The renewables sector is feeling the impact as COVID-19 begins to cause huge global disruption to supply chains. The renewables sector is heavily reliant on global supply chains for raw materials and components, as well as an available workforce to physically build, operate & maintain the power plants.
Whilst we note that Chinese factories are now at various stages of restarting and ramping back up capacity, production across the rest of the globe is currently being hindered and disrupted. Examples of the practical impacts COVID-19 is having in the renewables sector supply chain are:
- Imports/Exports stopped - countries are enacting different measures concerning import of goods and services from COVID-19 high risk countries. The European Commission has allowed each Member State to adopt measures (proportionate and not prejudicial) aimed at safeguarding the health of its citizens and to prevent the spread of the virus COVID-19.
- Factories and test facilities closing/reducing output – countries are adopting differing approaches as to whether or not production must halt, and this is changing almost daily.
- Reduced workforce – employees not coming to work due to self-isolation, sickness or fear of risks.
- Travel bans – many countries have begun to close borders. Certain work in the sector (such as specialist installation or operation and maintenance) may require overseas-based specialists who are unable to get to the location of work due to travel restrictions.
Renewables is also a sector packed with tight contractual deadlines and liquidated damages for delay. Some independent power producers (IPPs) are finding a mismatch between the relief they must grant to their EPC and O&M Contractors and the relief they are entitled to under the Power Purchase Agreement. There are also often deployment deadlines in countries’ auction systems.
The above all means that customers and suppliers are keen to understand their liabilities under their contracts should COVID-19 cause delay, and to work collaboratively to find solutions. Of particular interest is whether liquidated damages remain payable by the supplier, and whether the supplier has any other options such as suspension, termination or entitlement to increased costs under the change in law clause.
This note looks at how Italian contract law on force majeure and supervening excessive onerousness (eccessiva onersosità sopravvenuta) applies to the COVID-19 pandemic, and highlights other contractual hints and tips that both customers and suppliers should be aware of.
Step 1: Which law applies?
In assessing whether or not a party is entitled to relief from its obligations, it is important to check both:
- the governing law of the applicable contract; and
- the laws in the jurisdiction where the obligations are being performed (particularly with regards to any mandatory restrictions in place regarding imports/exports, production and travel bans). For example, the contract may be governed by Italian law meaning the language of the contract will be interpreted under Italian interpretation principles. However, the obligations under the contract may be being physically performed in France (for example at a factory or testing site) meaning the French law governing whether or not production must be suspended will be relevant to test the impact of the force majeure event (see steps 4 & 5 below).
Step 2: Is COVID-19 a force majeure event?
Although there is not a precise force majeure definition under Italian law, a "force majeure event" is usually defined as any event beyond the control of the party whose performance under a certain agreement has become impossible, it is rendered excessively onerous or it is delayed as consequence of the occurrence such events, resulting in an exoneration for the affected party to perform its contractual obligation.
It should be noted that in most cases, in the absence of specific provisions, it would not seem correct to establish a direct analogy between the spread of the virus COVID-19 and the impossibility of performance with liberating effects for the debtor; in fact, it will always be necessary to assess the actual causal impact of the event or of the related authoritative measure on the collectability of the performance. However, we note that, in these days, some contractors and suppliers have started to ask for the inclusion of specific references to pandemics, epidemics and health emergencies into the relevant definitions of force majeure in project contracts, in order to be able to take advantage of such clause should any problem related to the performance of the contract occur.
With reference to such authoritative measures, we note that the Italian Government has implemented some measures aimed at containing, or at least limiting as much as possible, contagion among citizens. Among the national measures is the Prime Ministerial Decree dated 22 March 2020 (as further amended, the "Lockdown Decree"), which provides, among others, for the suspension of production and commercial activities, with the exception of those listed in the document attached to such decree and identified by means of ATECO code, the performance of which remains permitted, subject to the adoption of certain safety measures.
