a comparison of remedies in the ucc to remedies …images.jw.com/com/publications/532.pdf ·...

Presented:The University of Texas School of Law

4th Annual Gas and Power Institute

October 20-21, 2005Houston, Texas

A COMPARISON OF REMEDIES IN THE UCC TO REMEDIES AVAILABLE UNDER THE NAESB, EEI, CTA AND ISDA

Craig R. EnochsAmy L. Head

Craig R. [email protected]

Amy L. [email protected]

Jackson Walker L.L.P.1401 McKinney, Suite 1900

Houston, Texas 77010(713) 752-4200 phone

I. INTRODUCTION

Article 2 of the Uniform Commercial Code (“the Code” or “U.C.C.” or “Article 2”)governs the sale between merchants of energy and energy commodities, like the sale of all goods.1 The U.C.C., in one of its several versions, has been enacted in 49 of the 50 states.2

Accordingly, when evaluating rights and remedies in energy commodity transactions, the provisions of Article 2 are often the lens through which these energy commodity transactions are viewed. However, standard form agreements used to document energy commodity transactions often contain remedies that differ from those promulgated in Article 2.

Since the provisions of Article 2 act merely as default language when a contract is ambiguous or fails to address a particular topic, a party relying on Article 2 to evaluate its legal risks may improperly assess its legal rights and remedies in a transaction.3 Looking to Texas law for the applicable U.C.C. provisions, this paper will summarize the Code’s remedies for breach of contract, summarize the remedies for breach of contract contained in some of the standard form agreements used to document certain energy commodity transactions,4 analyze the differences between the remedies of Article 2 and the standard form agreement remedies, and evaluate any inadequacies that may exist in these contractual remedies.

II. U.C.C. PROVISIONS

A. GENERAL PROVISIONS

Before beginning an analysis of the specific remedy provisions of the U.C.C., it is important to acknowledge the general manner in which the Code is applied. First, Section 1.103 of the U.C.C. gives the parties to a contract the ability to vary the terms of the U.C.C. as it applies to their relationship; this section is particularly important, as it gives the parties the right to contract around, or out of, the U.C.C.’s contractual remedies provisions.5 While this section seems fairly straightforward, parties to a contract must realize that there may be instances in which an issue has been addressed in a contract, but the terms of a contract are determined to be insufficient to preempt the application of the U.C.C.6 Therefore, if the parties to a contract believe that its provisions do not adequately protect the risks they face in the specific circumstances of their transaction, it is imperative that the parties carefully draft their agreementand include provisions that are sufficiently detailed and specific to preclude application of theU.C.C.’s default provisions.7

1 TEX. BUS. COM. C. §2.102.2 Louisiana, the sole holdout, has enacted much of the Code, but because Louisiana's commercial law is based oncivil law and the Napoleonic Code rather than on common law, Louisiana has failed to adopt Article 2 in its entirety because it is difficult to harmonize the state’s legal procedures and terminologies with Article 2.3 See TEX. BUS. COM. C. §§ 1.102; 2.201; 2.204; 2.301.4 This article analyzes the NAESB (gas), the Master Coal Agreement (coal); the EEI (power), and the ISDA (power and gas). 5 TEX. BUS. COM. C. §1.103.6 See id. 7 See id.

Second, Section 1.106 states that “[t]he remedies provided by this Act shall be liberally administered to the end that that the aggrieved party may be put in as good a position as if the other party had fully performed.” Most energy commodity contracts do not contain a provision analogous to this one, although most such contracts detail the remedies available to each party in the event of a breach. However, the application of Section 1.106 means that, in the event of any ambiguity, the U.C.C. remedies provisions may be construed against the breaching party.

B. BREACH

One of the most important characteristics of the U.C.C. is the manner in which it deals with the breach of a standard contract by the buyer or seller. The Code espouses what is commonly known as the “perfect tender” rule, which provides that any failure to conform to the obligations stated in the contract, regardless of how minor the deviation, constitutes a breach of the contract.8 Under Section 2.601, the seller breaches the contract if its delivery fails in any respect to conform to the contract. Conformity does not mean substantial performance; it means complete, perfect performance.9 However, Section 2.508 somewhat relaxes the perfect tender rule by allowing a seller to cure any improper tender if the time for performance has not yet expired.10 In the energy context, for example with the delivery of electric power, it would be impossible to cure imperfect tender (as the amount and type of electricity delivered is delivered; it generally is incapable of physical rejection by the buyer); however, application of this section could potentially be used to allow a seller who does not begin delivery on the date specified in the contract, or who improperly stops and then restarts delivery at some point during the term of the contract, to cure any defects in performance or delivery.11

It is also important to note that the U.C.C. treats the breach of an installment contract differently from the breach of other standard types of agreements, which is particularly important in any discussion of energy contracts, as most all energy contracts fall within the U.C.C.’s definition of “installment contract.”12 The Code defines an installment contract as one thatrequires the delivery of goods in separate lots to be separately accepted, even though the contract contains a clause stating that “each delivery is a separate contract” or the like.13 Section 2.612 allows the buyer to reject any installment that is non-conforming if the non-conformity substantially impairs only the value of the single installment and cannot be cured.14 But, if the non-conformity does not impair the value of the contract as a whole (as discussed below),

8 See TEX. BUS. COM. C. §§2.601; 2.703.9 TEX. BUS. COM. C. §2.601; Tex. Imps. v. Allday, 649 S.W.2d 730, 737 (Tex. App.—Tyler 1983, writ ref’d n.r.e); Printing Ctr., Inc. v. Supermind Publ’g Co., 669 S.W.2d 779, 783 (Tex. App.—Houston [14th Dist.] 1984, no writ).10 TEX. BUS. COM. C. §2.508.11 See id.12 See TEX. BUS. COM. C. §2.612(a).13 TEX. BUS. COM. C. §2.612, cmt. 3 (stating “[t]his Article rejects any approach which gives clauses such as “each delivery is a separate contract” their legalistically literal effect. Such contracts nonetheless call for installment deliveries. Even where a clause speaks of “a separate contract for all purposes,” a commercial reading of the language under the section on good faith and commercial standards requires that the singleness of the document and the negotiation, together with the sense of the situation, prevail over any uncommercial and legalistic interpretation.”) .14 TEX. BUS. COM. C. §2.612(a).

subsection (b) provides that if the seller can give assurances that it will cure the non-conformity with respect to the installment, the buyer must then accept the non-conforming installment. Subsection (c) provides that whenever a non-conformity with respect to one or more installments “substantially impairs the value of the whole contract, there is a breach of the whole.” Whether the non-conformity in any given installment justifies cancellation of all future transactions depends “not on whether such non-conformity indicates an intent or likelihood that the future deliveries will also be defective, but whether the non-conformity substantially impairs the value of the whole contract.”15 If only the seller's security in regard to future installments is impaired, he has the right to demand adequate assurances of proper future performance but does not have the immediate right to cancel the whole contract.16 Defects in installments are cumulative in effect, which means that acceptance “does not wash out the defect ‘waived.’”17 Subsection (c) also provides that when the nonconformity impairs the value of the whole contract, if a party then accepts a non-conforming installment, the contract is reinstated.

C. REMEDIES

1. Available to both parties

The Code permits either party to request and receive assurances of performance when abreach has not yet occurred if the counter-party’s performance, or continued ability to perform,has been called into question.18 This section recognizes the commercial reality that a seller needs to be able to protect against the risk of having to deliver a commodity on credit to an unreliable buyer, as well as against having to procure goods for that buyer, which could necessitate turning away other, credit-worthy buyers.19 The same section offers the identical protection to the buyer, who is not required to wait until the date for performance, when any failure by the seller at that point may seriously impair the buyer’s business.20 Given the price volatility of energy commodity markets, this right is an important way to ameliorate the market risk that commodity prices might change dramatically over short periods of time.

Section 2.609 allows either party to request adequate assurances of performance when the party has reasonable grounds for insecurity and allows the requesting party to suspend performance if it does not receive adequate assurances within a reasonable period of time, not to exceed thirty days, of the request.21 In order to receive such assurances, a party must make a

15 TEX. BUS. COM. C. §2.609, cmt. 6.16 Id.17 Id.18 TEX. BUS. COM. C. §2.609.19 TEX. BUS. COM. C. §2.609, cmt. 1. 20 See id.21 TEX. BUS. COM. C. § 2.609 (stating “(a) A contract for sale imposes an obligation on each party that the other’s expectation of receiving due performance will not be impaired. When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return; (b) Between merchants the reasonableness of grounds for insecurity and the adequacy of any assurance offered shall be determined according to commercial standards; (c) Acceptance of any improper delivery or payment does not prejudice the aggrieved party’s right to demand adequate assurance of future performance; (d) After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty

written request to the other party demanding assurances of future performance and may, if commercially reasonable, suspend his own performance until he receives such assurances.22

Failure to provide the requested assurance within the thirty-day window is deemed a repudiation of the contract.23 The reasonableness of a request for assurance, and the adequacy of the assurance offered, will be determined according to commercial standards.24 Further, the acceptance by the seller of a partial payment, or by the buyer of nonconforming goods, does not prejudice the party’s right to receive assurances under this section.25

The Code also addresses anticipatory repudiation by either party and provides that (i) when a party repudiates the contract and (ii) declares that performance not yet due under the contract will not be rendered, and that failure to perform will “substantially impair the value of the contract,” the aggrieved party may either await performance by the repudiating party26 or resort to any remedy available for breach and suspend performance.27 “Anticipatory repudiation” is defined as “an overt communication of intention or an action which renders performance impossible or demonstrates a clear determination not to continue with performance.” To constitute repudiation, it is not necessary that performance be made literally and utterly impossible. Repudiation can result from any action that “reasonably indicates a rejection of the continuing obligation.” However, the Code also allows a party to retract its repudiation until the next performance is due under the contract.28 Retraction may be made by any method that clearly indicates to the aggrieved party that the repudiating party intends to perform but must include any assurance justifiably demanded.29 Retraction reinstates the repudiating party's rights under the contract but requires the repudiating party to answer to the aggrieved party in damages for any delay occasioned by the repudiation.30

2. Remedies Available Exclusively to Seller

Article 2 includes several provisions addressing the seller’s remedies in the event of a breach by the buyer, or prior to a breach, in the event the buyer becomes insolvent. Section

days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the contract.”).22 Id. 23 TEX. BUS. COM. C. §2.609(d).24 TEX. BUS. COM. C. §2.609(b). 25 See id.26 TEX. BUS. COM. C. §2.610, cmt. 1 (stating that if the performing party awaits performance beyond a commercially reasonable time, he cannot recover resulting damages which he should have avoided by taking action).27 TEX. BUS. COM. C. §2.610 (stating that “[w] hen either party repudiates the contract with respect to a performance not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may (1) for a commercially reasonable time await performance by the repudiating party; or (2) resort to any remedy for breach, even though he has notified the repudiating party that he would await the latter's performance and has urged retraction; and (3) in either case suspend his own performance or proceed in accordance with the provisions of this chapter on the seller's right to identify goods to the contract notwithstanding breach or to salvage unfinished good.”).28 TEX. BUS. COM. C. § 2.611(a). 29 TEX. BUS. COM. C. § 2.611(b).30 TEX. BUS. COM. C. § 2.611(c).

2.702 identifies the seller’s remedies upon discovery of the buyer’s insolvency.31 Subsection (a) provides that when a seller discovers the buyer is insolvent, the seller may refuse to deliver additional goods unless the buyer pays, in cash, for the current shipment, and makes payment for all goods previously delivered under the contract.32 Section 2.702(b) allows a seller who delivered goods on credit to a buyer who was insolvent at the time of delivery to reclaim the goods within ten days of delivery; if more than ten days have passed since delivery, the seller may reclaim only if, within the three-month period preceding delivery, the buyer falsely represented to the seller in writing that the buyer was solvent.33 There are, however, two limitations on the seller’s right to reclaim delivered goods under subsection (b). First, the seller’s ability to reclaim is subject to the rights of a buyer in the ordinary course of business, another good faith purchaser, or a lien creditor.34 Second, the seller’s right of reclamation under this subsection is exclusive; if the seller reclaims goods under Section 2.702, no other remedy is available to the seller under Article 2.

Finally, it is important to note that the interplay of Section 2.702 with the provisions ofthe Bankruptcy Code has limited the use of the seller’s right of reclamation in the bankruptcy setting to only those attempts at reclamation made within ten days after delivery.35 In the bankruptcy context, confusion was caused by the fact that the U.C.C. effectively creates a lien under state law that conflicts with the provisions of the Bankruptcy Code that strike down disguised priorities.36 The inclusion of §546(c) in the Bankruptcy Code attempted to alleviatethat confusion by providing that the “rights and powers of the trustee under §§ 544(a), 545, 547 and 549 of this title are subject to any statutory right or common-law right of a seller, in the ordinary course of such seller's business, of goods to the debtor to reclaim such goods if the debtor has received such goods while insolvent, but (1) such a seller may not reclaim any such goods unless such seller demands in writing reclamation of such goods before ten days after receipt of such goods by the debtor.”37 The courts construing the interrelation of these two provisions have held that the Bankruptcy Code represents the exclusive remedy available when a buyer is in bankruptcy, and that unless a seller meets the strict ten-day notice requirement of Section 546(c), he retains no other common law or statutory right of action.38 When a buyer has

31 TEX. BUS. COM. C. § 2.702 (stating that “(a) Where the seller discovers the buyer to be insolvent he may refuse delivery except for cash including payment for all goods theretofore delivered under the contract, and stop delivery under this chapter (Section 2.705); (b) [w]here the seller discovers that the buyer has received goods on credit while insolvent he may reclaim the goods upon demand made within ten days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within three months before delivery the ten day limitation does not apply. Except as provided in this subsection the seller may not base a right to reclaim goods on the buyer’s fraudulent or innocent misrepresentation of solvency or intent to pay; (c) [t]he seller’s right to reclaim under Subsection (b) is subject to the rights of a buyer in ordinary course or other good faith purchaser or lien creditor under this chapter (Section 2.403). Successful reclamation of goods excludes all other remedies with respect to them.”).32 TEX. BUS. COM. C. §2.702(a). 33 TEX. BUS. COM. C. §2.702(b). 34 TEX. BUS. COM. C. §2.702(c). 35 See id.36 Id; In re Gibson Distributing Co., Inc.-Permian Basin, 40 B.R. 767 (Bkrtcy. Tex. 1984) (citing Deephouse Equip. Co., Inc., 22 B.R. 255, 257 (Bkrtcy D. Conn. 1982)). 37 11 U.S.C.A. §546(c). 38 See id.; see also In re Jeanes Mechanical Contractors, Inc., 32 B.R. 657 (Bkrtcy. W.D. Ky. 1983).

filed for bankruptcy, the sole remedy for an unpaid vendor is reclamation pursuant to Section 546(c); therefore, reclamation outside of the ten-day period is not permissible when a party has filed for bankruptcy, although it would appear to be permitted under the U.C.C.

Two additional points regarding the application of Section 2.702 may be particularly important in the energy context. First, the seller may only exercise its right of reclamation if the buyer is actually insolvent, which is defined as “having generally ceased to pay debts in the ordinary course of business other than as a result of a bona fide dispute,” or “being insolvent within the meaning of the federal bankruptcy law.”39 Second, and more important, is the fact that Section 2.702 allows a seller to refuse to deliver goods to a buyer who is insolvent without requiring that the seller also take steps to terminate the contract.

