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TRACTEBEL ENERGY MARKETING, INC. v. AEP POWER MARKETING

August 8, 2005.

TRACTEBEL ENERGY MARKETING, INC., Plaintiff,
v.
AEP POWER MARKETING, INC., AMERICAN ELECTRIC POWER COMPANY, INC. and OHIO POWER COMPANY, Defendants. OHIO POWER COMPANY and AEP POWER MARKETING, INC., Counterclaim Plaintiffs, v. TRACTEBEL ENERGY MARKETING, INC., TRACTEBEL S.A., Counterclaim Defendants.



The opinion of the court was delivered by: HAROLD BAER, JR., District Judge[fn*] [fn*] Scott Eckert, a summer 2005 intern in my Chambers, and currently a second year law student at Brooklyn Law School, provided substantial assistance in the research and drafting of this Opinion.

OPINION & ORDER

Tractebel Energy Marketing, Inc. ("TEMI") filed this action on September 5, 2003 and AEP Power Marketing, Inc., American Electric Power Company, Inc., and Ohio Power Company (collectively, "AEP") filed counterclaims. A bench trial was conducted on March 23-25, 28-31 and April 1, 4-8, 2005, with respect to TEMI's claims and AEP's counterclaims for breach of contract, and both parties' requests for declaratory judgments. The parties submitted post-trial briefs on April 29, 2005, and closing arguments were held on May 6, 2005. The matter is now sub judice. I. BACKGROUND

The dispute arises from an agreement entered into by the parties for the sale of energy products over a 20-year period. On November 3, 2004, this Court granted TEMI's motion to confirm the arbitration award, denied TEMI's motion for a primary jurisdiction referral and stay of proceedings, and denied AEP's motion for partial summary judgment on the issue of QF status.*fn1 On September 22, 2004, AEP moved for summary judgment in which it sought dismissal of Counts I and III of TEMI's Amended Complaint and a declaration that Counts V and VI are not grounds upon which the contract between the parties can be found unenforceable. On January 21, 2005, this Court denied summary judgment with respect to Counts III, V, and VI of the Amended Complaint, and entered a declaratory judgment on Count I, that stated that the absence of a Protocol did not void the parties' obligations under the contract. On March 23, 2005 the bench trial began.

  II. FINDINGS OF FACT

  A. Formation of the PPSA

  On November 15, 2000, TEMI entered into a requirements contract, the Power Purchase and Sale Agreement ("PPSA") with AEP. The PPSA stipulated that over a 20-year period of time, AEP would supply large quantities of electric power and related products and services to TEMI from a cogeneration plant to be constructed in Plaquemine, Louisiana (the "Plaquemine Facility").*fn2 This facility was to be located within an existing complex owned by the Dow Chemical Company ("Dow"). AEP had the "sole and exclusive right" to operate the Facility, and TEMI had the "exclusive right" to the products it was to purchase under the PPSA. PPSA § 9.2-3. The Plaquemine Facility was conceived at a time of great optimism about the future of electricity prices. That enthusiasm led to the development within Entergy*fn3 of a number of cogeneration and other merchant generation plants in addition to the Plaquemine Facility; as a result, by 2003, there was a glut of excess generation within the Entergy region. (Dr. Edward Krapels Decl., DX-C259; Dr. Gordon Rausser, Tr. 813:12, Mar. 28, 2005.) The electricity markets were further eroded when Enron collapsed in 2001 and when the anticipated energy deregulation within the Entergy territory did not materialize as expected. (William Utt, Tr. 847:17-20, Mar. 28, 2005.) As a result, current and future projections for electricity prices within Entergy fell significantly in 2001 and 2002. This state of affairs damaged the relationship between these parties. TEMI realized it would lose a lot of money if it were to fully perform under the PPSA and tried a number of ways to extricate itself, while AEP's conduct can best be described as an attempt to maximize its profits by gaining the upper hand in the relationship.