In the case in which the activities related to the energy market had not been included in such list, it would have been reasonable to conclude that the relevant contractors could ideally have been relieved of their contractual obligations because of the occurrence of a force majeure event. In any case, pursuant to the Lockdown Decree and generally speaking, works may continue to be carried out for all activities aimed at ensuring the supply of electricity, gas, steam and air conditioning remain permitted, whose corresponding ATECO code (35) is the one that, in most cases, identifies the companies operating in the energy sector, specifically in relation to the construction, management and maintenance of plants. Furthermore, Article 1, letter (d) of the Lockdown Decree provides that the activities that are functional to ensure the continuity of the supply chains of the activities listed in Annex 1 remain generally permitted.
Although it has been made clear that the Lockdown Decree allows the continuation of the abovementioned activities, there might be circumstances, arising from the health emergency, which could prevent or delay the performance of contractors such as, for example, strikes, difficulties in procurement of materials, etc. In such cases, therefore, the temporary impossibility would not be invoked by the contractor on the basis of such decree, but rather for different reasons related to the current situation. Even in such circumstances, a direct causal/effect relationship which would automatically relieve the debtor from the duty to fulfil his obligations shall not be established but, as previously stated, an analysis of the concrete case will be necessary in order to verify the legitimacy of the exception raised based, on the one hand, on the actual consecutio of the events and, on the other hand, on the specific clauses negotiated between the parties in the drafting of the relevant contracts.
Finally, it seems possible to state that, as of today, the worksite activities related to energy sector remain (mostly) permitted and, consequently, the health emergency may not be considered per se a force majeure event with liberating effects for the debtor.
Step 3: Should a supplier notify its customers of the force majeure event under a general 'alert'? Is notification a condition to claiming relief?
The affected party may feel that there it might be beneficial, from a relationship perspective, to communicate a force majeure event and the delay it has caused. It may wish to serve a general alert or early warning notice to its customers that COVID-19 is causing delay/disruption and that it is doing whatever it can to mitigate this.
Parties affected by COVID-19 should consider that, unless otherwise provided by the contract, Italian law does not set forth notification requirements as a condition to seek exoneration from liability as a result of the occurrence of a force majeure event.
However, should the affected party intend to send such notices, it should be wary that:
- a general ‘alert’ may not satisfy the force majeure notification requirements in the contract as more factual detail is likely to be required;
- a general alert may ‘set the clock ticking’ that the affected party considers the event to be a force majeure event, meaning formal notice should be served under the contract within the specified time period; and
- despite any alert (or due to the alert), the client may bring suit on the basis of any default and/or delay and the relevant contractor will bear the burden of proof regarding the fact that reliefs provided under Italian law applied.
As far as force majeure clauses are concerned, they are likely to require that the affected party serves notice of the force majeure event within a specified period. This may be drafted as a contractual obligation to serve notice, or as a condition to claiming relief. Look out for words/phrases such as “provided that” or “conditional upon” – these may indicate that if the affected party fails to serve notice within the required time period it loses its right to claim relief. The affected party must follow the requirements of the notice provision meticulously including which entity the notice should be addressed to, how it should be sent and information it needs to contain.
Step 4: What does an affected party need to do to show it has been 'prevented, hindered or delayed' from performing its obligations?
In the case in which a force majeure event has been established, the steps an affected party has to follow to claim relief will depend on (i) whether the contracts provides for a remedy and a procedure to be followed; and (ii) if so, the specific contractual discipline. Generally we find that the affected party has to show:
1. the occurrence of an event out of the parties' control determining the impossibility or the delay to perform the affected party's obligation; and
2. that, as a result of the occurrence of such event, the affected party has been prevented or delayed from performing its contractual obligations.
Prevent – To be prevented means that it must have become physically or legally impossible (and not merely difficult) to perform a certain obligation. For example, a contractor would have to show that the government has mandated its factory ceases operation through legislation or binding guidance. The affected party shall also show that it was “ready, willing and able” to perform its obligations under the contract and that such performance has become impossible because of the occurrence of such event.
