By Amit Kapur, Joint Managing Partner, J Sagar Associate
As the renowned economist Axel Leijonhufvud aptly put it, market economy is a system of voluntary cooperation (a web of interconnected contracts)[1]. It is a reality of regulated contracts today, that the context and underlying realities keep changing. Long-term contracts related to facilities with the characteristics of infrastructure, mould the elements of regulation for such arrangements established by law and/or policy. In this backdrop, I shall present to you my perspectives on the interplay between “freedom to contract” with respect to long-term infrastructure contracts that are regulated.
Contracts
Contracts permit us, so long as they fulfil three basic touchstones, to define our own bargains with each other – to agree upon and do something for each other, for value. The three touchstones are: i) there must be consensus-ad-idem amongst parties, that is, you and I must agree on the same thing in the same sense; ii) there must be something that I do for you in exchange for value; and iii) whatever is agreed upon must be lawful, both in terms of objects and consideration. Contracts and the freedom to negotiate our own bargains are the foundations of laissez-faire commercial arrangements across the world.
Infrastructure
Once you bring infrastructure into play, lots of other interesting things start to happen. There are five characteristics of infrastructure that actually define and fashion the need for regulating outcomes and behaviour. First, any infrastructure facility is inherently a “public good”, the supply of which is subject to “non-excludability”. Consider the implications. Let us say that you and I start a business enterprise, whether it is selling cloth or vehicles or television. Each of us can choose whether to deal with a person or not, and the terms and conditions of such dealings. If such a person happens to be a defaulter or otherwise problematic, I can say, “Sorry, I do not wish to entertain you.” But this is not the case with infrastructure. A consumer wants water supply or electricity. So long as the consumer comes forward and fills a form and pays the fee, we are obliged to provide them with the service. There is non-excludability, which arises due to inherent non-rivalry, that is, infrastructure services being natural monopolies. Other than the odd case, like in Bombay, where you may be able to choose your supplier of electricity, or in the case of mobile telephony, we have very little choice. Further, infrastructure brings a positive externality to the citizen and the economy. So, it is a public good, in the sense that it is of interest to the state from the “welfare” perspective.
The second element is that, these are inherently essential facilities. You cannot sit back and say, “We don’t feel like it, I will not take water supply for the next six months.” You need water. You need the highways, roads, ports, electricity, railways, etc. Therefore, being an essential facility provided by natural monopolies, these are also non-substitutable. So, if the public or private sector service provider is not paying attention to your needs in terms of safety, pricing and availability, it is a matter of concern.
The third element is that these facilities are all built on the premise of being concessions granted by the state (as in the government representing the citizen). Whether it is airways, airports, ports, highways, telecom or mining of natural resources – each activity requires a license. If the permission is not granted, a private entity cannot undertake that activity.
The fourth element is that it involves a significant upfront capital investment, but there is little control over what you invest, where and how you price your output, et al. You are not in a position to deny supply to anybody who asks for it, unless boundary conditions of non-payment, theft or default are met. And then, you are required to supply at a price that is determined by an external agency – the regulator, or in case of regulation by contract, the concessionaire. Now, in both these circumstances, since this is a capital-intensive investment upfront, and the asset thus created is meant to last for 30- 50 years, inevitably you will recover the cost of the project, including the working capital, over the life cycle of the asset. In some bargains, you may recover it slightly earlier. And 75-80 per cent of the investment comes from public money, which is your and my money.
The fifth element is that these assets are enmeshed in long-term contracts spread over the life cycle of such projects. Inherently, uncertainties are the most predictable reality. In 2016, two economists – Oliver Hart and Bengt Holmström – won the Nobel Prize for Economics for the “incomplete contract theory”. The theory states that when you enter long-term interconnected contracts, it is not possible to contractually provide for all contingencies and eventualities through a mechanism of role and responsibility allocation. It is advisable to have a renegotiation or reset/adjustment clause, so that the infrastructure asset is not put to peril. Within this last element is the fact that these arrangements are premised on a multitude of interconnected contracts. You and I may sign a contract for supply of power to your residence by me as the distribution licensee. Behind it is a generator who has tied up debt and equity. The generator has to arrange the land to install the equipment, plant and machinery, which shall be operated burning fuel, and then transport the power to your home. This multitude of contracts all partake in the rupee that you pay as a consumer, at the end of the day.
Regulation
In that context, the question that arises is: why do we need regulation? What is the purpose of regulation? Is regulation a good idea? I would cite to you Ronald Reagan, who said, “If it moves, tax it; if it keeps moving, regulate it; if it stops moving, subsidise it.” All governments follow this, even if they do not say it.
Perhaps the most suitable definition of regulation[2] is:
- A process established by law, which restricts or controls certain specified decisions made by an affected firm.