All remedies available under the U.C.C. to a seller in the event of a breach by the buyerare listed in Section 2.703, which is not used to apply any specific remedy, but merely “gathers together in one convenient place all of the various remedies open to a seller for any breach by the buyer.”40 Section 2.703 allows an aggrieved seller to, under certain circumstances, withhold delivery, stop delivery of goods already in transit, resell the goods and recover damages, recover damages for non-acceptance, or terminate the contract.41 The remedies of Section 2.703 are available to the seller when the buyer wrongfully rejects or revokes acceptance of conforming goods, fails to make a payment due, or repudiates any part of the contract.42 Section 2.705 allows a seller to withhold delivery or stop delivery of goods in transit when the seller discovers the buyer is insolvent, when the buyer repudiates the contract, or the buyer fails to make any payment due before delivery.43 The seller may stop delivery until the buyer has received the goods, the bailee or carrier has acknowledged to the buyer that the bailee or carrier holds the goods for the buyer, or until any negotiable instrument of title concerning the goods has been negotiated to the buyer.44 However, where a seller justifiably withholds delivery of goods because of the buyer’s breach, the buyer remains entitled to restitution of any amount by which the sum of his payments exceeds the liquidated damages to which the seller is entitled under the contract, or, if no liquidated damages are specified, twenty percent of the value of the total performance for which the buyer is obligated. 45

39 TEX. BUS. COM. C. §2.702(a). 40 TEX. BUS. COM. C. §2.703, cmt. 1. 41 TEX. BUS. COM. C. §2.703.42 TEX. BUS. COM. C. §2.703 (stating that “[w]here the buyer wrongfully rejects or revokes acceptance of goods or fails to make a payment due on or before delivery or repudiates with respect to a part or the whole, then with respectto any goods directly affected and, if the breach is of the whole contract (Section 2.612), then also with respect to the whole undelivered balance, the aggrieved seller may (1) withhold delivery of such goods; (2) stop delivery by any bailee as hereafter provided (Section 2.705); (3) proceed under the next section respecting goods still unidentified to the contract; (4) resell and recover damages as hereafter provided (Section 2.706); (5) recover damages for non-acceptance (Section 2.708) or in a proper case the price (Section 2.709); (6) cancel.”).43 TEX. BUS. COM. C. §2.705.44 TEX. BUS. COM. C. §2.705(b).45 TEX. BUS. COM. C. §2.718 (providing that “(b) Where the seller justifiably withholds delivery of goods because of the buyer's breach, the buyer is entitled to restitution of any amount by which the sum of his payments exceeds (1) the amount to which the seller is entitled by virtue of terms liquidating the seller's damages in accordance with Subsection (a), or (2) in the absence of such terms, twenty percent of the value of the total performance for which

Section 2.706 allows a seller to resell goods wrongfully rejected by the buyer or the undelivered balance of any goods identified to the contract.46 When the resale is made in good faith and in a commercially reasonable manner, the seller may recover the difference between the resale price and the contract price together with any incidental damages incurred as a result of the resale, but less expenses saved in consequence of the buyer’s breach.47

If the buyer is unable to stop delivery or is not made whole by the resale of the rejected goods, the Code also allows the seller to recover damages for the non-acceptance based on the difference between the market price and the contract price or the profit the seller would have received had the buyer fully performed (discussed below).48 The Code also allows the seller to terminate the contract in certain circumstances49

3. Remedies Available Exclusively to Buyer

The Code offers several remedies specific to the buyer in the event of a breach by the seller; however, not all remedies offered by the Code are applicable in the energy context. For example, Section 2.601 allows a buyer to reject non-conforming goods in whole or in part if the goods fail in any respect to conform to the terms of the contract.50 Section 2.602 is similar in its application to Section 2.601, in that it allows a buyer to reject the goods within a reasonable time after delivery or receipt.51 Both Section 2.601 and 2.602 are largely inapplicable in the energy industry, as most such contracts presume that acceptance occurs upon delivery.52

Section 2.711 outlines the remedies generally available under Article 2 to a buyer in the event of a breach by the seller.53 Subsection (a) provides that when the buyer rightfully rejects or

the buyer is obligated under the contract or $500, whichever is smaller. (c) The buyer's right to restitution under Subsection (b) is subject to offset to the extent that the seller establishes (1) a right to recover damages under the provisions of this chapter other than Subsection (a), and (2) the amount or value of any benefits received by the buyer directly or indirectly by reason of the contract. (d) Where a seller has received payment in goods their reasonable value or the proceeds of their resale shall be treated as payments for the purposes of Subsection (b); but if the seller has notice of the buyer's breach before reselling goods received in part performance, his resale is subject to the conditions laid down in this chapter on resale by an aggrieved seller.”).46 TEX. BUS. COM. C. §2.706(a) (stating that “[u]nder the conditions stated in Section 2.703, on seller’s remedies, the seller may resell the goods concerned or the undelivered balance thereof. Where the resale is made in good faith and in a commercially reasonable manner the seller may recover the difference between the resale price and the contract price together with any incidental damages allowed under the provisions of this chapter (Section 2.710) but less expenses saved in consequence of the buyer’s breach.”).47 TEX. BUS. COM. C. §2.706(a).48 TEX. BUS. COM. C. §§2.708(a); 2.709.49 TEX. BUS. COM. C. §§2.703; 2.612.50 TEX. BUS. COM. C. §2.601 (stating “[s]ubject to the provisions of this chapter on breach of installment contracts (Section 2.612) and unless otherwise agreed under the sections on contractual limitations of remedy (Sections 2.718 and 2.719) if the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may: (1) reject the whole; or (2) accept the whole; or (3) accept any commercial unit or units and reject the rest.”).51 TEX. BUS. COM. C. §2.602.52 See id. 53 TEX. BUS. COM. C. §2.711 (stating “(a) Where the seller fails to make delivery or repudiates or the buyer rightfully rejects or justifiably revokes acceptance then with respect to any goods involved, and with respect to the whole if the breach goes to the whole contract, the buyer may cancel and whether or not he has done so may in

revokes acceptance, the buyer may terminate the contract, recover the price paid, and either “cover” and have damages (as discussed below), or have damages for non-delivery.54

Subsection (b) allows the buyer the option of (1) recovering the goods (if the goods have been identified to the contract),55 (2) obtaining specific performance56, or (3) replevying the goods.57

Subsection (c) offers yet another option by creating an automatic security interest in goods in the buyer’s possession or control for any payments made on those goods and any expenses incurred in the receipt, inspection, and transportation of the goods.58 This section allows the buyer to sell any non-conforming goods in the buyer’s possession and keep the price received.59 However, Article 2 does not allow a buyer automatically to cancel the entire contract if the seller fails to deliver only one installment of conforming goods.60 Section 2.711, when read with other applicable Article 2 provisions, provides for cancellation of the entire contract only when the seller’s breach “goes to the whole contract,” which requires that the breach must impair the value of the entire contract.61

If the buyer rightfully rejects any goods delivered, or accepts but then later revokes his acceptance, Section 2.711 gives the buyer an automatic security interest in the goods in his possession and allows the buyer to sell the goods to offset the price paid, if any, and for any expenses reasonably incurred in their inspection, receipt, transportation and storage. This right could be important to a buyer who fails to evaluate the quality and composition of the energy

addition to recovering so much of the price as has been paid (1) “cover” and have damages under the next section as to all goods affected whether or not they have been identified to the contract; or (2) recover damages for non-delivery as provided in this chapter; (b) Where the seller fails to deliver or repudiates the buyer may also (1) if the goods have been identified recover them as provided in this chapter (Section 2.502); or (2) in a proper case obtain specific performance or replevy the goods as provided in this chapter (Section 2.716); (c) On rightful rejection or justifiable revocation of acceptance a buyer has a security interest in goods in his possession or control for any payments made on their price and any expenses reasonably incurred in their inspection, receipt, transportation, care and custody and may hold such goods and resell them in like manner as an aggrieved seller.”).54 TEX. BUS. COM. C.§2.711(a).55 See TEX. BUS. COM. C.§2.502.56 TEX. BUS. COM. C.§2.716(a) (stating that the buyer’s right to demand specific performance is generally available only where the goods are unique).57 See TEX. BUS. COM. C.§ 2.716.58 See TEX. BUS. COM. C.§2.711(c).59 Id. 60 TEX. BUS. COM. C.§2.711(a).61 TEX. BUS. COM. C.§2.612(c). Section 2.612 deals primarily with installment contracts. Under this section, a breach by either the seller or the buyer may impair either the installment in question, or the contract as a whole. Whether the non-conformity in any given installment is substantial enough to warrant cancellation of all future installments depends on the likelihood of whether any future deliveries will also be defective, as well as whether the non-conformity substantially impairs the value of the whole contract. Substantial impairment may be based on any number of factors, including the quality of the goods, the time of delivery, etc. Comment 6 to this section specifically states, however, that where the only impairment is the seller’s security in regard to future installments, the seller may demand adequate assurances of future performance, but does not have the right to immediately cancel the contract. But, it is important to note that defects in the performance of either the buyer or the seller are cumulative in effect. This section also provides that a buyer who accepts a non-conforming installment, or who does not receive an installment, may withhold his decision as to whether or not to cancel the entire contract pending a response from the seller as to any request for cure or adjustment. A seller also may withhold delivery of future shipments pending the receipt of payment for any prior shipments, and withhold his decision regarding cancellation.

commodity delivered prior to making payment to the seller or to a buyer requiring to prepare the seller before the commodity is delivered.

In addition to the remedies available above, Article 2 allows the buyer to terminate the contract if the buyer receives notification of a material reduction or delay in delivery.62

D. DAMAGES

The Code allows damages for breach by either party to be liquidated in the agreement between the parties but limits those damages to an amount that is reasonable “in light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or non-feasibility of otherwise obtaining an adequate remedy.”63 Any contract that provides for the payment of an “unreasonable” amount of liquidated damages is void as a penalty.64

1. Damages Available to Seller

If the contract does not contain a liquidated damages clause, Article 2 allows a seller torecover actual damages when a buyer wrongfully refuses acceptance of conforming goods or repudiates the contract.65 The seller’s damages for the buyer’s breach are determined by calculating the difference between the contract price and the market price.66 However, while the general goal of Article 2’s provisions relating to damages states that an aggrieved party should be placed in as good a position as if the other party had fully performed, consequential damages may not automatically be recovered under Article 2.67 Consequential damages are defined as those damages that “do not arise within the scope of the immediate buyer-seller transaction, but rather stem from losses incurred by the non-breaching party in its dealings, often with third parties which were an approximate result of the breach.”68 Article 2 specifically allows for the

62 TEX. BUS. COM. C. §2.616.63 TEX. BUS. COM. C. §2.718.64 Id. 65 The buyer is allowed to reject non-conforming goods without penalty, but is allowed to repudiate the entire contract only when there has been a previous breach by the seller, or the seller has clearly manifested an intent to not perform. At common law, actual damages can be either direct or consequential. Direct damages are the usual and necessary result of the defendant's wrongful conduct; they flow naturally and necessarily from the wrong. Arthur Andersen & Co. v. Perry Equip. Corp., 945 S.W.2d 812, 816 (Tex. 1997). Direct damages compensate the plaintiff for the loss, damage, or injury that is conclusively presumed to have been foreseen by the defendant as a consequence of his breach of contract or wrongful act. Id. On the other hand, consequential damages result naturally, but not necessarily, from the defendant's wrongful actions. Id.; Haynes & Boone v. Bowser Bouldin, Ltd., 896 S.W.2d 179, 182 (Tex. 1995). 66 TEX. BUS. COM. C. §2.708.67 TEX. BUS. COM. C. §1.106 (stating that consequential damages under the UCC may not be had unless specifically provided for). 68 USX Corp. v. Union Pacific Res. Co., 753 S.W.2d 845, n.5 (Tex. App.—Fort Worth 1988, no writ). Under the common law, consequential damages need not be the usual result of the wrong, but must be foreseeable and must be directly traceable to the wrongful act and result from it. Arthur Andersen, 945 S.W.2d at 816. Article 2 also has defined direct, incidental and consequential damages. Section 2.714(a) discusses “damages resulting in the ordinary course of events,” such as direct damages, while subsection (c) provides that incidental and consequential damages also may be recovered. TEX. BUS. & COMM. CODE. ANN. § 2.714. Section 2.715 defines both incidental and

recovery of consequential damages by an aggrieved buyer,69 but does not provide for recovery by a seller of consequential damages.70

The common benefit-of-the-bargain method of calculating a seller’s damages in the event of a buyer’s non-acceptance or wrongful repudiation is set forth in Section 2.708, which seeks to restore the injured party to the economic position it would have been in had the contract been performed.71 Subsection (a) allows a seller to recover the difference between the market price at the time and place for tender and the unpaid contract price, together with incidental damages but less expenses saved.72 Texas courts have yet to thoroughly interpret the meaning of “market price,” as used in Article 2, but the term is generally defined as the “prevailing price at which something is sold in a specific market.”73 Texas courts have held that when the resale price is determined by reference to an arm’s length transaction, it is an adequate reflection of market price.74 Texas courts also have found that the spot price may sometimes be an adequate representation of Article 2’s “market price” of a commodity.75 The Code does, however,

consequential damages. Section 2.715(a) defines incidental damages as those resulting from the seller's breach, including expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, plus any commercially reasonable charges, expenses or commissions incurred in connection with effecting cover and any other reasonable expenses incident to the breach. Section 2.715 defines consequential damages resulting from the seller’s breach as (1) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (2) injury to person or property proximately resulting from any breach of warranty. TEX.BUS. COM. C. §2.715; see also Wade & Sons, Inc. v. American Standards, Inc., 127 S.W.3d 814, (Tex. App.—San Antonio 2003) (discussing damages available under Article 2).69 TEX. BUS. COM. C. §§2.709; 2.710; 2.714(c); 2.715(b); see also USX Corp. v. Union Pacific Res. Co., 753 S.W.2d 845, 856 (Tex. App.—Fort Worth 1988, no writ) (instructing the jury not to include consequential damages in damage award); Tennessee Gas Pipeline Co. v. Lenape Resources Corp., 870 S.W.2d 286 (Tex. App.—San Antonio 1993, rev’d on other grounds) (holding that an aggrieved seller may not recover consequential damages under the Uniform Commercial Code). 70 Gray v. West, 608 S.W.2d 771, 781 n.3 (Tex. Civ. App.—Amarillo 1980, writ ref’d n.r.e.) (pointing to Article 2’s failure to specifically allow the seller to recover consequential damages in the energy context as justification for denying the recovery of damages under a gas farm-out agreement with a third party, finding that farm-out damages are consequential damages).71 TEX. BUS. COM. C. §2.708 (stating “(a) Subject to Subsection (b) and to the provisions of this Chapter with respect to proof of market price (Section 2.723), the measure of damages for non-acceptance or repudiation by the buyer is the difference between the market price at the time and place for tender and the unpaid contract price together with any incidental damages provided in this chapter (Section 2.710), but less expenses saved in consequence of the buyer’s breach; (b) If the measure of damages provided in Subsection (a) is inadequate to put the seller in as good a position as performance would have done then the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer, together with any incidental damages provided in this chapter (Section 2.710), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale.”); Sava Gumarska in Kemijska Industria v. Advanced Polymer Sciences, Inc., 128 S.W.3d 304, n.6 (Tex. App.—Dallas 2004)(finding that the Code’s remedies seek to restore the injured party to the economic position it would have been in had the contract been performed). 72 TEX. BUS. COM. C. §2.708(a) (stating that the “time and place for tender” is the time and place for delivery of the goods). 73 Id. (citing BLACK'S LAW DICTIONARY 1207 (7th ed. 1999)).74 Cook Composites, Inc. v. Westlake Styrene Corp., 15 S.W.3d 124, 138-39 (Tex. App.--Houston [14th Dist.] 2000).75 Id.

specifically provide that the market price is to be determined as of the date the non-breaching party learned of the breach.76

In the event that the seller is not made whole by the method of calculation set forth in subsection (a), subsection (b) provides an additional measure of protection to the seller by allowing a seller to measure damages as the profit, including overhead, that the seller would have made had the buyer fully performed.77 This section also allows the seller to recover incidental damages plus all costs reasonably incurred, but provides for an allowance to the buyer for any payments made or the proceeds of any resale.78 Subsection (b) is particularly useful in cases in which a buyer repudiates the contract before delivery and the goods are specially manufactured, so that there is no market available for resale, and in situations in which the contract is advantageous to the seller, such as when the seller has an above-market contract. In the energy context, the application of subsection (a) alone would be inadequate. A party bringing suit under Section 2.708(a) must plead and prove all elements of the section to make a prima facie case for damages, including the prevailing market price for the commodity.79

Section 2.709 sets forth a seller’s remedies when a buyer fails to pay the purchase price when it becomes due.80 Subsection (a) allows a seller to recover from a non-paying buyer either the purchase price of all goods accepted by the buyer, or the price of goods lost or damaged after risk of loss has passed to the buyer, plus incidental damages. This subsection also provides that if the seller is unable to resell goods identified to the contract, the seller may recover the price of such goods under this section if the seller is unable, after making a reasonable effort, to resell the goods.81 An action for the price under this section is available only if the goods have been delivered to the buyer.82

76 TEX. BUS. COM. C. §2.723 (providing that “(b) If evidence of a price prevailing at the times or places described in this chapter is not readily available the price prevailing within any reasonable time before or after the time described or at any other place which in commercial judgment or under usage of trade would serve as a reasonable substitute for the one described may be used, making any proper allowance for the cost of transporting the goods to or from such other place.(c) Evidence of a relevant price prevailing at a time or place other than the one described in this chapter offered by one party is not admissible unless and until he has given the other party such notice as the court finds sufficient to prevent unfair surprise.”).77 TEX. BUS. COM. C. §2.708(b).78 Id. 79 Cook Composites,at 138-39.80 TEX. BUS. COM. C. §2.709 (stating “(a) When the buyer fails to pay the price as it becomes due the seller may recover, together with any incidental damages under the next section, the price (1) of goods accepted or of conforming goods lost or damaged within a commercially reasonable time after risk of their loss has passed to the buyer; and (2) of goods identified to the contract if the seller is unable after reasonable effort to resell them at a reasonable price or the circumstances reasonably indicate that such effort will be unavailing; (b) Where the seller sues for the price he must hold for the buyer any goods which have been identified to the contract and are still in his control except that if resale becomes possible he may resell them at any time prior to collection of the judgment. The net proceeds of any such resale must be credited to the buyer and payment of the judgment entitles him to any goods not resold; (c) After the buyer has wrongfully rejected or revoked acceptance of the goods or has failed to make a payment due or has repudiated (Section 2.610), a seller who is held not entitled to the price under this section shall nevertheless be awarded damages for non-acceptance under the preceding section.”).81 Id; TEX. BUS. COM. C. §2.501(a) (stating that goods “identified to the contract” are those that have been set aside, identified, or purchased for the contract at issue).82 Nobs Chemical, U.S.A., Inc. v. Koppers Co., Inc., 616 F.2d 212, 215 (5th Cir. (Tex.) 1980).