  TEMI approved the Plaquemine deal in March 2002 based upon a valuation of the transaction that forecast a profit of $80 million. (Stibolt Memo, DX-A16.) Unfortunately, by September 2002, the PPSA projected that TEMI was approximately $360 million "out of the money." (O'Hara Decl., DX-C255 ¶ 30.) Due in part to these numbers, and also the notice from AEP that the completion of the Plaquemine Plant would be delayed, TEMI began to contemplate restructuring the PPSA. In August 2002, TEMI sent AEP a letter that stated TEMI's "interest in modifying certain elements of the PPSA in light of . . . significant changes in market conditions during the past 18 months." (Fairley Email, DX-A025.) Soon thereafter, TEMI and AEP began to negotiate elimination of a "Gas Peaking Product" from the PPSA. (Thakur Email, DX-A135.) In order to relieve TEMI's immediate financial pressures, TEMI proposed a delay of the start date for delivery of all other products, and asked to lengthen the period for plant completion. (Fairley Email, DX-A144.) The parties successfully negotiated the elimination of the Gas Peaking Product in January 2003. Pursuant to this amendment in the PPSA, TEMI agreed to pay AEP $250,000 per month for 24 months to commence at Actual COD.*fn4

  By February 2003, TEMI sought other significant revisions to the PPSA. (AEP Letter, DX-A148; Fairley Email, DX-A151.) For instance, TEMI proposed elimination of the contract provision that obligated TEMI to accept replacement products until the plant was completed, and suggested a delay of the Facility operation date ("Actual COD") to April 30, 2005. TEMI also asked for specific testing requirements in exchange for an increase in the capacity payments TEMI would make to AEP. Concurrently, TEMI calculated the amount that would be saved by such a delay of Actual COD at between $29 and $39 million. (Gelbaugh Email, DX-A116.) Responding to these numbers, TEMI's Joy Thakur emphasized: "the analysis implications are clear: WE WANT OUT!" (Thakur Email, DXA-150) (emphasis in original.)

  Despite the projected $29 to $39 million savings, TEMI eventually offered AEP just $10 million to delay Actual COD. (Fairley Call Tr., DX-A187 at T0215315.) After AEP rejected this offer, TEMI's chief negotiator, David Fairley, reported to TEMI's Board that "commercial negotiations were not progressing smoothly, and that the situation was trending toward a legal solution." (DX-A173.) During this time, TEMI's economic outlook continued to worsen. In April 2003, the net present value of the Plaquemine deal to TEMI had fallen to negative $742 million by AEP's calculation, and to negative $729 million according to TEMI. (O'Hara Decl., DX-C255 ¶ 46; Orhon Email, DX-A036.) At this point it appears that TEMI turned its attention to trying to free itself from its obligations under the PPSA.

  B. Negotiation of Protocol

  The PPSA, in order to be completely operational, contemplated another agreement. Specifically, the parties agreed to "enter into a mutually agreeable Dispatch/Operations Coordination Protocol (the "Protocol"), not later than June 1, 2001" which would "set forth the detailed requirements for notice, forecast, scheduling, dispatch, operation, maintenance, maintenance coordination, approvals and other matters related to the operations and maintenance (including outages) of the Project and the sale and delivery of the Products." PPSA § 9.1. However, the Protocol never came to be, and there is no evidence that either side cared, at least not until the completion deadline of June 1, 2001 had come and gone. TEMI executives testified that AEP ignored this deadline, and failed to respond to TEMI's inquiries in 2001 and early 2002 with a draft Protocol, and conversely, the testimony showed that TEMI never insisted on compliance with the June 1 deadline. (Mark Witt Dec., TX 748 ¶¶ 14-17; Fairley Dec., TX 749 ¶ 27); Scott Slisher Decl., DX-C249 ¶ 46; DeRuntz Decl., DX-C250 ¶ 35.) In fact, TEMI never communicated any particular drop-dead date by which the negotiations of the Protocol had to be concluded. (Fairley, Tr. 113:10.)

  Almost a year after the deadline in the PPSA for the completion of the protocol and on May 29, 2002, a "kick-off meeting" was held at TEMI's headquarters on May 29, 2002. There the parties agreed to exchange draft Protocol outlines within four weeks. (Jason Sweeney, Tr. 300:5-9, 327:18-330:18, Mar. 24, 2005.) AEP sent nothing by the deadline, and TEMI sent only a two-and-a-half page rough draft outline of the Protocol. (Moreland Email, DX-A55.) This outline was far from a final Protocol, and both parties agreed that the Protocol negotiations would be a back-and-forth process over several months. (DeRuntz Decl., DX-C250 ¶ 37; Fairley, Tr. 128:15.) On several occasions thereafter, various TEMI executives reminded AEP that it owed TEMI a draft Protocol, and on November 14, 2002, AEP responded to TEMI's rough outline with a much more thorough document. (Draft Protocol, TX 27.)