- It is designed to protect the public from exploitation by firms with monopoly, and carried out by a special agency assigned the task of administering and interpreting the law.
- Invariably, a regulator (or if you have a regulation by contract, a concessionaire) is required to safeguard the interests of the consumer.
Consider the scale of the infrastructure investments that we are talking about. If you look at the global situation, it is estimated that around 5 per cent of the global gross domestic product (GDP), that is, $4 trillion, has to be invested annually up to 2030. The National Infrastructure Pipeline has stocked around 111 lakh crores or $1.4 trillion over five years, which is also around 8.5 to 9 per cent of our GDP, that is, $ 280 to 300 billion per year.
A consumer’s abiding concern is to receive reliable supply that is reasonably priced. The investor’s concern is the viability of his investment, considering the long tenure over which the investment has to be recouped. The creditworthiness of the counter-party, effective enforcement of contracts, and the overall stability/predictability of the regime over the tenure are critical. Over the last 25-30 years, India has witnessed conflicts and contractual issues arising in the context of public-private partnerships (PPP) in infrastructure, wherein the regulatory mechanism has often influenced and shaped solutions. Our jurisprudence is evolving.
To appreciate how the only predictable reality of long-term infrastructure contracts – which is that sooner rather than later, something unforeseen will happen – has played out, let us use examine some judicial decisions. Do bear in mind that the fundamental issue of a regulated contract is that it clashes with the idea of freedom of contracting, since statutes and delegated legislation impose limits on the flexibility of negotiating a bargain by way of certain inherent conditions.
I will start with a judgement pronounced in 2000 in the India Thermal Power case[3]. This was regarding a dispute related to PPAs signed during the early euphoria of the Indian power sector opening up to private participation in the late 1990s. To attract private/foreign investment, the government had offered a layered payment security mechanism to independent power producers (IPPs). Bank guarantees given by the procuring state electricity board (SEB) were backstopped by counter guarantees by the state and escrow over revenue earned by the SEB. The state government realised that it had signed multiple PPAs for IPP investments, far beyond the revenue earning potential of the SEB (referred to as “escrowable capacity”). A well-considered decision was made by the state to pull out of such PPAs, and re-allocate the capacity based on efficient pricing. This was challenged. While deciding upon the issue, in a judgement authored by Justice G.T. Nanavati, the Supreme Court held that when a PPA is entered into between two parties, Schedule VI to the Electricity Supply Act, 1948, read with the notification issued by the Ministry under Section 43-A, defines the elements of tariff, that is, what kind of return you can get, what depreciation you can claim, what the asset life is, etc. These were the implied terms of the PPA, forced through by the law. PPAs to that extent were held to be statutory contracts. Once a contract becomes statutory, you cannot wish the conditions away; so, your framework of contractual arrangements has to fall in line. PPAs were thereafter seen as statutory contracts insofar as such terms were concerned.
In October 2002, while allowing a challenge to the Calcutta High Court’s redetermination of tariff for a power supplier in the West Bengal Electricity Regulatory Commission v. CESC Ltd. case, the Supreme Court[4] laid down certain guiding principles that have informed regulatory proceedings till date. It held that once a statute (in this case, the Electricity Regulatory Commissions Act, 1998) vested a right of hearing to a consumer, while the same could be regulated, it could not be denied on grounds of inconvenience. It further established that the High Court, while exercising appellate jurisdiction under Section 27 of the Act, could not have judged the validity of regulations. While accepting that normally, first appellate courts, whose powers are not statutorily limited, can consider all questions of fact and law, reappreciating evidence, it stated that this power must be exercised carefully when an appellate court is not an expert forum examining the findings of an expert body (the regulator). Noting that tariff determination is highly technical, requiring working knowledge of law, engineering, finance, commerce, economics and management, it held that regulatory commissions with multi-disciplinary expertise are better equipped to appreciate the technical and factual questions involved. The Supreme Court recommended that appellate powers against the orders of regulators be vested in similar expert appellate fora.
Another landmark judgement was pronounced on March 15, 2010 by a Constitution Bench of the Supreme Court in PTC Limited vs CERC and Ors[5]. The issue arose since the Central Electricity Regulatory Commission (CERC) chose to fix the trading margin for interstate traders. Within a few days of issuing a detailed order, the CERC notified the operative part of the order as a regulation. The order and the regulation were challenged by traders, like PTC, Tata Power Trading and Reliance Trading before the Appellate Tribunal for Electricity, for being violative of market development principles in the Electricity Act. In a detailed judgement, after traversing contentions from both sides, the Tribunal rejected the challenge due to the lack of jurisdiction to examine the validity of regulations. While expounding the jurisdictional boundaries of Regulatory Commissions and the Appellate Tribunal, the Supreme Court held that once a regulation is notified all existing and future contracts have to be aligned with it. It has left a curious gap in the statutory scheme.