Section 2.709(b) requires a seller bringing an action under this section that has attempted, but was unable, to sell goods identified to the contract, to hold the goods still in his possession for the buyer. If possible, the seller may sell the goods at any time before he collects a judgment from the buyer but must credit the buyer for the amount received.83 In addition, if the buyer pays the judgment in full, the buyer is entitled to receive all goods held by the seller.84

Overall, Section 2.709 provides a fairly powerful remedy for sellers who have delivered goods to a non-paying buyer. However, this remedy is available only after the price becomes due; a seller may not bring an action for the price before that time even if it is apparent that the buyer will not pay as required by the contract.85 Courts have held that the “crucial inquiry” with regard to the issue of whether payment has “become due” is simply whether acceptance, without a valid subsequent revocation of acceptance, has occurred.86 Acceptance of goods is defined under section 2.606, and occurs when the buyer fails to make an effective rejection or does “any act inconsistent with the seller's ownership.”87 The requirements of subsection (b) have been held to supplant any common-law duty of the seller to mitigate damages for goods delivered and accepted.88

Section 2.710 allows an aggrieved seller to recover incidental damages, including all reasonable expenses incurred in connection with the return or resale of the goods, resulting from any breach by the buyer.89 This section does not allow a seller to recover consequential damages, which are damages that do not arise within the scope of the immediate buyer-seller transaction, but rather stem from losses incurred by the non-breaching party in its dealings with third parties that were an approximate result of the breach. 90

2. Damages Available to Buyer

Section 2.712 is Article 2’s primary avenue of recourse for a buyer who attempts to minimize the damages suffered as a result of the seller’s breach by obtaining substitute goods or commodities.91 This section provides for the “cover standard” of calculating damages in the

83 TEX. BUS. COM. C. §2.709(b).84 Id. 85 See Custom Controls Co. v. Ranger Ins., 652 S.W.2d 449, 453 (Tex. App. – Houston [1st Dist.] 1983) (finding that an action for the price was not available to a seller when the goods were destroyed by fire, because the prerequisites of manufacture, sale, and delivery had not been met).86 See TEX. BUS. COM. C. §2.709 cmt. 5 (indicating that a valid revocation of acceptance "means that there has been a default by the seller which bars his rights under this section"); see also Bacchus Industries, Inc. v. Frontier Mechanical Contractors, 36 S.W.3d 579, 584 (Tex. App.--El Paso 2000) (discussing the application of §2.709).87 TEX. BUS. COM. C. §2.606; Bacchus Indus., Inc., at 584. 88 F & P Builders v. Lowe's of Texas, Inc., 786 S.W.2d 502 (Tex. App.—Dallas 1990).89 TEX. BUS. COM. C. §2.710 (stating that “[i] ncidental damages to an aggrieved seller include any commercially reasonable charges, expenses or commissions incurred in stopping delivery, in the transportation, care and custody of goods after the buyer’s breach, in connection with return or resale of the goods or otherwise resulting from the breach.”). 90 Tennessee Gas Pipeline, at 302; USX Corp. v. Union Pacific Resources Co., 753 S.W.2d 845, 856 (Tex. App.--Fort Worth 1988).91 TEX. BUS. COM. C. §2.712 (stating “(a) After a breach within the preceding section the buyer may ‘cover’ by making in good faith and without unreasonable delay any reasonable purchase of or contract to purchase goods in

event of any breach by the seller.92 The primary purpose of Section 2.712 is to provide the buyer with a remedy that enables him to obtain the goods or commodities he needs, thus allowing him to continue to run his business regardless of whether the seller performs under the contract. In comparison to the seller’s remedies, this remedy is the buyer’s equivalent of the seller’s right to resell.93

Subsection (a) provides that upon the seller’s breach, the buyer may effect “cover” by promptly purchasing substitute goods on commercially reasonable terms.94 Texas law requires that in order to be entitled to “cover” damages under this section, a plaintiff must plead and prove that the goods or commodity were either not delivered at all or were non-conforming in such a way that the value of the non-conforming or undelivered products was substantially impaired.95

This subsection has generated substantial litigation regarding whether the “cover” obtained by the buyer was “reasonable” within the meaning of the statute.96 Texas courts have held that the test of proper cover is whether at the time and place the buyer acted in good faith and in a reasonable manner.97 Courts also require that the type of substitute goods acquired by the buyer must be a reasonable substitute for the undelivered or non-conforming goods.98 The crucial time for determining the reasonableness of cover is the time at which the buyer learns of the breach; therefore, “it is immaterial that hindsight may later prove that the method of cover used was not the cheapest or most effective.”99 Courts have also held that the buyer must act to procure substitute goods “without unreasonable delay.”100 However, the requirement that the buyer cover “without unreasonable delay” does not act as a strict limit on the time the buyer may

substitution for those due from the seller; (b) The buyer may recover from the seller as damages the difference between the cost of cover and the contract price together with any incidental or consequential damages as hereinafter defined (Section 2.715), but less expenses saved in consequence of the seller’s breach; (c) Failure of the buyer to effect cover within this section does not bar him from any other remedy”); see also Aztec Corp. v. Tubular Steel, Inc., 758 S.W.2d 793, 799-800 (Tex. App. -- Houston [14th Dist.] 1988) (stating that “[d]amages may exceed the price paid upon findings by the jury of cost of cover exceeding contract price and by findings of incidental or consequential damages”).92 TEX. BUS. COM. C. §2.712; Manon v. Tejas Toyota, Inc., 162 S.W.3d 743, 747 (Tex. App.-- Houston [14th Dist.] 2005).93 TEX. BUS. COM. C. §2.712, cmt. 1.94 TEX. BUS. COM. C. §2.712(a).95 Manon v. Tejas Toyota, Inc., 162 S.W.3d 743, 747 (Tex. App.--Houston [14th Dist.] 2005, no pet.) (finding that in order for the value of a good to be “substantially impaired,” the good or commodity must not be capable of its intended use by the party).96 See, e.g., id.; Equitable Res. Marketing Co. v. U.S. Gas Transp., Inc., 2001 WL 533808 (Tex. App. – Dallas 2001).97 Aquamarine Associates v. Burton Shipyard, Inc., 645 S.W.2d 477, 480 (Tex. App. 9 Dist., 1982) (citing Teenan v. Jurek, 215 N.W.2d 698, 702 (Minn. Sup. 1977)). 98 Mueller v. McGill, 870 S.W.2d 673, 675 (Tex. App.—Houston [1st Dist.] 1994) (discussing whether a 1986 automobile was a reasonable substitute for a 1985 automobile).99 TEX. BUS. COM. C. §2.712, cmt. 2; §2.713, cmt. 1 (discussing the buyer’s damages for non-delivery or repudiation in the event that the buyer does not choose to cover, and stating that “the crucial time is the time at which the buyer learns of the breach”); see also Jon-T Farms, Inc. v. Goodpasture, Inc., 554 S.W.2d 743, 749-50 (Tex. Civ. App. 1977, rev’d on other grounds) (discussing the time at which the buyer discovers the breach).100 Mueller, at 675-76; Aquamarine, at 480.

take “to examine the situation and available remedies, and determine the best method of effecting cover.”101

Article 2 presumes that the cost of cover will approximate the market price of the undelivered goods.102 Therefore, the U.C.C. presumes that the “cover” procured by the buyer, and the price paid for it, is proper. The burden, therefore, is on the seller to show otherwise; however, the presumption of propriety and reasonableness arises only when the buyer proves that it has complied with the requirements of Section 2.712.103 This burden does not, however, require the buyer to show the market price at the time of the breach, unless the reasonableness of the price paid for the substitute goods is called into question.

Section 2.712(b) provides that if the buyer is able to purchase substitute goods, the buyer may then recover from the seller the difference between the cost of cover and the contract price, together with any incidental or consequential damages, but less expenses saved in consequence of the seller’s breach. Subsection (c) provides that the buyer may “cover” at its option; the wronged buyer may “cover” as a means of minimizing damages, but his failure to effect cover does not bar him from any other remedy. Neither this Section 2.712(c), nor any other Code provision, actually requires the buyer to purchase or attempt to purchase substitute goods in the event of a breach by the seller; the buyer may elect not to cover and still sue the seller for damages, including any consequential damages incurred as a result of the breach. However, the buyer’s recovery of consequential damages will be limited to those damages that could not have been prevented had substitute goods been obtained.104 Therefore, the buyer is always free to choose between damages based on the difference between the contract price and the cost of cover under Section 2.712, and damages for non-delivery under Section 2.713, which consist of the difference between the market price at the time when the buyer learns of the breach and the contract price.105

Section 2.713 outlines the buyer’s primary recourse against the seller in cases in which the buyer does not cover and obtain substitute goods.106 Subsection (a) provides that the buyer’s measure of damages when the buyer does not cover is the difference between the market price at the time the buyer learned of the breach and the contract price, plus any incidental and consequential damages, but less any expenses saved as a result of the breach.107 Subsection (b) requires that, in the event of complete non-delivery, the market price be determined as of the

101 TEX. BUS. COM. C. §2.712, cmt. 2.102 Kiser v. Lemco Indus., Inc., 536 S.W.2d 585, 589 (Tex. Civ. App.—Amarillo 1976, no writ).103 Id.104 TEX. BUS. COM. C. §2.712, cmt. 3.105 TEX. BUS. COM. C. §2.712, cmt. 3106 TEX. BUS. COM. C. §2.713 (stating “(a) Subject to the provisions of this chapter with respect to proof of market price (Section 2.723), the measure of damages for non-delivery or repudiation by the seller is the difference between the market price at the time when the buyer learned of the breach and the contract price together with any incidental and consequential damages provided in this chapter (Section 2.715), but less expenses saved in consequence of the seller’s breach; (b) Market price is to be determined as of the place for tender or, in cases of rejection after arrival or revocation of acceptance, as of the place of arrival; (c) Evidence of a relevant price prevailing at a time or place other than the one described in this chapter offered by one party is not admissible unless and until he has given to the other party such notice as the court finds sufficient to prevent unfair surprise.”). 107 TEX. BUS. COM. C. §2.713(a).

place for tender or, in the event that non-conforming goods are delivered, as of the place of arrival.108

As discussed above, Article 2 assumes that the cover obtained, and the amount paid for it,is proper; therefore, under Section 2.713, “[t]he general baseline… uses as a yardstick the market in which the buyer would have obtained cover had he sought that relief.”109 The market price to be used in calculating damages under this section is the price for goods of the same kind and in the same branch of trade.110 However, determining the applicable market price is not as simple as it may appear at first glance; parties’ attempts to determine the applicable market price has led to substantial litigation in many industries. Making this determination in the energy industry can be particularly problematic, because of the volatile nature of commodity prices, and the use of different internally calculated price curves to determine the market price.

In effort to alleviate the difficulty in determining market price, Article 2 specificallyprovides for reference to the market price of a comparable commodity, or, more commonly, of the same commodity in a comparable market. Section 2.723(b) sets forth the acceptable method of proving market price in such a situation.111 Where determining the market price at the time of breach is difficult, the parties may reference the prevailing price for the commodity at any reasonable time either before or after the breach or at any other commercially reasonable location.112 Article 2 also specifically contemplates reference to the applicable spot sales price when no market price is available.113 When the market price is unavailable because of the scarcity of the good or commodity, opinion evidence regarding the value of the goods or commodity is admissible.114 In such a situation, a liberal construction of allowable consequential damages should also result.115

Section 2.714 sets forth the method by which a buyer who has accepted non-conforming goods may recover damages.116 Generally, this remedy will be applicable only in cases in which

108 TEX. BUS. COM. C. §2.713(b).109 TEX. BUS. COM. C. §2.713, cmt. 1.110 TEX. BUS. COM. C. §2.713, cmt. 2.111 TEX. BUS. COM. C. §2.723 (stating “(b) If evidence of a price prevailing at the times or places described in this chapter is not readily available the price prevailing within any reasonable time before or after the time described or at any other place which in commercial judgment or under usage of trade would serve as a reasonable substitute for the one described may be used, making any proper allowance for the cost of transporting the goods to or from such other place”).112 TEX. BUS. COM. C. §2.723(b).113 TEX. BUS. COM. C. §2.713, cmt. 3.114 TEX. BUS. COM. C. §2.713, cmt. 3. 115 TEX. BUS. COM. C. §2.713, cmt. 3.116 TEX. BUS. COM. C. §2.713 (stating “(a) Where the buyer has accepted goods and given notification he may recover as damages for any non-conformity of tender the loss resulting in the ordinary course of events from the seller’s breach as determined in any manner which is reasonable; (b) The measure of damages for breach of warranty is the difference at the time and place of acceptance between the value of the goods accepted and the value they would have had if they had been as warranted, unless special circumstances show proximate damages of a different amount; (c) In a proper case any incidental and consequential damages under the next section may also be recovered.”).

the time for revocation of acceptance has passed.117 However, the remedy of Section 2.714 is available not only in the event of a breach of warranty by the seller (i.e. the delivery of non-conforming goods), but also in the event of any failure of the seller to perform his obligations under the contract.118 This section is somewhat unique, as it provides that the buyer may recover in damages any loss resulting in the ordinary course of events from the seller’s breach, “as determined in any manner which is reasonable.”119 A buyer who elects to pursue a remedy under this subsection (a) must, however, strictly comply with its notice requirements.120 This section also offers an additional remedy for a buyer who may still owe part of the purchase price.121

Further, subsection (b) describes the usual measure of damages for a breach of warranty by the seller, which is measured as the difference at the time and place of acceptance between the value of the goods accepted and the value the goods would have had if they had been as warranted.122 This subsection does, however, contemplate that special circumstances may warrant a recovery by the buyer of an amount of damages different from that calculated under the usual method outlined in subsection (b).

Section 2.715 describes the method of calculating incidental and consequential damages available under Sections 2.712, 2.713, and 2.714.123 This section is intended to reimburse the buyer who incurs reasonable expenses in connection with rightfully rejected goods or in connection with effecting cover where the seller breached by delivering non-conforming goods, or none at all.124 Article 2 defines incidental damages resulting from the seller’s breach as those expenses reasonably incurred in the inspection, receipt, transportation, care and custody of goods rightfully rejected, together with any commercially reasonable expenses incurred in effecting

117 See TEX. BUS. COM. C. §2.714, cmt. 1.118 TEX. BUS. COM. C.§2.714, cmt. 2.119 TEX. BUS. COM. C. §2.714(a).120 The notice requirements under this subsection reference §2.607. Section 2.607 requires that when a buyer has initially accepted goods, the buyer must notify the seller of the breach within a reasonable time after the buyer discovers, or should have discovered, the breach; failure to give such notice will bar the buyer from recovering under any remedy. Section 2.607 also states that a buyer cannot later reject goods if, at the time of acceptance, the buyer had knowledge of the non-conformity, unless the buyer accepted on the reasonable assumption that the non-conformity would seasonably be cured. 121 The primary remedy for a buyer who still owes is under §2.717, which allows the buyer to deduct all or any partof damages resulting from any breach of the contract from any part of the price still due under the same contract. See also §2.714, cmt. 1 (stating that the ability of a buyer to deduct damages from the price owed is an additional remedy for a buyer who still owes part of the purchase price). 122 TEX. BUS. COM. C. §2.714(b).123 TEX. BUS. COM. C. §2.715 (stating that “(a) Incidental damages resulting from the seller’s breach include expenses reasonably incurred in the inspection, receipt, transportation and care and custody of good rightfully rejected, any commercially reasonable charges, expenses or commissions in connection with effecting cover and any other reasonable expense incident to the delay or other breach; (b) Consequential damages resulting from the seller’s breach include: (1) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (2) injury to person or property proximately resulting from any breach of warranty.”)124 TEX. BUS. COM. C. §2.715, cmt. 1.

cover. The buyer’s incidental damages also may include any other reasonable expenses incident to any delay or other breach by the seller.125

Section 2.715(b) allows the buyer to recover consequential damages resulting from the seller’s breach. However, the standard “tacit agreement” test is rejected by Article 2 in this section. The general common-law approach to consequential damages made the breaching party liable for all such damages of which he knew or had reason to know of prior to the breach. The approach taken by Article 2 in this section limits the buyer’s recovery of consequential damages to only those damages the buyer could not reasonably have prevented through effecting cover or otherwise.126 In order to charge the seller with knowledge sufficient to enable the buyer to recover consequential damages, any particular needs of a buyer must generally be made known to the seller, while general needs must rarely be made explicitly known in order to charge the seller with knowledge.127 The burden of proving the extent of the loss incurred as consequential damages is on the buyer, but loss may be determined in any manner that is considered reasonable under the circumstances.128

III. CONTRACTUAL RIGHTS AND REMEDIES

A. NAESB BASE CONTRACT FOR SALE AND PURCHASE OF NATURAL GAS

The North American Energy Standards Board Base Contract for Sale and Purchase of Natural Gas (the “NAESB”) is the master agreement most commonly used to document natural gas transactions. The NAESB provides specific remedies for a failure to deliver or receive gas and upon the occurrence of Events of Default. The NAESB also contains specific provisions granting the parties the right to demand adequate assurances of performance and provides a remedy to the demanding party if the other party fails to comply with a proper request for assurances.