  The facts show that while TEMI did make inquiries, neither party acted expeditiously as the negotiations continued. TEMI now complains that it was "urgent" for the parties to finalize the Protocol quickly, but TEMI took the next two-and-a-half months to improve AEP's November 14, 2002 draft, and did not provide a marked-up draft until January 31, 2003. (Fairley Decl., TX 749 ¶¶ 47-48; Draft Protocol, TX 29.) Even then the parties agreed this draft was not final, and had significant "gaps." (Slisher Decl., DX-C249 ¶ 77; Fairley, Tr. 194:1-3.)

  On February 4, 2003, AEP advised TEMI that AEP was in general agreement with TEMI's January 2003 draft and would convert that draft into a Word document, without change, and send it to TEMI in a few days to conclude the Protocol discussions. (Joseph DeRuntz, Tr. 1179:4-6, Apr. 4, 2005.) Instead, on April 4, 2003, AEP sent another draft which, according to TEMI, was substantially different and done to thwart the completion of the Protocol. (Draft Protocol, TX 32.) However, the proof demonstrates that AEP's April 2003 draft was offered as a legitimate attempt to complete — rather than frustrate — the protocol, and the changes do not appear to be significant. For instance, the PPSA provided for the Steam Peaking Product to be available on ten minutes' notice, yet AEP's April draft Protocol provided that this Product would only be available on notice of thirty minutes, and only on thirty minutes' notice before the top of the hour (i.e., as much as 89 minutes). (PPSA § 3.3.4.1; Draft Protocol, TX 32.) This change according to AEP was included so the Protocol would comply with Entergy's scheduling requirements; such compliance was mandated by several provisions in the PPSA. PPSA §§ 9.3, 9.6, 9.8, 9.9. While TEMI's executives understood the importance of compliance with Entergy's requirements, apparently neither side considered it ahead of time. In fact, even TEMI's own June 2002 Protocol outline referred directly to the "need to conform to Entergy scheduling protocols." (Moreland Email, DX-A55.)

  TEMI finds further fault with the April 2003 draft due to the fact that AEP eliminated references to how the qualifying facility ("QF") status of the plant could be exercised for TEMI's benefit. (Fairley Dec., TX 749 ¶ 81(c); Draft Protocol, TX 32.) During trial, the Court ruled that TEMI's arguments with regard to QF status were without merit since both the PPSA itself and federal law already dictated how the QF distribution of power would be handled. (Tr. 1737:01-38:15; Marvin Carraway, Tr. 363:17, Mar. 24, 2005; Joel Jansen, Tr. 1295:10, Apr. 4, 2005.)

  Finally, TEMI contends that while the PPSA required AEP to make operating data available to TEMI on a "real-time" basis, the April 2003 draft stipulated that the majority of the operating data would be made available only on a daily basis. (PPSA § 9.7; Draft Protocol, TX 32 § 1.2, 1.3.) But there is no evidence that this was done in an effort to delay execution of the Protocol. The language of this draft Protocol makes clear that such data would be provided on a daily basis only in the event of "unplanned outages, force majeure events, etc." Furthermore, in making this claim, TEMI flatly ignores § 1.3 of AEP's draft, captioned "Real-Time Information," which stated that "[r]ealtime information, including but not limited to generating, dispatch and outage information, will be conveyed to [TEMI] from [AEP] via telemetering, with back-up via email and telephone." (Draft Protocol, DXA-73 at § 1.3) (emphasis added.)

  C. AEP's Credit Guaranty Increase Request

  In order to cover a termination payment*fn5 in the event of either party's default, the parties agreed to a $50 million guaranty upon execution of the PPSA, and to provide a copy of its annual report and financial statements upon request by either party. PPSA §§ 7.1.1, 7.2.1, 7.3. If at any time a party had "reasonable grounds to believe" that the other party's termination payment "would exceed the value of the guaranty," it could provide written notice and request an increase in the guaranty in the amount of the projected termination payment. PPSA §§ 7.1.2, 7.2.2. The other party would then have five business days to increase its guaranty or it would be in default. Id. In April 2003, AEP requested an increase in TEMI's guaranty based on its calculation of TEMI's projected termination payment, but TEMI refused to provide any additional guaranty based on its belief that AEP had made an unfounded demand that violated the "reasonable grounds" requirement of the PPSA.

