PPAs thereby requiring relief; and

(iii)       Whether the CERC possesses general powers under the Electricity Act, 2003 and the National Electricity Policy and tariff policy to grant the requested relief to Adani Power.


The first question is largely a factual matter that the CERC considered in detail. It found that the non-availability of coal from domestic sources and the lack of attractiveness of sourcing from the international markets meant that the Indonesian markets were the most feasible. However, due to the Indonesian regulations, the viability of sourcing coal from Indonesia has been put to serious doubt as it has altered the basic premise upon which Adani Power had quoted the tariff to the state utilities.

Given the affirmative response of the CERC to the first question, it became necessary to deal with the legal matters that arose in the second question, i.e. whether the force majeure or “change in law” provisions in the PPAs would be attracted in this case. The CERC interpreted force majeure narrowly such that it can be invoked only “where any event or circumstance or combination of events or circumstances wholly or partly prevents or unavoidably delays the affected parties in the performance of its obligations”. Since there is no prohibition as such on Adani Power buying coal from Indonesian sources, the CERC came to the conclusion that the force majeure clause is not attracted. Mere rise in price of a commodity does not result in impossibility of performance. As regards “change in law”, the CERC interpreted the terms of the PPAs. “Law” was defined to mean the laws in India, and was not meant to include foreign laws. Hence, a change in Indonesian law was not covered by the “change in law” clause. No protection was afforded to Adani Power on account of such measures that would have resulted in a situation akin to a frustration of contract.

That led to the CERC’s determination in the third question of whether it had inherent powers under law to accord relief to Adani Power. The CERC found that since there was no price escalation clause in the PPAs, in its view “ways and means need to be found to compensate [Adani Power] for the loss or additional expenditure incurred by it on account of procurement of coal from Indonesia as the international benchmark price …” [emphasis added]. The CERC analyzed the objective and scheme of the Electricity Act and related laws and policies, and rationalized its decision as follows:

82. The common threads running along the length and breadth of the statutory scheme under the Act and the statutory instruments framed thereunder are the protection of the consumers’ interest and ensuring adequate return on the investments in the sector. The consumers’ interest is protected not only by fixing competitive tariff but it is equally imperative to ensure continuous, uninterrupted and reliable supply of electricity. … Therefore, in the final analysis, the recovery of costs of the investors serves the consumers’ interest by attracting investments in the sector by improving quality of supply of electricity to the consumers. Thus, twin objectives of protection of consumers’ interest and recovery of cost of services provided are complementary. All the authorities established under the Act, have to strive towards achieving these objectives. This Commission as the apex regulatory body for power sector has the additional responsibility for meeting the objectives of law.

Relying upon “its statutory responsibility to balance the interest of the consumers with the interest of the project developers while regulating the tariff of the generating companies”, the CERC granted a compensatory tariff to Adani Power. It also ordered the establishment of a committee to undertake a consultative process to find an acceptable solution in the form of the compensatory tariff.

The dissenting order, however disagrees with the majority on the first issue, i.e. on the impact of the Indonesian regulations on Adani Power’s ability to continue with its obligations under the PPA. However, it agrees with the majority as regards the non-applicability of the force majeure and “change in law” clauses. More importantly, the dissenting view finds that the case primarily involves an adjudication of specific disputes and does not justify a general exercise of regulatory power by the CERC as it “amounts to an invasion on the exercise of free will by the parties”.


While the CERC order has enormous implications for the power industry and possibly other infrastructure sectors in India, it also raises important legal questions. First, it erodes the principle of sanctity of contract. While courts and regulators are generally hesitant to interfere in contractual understandings between the parties, in this particular case the CERC has stepped in to alter the contractual relations between the parties. Of course, it can be argued that a PPA is not a plain-vanilla contract, but one that is susceptible to industry regulation, the extent to which freedom of contract can be violated is an open question. This is also a significant point of dissent in the minority opinion.

Second, CERC’s interference comes in not through the contract, but rather through exercise of its general powers as an industry regulator. For example, contractual principles of frustration and their practical manifestations in contracts in the form of force majeure and “change in law” clauses were held inapplicable here. CERC’s use of its general powers to intervene in contractual matters would lend an element of subjectivity to commercial contracting in the sector. In its zeal to resolve a dispute in an existing situation, it remains to be seen whether it has opened a Pandora ’s Box that is likely to cause some uncertainty in the sector. In seeking to protect the commercial viability of the electricity sector and the access to power to the populace in the two states involved, the CERC may very well have dampened the sentiment. If this principle is extended, surely power generators may themselves carry the risk that they might find themselves to be at the wrong end of the CERC interference, which may cause additional concerns to the sector.

Finally, the issue of moral hazard has already been raised. The question remains whether such developments would shift undue risk to the state utilities, and thereby engender excessive risk-taking amongst the power producers. The classic way of addressing risk is through contract, but if the freedom of contract is constantly eroded as it has been in this case, the risk allocation mechanisms will be determined by the regulator rather than left to the wisdom of the parties.

Surely, there are lessons to be drawn from this case. Not the least among them might be the need to capture more details (as is reasonably possible in a cost-effective and timely manner) in contracts regarding the obligations and responsibilities of parties on matters such as fuel linkages.

For more, The Firm – Corporate Law in India has an interesting debate on the CERC order.


Badrinath Srinivasan said...

The majority has introduced into Indian contract law the doctrine of hardship. Indian law does not recognise the doctrine of hardship simpliciter unless it comes within the purview of Section 56 Contract Act. Besides, if a strict view is taken, even the hardship doctrine would not apply as Adani had deliberately taken the risk of providing for fixed fuel costs (without escalation) at the time of bidding. Consumers have to bear the burden for Adani's folly.

vswami said...

The viewpoints aired but with a different stroke in another published article @ the blogs. economic times.../an-unequal-battle,
make for an interesting reading.