1. Failure to deliver or receive gas

Section 3.2 of the NAESB provides for liquidated damages in the event the seller fails to deliver, or the buyer fails to receive, quantities of gas agreed to in a transaction. The NAESB requires the parties to elect to use either the “cover standard” or the “spot price standard” for calculating liquidated damages.129 Once a remedy is selected, that remedy becomes the exclusive remedy in the event of a breach of an obligation to deliver or receive gas.130

125 TEX. BUS. COM. C. §2.715(a).126 TEX. BUS. COM. C. §2.715, cmt. 2.127 TEX. BUS. COM. C. §2.715, cmt. 3.128 TEX. BUS. COM. C. §2.715, cmt. 4.129 NAESB §3.2. 130 See NAESB §3.2; see also §2.17 (stating that “Firm” shall mean that either party may interrupt its performance without liability only to the extent that such performance is prevented by reasons of Force Majeure; provided however that during Force Majeure interruptions, the party invoking Force Majeure may be responsible for any Imbalance Charges as set forth in Section 4.3 related to its interruption after the nomination is made to the Transporter and until the change in deliveries and/or receipts is confirmed by the Transporter”).

The “Cover Standard” is defined by the NAESB to require the non-breaching party to use commercially reasonable efforts to either obtain gas or an alternate fuel, or sell gas, at a price that is reasonable for the delivery point or production area.131 The price paid or received by the non-breaching party attempting to effect cover in this manner is the price that will be used to calculate any payment due under Section 3.2. Under this “Cover Standard,” the reasonableness of the price received or paid for gas may be affected by several factors, including (1) the amount of notice provided by the nonperforming party; (2) the immediacy of the buyer’s consumption needs or the seller’s sales requirements; (3) the quantities involved; and (4) the anticipated length of failure by the breaching party.132

Section 3.2 sets forth the “Cover Standard” for calculating damages.133 Under this section, if the seller fails to deliver the gas as required by the contract, the seller must pay to the buyer the difference between the purchase price paid by the buyer utilizing the Cover Standard and the Contract Price.134 Similarly, if the buyer fails to receive the gas as required by the contract, the seller is entitled to the difference between the Contract Price and the price received by the seller utilizing the Cover Standard.135 The damages calculated pursuant to this method will, in both instances, be adjusted for commercially reasonable differences in transportation costs to or from the delivery points, and for the percentage of the contracted-for quantity gas actually taken by the buyer or delivered by the seller.136

131 NAESB §2.9 (providing that “Cover Standard shall mean that if there is an unexcused failure to take or deliver any quantity of Gas pursuant to this Contract, then the performing party shall use commercially reasonable efforts to (i) if Buyer is the performing party, obtain Gas (or an alternate fuel if elected by Buyer and Gas is not available), or (ii) if Seller is the performing party, sell Gas, in either case, at a price reasonable for the delivery or production area, as applicable, consistent with: the amount of notice provided by the nonperforming party; the immediacy of the Buyer’s Gas consumption needs or Seller’s Gas sales requirements, as applicable; the quantities involved; and the anticipated length of failure by the nonperforming party”).132 NAESB §2.10.133 NAESB §3.2 (defining “Cover Standard” as “[t]he sole and exclusive remedy of the parties in the event of a breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the positive difference, if any, between the purchase price paid by buyer utilizing the Cover Standard and the Contract Price, adjusted for commercially reasonable differences in transportation costs to or from the Delivery Point(s), multiplied by the difference between the Contract Quantity and the quantity actually delivered by Seller for such Day(s); or (ii) in the event of a breach by Buyer on any Day(s), payment by Buyer to Seller in the amount equal to the positive difference, if any, between the Contract Price and the price received by Seller utilizing the Cover Standard for the resale of such Gas, adjusted for commercially reasonable differences in transportation costs to or from the Delivery Point(s) multiplied by the difference between the Contract Quantity and the quantity actually taken by Buyer for such Day(s); or (iii) in the event that Buyer has used commercially reasonable efforts to replace the Gas or Seller has used commercially reasonable efforts to sell the Gas to a third party, and no such replacement or sale is available, then the sole and exclusive remedy of the performing party shall be any unfavorable difference between the Contract Price and the Spot Price, adjusted for such transportation to the applicable Deliver Point, multiplied by the difference between the Contract Quantity and the quantity actually delivered by Seller and received by Buyer for such Day(s). Imbalance Charges shall not be recovered under this Section 3.2, but Seller and/or Buyer shall be responsible for Imbalance Charges, if any, as provided in Section 4.3. The amount of such unfavorable difference shall be payable five Business Days after presentation of the performing party’s invoice, which shall set forth the basis upon which such amount was calculated.”).134 Id.135 NAESB §3.2.136 NAESB §3.2.

The “Spot Price Standard,” offered as an alternative to the Cover Standard, sets forth a materially different method of calculating damages.137 If a party fails to take or receive gas as required by a transaction, the non-performing party must pay to the performing party the difference between the Contract Price and the Spot Price. “Spot Price” is defined as the price listed in the publication indicated on the Base Contract for the geographic location in closest proximity to the delivery points for the relevant days.138 Additionally, both standards provide that all charges assessed using either standard must be paid five business days after the presentation of the performing party’s invoice setting forth the basis upon which such amount was calculated.139

The NAESB allows the parties to elect an alternative measure of damages if they are unsatisfied with the option offered by either the Cover Standard or the Spot Price Standard. “Alternative Damages” are defined as any measure or amount of damages agreed upon by the parties in a Transaction Confirmation.140 Alternative Damages may be used only when the parties have expressly agreed to their use in a written transaction confirmation executed by both parties.141

The NAESB requires the parties to make “commercially reasonable efforts” to buy or sell gas before the aggrieved party will be entitled to damages for any failure to take or deliver.142

The NAESB also requires that the performing party’s efforts to obtain “cover” in this respect be “commercially reasonable.” In addition to the “commercially reasonable” requirement, the NAESB allows the non-breaching party, when assessing the reasonableness of the price of cover, to take into account not only the time and place for tender, but also the amount of notice provided by the nonperforming party, the immediacy of the buyer’s consumption needs or the

137 NAESB §3.2 (defining “Spot Price Standard” as “[t]he sole and exclusive remedy of the parties in the event of a breach of a Firm obligation to deliver or receive Gas shall be recovery of the following: (i) in the event of a breach by Seller on any Day(s), payment by Seller to Buyer in an amount equal to the difference between the Contract Quantity and the actual quantity delivered by Seller and received by buyer for such Day(s), multiplied by the positive difference, if any, obtained by subtracting the Contract Price from the Spot Price; or (ii) in the event of a breach by Buyer on any Day(s), payment by Buyer to Seller in an amount equal to the difference between the Contract Quantity and the actual quantity delivered by Seller and received by Buyer for such Day(s), multiplied by the positive difference, if any, obtained by subtracting the applicable Spot Price from the Contract Price. Imbalance Charges shall not be recovered under this Section 3.2, but Seller and/or Buyer shall be responsible for imbalance Charges, if any, as provided in Section 4.3. The amount of such unfavorable difference shall be payable five Business Days after presentation of the performing party’s invoice, which shall set forth the basis upon which such amount was calculated.”).138 NAESB §2.26. This section refers to the “price listed in the publication indicated on the Base Contract;” thus, if the parties choose the Spot Price Standard for calculating damages, the parties must then select a reliable market publication that will allow them to determine the spot price on any given day. This section also provides that if there is no single spot price published for a particular location on a particular day, but there is a published range of prices, then the spot price will be the average of the highest and lowest prices listed. If there is no range of prices published, then the spot price will be the average of (1) the price for the first day for which a price or range of prices is published that next precedes the day(s) of the breach, and (2) the price for the first day for which a price or range of prices is published after the day of the breach. 139 NAESB §3.2.140 NAESB §2.1.141 NAESB §3.3. 142 NAESB §3.2.

seller’s sales requirements, the quantities involved, and the anticipated length of failure by the nonperforming party.143 Notably, both the Cover Standard and the Spot Price Standard expressly address the payment of imbalance charges and provide that such charges will be paid by the party whose act or omission caused such charges to be imposed.144 The NAESB also requires that any amount owed for failure to deliver or accept must be paid within five business days after receipt of an invoice detailing the manner in which any damages were calculated.

These remedy elections differ in scope from those offered in the U.C.C. First, unlike the NAESB, the U.C.C. applies the “perfect tender” rule, which labels any failure by either party to deliver or receive goods in perfect conformity with the terms of the contract as a “breach.”145

Under the U.C.C., any breach gives the non-breaching party the right to exercise certain remedies, and, in certain circumstances, terminate the contract. The NAESB, like most energy commodity contracts, does not apply the “perfect tender” rule, but instead lists certain Events of Default, the occurrence of which gives the performing party the right to suspend its performance and/or terminate the contract. Not every failure to comply with the obligations of the contract constitutes an Event of Default. Most notably, perhaps, is that the failure to deliver or receive the quantity of a commodity identified by the contract does not constitute an Event of Defaultunder the NAESB; the NAESB simply sets forth a method of calculating the payment that must be made to the performing party in the event the counterparty fails to delver or receive the requisite amount of gas. Under the U.C.C., upon a failure by the buyer to receive gas, the seller may be entitled to suspend further deliveries, resell the gas not received by buyer and recover costs and incidental damages associated with the resale, and, if the rejection goes to the whole contract, terminate the contract.146 Upon the failure by the seller to deliver gas, the buyer may be entitled to cancel the contract if the seller’s failure goes to the whole contract, and/or cover damages or specific performance of seller’s obligations.147 The NAESB requires both seller and buyer to sacrifice the opportunity to exercise powerful remedies in exchange for the certainty that their liability will be limited to cover damages and costs.

The NAESB also requires the parties to make “commercially reasonable efforts” to buy or sell gas before the aggrieved party will be entitled to damages for any failure to take or deliver; the Code, however, does not require the non-breaching party to attempt to mitigate its damages before being entitled to exercise any remedy. The Code merely limits the non-breaching party’s recovery of consequential damages in the event the party fails to cover.148

143 NAESB §2.9.144 NAESB §4.3 (providing that “[t]he parties shall use commercially reasonable efforts to avoid the imposition of Imbalance Charges. If Buyer or Seller receives an invoice from a Transporter that includes imbalance charges, the parties shall determine the validity as well as the cause of such Imbalance Charges. If the Imbalance Charges were incurred as a result of Buyer’s receipt of quantities of Gas greater than or less than the Scheduled Gas, then Buyer shall pay for such Imbalance Charges or reimburse Seller for such Imbalance charges paid by Seller. If the Imbalance Charges were incurred as a result of Seller’s deliver of quantities of Gas greater than or less than the Scheduled Gas, then Seller shall pay for such Imbalance Charges or reimburse buyer for such Imbalance Charges paid by Buyer”).145 Tex. Bus. Com. C. §2.601; 2.703.146 See infra [fill in reference to final section numbers]; TEX. BUS. COM. C. §§2.609; 2.612; 2.703. 147 See infra [fill in reference to final section numbers]; TEX. BUS. COM. C. §§2.612; 2.711; 2.716.148 See Tex. Bus. Com. C. §2.712(c).

2. Events of Default

The NAESB sets forth specific acts and omissions of either a party or a party’s guarantor that constitute Events of Default, including (1) failing to give adequate assurance of performance within 48 hours after a request; (2) failing to pay any amount due on or before the second day following written notice that such payment is due; (3) making an assignment or any general arrangement for the benefit of creditors; (4) filing a petition in bankruptcy; and (5) being unable to pay debts as they become due.149 As discussed above, neither the seller’s failure to comply with its delivery obligations nor the buyer’s failure to receive the amount of gas contracted for constitutes an Event of Default.150

Upon the occurrence of an Event of Default, the non-defaulting party may withhold or suspend deliveries or payments upon notice to the defaulting party.151 If any Event of Default has occurred and is continuing, the non-breaching party may designate an Early Termination Date, and liquidate and terminate all transactions under the contract upon notice to the defaulting party.152 The NAESB prohibits the non-breaching party from terminating less than all transactions existing under the agreement between the parties.153

If an Event of Default occurs, and the non-breaching party elects to declare an early termination date instead of merely suspending its own performance, the parties may choose whether early termination damages will be applied.154 If the parties have elected early termination damages, the non-defaulting party will determine the amount owed by each party with respect to all gas delivered and received on or before the early termination date and the market value of each terminated transaction. The non-defaulting party will then liquidate and accelerate each terminated transaction at its market value. If the market value155 exceeds thecontract value,156 a termination payment will be owed to the buyer; if the contract value exceeds the market value, a payment will be owed to the seller.157 The amount calculated using this formula will be discounted to present value in a commercially reasonable manner.158

149 NAESB §10.2.150 See id.151 NAESB §10.2.152 NAESB §10.3. 153 NAESB §10.3.154 NAESB §10.3.1.155 Market value means the amount of gas remaining to be delivered or purchased under a transaction multiplied by the market price for a similar transaction at the Delivery Point determined by the non-defaulting party in a commercially reasonable manner. To ascertain the Market Value, the non-defaulting party may consider, among other valuations, any or all of the settlement prices of NYMEX Gas futures contracts, quotations frm leading dealers in energy swap contracts or physical gas trading markets, similar sales or purchases and any other bona fide third-party offers, all adjusted for the length of the term and differences in transportation costs.156 Contract value means the amount of Gas remaining to be delivered or purchased under a transaction multiplied by the contract price. 157 NAESB §10.3.1.158 NAESB §10.3.1.

If early termination damages do not apply, as of the early termination date, the non-defaulting party will determine in good faith and in a commercially reasonable manner the amount owed by each party with respect to all gas delivered and received between the parties in the terminated transactions on or before the early termination date for which payment has not yet been made, and the only payment owed between the parties will be this amount.159 The NAESB also allows the parties to select whether they want the netting and set-off provisions to apply to other agreements existing between the parties or just to the NAESB itself.160

The occurrence of an events of default under the NAESB results in damages very similar to what the parties would receive under the U.C.C. in the event of a breach. While the NAESB adds specificity as to how the damages will be calculated and remedies enforced, the end result following an Event of Default will be substantially similar under the NAESB and UCC.

However, there are some distinctions to be made. First, while the NAESB would likely be considered an installment contract under the U.C.C., parties to the NAESB are not required to determine whether a breach “impairs the value of the contract as a whole” in order to determine whether they may terminate the contract; if an act or omission listed as an Event of Default in the NAESB occurs, the non-breaching party may terminate the contract, with no further analysis required.161

Also, under the U.C.C., the mere occurrence of a breach gives the performing party the right to terminate the contract.162 Under the NAESB, an Event of Default must “have occurred and be continuing” in order to allow the non-breaching party the right to terminate; cure by the defaulting party will eliminate the performing party’s right to terminate. In addition, the NAESB allows a non-breaching party to suspend its performance only when terminating and liquidating the contract in its entirety upon the occurrence of an Event of Default. The Code, however, allows the parties to exercise certain remedies, such as refusing to deliver goods to a buyer who is insolvent, without requiring termination of the contract.163

The NAESB also allows the parties to choose whether certain Early Termination Damages will be applied if an Event of Default occurs, and the non-breaching party elects to terminate all outstanding transactions; no such damages are available under the Code.164 Unlike the NAESB, the Code also does not provide a mechanism by which any amounts calculated may be discounted to present value.165 The NAESB allows the parties to net and set-off the amounts owed between different transactions existing between the parties, and even between agreements other than the NAESB. There is no right of netting and setoff recognized under the U.C.C.