Delay - Delay has a wider scope and it is generally easier to be proved by the affected party than prevention. However, the relevant contractor shall still have to establish that as a direct result of the occurrence of a specific event, performance of its obligations is taking longer (or finishing later) than planned.
Hinder – Generally speaking, under Italian law, hindrance (i.e. the event in which a contract has become more expensive to perform, even dramatically) does not allow the affected party to claim the reliefs described under step 1; different reliefs such as excessive onerousness (described under step 9) are usually provided in these cases. However, it should be taken into account that an analysis of the relevant force majeure clause is suggested, since it may contain a specific reference to hindrance.
Step 5 - Does a supplier need to take steps to mitigate the impact of the force majeure event?
Under the general contractual principle of good faith set forth by Article 1375 of the Italian Civil Code, the affected party shall be able to prove that it has taken all reasonable steps to avoid, or at least to mitigate, the consequences of the occurrence of the events giving rise to the remedies listed under step 1.
It will be a question of fact as to whether an affected party has taken the necessary steps to mitigate the impact of the above-mentioned events, but relevant factors could be:
- what the affected party could have done in order to keep performing its contractual obligations?
- has the affected party considered all possible alternatives in order to continue the performance of its contractual obligations?
Mere difficulties or additional expenses are not usually a sufficient ground for the force majeure provisions to be invoked. Therefore, just because a contract has become more expensive as a result of COVID-19, or even uneconomic to perform, that will not always automatically constitute a force majeure event. However, the fact that performance became more expensive may determine the right for the affected part to seek a different relief described under step 9.
Step 6 - If I am entitled to force majeure 'relief', what does this actually mean under the contract?
Generally speaking, under Italian law, an entitlement to “force majeure” relief means that the affected party is excused from contractual liability, including damages (of any kind), in relation to its non-performance (or delay).
According to Italian law, a defaulting party is exonerated from liability (i) if the service to be rendered under the contract becomes excessively onerous due to “extraordinary or unforeseeable events”; or (ii) if the non-performance or delay in performance is due to the supervening impossibility to render the service, which is not attributable to the non-performing party: in this cases the non-performing party may also ask for the termination of the contract. In this regards, the Italian Civil Code also provides that the parties, within certain limits, may derogate from the above, establishing different effects resulting from the occurrence of certain events. This is the case, for example, in project contracts, where commercial standards usually state that, where the performance of a party is in some way impacted by a force majeure event that makes it impossible or excessively onerous, the obligations of that party are suspended for the duration of the event and, if such event continues for a certain period of time, that both parties may withdraw from the contract.
Step 7 - Does the non-affected party have to do anything to help the affected party?
Under the abovementioned general principle of good faith, the non-affected party may have an obligation to help (to the extent this is reasonable and possible) the affected party to mitigate the impact of the force majeure event. The contract may provide for further obligations to be evaluated on a case-by-case basis.
Step 8 - What other provisions of the contract might be relevant?
We suggest taking a holistic view of the entire contract. The following clauses may be particularly relevant:
- Payment – any rights for the customer to withhold payments if obligations are not performed (even if due to force majeure)?
- Suspension/hardship – any rights for the affected party to suspend its performance (for example due to economic change or under an express ‘hardship’ clause)?
- Termination – any compensation payable for termination for force majeure?
- Change in Law – many countries are introducing new laws to deal with COVID-19 which could make performance of obligations more expensive. How is this risk dealt with? How is “applicable law” defined for the change in law clause and does this cover guidance and legislation?
- Availability/take or pay service credits – do service credits still apply even if the reason the supplier has not supplied is force majeure?
- Material adverse effect – are there any clauses entitling a party to terminate the contract if there is an event that has material adverse consequences or means that the contract would be loss making?
- Health & safety – can the supplier still comply with health & safety regulations and guidance that it may be contractually bound to comply with?
- Key personnel – are specified people earmarked for particular obligations?
