Home / Chapter 9 – Resolving Disputes - Preplanning / Proactively Drafting Against Disputes

Proactively Drafting Against Disputes

The myriad contracts associated with algae biofuels development project, including technology licensing, supply/offtake agreements, and construction-related agreements, can provide ample grounds for litigation.  Retaining experienced counsel to assist with the drafting of the contracts, however, can minimize future disputes and, most importantly, provide a clear roadmap for resolution should a dispute over contract performance arise.  Although contracts may specify that alternative dispute resolution (“ADR”) be used either as a prerequisite to the initiation of a lawsuit or as an alternative to litigation in state or federal court, ADR, depending on how it is drafted, can be just as costly as litigation.  Therefore, careful consideration should be given to the pros and cons of ADR, as discussed later in this chapter.  As the algae biofuels industry matures, contracting parties are discovering that they need to look not just at the financial terms of their commercial agreements, but at the default and cancellation provisions as well.  Unfortunately, a myth exists that the language at the back of a contract (default provisions, limitations of liability, attorneys’ fees, etc.) is just “boilerplate.”  In fact, these contractual provisions can be the heart of a dispute, so a developer would be wise to make sure that these areas receive some attention by an experienced attorney.

Output and Requirements Clauses in Shutdown Mode 

A hypothetical supply/offtake contract would provide for an algae-vegetable oil (feedstock) producing facility to sell, and the biofuels refinery to purchase, a set amount, an amount within a range, the total supplier output, or the total offtaker requirements of the feedstock for the eventual production of biofuels.  This contract will often contain estimates of supply and demand and may require one of the parties to provide updated estimates during the term of the agreement.  However, in most cases these estimates are for planning purposes only and are expressly not binding on either party.  A pertinent question often asked is, if the feedstock facility is bleeding cash due to the high cost of the feedstock production and a good-faith decision is made to shut down operations, can the feedstock facility inform the requirements seller that its requirements are now reduced to zero and inform the output buyer that its output is now reduced to zero, and then walk away?  Surprisingly, the answer may be “yes,” based on judicial interpretations of section 2 306(1) of the Uniform Commercial Code (“UCC”). 

Section 2 306(1) of the UCC says contracts that measure the quantity sold by either the requirements of the buyer or the output of the seller are enforceable, provided that the amount of promised product is not unreasonably disproportionate to any stated estimate or, if there is no stated estimate, to the normal supplier output or offtaker requirements.  However, some courts have allowed buyers to reduce in good faith their requirements to any amount, including zero.  These cases demonstrate the importance of protecting sellers by requiring minimum purchases from the buyer; otherwise, in the event of a buyer shutdown, they may find themselves without a customer and without a remedy.  Similar analysis has been applied to output contracts when the seller’s output, for good-faith reasons, drops significantly below the expected output, i.e., estimates of output should not be considered a binding obligation because forcing the facility to stick to an obligation to sell the estimated amounts may compel the seller to make inefficient business decisions that were not contemplated when the contract was signed.

Insecurity and Grounds for Reassurance

In the past, default provisions were often not negotiated or discussed when supply and output agreements were executed.  Even before default though, a buyer or seller who has reasonable grounds for insecurity is entitled to adequate assurance of performance under section 2 609 of the UCC.  If one contracting party has reasonable grounds for insecurity, it may suspend performance pending assurance of performance.  A failure to provide adequate assurance of performance within a reasonable time (usually 30 days or less) amounts to a repudiation of the contract, and the aggrieved party can choose to continue to wait and hope for performance or act as though the contract was breached.

Reasonable grounds for insecurity is usually a question of fact.  If one party suspends its own performance because it has reasonable grounds to feel insecure, that party is still subject to the risk that its belief will be found to be unreasonable, and that party will then be in breach.  It is important to note that the grounds for insecurity need not arise from circumstances directly related to the parties or the contract itself.  If the market price of a commodity is rising, the buyer may be justified in seeking assurances of performance from the seller even though the seller did nothing to cause the buyer’s insecurity.

Requesting adequate assurance of performance is a powerful tool because the counterparty is then in a position in which it must provide that assurance or risk having the contract be deemed anticipatorily repudiated.  It also contains many traps for the unwary when used indiscriminately or when contracts are drafted without regard to its existence.  The law is clearer on what will not be considered adequate assurance than on what will be.  For example, when one party to a hedging contract demanded assurance that the counterparty would deliver product, the counterparty responded by saying it would deliver “if the contract were later determined to be legal”—that is, not adequate assurance.  Also, contractual remedies may be broader than the UCC damages.

Attorneys’ Fees Clauses 

Many people insert attorneys’ fees clauses into supply and offtake agreements without much thought.  In some states, all attorneys’ fees are automatically (regardless of the contractual terms) transformed into “prevailing party” clauses.  In other words, even though the contract might say, “Seller gets attorneys’ fees if it has to sue,” the state law may interpret that clause to mean, “Winner gets attorneys’ fees.”  Of course, many clauses are drafted that way anyway.  If the parties omit an attorneys’ fees clause, the “American rule” applicable in most states in most commercial contracts says each party bears its own fees, regardless of a win or a loss.  Thus, in the absence of an attorneys’ fees clause, neither party can expect the other party to pay its fees.

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