3. Adequate assurance of performance

159 NAESB §10.3.1.160 NAESB §10.3.2161 TEX. BUS. COM. C. §2.612.162 See TEX. BUS. COM. C. §2.712(c). 163 See TEX. BUS. COM. C. §2.702.164 NAESB §10.3.1.165 NAESB §10.3.1.

The NAESB allows either party to demand adequate assurance of performance if the party has reasonable grounds for insecurity regarding the performance of any obligation by the other party, whether or not the obligation is then due.166 A “reasonable” ground for insecurity specifically includes the occurrence of a material change in the creditworthiness of the party.167

The NAESB describes an “adequate assurance of performance” as sufficient security in a form, amount, and term reasonably acceptable to the requesting party, which may include a letter of credit, a prepayment, a security interest, or a performance bond or parental guarantee.168 Failure to provide properly requested assurance within 48 hours of the request constitutes an Event of Default.169

The NAESB’s adequate assurance rights are both more limited and more strict than those provided in the UCC. The principal differences between the NAESB’s adequate assurances provision and the equivalent provision in the UCC are (i) the UCC permits the demanding party to suspend performance during the period between the date the demand is delivered to the other party and the earlier of the date the assurance is posted or the period for delivering assurance expires, while the NAESB does not allow the suspension of performance by the demanding party; and (ii) the NAESB requires the delivery of adequate assurance within forty-eight hours of the demand, which is substantially different than the U.C.C. that provides a thirty-day window in which assurance must be posted.170 The cure period allowed by the NAESB is much shorter than that allowed by the U.C.C., and so offers more protection to a party who reasonably requests such assurances.171

Unlike the Code, the NAESB does not address anticipatory repudiation by either party, although any failure to perform any obligation relating to Credit Support will constitute an Event of Default.172 Under the NAESB, however, insolvency by either party is an Event of Default, which gives the non-defaulting party the right to immediately withhold and/or suspend deliveries or payments upon giving notice to the defaulting party, or terminate and liquidate all transactions.173 There is, however, no right to reclaim under the NAESB. Furthermore, the nature of the commodity sold under the NAESB makes stopping delivery or reclamation not feasible in most cases.

The NAESB also specifically addresses imbalance charges and provides that they will be paid by the party who caused such charges.174 The NAESB also specifically requires the buyer,

166 NAESB §10.1.167 Id.168 NAESB §10.1.169 NAESB §10.2.170 TEX. BUS. COM. C. §2.609.171 The seller may only exercise these rights if the buyer is actually insolvent. ‘Insolvent’ is defined as “having generally ceased to pay debts in the ordinary course of business other than as a result of a bona fide dispute,” or “being insolvent within the meaning of the federal bankruptcy law.” TEX. BUS. COM. C. §1.201(23)(a).172 NAESB §10.2.173 NAESB §10.2(iv).174 NAESB §4.3 (providing that “[t]he parties shall use commercially reasonable efforts to avoid the imposition of Imbalance Charges. If Buyer or Seller receives an invoice from a Transporter that includes imbalance charges, the parties shall determine the validity as well as the cause of such Imbalance Charges. If the Imbalance Charges were

in the event of a breach by the seller, to obtain an alternate fuel if buyer is capable of utilizing the alternate fuel, or if gas is not available.175 Also of note is the fact that the NAESB allows the parties to elect to use “alternative damages,” which are any measure or amount of damages agreed upon by the parties in a Transaction Confirmation. Alternative Damages may be used only when the parties have expressly agreed to their use in a written transaction confirmation executed by both parties.176

B. MASTER COAL PURCHASE AND SALE AGREEMENT

The Master Coal Purchase and Sale Agreement (the “Master Agreement”) is commonly used in the purchase and sale of coal in North America. 177

1. Failure to deliver or receive coal

Like the NAESB, the Master Agreement does not adhere to the perfect tender rule and thus does not label every failure to deliver or receive in perfect conformity with the terms of a transaction as a “breach.” A failure to deliver or receive coal as specified in the applicable transaction does not constitute a breach or an event of default; the Master Agreement provides a specific method for calculating damages if the seller or buyer fails in its delivery or receipt obligations prior to the non-defaulting party’s early termination of a transaction due to the occurrence of an event of default under Section 8.1.178 If the seller fails to deliver, the seller must pay to the buyer the difference between the lowest reasonable market price at which buyer is able, or would have been able at the time of the breach, to purchase coal of comparable quality minus the contract price on an SO2 adjusted basis.179 If buyer fails or refuses delivery of conforming coal, the buyer must pay to the seller the difference between the contract price, and the highest reasonable market price at which seller is able or would be able to sell the coal at the time of the breach.180 The Master Agreement requires the non-defaulting party to make “commercially reasonable” efforts to mitigate its damages when making a claim for a failure to deliver or receive.181 If the parties agree in writing, the non-defaulting party may schedule deliveries or receipts in order to discharge the defaulting party’s obligation to pay damages.182

Furthermore, section 8.4(a) allows for the payment of alternative damages using any method specified by the parties and agreed to in writing.

incurred as a result of Buyer’s receipt of quantities of Gas greater than or less than the Scheduled Gas, then Buyer shall pay for such Imbalance Charges or reimburse Seller for such Imbalance charges paid by Seller. If the Imbalance Charges were incurred as a result of Seller’s deliver of quantities of Gas greater than or less than the Scheduled Gas, then Seller shall pay for such Imbalance Charges or reimburse buyer for such Imbalance Charges paid by Buyer.”).175 NAESB §2.9. 176 NAESB §3.3. 177 NAESB §2.9. 178 Master Agreement §8.4.179 Master Agreement §8.4(b).180 Master Agreement §8.4(c).181 Master Agreement §8.4(d).182 Master Agreement §8.4(a).

Section 5.2 of the Master Agreement allows a buyer to reject any non-conforming shipment of coal that falls within the Rejection Limits identified in each transaction by giving notice to the seller within twenty-four hours of the time the buyer receives an analysis indicating that the coal is non-conforming; however, the delivery of non-conforming coal constitutes an Event of Default only if the failure occurs on more than one occasion within a specific time period.183 If a seller delivers non-conforming coal, and the delivery does not constitute an Event of Default, the seller must remove any non-conforming coal rejected by the buyer from the buyer’s place of business at seller’s expense and replace the non-conforming coal within a reasonable period of time if the buyer notifies seller of a desire to receive replacement coal within 48 hours.184

Upon giving the required notice to the seller, the buyer may either reject the shipment at the delivery point or while the coal is in route (but prior to unloading the coal from the transporter’s equipment), or accept the non-conforming coal and adjust the contract price by using the very specific formula set forth in Section 5.2.185 Under Section 5.2, if the buyer accepts the non-conforming coal, the buyer may adjust the contract price of all non-conforming shipments by 12.5 percent of the FOB Mine Price if the FOB Mine Price is greater than $8.00 per ton, or 25 percent of the FOB Mine Price if the FOB Mine Price is equal to or less than $8.00 per ton. Notably, the Master Agreement specifically states that the buyer’s failure to provide notice of the rejection to the seller within the requisite 24-hour time period does not act as a bar to the buyer’s ability to recover a penalty adjustment calculated under the formula set forth

183 See Master Agreement §4.4. The seller, who is identified as the Sampling Person, designates a certified lab, known as the Analysis Person, to perform the requisite analysis of each shipment of coal. The Analysis Person determines whether the coal is falls within the Rejection Limits specified in the confirmation. “Rejection Limits” may differ between loads; the Rejection Limits for each load as identified by the seller in a written confirmation that is delivered to the buyer after an oral transaction is made. Master Agreement §1.2. Section 5.2 of the Master Agreement identifies the Buyer’s Rejection Rights, and states “[u]nless otherwise specified in the relevant Confirmation, if any Shipment of Coal triggers any of the Rejection Limits specified in the Confirmation for a Transaction (a “Non-Conforming Shipment”), Buyer shall have the option, exercisable by notice to Seller within twenty-four hours of Buyer’s receipt of the Sampling Person’s short proximate analysis and additional analysis, if any, of the Coal provided pursuant to Article 4.4, of either (i) rejecting such Non-Conforming Shipment at the Delivery Point or in route, but prior to unloading from Transporter’s equipment or (ii) accepting any Non-Conforming Shipment with a Contract Price adjustment equal to (1) 12.5% of the FOB Mine Price if such FOB Mine Price is greater than $8.00 per ton or (2) 25% of the FOB Mine Price if such FOB Mine Price is equal to or less than $8.00 per ton. If Buyer fails timely to exercise its rejection rights under this Article 5.2 as to a Shipment, Buyer shall be deemed to have waived such rights to reject with respect to that Shipment only. Buyer’s failure to timely exercise such notice does not however, constitute a waiver of its right to any penalty adjustment provided for herein or in the relevant confirmation with respect to such Non-Conforming Shipment. If Buyer timely rejects the Non-Conforming Shipment, Seller shall be responsible for promptly transporting the rejected Coal to an alternative destination determined by Seller and, if applicable, promptly unloading such coal and shall reimburse Buyer for all reasonable costs and expenses associated with the transportation, storage, handling and removal for the Non-Conforming Shipment. Seller shall, at Buyer’s election, replace the rejected coal within a reasonable period of time, provided that Buyer gives written notice to Seller of its desire for replacement coal within forty-eight hours after rejection for the Non-Conforming Shipment.” 184 Master Agreement §5.2.185 Master Agreement §5.2.

above; however, it appears that the buyer’s failure to provide notice of rejection within the 24-hour time period does waive the buyer’s right to reject the shipment entirely.186

Additionally, section 3.5 allows the seller the right to give timely notice to the buyer, andprovide coal from a source other than that identified in the confirmation, without those actions constituting an Event of Default; while the buyer must approve the substitution, the approval may not be unreasonably withheld, provided, however, that the seller will be responsible for any increased costs associated with the substitution.187

This general standard for calculating liquidated damages in the event of a failure to deliver or receive coal by the buyer or seller is closely analogous to the “cover standard” adopted by the U.C.C. However, unlike the Code, the Master Coal Agreement requires that the non-defaulting party use commercially reasonable efforts to mitigate its damages when making a claim for a failure to deliver or receive.188

The Master Agreement requires the buyer to give notice of the rejection within 24 hours after receipt of the sample analysis; the requirement that the buyer act within 24 hours of receiving notice that a shipment is non-conforming is different from Article 2’s requirement that the buyer reject and cover only without “unreasonable delay.”189 The Master Agreement additionally allows a buyer to reject non-conforming coal while it is in route or at the delivery point, but requires the rejection to take place before the coal is unloaded from the transporter’s equipment.190 Article 2 imposes no such time limitations on the buyer’s right to reject non-conforming goods. The Master Agreement also requires the seller to remove any non-conforming coal from buyer’s place of business at seller’s expense, and replace the non-conforming coal within a reasonable period of time if the buyer notifies seller of a desire to receive replacement coal within 48 hours.191 While Article 2 allows for the recovery of additional transportation costs by the non-breaching party, it does not directly impose the responsibility for transporting the non-conforming goods to an alternate location on the defaulting party, as is the case under the Master Agreement.192 Article 2 does provide for the recovery by the buyer of all costs associated with the receipt, storage, care and transportation of any goods delivered but later rightfully rejected by the buyer; however, Article 2 does not require the seller to remove the goods from the delivery location and replace the rejected goods with conforming goods within such a strict time period.193

186 Master Agreement §5.2.187 Master Agreement §3.5 (stating “[u]nless otherwise restricted by the subject Confirmation, Seller shall, by giving timely notice as provided in Section 3.2 above, have the option, subject to Buyer’s approval, not to be unreasonably withheld, to provide the Coal from any alternate source Seller may select. Any such substituted Coal must comply with all Specifications for the Coal to be replaced and be otherwise acceptable to Buyer.”).188 Master Agreement §§8.3; 8.4(d).189 TEX. BUX. COMM. C. §2.712(a).190 TEX. BUS. COM. C. §2.602.191 Master Agreement §5.2192 TEX. BUS. COM. C. §2.712; 2.715.193 TEX. BUX. COMM. C. §2.715.

Section 3.3(d) addresses charges or penalties incurred as a result of a party’s failure to timely and appropriately load or unload coal.194 Under this subsection, unless the failure to properly load or unload is a result of Force Majeure, the party whose failure incurred the charges must either pay the charges or penalties directly, or reimburse the other party who paid the charges. No such provision is made in Article 2.

Another important distinction between Article 2 and the Master Agreement is the Master Agreement’s inclusion of a very specific formula for calculating damages upon the delivery ofnon-conforming coal, which is based on the FOB mine price per ton.195 Use of Article 2’s cover standard for calculating damages would result in a substantially different amount of damages owed than that calculated using the formula set forth in the Master Agreement.

2. Events of Default

Section 8.1 identifies Events of Default that may apply to either party, which include (1) the failure to pay when due any required payment if such failure is not remedied within three business days after receiving written notice thereof; (2) the failure to comply with any “material obligations” under a transaction, if the failure is not remedied within 10 business days after written notice thereof; (3) being subject to a bankruptcy proceeding; (4) the failure of a party’s guarantor, if any, to perform any covenant in its guaranty, such as allowing the guaranty to expire; and (5) any representation or warranty made by a party is untrue in any material respect when made.196

The Master Agreement also includes a separate section setting forth the specific circumstances in which the buyer may declare an Event of Default with respect to a specific transaction.197 If there are three non-conforming shipments within any three-month period, or if

194 Master Agreement § 3.3(d) (stating “[i]f a Party involved in a Transaction is charged for any increased transportation charges, penalties, or other costs, including demurrage, attributable to the other Party’s failure to timely and appropriately load or unload the Coal in accordance with the terms of the Transaction or the timing and tonnage requirements of the Transportation Specification, and if such failure is not due to Force Majeure, failure of the other party or the other Party’s railcars or transportation carrier, such failing Party shall promptly reimburse the other for such actual charges, if such charges are usual and customary, after written notice thereof.”)195 Master Agreement §5.2(ii). 196 Master Agreement §8.1. Notably, the term “material obligations” is not defined by the Master Agreement.197 Master Agreement §5.3 (stating “[i]f there are three (3) Non-Conforming Shipments, whether rejected or not, under a Transaction in any three (3) month period or if two (2) out of four (4) consecutive Shipments under a Transaction (with respect to barge coal the preceding test shall be determined by one (1) or more rejectable barges being loaded in each of two days of sequential Shipments under a given Transaction whether or not there are any intervening days without Shipments) are Non-Conforming Shipments, or should Seller fail to meet one or more Schedule 2 Periodic Performance Quality Limits as set forth in a Schedule 2 to a Confirmation, as the case may be, then Buyer may upon notice to Seller suspend the receipt of future Shipments (except Shipments already loaded or in transit to Buyer) under such Transaction. A waiver by Buyer of the suspension right for any one period shall not constitute a waiver for subsequent periods. If Seller, within ten days of its receipt of such notice, provides reasonable assurances in writing to Buyer that Future Shipments under the Transaction will conform to the Specifications and Buyer has accepted such assurances ) such acceptance not to be unreasonably withheld), Shipments shall resume and any tonnage deficiency shall be made upon within the Term at Buyer’s option. If (i) Seller fails to provide such acceptable assurances within such ten day period, or (ii) after such assurances are provided and for a period of three months thereafter, any Shipments of Coal trigger any of Buyer’s rejection rights under Article 5.2 for the Rejection Limit parameter for which there was a prior suspension under such Transaction

two out of four consecutive shipments under a single transaction are non-conforming, the buyer may give notice to the seller and suspend the receipt of all future shipments, except those already loaded or in transit.198 Upon receipt of notice, the seller is then allowed ten days in which to provide assurances of performance acceptable to buyer and cure the Event of Default.199 If the seller either fails to deliver the assurances of performance, or delivers any non-conforming shipments within the three-month period following the request for assurances of performance, the buyer may declare that an Event of Default has occurred with respect to the transaction.200

If an Event of Default occurs with respect to either party, the non-defaulting party may, during the continuance of an Event of Default, either suspend its own performance, (including all payment obligations). until the Event of Default is cured or accelerate and liquidate the Parties’ obligations under the Master Agreement and all transactions by deciding on and notifying the defaulting party of an early termination date and suspending performance of its obligations under the Master Agreement until the default is cured.201 If an early termination date is established, the non-defaulting party will net and offset all outstanding amounts owed between the parties for all terminated transactions; the Master Agreement does not allow parties the option to net and setoff amounts owed between the parties pursuant to agreements other than the Master Agreement.202

However, unlike the NAESB, in most situations, the Master Agreement allows the non-defaulting party the option to terminate all transactions under the Master Agreement, or only the transaction that gave rise to the Event of Default.203

The Master Agreement does provide a ten-day cure period, in which the seller may cut off the buyer’s right to terminate the contract by providing adequate assurances of performance to the buyer that all future shipments will conform to the requirements of the contract.204 Upon receipt of notice, the seller is then allowed ten days in which to provide assurances of performance acceptable to buyer, and cure the Event of Default. If the seller either fails to deliver the assurances of performance, or delivers any non-conforming shipments within the three-month period following the request for assurances of performance, the buyer may declare that an Event of Default has occurred with respect to the transaction.205

or should Seller fail to meet one or more Schedule 2 Periodic Performance Quality Limits as set forth in a Schedule 2 to a Confirmation, as the case may be, then such failure shall constitute an Event of Default (as hereinafter defined) with respect to such Transaction.”). 198 Master Agreement §5.3199 Master Agreement §5.3200 Master Agreement §5.3.201 Master Agreement §8.2.202 Master Agreement §8.3. It is important to note that if a non-breaching party declares an Early Termination Date, that party may, in its sole discretion, choose to terminate all Transactions between the parties, or terminate only the transactions giving rise to the Event of Default. Master Agreement §8.2.203 Master Agreement §8.2. Allowing the non-defaulting party the option to terminate all transactions or only the transaction that gave rise to the Event of Default if the triggering “Event of Default” is one described in Sections 8.1(a)(i), (ii), or (iv)-(x). 204 Master Agreement §5.3.205 Master Agreement §5.3.