In 2016, the Supreme Court announced another landmark judgement in All India Engineers Association vs Sasan Power Limited,[6] which exemplifies how the statutory scheme and the regulatory regime constrain the freedom to contract. Sasan Power Limited, a coal-fired ultra-mega power project using supercritical technology, announced the commissioning of its first 660 MW unit by demonstrating generation for 72 hours of around 100 MW. It had some correspondence with the lead procuring state of Madhya Pradesh to support its claim acquiescence/waiver. The Supreme Court held that “Waiver of contractual rights inter-se parties is premised on voluntary choice. Where there is any element of public interest involved, the court steps in to thwart any waiver contrary to public interest … would have to pass muster with the appropriate commission under sections 61 to 63 of the Electricity Act.”
In 2017, another landmark judgement was delivered, which is a watershed so far as regulated tariffs and the impact of unforeseen change in Energy Watchdog vs the CERC & others[7]. The issue at hand pertained claims made by various generators/IPPs seeking restitution for unforeseen developments such as the failure of Coal India and its subsidiaries to supply the quantum of domestic coal as per the New Coal Distribution Policy of 2007, and the unprecedented rise in coal prices in Indonesia overriding all contracts by Indonesian law. The generators invoked force majeure and change in law provisions of the PPA read with the Competitive Bidding Guidelines under Section 63 of the Electricity Act, as also regulatory powers under Section 79 of the Act. While rejecting the plea under force majeure, the Supreme Court upheld the claim that the generators are entitled to restitution due to failure of supply under NCDP-2007 constituting in terms of Article 13 of the PPA. The bid framework provided investor protection for such unforeseen change leading to stranded investment. It was assured that anybody who invested in power generation will get all the coal they need for power production, but the lack of coal constituted a change in law. The matter went to the Cabinet Committee of Economic Affairs, which decided that the matter deserves a solution. They reduced the minimum assured quantity in FSAs, allowed generators to procure alternate supplies of coal, which would be compensated for in full-through tariff. This doctrine of restitution or compensation was established by the policymakers and upheld by the Supreme Court, giving effect to the allocation of risk under the contract and the law. This led to a spate of proceedings and compensation claims including interest/carrying cost due to delays in payment. The additional payments were passed-through in tariff to consumers[8].
Tackling the apparent conflict amongst laws, Justice Indira Banerjee’s judgement in Vidarbha[9] has struck down and remanded back a judgement of NCLAT since NCLAT failed to consider the fact that the IPP had a judgement in its favour to recover Rs 1,740 crores while proceedings with insolvency under the Indian Bankruptcy Code qua a claim of Rs 550 crores.
Evidently, the “Samundramanthan” in courts and amongst policymakers seeks to balance the interest of consumers (affordability) and investors (viability). The core issue revolves around discerning from the law, regulations, policy and contract, the risk allocation inter-se parties to determine how to deal with unforeseen changes and restore these situations to equilibrium. Several of the above principles established by judgements are now being tested, validated and sometimes deviated from. This reflects the challenges these issues pose and the pursuit of the utopian perfect balance. Let us consider some such judgements.
In a recent judgement titled Haryana Power Procurement Centre vs Sasan Power Limited,[10] the procurers’ appeals were allowed to quash APTEL’s granting compensatory relief for change in law claims during the construction period since:
- Delays in the performance of certain tasks (land) entitled the generator to rescind the contract and claim refund of equity capital. The generator chose not to exercise that right.
- The claim of compensation of change in law arose from the second WAPCOS report on water linkage changing the route and length of the water intake pipeline. This was done by the generator of its own accord – not forced by procurers, or occasioned after constructing and using the original water linkage pipeline, which was found inadequate. Further, the procurers were not consulted or informed.
- It was held that the generators’ claims did not qualify as change in law. It was held that there was a lack of diligence since the IPP took over four years to claim change in law. It was also held that the bidder/IPP had failed to take note of the extensive disclaimers given by procurers in the bid documents calling upon bidders to do their own diligence with respect to the water intake system.
- A notice of change in law is required to be given as soon as reasonably possible after its occurrence. In this case, the WAPCOS study was commissioned in December 2007 and the report received in April 2008. The notice was given on December 15, 2012.
- A regulation can extricate a party from its contractual obligations. The restitutive principle in Article 13.2 of the PPA or the general regulatory power under Section 79 cannot empower a Commission to
- grant compensation by ignoring the formula given in Article 13(2)(a), that is, de-hors the PPA, or
- rewrite a contract, or
- disregard express terms of a contract including disclaimers and obligations to conduct due diligence.
