CHAPTER 6 LITIGATING LONG TERM COAL SUPPLY AGREEMENTS
| Jurisdiction | United States |
(Dec 1989)
LITIGATING LONG TERM COAL SUPPLY AGREEMENTS
Davis, Graham & Stabbs
Salt Lake City, Utah
TABLE OF CONTENTS
Page
I. LEGAL THEORIES: WAYS OF ANALYZING DISPUTES OVER LONG TERM COAL SUPPLY CONTRACTS
A. Origins
1. Why Long Term Contracts?
2. Producer and Consumer Dissatisfaction
B. Using Prelitigation Investigation to Understand the Facts Completely
C. Placing the Dispute in a Familiar Legal Context
1. The Uniform Commercial Code
(a) Cancellation and Termination
(b) Modification of Long Term Coal Supply Contracts Under the UCC
2. Common Law Theories
3. Force Majeure Clauses
4. Gross Inequities Clause
5. Market Reopening Clauses
II. PRACTICAL CONCERNS: APPLYING LEGAL THEORIES TO THE REAL WORLD RESOLUTION OF DISPUTES
A. Managing Discovery
B. Summary Judgment
C. Choice of Forum
CONCLUSION
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"There is only so much oil in the ground."
Tower of Power from the song of the same name on their Urban Renewal Album
The finite nature of fossil fuel reserves became evident to consumers in the United States in the early 70's when oil production restrictions by OPEC forced dramatic changes in the price and availability of gasoline. OPEC's strategy was successful in part because domestic oil producers in the 60's and early 70's began to pump the last of the oil in United States' ground and began to rely more heavily on imported oil.
The shock wave from OPEC's action rippled through the coal industry and spurred a rise in coal prices in the mid to late 70's. Many producers who were parties to long term supply contracts then sought ways to capture opportunities which they were losing because of their long term commitments.
These developments gave rise to numerous lawsuits concerning the nature of a contracting party's obligation in a long term agreement. They also gave rise to changes in the way in which long term contracts were drafted. Parties to long term coal supply contracts began to include detailed "adjustment clauses" to adjust the price of coal over time, "market reopener clauses" which allow one party to reset the contract price to be reset based on market price, and "gross inequities clauses" which call for negotiations to alleviate gross inequities (mostly undefined) and various combinations of these clauses.
In the early to mid 1980's the energy cost cycle began a downturn leading to falling or flat coal prices. The coal consumers (mostly utilities) who had entered into long term price adjusted contracts began to yearn for an opportunity to lower fuel costs. This trend has also given rise to numerous negotiating sessions, lawsuits and seminars.1 This particular type of dispute between producers and consumers over pricing questions (although the dispute may be couched as something else) is the topic of this paper.
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The paper will focus on legal theories available in disputes over provisions in long term supply contracts and on ways in which a choice of legal theory can influence the course of litigation.
I. LEGAL THEORIES: WAYS OF ANALYZING DISPUTES OVER LONG TERM COAL SUPPLY CONTRACTS
One of the most important aspects of litigation is maintaining control of the discovery and motion process. The number of issues and amount of discovery can expand enormously. One method of gaining control of the litigation is deciding early in the case what legal theory or theories will be used. This helps control discovery and many other facets of the case including developing the theme of the case for trial.
One of the first steps toward developing a theory of the case is to understand the background of the contract at issue. This includes understanding the reasons for long term contracts and for the disputes which develop.
A. Origins
1. Why Long Term Contracts?
Long term contracts are fairly common in the coal industry.2 The reasons for the prevalence of long term contracts are mostly economic and are related to the nature of coal extraction and of the utility industry which is the largest single consumer of coal.3
A coal mine requires a large capital investment which can only be justified if the coal from the mine can be sold. A coal fired electrical generating plant requires a similarly high level of investment and cannot earn a return unless it can produce electricity for sale. Both of these facilities must be in operation for a significant amount of time before they can recoup their initial capital investment and return a profit.
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Thus one of the reasons for long term contracts is that the coal producer is interested in an established market for its coal and the utility is interested in a stable source of supply.4 There are a limited number of options which allow coal producers and consumers to accomplish their objectives. The utility can purchase a coal mine, purchase coal under short term repeatedly renewed contracts, or enter into a long term contract.
The viability of these options depends in part on the relative location of the coal mine and the generating station. If the generating station has easy access to a number of coal suppliers the short term contract is a possible alternative. However, where demand by the utility and transportation costs of the coal limit the number of potential suppliers, either direct investment in a mine or a long term relationship with one or more producers is a more practical alternative.
The equation is similar from the producer's side. Its viability depends on the number of consumers it can reach cost effectively. If that number is low it must seek long term commitments to ensure its continued existence. Thus, both producers and consumers are interested in long term arrangements.
Another impetus for long term contracts is the instability of prices. Both the producer and the consumer desire price predictability to ensure the ability of the business to survive and to enhance the ability to plan for the future.5
2. Producer and Consumer Dissatisfaction.
The trend in coal prices for the last several years has been down while the general trend in the economy has been slightly inflationary. The result is that in many contracts which allow price adjustment based on inflation, the contract
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price of coal is greater than the market price.6 Although utility companies, the main customer for long term coal suppliers, often are able to pass through all of the cost of fuel to the rate payers, public utilities commissions have begun examining pass through requests very closely.7 Several utilities have been stung because their fuel procurement contracts have been found by commissions to be imprudent. The sanctions for such a finding include disallowing the pass through of what the commission identifies as the excess costs of the contract.8
If utilities are not permitted to pass through fuel costs, profits are reduced. When a public utilities commission clamps down on a utility's fuel costs, the utility will consider using resources in some way to reduce the price of its fuel. The utility will attempt to negotiate a solution or, if that is unworkable, will use its resources to litigate the issue.
The combination of more vigilant public utilities commissions, price adjusted long term contracts and falling market price of coal has caused many utilities to seek relief from producers.9
B. Using Prelitigation Investigation to Understand the Facts Completely
The parties to a long term coal supply contract are generally aware of difficulties in the relationship and realize when litigation is imminent. When the parties come to this realization and consult counsel, the first step in preparing for the court action is to determine the nature of the claims involved and determine the factual basis for the claims.
While a complete factual investigation is desirable, it cannot be thoroughly effective unless the nature of the claims on
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both sides is understood. However, the refinement of the claims is dependent on a thorough knowledge of the facts. The best approach is to outline generally all of the claims on both sides of the controversy which are supported by the facts as then known and begin the factual investigation.
The factual investigation should include interviewing all present and former employees who had responsibility for negotiating and drafting the contract and all present and former employees who had responsibility for overseeing the implementation of the contract. In addition, the client and attorney should form some general idea of the volume of correspondence, reports and other documents which would be involved in the case if the opposition succeeds in asserting its broadest claim.
A thorough pre-litigation review of the facts provides a number of advantages. First, the investigation allows one to select one or two legal theories for use throughout the litigation without the danger of their usefulness being lost by the discovery of a previously hidden fact. Second, a complete factual investigation coupled with a well chosen legal theory allows one to begin discovery soon after the action has commenced and to press forward with discovery proceedings until they have been completed. This permits one to gain momentum in the litigation and steer the proceedings in a way that is most advantageous. If, for example, one can begin the deposing adverse witnesses quickly with a complete knowledge of where one wants to end up and good guesses about where the opposition will go, it is possible to obtain information from those witnesses which is important to the case but which the opposition might not have had a chance to consider.
Third, this preparation allows the attorney to consider in advance what motions might be appropriate and to develop them properly. For example, a thorough understanding of the facts will allow one to determine with some certainty whether a...
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