The Supreme Court of Texas (“Court”) recently held that a liquidated damages provision in a contract for renewable energy was unenforceable because it operated as a penalty without having any reasonable relationship to actual damages.1
In 2000, FPL Energy, LLC, a predecessor of NextEra Energy, Inc. (“FPL”), contracted with Luminant Energy Company, LLC (“Luminant”) to sell electricity and renewable energy credits (“RECs”) generated by three of FPL’s wind farms. FPL fell behind in its contractual commitment to deliver stated quantities of electricity and RECs as a result of grid congestion and curtailment by the state regulators. With respect to REC deliveries, FPL failed to deliver 580,000 RECs to Luminant over a period of four years. Under the parties’ contract, if FPL failed to deliver RECs, then FPL would owe a liquidated damages payment to Luminant equal to (i) the deficiency of RECs, multiplied by (ii) the lesser of $50 per REC or twice the annual average market value of a REC as determined by the Public Utility Commission of Texas (“PUCT”). At the time Luminant calculated the liquidated damages payment allegedly owed by FPL, the PUCT declined Luminant’s request for a REC market value determination. As a result, Luminant based its liquidated damages calculation on the $50 per REC metric and claimed that FPL owed damages equal to $29 million.
Despite the uncertainty surrounding the correct market value of the RECs, the Court held that Luminant’s approach strayed too far from the standard of a reasonable calculation of damages. According to the Court, if “liquidated damage provisions operate with no rational relationship to actual damages, thus rendering the provisions unreasonable in light of actual damages, they are unenforceable.”2 The Court noted that the market rate for RECs at the time of FPL’s under-deliveries fluctuated between $4 and $14 per REC. If these values were doubled according to the liquidated damages provision in the parties’ contract, this would have yielded a range of $8-$28 per REC instead of the $50 per REC used in Luminant’s calculations.
The FPL decision serves as a reminder that parties should be cautious when drafting liquidated damages provisions to ensure that (i) the market price used to calculate the damages will be readily ascertainable, and (ii) the liquidated damages include a fair market mechanism that will not be construed as a penalty payment.