On April 11, 2011, FPL Energy, LLC, et al., filed with the Texas Supreme Court a petition for review of the Texas Court of Appeals’ decision FPL Energy, LLC, v. TXU Portfolio Management Company, L.P. The case illustrates the significant economic impact that curtailment can have on variable energy resources. For a detailed description of the case and its implications, see our Renewable + Law Blog entry on the Court of Appeals’ decision here.

The petition for review focuses on the question of whether the Court of Appeals was correct in enforcing the liquidated damages provisions contained in three wind energy power purchase agreements. The pertinent provisions in each PPA required the petitioners to pay $50 for every MWh that the plants fell short of achieving the their minimum REC output guarantees—the Court of Appeals’ holding meant that the petitioners owed TXU roughly $29 million in shortfall damages for a four year period of curtailment imposed by the transmission provider (ERCOT), on top of the pain of losing the contract price and the production tax credit on each MWh of energy curtailed.

Petitioners argue that the Court of Appeals should have held the liquidated damages clause to be unenforceable, as the trial court did, because (1) the $50/MWh liquidated damages amount was based on a regulatory penalty for a renewable energy credit (REC) shortfall that was never imposed on TXU or its assignee, and (2) the $50/MWh sum “exceeds any conceivable damage” actually suffered by the buyer.

The petitioners also argue that the Court of Appeals’ reasonableness determination was based on a comparison of $50/MWh to the bundled market price per MWh (energy plus RECs), rather than the market price for RECs alone. According to petitioners, TXU’s cost to cover the REC shortfall was in the range of $4 to $14 per MWh, not $50, and TXU was able to cover the energy shortfall with coal-fired electricity at $12 to $13 per MWh vs. the $24/MWh price in the PPAs. By giving TXU a windfall, say petitioners, the Court of Appeal’s holding violates the principle of “just compensation.”

I’m sympathetic to the arguments that FPL is making on liquidated damages, but I won’t speculate about how the Texas Supreme Court will finally rule. The case does, however, show that liquidated damages clauses should be handled with care in any negotiation, especially around PPAs. The basic rule is that a provision that sets unreasonably large liquidated damages is unenforceable as a penalty. PPAs with hard-wired liquidated damages amounts (e.g,, $x per MWh regardless of actual market conditions) may be subject to scrutiny and ultimately may not be enforced, especially if a court concludes that the resulting damages look like a penalty. Liquidated damages provisions that use cost-to-cover tied to a market index are much less likely to draw the unwanted attention of a court or arbitrator, since the link to the market will cause the liquidated damages to appear reasonable relative to market conditions.

The petition also challenges the Court of Appeals ruling that TXU only had an obligation to provide transmission services sufficient to accept and transmit the “Net Energy” of the three plants (i.e., the energy that hit the busbar after ERCOT’s curtailments were imposed). The argument seems to be that because TXU was responsible for “purchasing or arranging all services, including without limitation Transmission Services, . . .necessary to deliver Net Energy to TXU Electric’s load from the Renewable Resource Facility throughout the Contract Term,” it had a duty to do whatever it took to obtain transmission services sufficient to take everything the three plants could generate regardless of congestion—even if that meant arranging and paying for substantial improvements to the transmission system to eliminate the congestion problem.

Our litigators tell me that, as a general matter, if you are going to place a multi-million dollar obligation on a party to a contract, you should be really explicit about it, and that’s a good lesson to apply generally in negotiating PPAs. A fair reading of Section 2.03 is that it required TXU to obtain whatever transmission service was offered on the transmission system to take away whatever the plant was able to generation after taking into account ERCOT curtailments, but not—without a very clear obligation in the PPA—that it was obliged to build transmission or pay for curtailments if it didn’t. Of course, that’s just my opinion from afar, and the Texas Supreme Court might take a different view after a careful review of the record.