- Notice clause – ensure compliance in order to ensure that notices are valid and can be relied upon.
- Variations – any amendments agreed due to COVID-19 will need to be made in accordance with any variations clause (which may require variations to be in writing).
- No waiver – a no waiver clause does not necessarily protect a party from post-breach inaction. A non-breaching party should still reserve its rights and remedies and notify the party in breach by notice.
- Dispute resolution which may include an escalation clause which includes parties’ agreement to resolve any dispute on a staged basis.
Step 9 - Could any other implied Italian law be relevant?
In addition to the considerations provided above related to force majeure, the issue of the impacts that measures to combat the COVID-19 emergency could have in terms of excessive burdens on project documentation in the energy markets shall be kept in consideration.
The concept of "excessive onerousness", introduced by Article 1467 of the Italian Civil Code, is not defined by the legislator, but on the basis of the elaborations of jurisprudence and scholars it can be deemed that such a case shall be assessed on the basis of objective criteria and requires the occurrence of extraordinary and unforeseeable events that determine an alteration of assets capable of significantly affecting the value of one service with respect to the other, or that diminish or cease the usefulness of the counter-performance. According to Article 1467, the party who owes the performance can demand the termination of the contract. Termination cannot be demanded if the supervening excessive onerousness falls within the normal risk of the contract.
Thus, COVID-19 emergency could abstractly integrate a case of supervening excessive onerousness with the activation of remedies provided for by law or contract, where in the specific case the impacts are of such importance that they substantially alter the contractual mutual interest.
That being said, in project contracts the consequences of cases of supervening excessive onerousness are commonly subject to specific regulations, also in derogation of the abovementioned code-based provisions, so as to define in advance the relative consequences on the contractual relationship and the related protections that may be activated.
In this regard, it should be noted that in contracts for the construction, maintenance and management of energy works, the parties (especially in more structured operations that comply with the bankability criteria) often acknowledge the random nature of the contractual relationship with the consequent express waiver of the rights and remedies provided for in the Civil Code in the event of excessive onerousness.
In any case, the occurrence of an event of supervening excessive onerousness would not legitimize the automatic suspension of the affected party's performance (as happens in cases of force majeure) and the party against whom the contract termination is requested could still offer to modify the conditions of the contract in an equitable manner.
Step 10 – Anything else to think about?
1. Pay constant attention to new legislation issued from time to time in order to timely undertake any necessary step;
2. Always determine the steps to be taken trying to limit the damages contractual counterparties may incur in: a conservative and cooperative approach may protect you from allegations of bad faith;
3. Follow the contractual process for notification meticulously and, if the contract does not contain any hardship or force majeure provision, carefully tailor any communication in the light of potential litigation;
4. Take a holistic view of the contract analysis – consider which clauses may help/hinder and do not forget to look at the boilerplate;
5. Retain documented evidence of steps you are taking, of the reasons surrounding those steps, of the steps taken to mitigate and also steps counterparties may be taking if they are the ones invoking force majeure. This could include credible records – containing trustworthy public domain information where available – which set out the factual context for the decision in question. It is important to document the alternative options available at the time of performance (or lack of them!);
6. Consider whether you wish to adopt a collaborative/non-adversarial approach to resolve the issue. Early engagement with contract counterparties and a collaborative resolution of issues may be preferable to an adversarial approach;
7. Re-source supply wholly or partially – risks can be reduced or removed if you have a viable alternative which can be implemented quickly. Consideration should be given to the lead times for re-supply and how these fit with existing inventory. Be careful as re-sourcing may be in breach of existing supply contracts.
8. Recover assets – you may have supplied tools or certain assets may be used under license. Equally, there may be stock or other materials on site which belong to you. The terms of any applicable contract will strongly influence your ability to recover these items, however, in case the difficulties the counterparty is undergoing end up by causing the commencement of insolvency proceedings, such recovery might become exponentially more difficult.
9. Ensure you make all required third party notifications in timely fashion (including insurance, industry regulators, etc.).