The Master Agreement also allows the parties the right to net and setoff all obligationsowing between the parties, whether for a particular transaction, or for all transactions under the Master Agreement.206

Additionally, the Master Agreement includes an arbitration provision, requiring all disputes under the agreement to be submitted to binding arbitration.

Events of Default under the Master Agreement differ from the Code in several ways. First, the Master Agreement offers a substantial improvement in the enforceability of oral transactions than that offered by the Code. The Master Agreement expressly recognizes the validity and enforceability of oral transactions, an option not offered by the Code, which requires a writing for all transactions over $500.00. Second, the Master Agreement allows a failure to deliver by the seller to constitute an Event of Default only if the failure occurs on more than one occasion, and within the time period specified in the contract. This leniency clearly is not mirrored by the Code, which labels any failure by the seller to make perfect tender a breach.207

Third, the Master Agreement sets forth very specific circumstances in which the buyer can rightfully suspend future shipments of coal, except those shipments already loaded or in transit.208 The Master Coal Agreement varies from both the NAESB and the U.C.C., as it does not allow the seller the right to refuse delivery if the buyer is insolvent; the seller may only suspend its performance if the buyer becomes subject to a bankruptcy proceeding. Mere insolvency, as defined by the U.C.C., is insufficient to allow the seller to suspend its performance under the Master Agreement. This provision does not correspond with Article 2, which allows a seller to stop delivery of goods in the possession of a carrier when he discovers the buyer to be insolvent.209 Furthermore, the seller has no right to reclaim under the Master Coal Agreement, as it would under the Code.

Further, unlike the Code, the Master Coal Agreement provides that the failure of a party’s guarantor to perform any obligation under its guaranty, such as allowing the guaranty to expire, will constitute an Event of Default.210 While a guaranty clearly is related to the underlying agreement (here, the Master Coal Agreement) such that a breach of any obligations in the guaranty could rationally be imputed to the underlying agreement, the Code does not specifically provide that the breach of a party’s obligations under a separate agreement such as a guaranty automatically will constitute a default under the main agreement between the parties. The Code certainly does not label any failure by a third party to perform its obligations under a separate agreement as a breach of a party’s obligations under the main agreement. Furthermore, the Master Coal Agreement allows the parties to select a provision that makes the parent’s or guarantor’s default on any indebtedness to third parties that results in such indebtedness being

206 Master Agreement §§6.2; 8.3.207 TEX. BUS. & COM. C. §§2.601; 2.703. 208 Master Agreement §5.3.209 TEX. BUS COMM. C. §2.705.210 Master Agreement §8.1(iv).

accelerated or being capable of becoming accelerated as an Event of Default.211 There is no analogous mechanism in the Code.

Additionally, the Master Coal Agreement sets forth very specific circumstances in which the buyer can rightfully suspend future shipments of coal.212 While Article 2 does allow a buyer to refuse future shipments, the buyer is only allowed to do so under Article 2 when exercising termination rights.213 The Master Coal Agreement, however, provides a ten-day cure period, in which the seller may cut off the buyer’s right to terminate the contract by providing adequate assurances of performance to the buyer that all future shipments will conform to the requirements of the contract.214 Article 2 also provides a mechanism by which the non-breaching party may request assurances of performance, but the time period for cure is 30 days, rather than the ten allowed by the Master Coal Agreement.215

The Master Coal Agreement’s arbitration provision also is not found in the remedies provided by the Code.

3. Adequate Assurances of Performance

The Master Coal Agreement addresses adequate assurances of performance in several sections. First, in section 5.3, a seller who delivers non-conforming coal may cut off the buyer’s right to terminate the contract by providing adequate assurances of performance to the buyer that all future shipments will conform to the requirements of the contract. Upon receipt of notice, the seller is then allowed ten days in which to provide assurances of performance acceptable to buyer. If the seller either fails to deliver the assurances of performance, or delivers any non-conforming shipments within the three-month period following the request for assurances of performance, the buyer may declare that an Event of Default has occurred with respect to the transaction.

Performance assurances also are addressed under Section 6.5, which allows the parties the option of allowing a party to request a performance assurance in an amount equal to the early termination payment that would be owed to the requesting party in the event of a default if the outstanding balance owed by the counterparty exceeds a certain threshold level. Additionally, under Section 6.6, a party is allowed to retain any interest received on cash collateral provided by the counterparty as a performance assurance until the non-performing party satisfies its obligations under the Master Coal Agreement.

C. EEI MASTER POWER PURCHASE & SALE AGREEMENT

The fact that Article 2 governs the sale of electric energy creates interesting problems for lawyers and industry professionals alike, because electric energy has properties vastly different

211 Master Agreement §8.1(vii).212 Master Agreement §5.3.213 TEX. BUS. COMM. C. §2.214 Master Agreement §5.3.215 TEX. BUS. COMM. C. §2.609.

from other energy commodities and most of the other things considered to be “goods.”216

Electricity, unlike other goods, cannot be stored, and the system for delivering electricity is structured in a way that ensures that even if the seller fails to put the required electricity onto the grid, the end user will usually still receive the product. Despite these unique characteristics, damages in wholesale electricity contracts are similar to those found in contracts for other wholesale commodities.

The EEI Master Agreement (the “EEI”) is a form contract for the sale of electric power drafted by the Edison Electric Institute and the National Energy Marketers Association. The Agreement is comprised essentially of three parts: (1) the Cover Sheet, which is specific to each party, and identifies the parties to the Agreement and sets forth the specifics regarding delivery, credit, payment, and collection; (2) the General Terms and Conditions, which generally are not renegotiated between the parties and form the substance of the parties’ agreement; and (3) the Confirmation Letter, which is used to confirm individual transactions made by telephone between the parties. The provisions addressing breach and damages discussed below are included in the General Terms and Conditions section and therefore are common to every EEI contract, unless specifically altered by the contracting parties.

The EEI contains liquidated damages provisions that apply in the event of a failure to deliver or receive electricity and specific remedies for use upon the occurrence of an Event of Default. It also contains multiple provisions addressing the parties’ credit risks, including adequate assurances, threshold margining, and credit rating downgrades.

1. Failure to deliver or receive electricity.

Article 4 of the EEI addresses remedies for any failure to deliver or receive electricity.Despite the fact that any failure on the part of the seller to deliver electricity onto the grid will not affect whether the buyer receives power, the EEI includes a provision addressing the method of calculating damages in just such a situation because although a purchaser will usually still receive electricity from the grid in the event the seller fails to deliver the contract quantities, damages are necessary to compensate the buyer for either the cost of obtaining alternative supplies or for the costs imposed by the grid operator for buyer’s consumption of power in excess of the quantities delivered to the grid for buyer’s use. 217

Section 4.1 provides for the buyer’s recovery of the difference between the Contract Price and the Replacement Price in the event of a breach by the seller.218 The Contract Price is defined

216 TEX. BUS. COMM. C. §2.102. 217 EEI §4.1.218 EEI §4.1 (addressing a failure by the seller to perform its delivery obligations under the contract, stating “[i]f Seller fails to schedule and/or deliver all or part of the Product pursuant to a Transaction, and such failure is not excused under the terms of the Product or by Buyer’s failure to perform, then Seller shall pay Buyer, on the date payment would otherwise be due in respect of the month in which the failure occurred or, if “Accelerated Payment of Damages” is specified on the Cover Sheet, within five (5) Business Days of invoice receipt, an amount for such deficiency equal to the positive difference, if any, obtained by subtracting the Contract Price from the Replacement Price. The invoice for such amount shall include a written statement explaining in reasonable detail the calculation of such amount.”).

as the price to be paid by the buyer to the seller for the purchase of the product,219 while the Replacement Cost is generally defined as the price the buyer pays for substitute power.220

Section 4.2 addresses a breach by the buyer and provides that if a buyer fails to schedule or receive any portion of the product under a transaction, the seller is entitled to a payment based on the difference between the Sales Price and the Contract Price.221 The Sales Price is generally defined as the price at which the seller is able to resell the commodity, plus any costs reasonably incurred in reselling the product, and any additional transmission charges reasonably incurred.222

This section also allows the seller the option to use the market price at the delivery point for the calculation of damages.223

Both sections 4.1 and 4.2 require that the amount calculated under each section must be paid either on the date payment would otherwise be due had the failure to take or deliver not occurred, or, if the parties have selected “Accelerated Payment of Damages” on the Cover Sheet, within five business days of receiving an invoice.224

219 EEI §1.10 (stating that the ‘Contract Price’ means “the price in $U.S. (unless otherwise provided for) to be paid by Buyer to Seller for the purchase of the Product, as specified in the Transaction”).220 EEI §1.51 (stating that the Replacement Price “means the price at which Buyer, acting in a commercially reasonable manner, purchases at the Delivery Point a replacement for any Product specified in a Transaction but not delivered by the Seller, plus (i) costs reasonably incurred by Buyer in purchasing such substitute product and (ii) additional transmission charges, if any, reasonably incurred by Buyer to the Delivery Point, or at Buyer’s option, the market price at the Delivery Point for such Product not delivered as determined by Buyer in a commercially reasonable manner; provided, however, in no event shall such price include any penalties, ratcheted demand or similar charges, nor shall Buyer be required to utilize or change its utilization of its owned or controlled assets or market positions to minimize Seller’s liability. For the purposes of this definition, Buyer shall be considered to have purchased replacement Product to the extent that Buyer shall have entered into one or more arrangements in a commercially reasonable manner whereby Buyer repurchases its obligation to sell and deliver the Product to another party at the Delivery Point.”).221 EEI §4.2 (addressing a failure by the buyer, stating “[i]f Buyer fails to schedule and/or receive all or part of the Product pursuant to a Transaction, and such failure is not excused under the terms of the Product or by Seller’s failure to perform, then Buyer shall pay Seller, on the date payment would otherwise be due in respect of the month in which the failure occurred or, if “Accelerated Payment of Damages” is specified on the Cover Sheet, within five (5) Business Days of invoice receipt, an amount for such deficiency equal to the positive difference, if any, obtained by subtracting the Sales Price from the Contract Price. The invoice for such amount shall include a written statement explaining in reasonable detail the calculation of such amount.”).222 EEI §1.53 (defining ‘Sales Price’ as “[t]he price at which Seller, acting in a commercially reasonable manner, resells at the Delivery Point any Product not received by Buyer, deducting from such proceeds any (1) costs reasonably incurred by Seller in reselling such Product and (ii) additional transmission charges, if any, reasonably incurred by Seller in delivering such Product to the third party purchasers, or at Seller’s option, the market price at the Delivery Point for such product not received as determined by Seller in a commercially reasonable manner; provided, however, in no event shall such price include any penalties, ratcheted demand or similar charges, nor shall Seller be required to utilize or change its utilization of its owned or controlled assets, including contractual assets, or market positions to minimize Buyer’s liability. For purposes of this definition, Seller shall be considered to have resold such Product to the extent Seller shall have entered into one or more arrangements in a commercially reasonable manner whereby Seller repurchases its obligation to purchase and receive the Product from another party at the Delivery Point.”).223 EEI §1.53.224 EEI §4.2.

The EEI also provides for the seller’s recovery of incidental damages or costs reasonably incurred in reselling the product, including any additional transmission charges.225 The EEI requires the seller to act in a “commercially reasonable manner” when reselling any product received by the buyer.226

The damages contained in the EEI for a failure to deliver or receive electricity are similar to the remedies in the NAESB and accordingly differ from the U.C.C. in a similar fashion. Byagreeing to use the EEI instead of relying on the provisions of the U.C.C., the seller sacrifices the right to suspend further deliveries and, if the failure goes to the whole contract, cancel the contract.227 Likewise, by using the EEI and not the U.C.C., the buyer sacrifices the right to demand specific performance or, if the failure goes to the whole contract, cancel the contract.228

As in the case of the NAESB, the EEI does not adhere to the “perfect tender” rule espoused by the U.C.C., but instead discusses the payment of liquidated damages in the event of a failure to deliver on receive, and the failure of a party to perform as an Event of Default rather than as a “breach.” Unlike the U.C.C., the Events of Default enumerated by the EEI include the acts or omissions of certain specifically-identified third parties including a party’s guarantor, and events of cross-default with respect to such third parties. Like the NAESB, a party’s failure to deliver or receive product is specifically exempted from this list of Events of Default.229

Despite this difference in the way they approach the issue, the EEI and Article 2 both address a failure to deliver or receive using the cover standard. The EEI provides that the seller’s measure of damages is the difference between the Contract Price and the Replacement Price, and the buyer’s measure of damages is the difference between the Contract Price and the Sales Price. These measures of damages are identical to the standards for breach identified in Article 2.230

Both the EEI and Article 2 require the parties to act in a “commercially reasonable manner”when reselling any product received by the buyer.231

Any damages payment for the failure by a buyer or seller to deliver or receive must be paid on the date payment would otherwise be due, or within five business days of receipt of invoice.232 While the U.C.C. clearly contemplates timely payment of all amounts owed, the specific time period for repayment set forth by the EEI is not mirrored by the Code.233

Any “failure to schedule” all or part of the product pursuant to a transaction constitutes a failure by the seller or buyer to fulfill its delivery or receipt obligations.234 Article 2 allows a

225 EEI §1.53.226 EEI §1.53.227 TEX. BUS. COM. C. §2.612.228 TEX. BUS. COM. C. §2.612.229 EEI §5.1(c).230 TEX. BUS. COM. C. §2.712.231 TEX. BUS. COM. C. §2.712.232 EEI §§4.1; 4.2233 EEI §4.2.234 EEI §4.1; 4.2.

seller to recover damages for “non-acceptance or repudiation by the buyer”.235 It is unclear whether a “failure to schedule” would be considered “non-acceptance or repudiation” under Article 2. While it seems likely that courts would interpret the Code provision in conformity with the manner in which the commodity is treated generally in the industry, it may be prudent to address this in contracts to avoid any uncertainty as to this issue.

2. Events of Default.

a. Events of Default under the EEI

The Events of Default specifically enumerated in the EEI include the occurrence of anyof the following (1) a party fails to make any payment when due and such failure is not remedied within three business days after the non-breaching party receives notice of the delinquency; (2) a party fails to perform any material obligation under the agreement; (3) a party becomes bankrupt; (4) any representation or warranty made by a party is false or misleading in any material respect when made; or (5) a party fails to satisfy the creditworthiness/collateral requirements agreed to in the contract.236 Additionally, certain acts or omissions of a party’s guarantor or another third party identified in the EEI may constitute an Event of Default under the agreement, as may the occurrence and continuation of an event of cross-default under a different contract.237 However, a party’s failure to deliver or receive electricity is specifically exempted from the penalties of Article 5 and does not constitute an event of default.238

When an Event of Default occurs and is continuing, the non-defaulting party may withhold payments, suspend its performance, and/or designate an early termination date, thereby accelerating all amounts owing between the parties.239 Effective on the Early Termination Date the non-defaulting party may terminate and liquidate all transactions between the parties.240 It is important to note that under the EEI, it is not enough that the Event of Default has occurred; it must be continuing in order for the non-breaching party to declare an Event of Default and terminate all transactions.241 The EEI also offers the parties the option to elect whether to net and setoff any amounts owing pursuant to other agreements between the parties or other agreements between the parties and their affiliates.242 Any payments owed between the parties must be paid within two business days of receipt of the invoice enumerating the final settlement amount owed following termination, liquidation and setoff.243

The U.C.C. gives a seller certain rights upon discovering that the buyer is insolvent, such as refusing to deliver additional goods, or reclaiming previously delivered goods.244 Under the

235 TEX. BUS. COM. C. §2.708.236 EEI §5.1.237 EEI §5.1(g);(h).238 EEI §5.1(c).239 EEI §5.2.240 Id.241 Id.242 EEI §5.3.243 EEI §5.4.244 TEX. BUS. COM. C. §2.702.