Another recent judgement was in the ReNew Power case[11]. As per the judgement, the regulations framed under the Electricity Act can be made applicable to existing contracts. Observations in PTC India Ltd. vs CERC & Ors., (2010) 4 SCC 603 are regulations of general application, dealing with a range of commercial activity, and no existing contracts could operate in isolation outside of their framework. In the present case, PPAs were entered into with equal bargaining power, after due negotiation by the parties, and within the framework of existing central and state regulations. Unless any later amendment expressly overrides existing contracts, the terms of such agreements bind the parties.
Another noteworthy development was the amendment to the Specific Relief Act (with effect from October, 1, 2018), pursuant to the Dr Kelkar Committee Report on Rejuvenating PPP in Infrastructure Development (2016). The amendment excludes normal civil courts from entertaining disputes related to infrastructure, once special courts are established. Injunctions will not be granted against infrastructure projects since inherently infrastructure involves public good and welfare of the citizens. Special courts must decide the dispute within one year, and expert opinions can be used to help courts decide.
Bringing back R.K. Laxman’s Common Man has been the focus of much of the legislative, executive and judicial efforts while securing investments and growth. As time goes by, we will find out how far we have succeeded.
To conclude, today, with 20-25 years of experience in PPPs in India, contractual structures are far more evolved. The Supreme Court is taking note of various economic theories while trying to balance the interests of the consumer and the investor/lender.
So, regulation is neither a boon nor a bane. It is an evolving reality you have to deal with it.
[1] Leijonhufvud, A. (2012). The Unstable Web of Contracts. Lecture.
[2] Drawn from the writings of William Baumol, a celebrated economist whose work on “cost disease” is a cornerstone of behavioural economics today.
[3] India Thermal Power Ltd. v. State of Madhya Pradesh, reported as (2000) 3 SCC 379, Judgement dated 16.02.2000. Authored by G.T. Nanavati J.
[4] WBERC v. CESC Ltd., reported as (2002) 8 SCC 715. Judgement dated 03.10.2002. Authored by Santosh Hegde J.
[5] PTC v. CERC & Others, reported as (2010) 4 SCC 603. Judgement dated 15.03.2010. Authored by S.H.Kapadia J.
[6] All India Engineers Association v. Sasan Power Ltd., reported as (2017) 1 SCC 497. Judgement dated 08.12.2016. Authored by R.F.Nariman J.
[7] Energy Watchdog v. CERC & Ors., reported as (2017) 14 SCC 80. Judgement dated 11.04.2017. Authored by R.F.Nariman J.
[8] Being – (a) UHBVNL v. Adani Power Ltd., reported as (2019) 5 SCC 325. Judgement dated 25.02.2019. Authored by R.F.Nariman J. (b) MSEDCL v. MERC, reported as (2022) 4 SCC 657. Judgement dated 08.10.2021. Authored by Indira Banerjee J. (c) UHBVNL v. Adani Power (Mundra) Ltd., reported as (2023) 2 SCC 624. Judgement dated 24.08.2022. Authored by Hima Kohli J. (d) MSEDCL v. Adani Power Maharashtra Ltd., reported as 2023 SCC Online SC 233. Judgement dated 03.03.2023. Authored by B.R.Gavai J (e) UHVNL v. Adani Power (Mundra) Ltd., reported as 2023 SCC Online SC 459. Judgement dated 20.04.2023. Authored by B.R.Gavai J. (f) UHVNL v. Adani Power (Mundra) Ltd., reported as 2023 SCC Online SC 460. Judgement dated 20.04.2023. Authored by B.R.Gavai J. (g) UHVNL v. Adani Power (Mundra) Ltd., reported as 2023 SCC Online SC 461. Judgement dated 20.04.2023. Authored by B.R.Gavai J. (h) MSEDCL v. Adani Power Maharashtra Ltd., reported as 2023 SCC Online SC 462. Judgement dated 20.04.2023. Authored by B.R.Gavai J. (i) MSEDCL v. Adani Power Maharashtra Ltd., reported as 2023 SCC Online SC 463. Judgement dated 20.04.2023. Authored by B.R.Gavai J. (j) GMR Warora Energy Ltd. v. CERC, reported as 2023 SCC Online SC 464. Judgement dated 20.04.2023. Authored by B.R.Gavai J.
[9] Vidarbha Industries Power Ltd. v. Axis Bank Ltd., reported as (2022) 8 SCC 352. Judgement dated 12.07.2022. Authored by Indira Banerjee J.
[10] HPPC v. Sasan Power Ltd. dated 06.04.2023, reported as 2023 SCC Online SC 577. Authored by K.M.Joseph J.
[11] GUVNL v. ReNew Power Ltd. dated 13.04.2023, reported as 2023 SCC Online SC 411. Authored by S.R.Bhat J.