EEI, however, bankruptcy or failure to meet creditworthiness requirements by either party is an Event of Default, and is not treated differently than the occurrence of any other Event of Default.

b. Damages

Paralleling the NAESB, the Events of Default under the EEI result in damages similar to those that would be realized under the U.C.C., but the EEI offers greater specificity as to what constitutes an Event of Default and the method for calculating damages. One important difference from the NAESB and the U.C.C. is the EEI’s right of parties under the EEI to suspend performance under any or all transactions upon any event which, with the delivery of notice or the passage of time, would constitute an Event of Default.245 Thus, although the buyer sacrifices the U.C.C. right to demand specific performance when entering into an EEI, it and the seller gain a valuable suspension right that may enable it to cease doing business with an unreliable counterparty or a counterparty spiraling downward into insolvency.

c. Right to terminate

Unlike the Code, under the EEI it is not enough that an Event of Default has occurred; it must have occurred and be continuing in order for the non-breaching party to declare an Early Termination Date and terminate all transactions, as the performing party’s right to terminate is eliminated upon cure by the non-performing party.246

Article 2 requires that in order for a party to have the right to terminate the contract as a whole, the breach must “impair the value of the whole contract.”247 The EEI clarifies this ambiguous standard, requiring only that an Event of Default must have occurred and be continuing for termination to occur.

An additional difference is that when a party declares an early termination date under the EEI, it must terminate all transactions between the parties. In contrast, there is no requirement in the Code that a party terminate all transactions following a breach.

Section 2.616 allows the buyer to terminate the contract if the buyer receives notification of a material reduction or delay in delivery; but no such right is recognized by the EEI. Like most energy contracts, the EEI allows termination by the buyer only if an Event of Default has occurred and, in most cases, termination would not be allowed because a delay or reduction in delivery does not constitute an Event of Default.

d. Payment of damages following termination

The EEI specifies the timing of payments in greater detail than does the U.C.C., requiring any payments owed between the parties upon declaration of an early termination date to be paid

245 EEI §5.7.246 EEI §5.2.247 TEX. BUS. COM. C. §2.612.

within two business days of receipt of the invoice.248 The U.C.C. does not specify the time frame by which payment of damages must be made following termination.

Like Article 2, the EEI provides for the seller’s recovery of incidental damages, or costs reasonably incurred in reselling the product. However, the EEI also provides for the recovery of any additional transmission charges incurred. It is unclear whether a seller would be able to recover additional transmission charges under the Code, as such charges are not specifically enumerated.

e. Setoff

If the parties terminate all outstanding transactions, the EEI allows the parties to net and setoff the amounts owed between them pursuant to other agreements in addition to the EEI, if that option is selected by the parties.249 There is no right of netting and setoff recognized under the Code.

f. Suspension

The U.C.C. allows a seller to stop delivery of goods in transit when the seller discovers the buyer is insolvent, the buyer repudiates the contract, or the buyer fails to make any payment due before delivery.250 Under the EEI there is no right to suspend performance immediately upon learning of the buyer’s insolvency; and performance may be suspended only when the non-breaching party takes steps to terminate the contract by declaring an Event of Default, or when a Potential Event of Default has occurred and is continuing. Potential Events of Default are defined as events which, with notice or passage of time or both, would constitute an actual Event of Default.251 The EEI provides that when a Potential Event of Default has occurred and is continuing, the non-defaulting party may give written notice thereof to the defaulting party and suspend performance under any or all transactions for 10 business days per transaction before the suspension must end or the contract must be terminated.252

3. Credit protection.

Unlike the NAESB, Master Coal Agreement and U.C.C., the EEI contains multiple methods of mitigating credit risk.

a. Adequate assurance of performance.

The EEI allows a party to demand assurances of performance if the party has reasonable grounds to believe that the counterparty’s creditworthiness or performance has become

248 EEI §5.4.249 EEI §5.6.250 TEX. BUS. COM. C. §2.703.251 EEI §1.46.252 EEI §5.6. This section allows the suspension to continue for up to ten (10) NERC Business Days, which are any days except a Saturday, a Sunday or a holiday defined by the North Americn Electric Reliability Council or any successor organization. EEI §1.31.

unsatisfactory.253 If the performance assurance is not delivered in an amount reasonably acceptable to the requesting party within three business days after receipt of the request therefor, then an Event of Default will be deemed to have occurred.254 Under the U.C.C., a party must deliver adequate assurance within a commercially reasonable time period, not to exceed thirty days. The cure period allowed by the EEI is much shorter than that allowed by the U.C.C., and therefore, like the NAESB, it offers more protection to a party who properly requests such assurances than is found in the U.C.C.

Other than the difference in time periods for delivering the assurance and the ability to elect on the EEI Cover Sheet whether or not to use adequate assurances, the U.C.C., NAESB and EEI are substantially similar in their treatment of the right to demand adequate assurances of performance.

b. Threshold margining.

The EEI goes beyond the subjective adequate assurance provisions of the U.C.C. and NAESB by adding an objective method of determining when and the amount of collateral that must be exchanged by the parties.255 Under threshold margining the parties measure their respective mark-to-market exposure under the EEI, subtract from that figure the collateral threshold of the other party, and the party with the subsequent net positive exposure may demand collateral from the other party equal to such amount. In the event collateral is not delivered within three business days of the date of the demand therefor, such failure will constitute an Event of Default.256

c. Credit rating downgrade.

One risk that exists when relying on rights to demand adequate assurance of performance is that the party from which collateral is demanded may dispute whether reasonable grounds exist for demanding the assurance, leaving the demanding party in the difficult position of choosing between continuing to perform under the contract without collateral or terminating the contract on grounds that the other party failed to deliver performance assurance when required and risk being sued for wrongful termination of the contract. The EEI addresses this risk by offering the parties the option to elect the applicability of downgrade event, under which the occurrence of a credit rating downgrade below the minimum level listed on the Cover Sheet for a party triggers the right of the other party to request collateral in an amount determined by the requesting party in a commercially reasonable manner.

d. Objective versus subjective collateral triggers

These credit support options offer three approaches to addressing credit risk instead of the single approach offered by the U.C.C. and NAESB. These methods utilize different combinations of subjective and objective rights for the party demanding credit assurance. The

253 EEI §8.1(b).254 EEI §8.1. 255 EEI 8.1(c)256 Id.

adequate assurance right contains a subjective trigger and a subjective calculation of the amount of collateral that must be delivered. The collateral threshold contains an objective trigger and the amount of collateral to be delivered is based on objective mathematical calculations. The downgrade event option contains an objective trigger but a subjective method of calculating the amount of collateral to be delivered.

D. ISDA MASTER AGREEMENT

The International Swaps and Derivatives Association drafted the ISDA Master Agreement (the “ISDA”) for use in documenting swap and derivative transactions. Although derivatives are not goods and therefore would not fall under the scope of Article 2 of the U.C.C.,the ISDA is so commonly used in energy commodity transactions and negotiated in tandem with other energy commodity master agreements that it is useful to compare the ISDA to the NAESB, Master Coal Agreement and EEI as well as the U.C.C. The ISDA, like the NAESB, Master Coal Agreement and EEI; is a Master Agreement that the parties agree will govern the terms of any subsequent transactions the parties may enter into. The Schedule to the Master Agreement is the part of the ISDA that is customized by the parties for the particulars of their transactions. The Schedule includes the names of the parties, any Credit Support Providers or Specified Parties (discussed below), plus certain credit and payment obligations.

1. Events of Default.

Section 5 addresses Events of Default and Termination Events with respect to either party or with respect to any Credit Support Provider of either party. The ISDA, like the NAESB, Master Coal Agreement, and EEI, differs from the Code in that the acts or omissions of a thirdparty, the Credit Support Provider or a Specified Entity, may constitute an Event of Default or Termination Event.257 Both the “Credit Support Providers” and the “Specified Entities” areidentified by the parties in the Schedule.

Section 5(a) defines Events of Default as the occurrence of any of the following acts or omissions by a party, a Credit Support Provider, or a Specified entity: (1) any failure to make any payment when due,258(2) any failure to comply with or perform any agreement or obligation or any repudiation or rejection of the Master Agreement or any Transaction or Confirmation,259

257 ISDA §5(a).258 ISDA §5(a)(1): “Failure by the party to make, when due, any payment under this Agreement or delivery under Section 2(a)(i) or 9(h)(i)(2) or (4) required to be made by it if such failure is not remedied on or before the first Local Business Day in the case of any such payment or the first Local Delivery Day in the case of any such deliver after, in each case, notice of such failure is given to the party.”259 ISDA §5(a)(ii): “(1) Failure by the party to comply with or perform any agreement or obligation (other than an obligation to make any payment under this Agreement or delivery under Section 2(a)(i) or 9(h)(i)(2) or (4) or to give notice of a T under Section 4(a)(i), 4(a)(iii) or 4(d)) to be complied with or performed by the party in accordance with this Agreement if such failure is not remedied within 30 days after notice of such failure is given to the party; or (2) the party disaffirms, disclaims, repudiates or rejects, in whole or in part, or challenges the validity of, this Master Agreement, any Confirmation executed and delivered by that party or any Transaction evidenced by such a Confirmation (or such action is taken by any person or entity appointed or empowered to operate it or act on its behalf).”\

(3) any Credit Support Default;260 (5) the making or repeating of any material misrepresentation;261 (6) any default under a specified transaction;262 (7) any event of Cross-Default;263 (8) bankruptcy;264 or (9) any merger, if the new entity fails to assume all the obligations of the original party to the contract.265

260 ISDA §5(a)(iii) (stating that “(1) Failure by the party or any Credit Support Provider of such party to comply with or perform any agreement or obligation to be complied with or performed by it in accordance with any Credit Support Document if such failure is continuing after any applicable grace period has elapsed; (2) the expiration or termination of such Credit Support Document or the failing or ceasing of such Credit Support Provider to the other party pursuant to any such Credit Support Document, to be in full force and effect for the purpose of this Agreement (in each case other than in accordance with its terms) prior to the satisfaction of all obligations of such party under each Transaction to which such Credit Support Document relates without the written consent of the other party; or (3) the party or such Credit Support Provider disaffirms, disclaims, repudiates or rejects, in whole or in part, or challenges the validity of, such Credit Support Document (or such action is taken by any person or entity appointed or empowered to operate it or act on its behalf)”).261 ISDA §5(a)(iv) (stating that “[a] representation (other than a representation under Section 3(e) or 3(f) made or repeated or deemed to have been made or repeated by the party or any Credit Support Provider of such party to this Agreement or any Credit Support Document proves to have been incorrect or misleading in any material respect when made or repeated or deemed to have been made or repeated.”).262 ISDA §5(a)(v) (stating “[t]he party, any Credit Support Provider of such party or any applicable Specified Entity of such party: - (1) defaults (other than by failing to make a delivery) under a Specified Transaction or any credit support arrangement relating to a Specified Transacting and, after giving effect to any applicable notice requirement or grace period, such default results in a liquidation of, an acceleration of obligations under, or an early termination of, that Specified Transaction; (2) defaults, after giving effect to any applicable notice requirement or grace period, in making any payment due on the last payment or exchange date of, or any payment on early termination of, a Specified Transaction (or, if there is no applicable notice requirement or grace period, such default continues for at least one Local Business Day); (3) defaults in making any delivery due under (including any delivery due on the last delivery or exchange date of a Specified Transaction or any credit support arrangement relating to a Specified Transaction and, after giving effect to any applicable notice requirement or grace period, such default results in a liquidation of, an acceleration of obligations under, or an early termination of, all transactions outstanding under the documentation applicable to that Specified Transaction; or (4) disaffirms, disclaims, repudiates or rejects, in whole or in party, or challenges the validity of, a Specified Transaction or any credit support arrangement relating to a Specified Transaction that is, in either case, confirmed or evidenced by a document or other confirming evidence executed and delivered by that party, Credit Support Provider or Specified Entity (or such action is taken by any person or entity appointed or empowered to operate it or act on its behalf)”).263 ISDA §5(a)(vi) (stating “[i]f ‘Cross-Default’ is specified in the Schedule as applying to the party, the occurrence or existence of: - (1) a default, event of default or other similar condition or event (however described) in respect of such party, any Credit Support Provider of such party or any applicable Specified Entity of such party under one or more agreements or instruments relating to Specified Indebtedness of any of them (individually or collectively) where the aggregate principal amount of such agreements or instruments, either alone or together with the amount, if any, referred to in clause (2) below, is not less than the applicable Threshold Amount (as specified in the Schedule) which has resulted in such Specified Indebtedness becoming, or becoming capable at such time of being declared, due and payable under such agreements or instruments before it would otherwise have been due and payable; or (2) a default by such party, such Credit Support Provider or such Specified Entity (individually or collectively) in making one or more payments under such agreements or instruments on the due date for payment (after giving effect to any applicable notice requirement or grace period) in an aggregate amount, either alone or together with the amount, if any, referred to in clause (1) above, of not less than the applicable Threshold Amount”).264 ISDA §5(a)(vii). 265 ISDA §5(a)(viii) (stating that “[t] he party or any Credit Support Provider of such party consolidates or amalgamates with, or merges with or into, or transfers all or substantially all its assets to, another entity and, at the time of such consolidation, amalgamation, merger or transfer: (1) the resulting, surviving or transferee entity fails to assume all the obligations of such party or such Credit Support Provider under this Agreement or any Credit Support Document to which it or its predecessor was a party by operation of law or pursuant to an agreement reasonably

If an Event of Default has occurred and is then continuing, the non-defaulting party may give notice to the defaulting party specifying the applicable Event of Default and designate a date as an Early Termination Date in respect to all outstanding Transactions.266 When an Early Termination Date is designated, the termination will occur on the Early Termination Date regardless of whether the default has been cured prior to that date.267 Upon the designation of an Early Termination Date no further payments or deliveries will be made by either party; each party will calculate the amounts owed between the parties, and each party will provide a statement to the other party showing the calculations made, specifying the amount payable, and giving details of the account into which the payment should be made.268

a. Cure periods

In order for a failure to pay or deliver not to be considered an Event of Default under Section 5(a), the failure must be remedied by the first Local Business Day or the first Local Delivery Day, whichever is applicable, after notice of the failure is given to the non-performing party.269 Failure to comply with any other agreement or obligation must be remedied within thirty days after notice is given in order to avoid constituting an Event of Default. The ISDA provides no cure period for any rejection or repudiation of the Master Agreement, or a Transaction or Confirmation. Further, all Credit Support Defaults will constitute an Event of Default unless cured by the time any grace period identified in the applicable Credit Support Document(s) has elapsed.

b. Events of Default and Termination Events

Under Section 5(b), Termination Events are distinct from Events of Default, and include: (1) any transaction or portion thereof becomes unlawful or illegal;270 (2) the occurrence of an

satisfactory to the other party to this Agreement; or (2) the benefits of any Credit Support Document fail to extend (without the consent of the other party) to the performance by such resulting, surviving or transferee entity of its obligations under this Agreement.”).266 If at any time an Event of Default with respect to a party (the "Defaulting Party") has occurred and is then continuing, the other party (the "Non-defaulting Party") may, by not more than 20 days notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions. If, however, "Automatic Early Termination" is specified in the Schedule as applying to a party, then an Early Termination Date in respect of all outstanding Transactions will occur immediately upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(l), (3), (5), (6) or, to the extent analogous thereto, (8) and as of the time immediately preceding the institution of the relevant proceeding or the presentation of the relevant petition upon the occurrence with respect to such party of an Event of Default specified in Section 5(a)(vii)(4) or, to the extent analogous thereto, (8).267 ISDA §6(c)(i).268 ISDA §6(c)(ii).269 ISDA §5(a)(i).270 ISDA §5(b) (i) (addressing illegality, and stating that “[d]ue to the adoption of, or any change in, any applicable law after the date on which a Transaction is entered into, or due to the promulgation of, or any change in, the interpretation by any court, tribunal or regulatory authority with competent jurisdiction of any applicable law after such date, it becomes unlawful (other than as a result of a breach by the party of Section 4(b)) for such party (which will be the Affected Party): (1) to perform any absolute or contingent obligation to make a payment or delivery, or to receive a payment or delivery in respect of such Transaction or to comply with any other material provision of this Agreement relating to such Transaction; or (2) to perform, or for any Credit Support Provider of such party to

event of force majeure;271 (3) a tax event;272 (4) a tax event upon merger;273 (5) a credit event upon merger;274 or (6) an additional termination event, if one is specified by the parties.275

perform, any contingent or other obligation which the party (or such Credit Support Provider) has under any Credit Support Document relating to such Transaction.”).271 ISDA §5(b)(iii) (stating “[a]fter giving effect to any applicable provision, disruption fallback or remedy specified in, or pursuant to, the relevant Confirmation or elsewhere in this Agreement, by reason of force majeure or act of state occurring after a Transaction is entered into, on any day: -- (1) the Office through which such party (which will be the Affected Party) makes and receives payments or deliveries with respect to such Transaction is prevented from performing any absolute or contingent obligation to make a payment or delivery in respect of such Transaction, from receiving a payment or delivery in respect of such Transaction or from complying with any other material provision of this Agreement relating to such Transaction (or would be prevented if such payment, delivery or compliance were required on that day), or it becomes impossible or impartibly for such Office so to perform, receive or comply (or it would be impossible or impracticable for such Office so to perform, receive or comply if such payment, delivery or compliance were required on that day); or (2) such party or any Credit Support Provider of such party (which will be the Affected Party) is prevented form performing any absolute or contingent obligation to make a payment or delivery which such party or Credit Support Provider has under any Credit Support document relating to such Transaction, from receiving a payment or delivery under such Credit Support Document or from complying with any other material provision of such Credit Support Document ( or would be so prevented if such payment, delivery or compliance were required on that day), or it becomes impossible or impracticable for such party or Credit Support Provider so to perform, receive or comply (or it would be impossible or impracticable for such party or Credit Support Provider so to perform, receive or comply if such payment, delivery or compliance were required on that day); so long as the force majeure or act of state is beyond the control of such Office, such party or such Credit Support Provider, as appropriate, and such Office, party or Credit Support Provider could not, after using all reasonable efforts (which will not require such party or Credit Support Provider to incur a loss, other than immaterial, incidental expenses), overcome such prevention, impossibility or impracticability.”).272 ISDA §5(b)(iii) (addressing tax events, and stating that “[d]ue to (x) any action taken by a taxing authority, or brought in a court of competent jurisdiction, on or after the date on which a Transaction is entered into (regardless of whether such action is taken or brought with respect to a party to this Agreement) or (y) a Change in Tax Law, the party (which will be the Affected Party) will or there is a substantial likelihood that it will, on the next succeeding Scheduled Payment Date (1) be required to pay to the other party an additional amount in respect of an Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) or (2) receive a payment from which an amount is required to be deducted or withheld for or on account of a Tax (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) and no additional amount is required to be paid in respect of such Tax under Section 2(d)(i)(4) (other than by reason of Section 2(d)(i)(4)(A) or (B)).”).273 ISDA §5(b)(iv) (addressing tax events upon merger, and stating that “[t]he party (the "Burdened Party") on the next succeeding Scheduled Payment Date will either (1) be required to pay an additional amount in respect of an Indemnifiable Tax under Section 2(d)(i)(4) (except in respect of interest under Section 2(e), 6(d)(ii) or 6(e)) or (2) receive a payment from which an amount has been deducted or withheld for or on account of any Indemnifiable Tax in respect of which the other party is not required to pay an additional amount (other than by reason of Section 2(d)(i)(4)(A) or (B)), in either case as a result of a party consolidating or amalgamating with, or merging with or into, or transferring all or substantially all its assets to, another entity (which will be the Affected Party) where such action does not constitute an event described in Section 5(a)(viii)”).274 ISDA §5(b)(v) (addressing credit events upon merger, and stating that “[i]f "Credit Event Upon Merger" is specified in the Schedule as applying to the party, such party ("X"), any Credit Support Provider of X or any applicable Specified Entity of X consolidates or amalgamates with, or merges with or into, or transfers all or substantially all its assets to, another entity and such action does not constitute an event described in Section 5(a)(viii) but the creditworthiness of the resulting, surviving or transferee entity is materially weaker than that of X, such Credit Support Provider or such Specified Entity, as the case may be, immediately prior to such action (and, in such event, X, or its successor or transferee, as appropriate, will be the Affected Party)”).275 ISDA §5(b)(vi) (addressing additional termination events, and stating that “[i]f any ‘Additional Termination Event’ is specified in the Schedule or any Confirmation as applying, the occurrence of such event (and, in such event, the Affected Party or Affected Parties shall be as specified for such Additional Termination Event in the Schedule or such Confirmation)”).

Because of the distinction made between Termination Events and Events of Default, the ISDA also includes a section regarding the hierarchy of such events, which addresses the interplay between Events of Default and Termination Events. 276

Termination Events are treated differently than Events of Default under the ISDA and, in some cases, differently than other Termination Events. If a Termination Event occurs, the non-defaulting party must give notice to the defaulting party, and may, under very specific circumstances, declare an Early Termination Date with respect only to those Transactions affected by the Termination Event.277 The designation of an Early Termination Date because of the occurrence of a Termination Event creates essentially the same obligations between the parties as those created when an Early Termination Date is designated as a result of an Event of Default; however, the payments owed between the parties are calculated using a different formula than that applicable to Events of Default. The formula varies depending on whether one

276 ISDA §5(c) (stating that “[a]n event or circumstance that constitutes or gives rise to an Illegality or a Force Majeure Event will not, for so long as that is the case, also constitute or give rise to an Event of Default under Section 5(a)(i) or 5(a)(ii)(1) or 5(a)(iii)(1) insofar as such event or circumstance relates to the failure to make any payment or delivery or a failure to comply with any other material provision of this Agreement or a Credit Support Document, as the case may be. (ii) Except in circumstances contemplated by clause (i) above, if an event or circumstance which would otherwise constitute or give rise to an illegality or a Force Majeure Event also constitutes an Event of Default or any other Termination Event, it will be treated as an Event of Default or such other Termination Event, as the case may be, and will not constitute or give rise to an Illegality or a Force Majeure Event. (iii) If an event or circumstance which would otherwise constitute or give rise to a Force Majeure Event also constitutes an Illegality, it will be treated as an Illegality, except as described in clause (ii) above, and not a Force Majeure Event.”).277 ISDA §6(b) (stating “(i) If a Termination Event occurs, an Affected Party will, promptly upon becoming aware of it notify the other party, specifying the nature of that Termination Event and each Affected Transaction and will also give such other information about that Termination Event as the other party may reasonably require.”); (ii) Transferto Avoid Termination Event. If either an Illegality under Section 5(b)(i)(1) or a Tax Event occurs and there is only one Affected Party, or if a Tax Event Upon Merger occurs and the Burdened Party is the Affected Party, the Affected Party will, as a condition to its right to designate an Early Termination Date under Section 6(b)(iv), use all reasonable efforts (which will not require such party to incur a loss, excluding immaterial, incidental expenses) to transfer within 20 days after it gives notice under Section 6(b)(i) all its rights and obligations under this Agreement in respect of the Affected Transactions to another of its Offices or Affiliates so that such Termination Event ceases to exist. If the Affected Party is not able to make such a transfer it will give notice to the other party to that effect within such 20 day period, whereupon the other party may effect such a transfer within 30 days after the notice is given under Section 6(b)(i). Any such transfer by a party under this Section 6(b)(ii) will be subject to and conditional upon the prior written consent of the other party, which consent will not be withheld if such other party's policies in effect at such time would permit it to enter into transactions with the transferee on the terms proposed.; (iii) Two Affected Parties. If an Illegality under Section 5(b)(i)(l) or a Tax Event occurs and there are two Affected Parties, each party will use all reasonable efforts to reach agreement within 30 days after notice thereof is given under Section 6(b)(i) on action to avoid that Termination Event; (iv) Right to Terminate. If: (1) a transfer under Section 6(b)(ii) or an agreement under Section 6(b)(iii), as the case may be, has not been effected with respect to all Affected Transactions within 30 days after an Affected Party gives notice under Section 6(b)(i); or (2) an Illegality under Section 5(b)(i)(2) a Credit Event Upon Merger or an Additional Termination Event occurs, or a Tax Event Upon Merger occurs and the Burdened Party is not the Affected Party, either party in the case of an Illegality, the Burdened Party in the case of a Tax Event Upon Merger, any Affected Party in the case of a Tax Event or an Additional Termination Event if there is more than one Affected Party, or the party which is not the Affected Party in the case of a Credit Event Upon Merger or an Additional Termination Event if there is only one Affected Party may, by not more than 20 days notice to the other party and provided that the relevant Termination Event is then continuing, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all Affected Transactions.

or two parties are effected by the Termination Event. If only one party is affected, the formula used is the same used upon the occurrence of an Event of Default.278

c. Damages

If the designation of the Early Termination Date results from an Event of Default, the damages owed will be the sum of the close-out amounts for all Terminated Transactions, as determined by the non-defaulting party, plus any unpaid amounts owed to the non-defaulting party, minus the unpaid amounts owed to the defaulting party.279 Interest will accrue on all unpaid and early termination amounts. The date for payment for an Early Termination Date designated as a result of the occurrence of an Event of Default is the day on which notice of the amount payable is effective.280

As previously indicated, the designation of an Early Termination Date because of the occurrence of a Termination Event creates essentially the same obligations between the parties as those created when an Early Termination Date is designated as a result of an Event of Default, but the payments owed between the parties are calculated using a different formula than that applicable to Events of Default. The formula varies depending on whether one or two parties are

278 ISDA §6(e)(ii) (providing that “[i]f the Early Termination Date results from a Termination Event: (1) One Affected Party. Subject to clause (3) below, if there is one Affected Party, the Early Termini on Amount will be determined in accordance with Section 6(e)(i), except that references to the Defaulting Party and to the Non-defaulting Party will be deemed to be references to the Affected Party and to the Non-Affected Party, respectively. (2) Two Affected Parties. Subject to clause (3) below, if there are two Affected Parties, each party will determine an amount equal to the Termination Currency Equivalent of the sum of the close-out Amount or Close-out Amounts (whether positive or negative) for each Terminated Transaction nor group of Terminated Transactions, as the case may be, and the Early Termination Amount will be an amount equal to (A) the sum of (I) one-half of the difference between the higher amount so determined (by party X) and the lower amount so determined (by party “Y”) and (II) the Termination Currency Equivalent of the Unpaid Amounts owing to X less (B) the Termination Currency Equivalent of the Unpaid Amounts owing to Y. If the Early Termination Amount is a positive number, Y will pay it to X; if it is a negative number, X will pay the absolute value of the Early Termination Amount to Y. (3) Mid-Market Events. If that Termination Event is an Illegality or a Force Majeure Event, then the Early Termination Amount will be determined in accordance with clause (1) or (2) above, as appropriate, except that, for the purpose of determining a Close-out Amount or Close-out Amounts, the Determining Party will: (A) if obtaining quotations from one or more third parties (or from any of the Determining Party’s Affiliates), ask each third party or Affiliate (I) not to take account of the current creditworthiness of the Determining Party or any existing Credit Support Document and (II) to provide mid-market quotations; and (B) in any other case, use mid-market values without regard to the creditworthiness of the Determining Party. [ADD SECTIONS (iii) – (v)]279 ISDA §6(e)(i): “If the Early Termination Date results from an Event of Default, the Early Termination Amount will be an amount equal to (1) the sum of (A) the Termination Currency Equivalent of the close-out Amount or close-out Amounts (whether positive or negative) determined by the Non-defaulting Party for each Terminated Transaction or group of Terminated Transactions, as the case may be, and (B) the Termination Currency Equivalent of the Unpaid Amounts owing to the Non-defaulting Party less (2) the Termination Currency Equivalent of the Unpaid Amounts owing to the Defaulting Party. If the Early Termination Amount is a positive number, the Defaulting Party will pay it to the Non-defaulting Party; if it is a negative number, the Non-defaulting Party will pay the absolute value of the Early Termination Amount to the Defaulting Party.”280 ISDA §6(d)(ii).

effected by the Termination Event. If only one party is affected, the formula used is the same used upon the occurrence of an Event of Default.281

The ISDA also expressly provides that neither party will be liable for consequential, incidental, punitive, exemplary or indirect damages, lost profits or other business interruption damages.

d. Setoff

The ISDA, like the NAESB, Master Coal Agreement and EEI, also provides for the netting and set off of all amounts owed between the parties pursuant to any agreements, not just those amounts owed pursuant to the ISDA itself.282

e. Suspension

Section 5(a)(vii) of the ISDA lists insolvency by the buyer as an Event of Default. However, in order to have the right to suspend performance upon the buyer’s insolvency, the seller must first declare an Early Termination Date and give notice of the declaration to the buyer. Upon the effective designation of the Early Termination Date, the seller may suspend performance under all outstanding transactions.283 While the U.C.C. provides a right of reclamation, as previously discussed, the ISDA follows the NAESB and EEI and does not provide a right of reclamation.

2. Credit Protection.

The ISDA provides the most detailed and flexible credit protection provisions of any of the energy commodity master agreements. Parties to an ISDA may elect to include the Credit Support Annex (“CSA”), which contains substantive provisions and a schedule for customizing

281 ISDA §6(e)(ii) (stating that “[i]f the Early Termination Date results from a Termination Event: (1) One Affected Party. Subject to clause (3) below, if there is one Affected Party, the Early Termini on Amount will be determined in accordance with Section 6(e)(i), except that references to the Defaulting Party and to the Non-defaulting Party will be deemed to be references to the Affected Party and to the Non-Affected Party, respectively. (2) Two Affected Parties. Subject to clause (3) below, if there are two Affected Parties, each party will determine an amount equal to the Termination Currency Equivalent of the sum of the close-out Amount or Close-out Amounts (whether positive or negative) for each Terminated Transaction nor group of Terminated Transactions, as the case may be, and the Early Termination Amount will be an amount equal to (A) the sum of (I) one-half of the difference between the higher amount so determined (by party X) and the lower amount so determined (by party “Y”) and (II) the Termination Currency Equivalent of the Unpaid Amounts owing to X less (B) the Termination Currency Equivalent of the Unpaid Amounts owing to Y. If the Early Termination Amount is a positive number, Y will pay it to X; if it is a negative number, X will pay the absolute value of the Early Termination Amount to Y. (3) Mid-Market Events. If that Termination Event is an Illegality or a Force Majeure Event, then the Early Termination Amount will be determined in accordance with clause (1) or (2) above, as appropriate, except that, for the purpose of determining a Close-out Amount or Close-out Amounts, the Determining Party will: (A) if obtaining quotations from one or more third parties (or from any of the Determining Party’s Affiliates), ask each third party or Affiliate (I) not to take account of the current creditworthiness of the Determining Party or any existing Credit Support Document and (II) to provide mid-market quotations; and (B) in any other case, use mid-market values without regard to the creditworthiness of the Determining Party. [ADD SECTIONS (iii) – (v)]282 ISDA §6(f).283 EEI §§6(a); 6(c).

those provisions to the specifics of the parties and their transactions. Although a comprehensive discussion of the ISDA credit provisions is outside of the scope of this paper, a limited analysis of some of these rights are discussed below.

a. Adequate assurances

Unlike the NAESB, Master Coal Agreement and EEI, the ISDA itself makes no provision for allowing a party to demand assurances of performance if the party has reasonable grounds to believe that the counterparty’s creditworthiness or performance has become unsatisfactory. This right is usually viewed as unnecessary and undesirable because of the other credit risk management tools available under the ISDA, but parties often add the right to demand adequate assurances of performance when the CSA is not used and therefore no other credit protection exists for the parties under the ISDA.

b. Threshold margining

The ISDA contains detailed provisions in the CSA by which the parties establish a matrix of credit thresholds based on the ratings of the parties or their guarantors which, although detailed, is structured and functions almost identically to that contained in the EEI. Like the EEI, the ISDA offers the parties greater credit protection than does the U.C.C. by including threshold margining and increases the objectivity of the parties’ rights in doing so.

c. Credit rating downgrade

Another tool offered by the ISDA that mirrors that found in the EEI is the right to demand collateral upon a credit rating downgrade. The flexibility to include or omit this right in the standard ISDA gives parties additional comfort that they will be able to demand adequate assurances and collateralize their risk before the counterparty defaults on its payment obligations. However, the inclusion of this right also exposes each party to increased risk that the amount it may be obligated to post to the other party may be determined in a subjective manner that is greater than the amount that would be owed under purely objective calculations.

IV. CONCLUSION

Energy practitioners often assume that the remedies for breach provided in the master agreements such as the NAESB, the Master Coal Agreement, the EEI and the ISDA arose from, and are therefore identical to, the remedies contained in the Uniform Commercial Code.Practitioners also may assume that those remedies are adequate to protect each party against all risks it faces in the relevant energy transaction. However, many distinctions exist between the remedies offered by the Code and those contained in each master agreement. Moreover, the remedies offered by both the Code and the master agreements may not adequately address the specific risks faced by the parties in certain situations. Accordingly, the parties should rely on neither the Code nor the standard provisions of the master agreements for protection. Before any agreement is executed, the risks faced by each party should be independently evaluated for the transaction to ensure no differences exist between the expectations of the parties and the remedies that govern the contract.

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