  Section 7.3 of the PPSA required the parties to exchange $50 million guaranties to cover their potential credit exposures. AEP could also request an increase in TEMI's guaranty at any time AEP had "reasonable grounds" to believe that the present value of "Gains" and "Losses," determined by PPSA § 7.1.2, exceeded $50 million. PPSA § 7.2.2. Under § 7.1.2, the Gains and Losses were to be determined by comparing the long-term Contract Price with the "market price" for each energy Product. The market price was to be "based on broker, dealer or exchange quotations" for the immediately ensuing "five year period . . . or such longer period for which a market is available." PPSA § 7.1.2. Section 7.1.2 also specified that, to calculate the projected Termination Payment, the market price of the Products sold to TEMI "shall be based on broker, dealer or exchange quotations" for five years, escalated at 3% per year through the remaining term of the PPSA.

  AEP made requests in May and June 2003 for increases in the $50 million guaranty, and claimed the right to new guaranties, variously, $436 million, $337 million, and finally $150 million. Both AEP and TEMI recognized that when AEP made its 2003 credit requests, the Entergy market was illiquid and lacked market prices going out to 2008 that could be escalated pursuant to PPSA § 7.1.2. (Thomas Barry, Tr. 1406:10-1409:3, 1411:14-17, 1425:4-13, 1426:15-1427:22, Apr. 5, 2005; Krapels Rpt., DX-C259 Ex. A at 7, 47, 48; Rausser Rpt., TX 757 Ex. A at 3, 12-21.) Therefore, AEP made a series of bids and offers (known as "two-ways") in order to ascertain the relevant market prices. Of the 137 calendar year quotes for 2004-2008 "into Entergy" products, AEP made 135 of them over a period of two days, May 2 and June 13, 2003.

  TEMI contends that these "two-ways" were dishonest attempts to inflate a non-existent market, and that AEP effectively planted its own quotations, then made credit demands as if those quotations reflected that market. While AEP's actions in placing so many bids over just two days may have been disingenuous, it doesn't negate the fact that AEP was entitled to request a credit guaranty increase, nor does it negate the fact that AEP had few alternatives under the terms of the PPSA. The PPSA called for market prices to be set based on "broker, dealer or exchange quotations" for the ensuing five years. PPSA § 7.1.2. Essentially, AEP has done just this. Thus, it is difficult for TEMI to claim that AEP acted inappropriately in this regard.

  Furthermore, the facts demonstrate that this use of "two-ways" as a means of price discovery was a common practice at AEP, used in a variety of contexts, and that TEMI itself had used "two-ways" as a means of market price discovery. (Barry Decl., DX-C253 ¶ 11; Moreland, Tr. 1399:14-18; Faizmin Lokhandwalla Dep., DX-C229 at 47-50.) Additionally, AEP's traders confirmed at trial that AEP's bids and offers were fully executable, that if another party decided to act on AEP's numbers, AEP would actually follow through and consummate the transaction, and that the brokers to whom these "two-ways" were communicated understood this as well. (Barry Decl., DX-C253 ¶ 17; Moreland Decl., DX-C254 ¶ 10; Scott Lombino, Tr. 283:9-284:5, Mar. 24, 2005; Christopher McGee, Tr. 491:17, Mar. 25, 2005; Wassersug Dep., DX-C243 at 55, 56; Gonzalez Dep., DX-C225 at 35; Feeley Dep., DX-C223 at 33.)

  Also, TEMI was fully aware that its liability on the Plaquemine deal was greater than the $50 million guaranty. On April 22, 2003, Lora Kinner, Director of Credit at TEMI sent an internal email that read in part, "[w]e are also aware that the exposure on this deal far exceeds the $50 million TSA guaranty currently held by AEP. Under the current contract terms, AEP has the right to call for additional credit assurance, and . . . I anticipate the possibility of AEP making such a request." (Fairley Email, DX-A033.) On April 23, 2003, TEMI calculated its own Termination Payment due AEP to be $667 million, and that shortly thereafter, TEMI's calculation produced a projected Termination Payment due AEP of $729 million. (Ansari Email, DX-A034; Roger Stibolt, Tr. 557:16, 559:25, Mar. 25, 2005; Orhon Email, DX-A036.)

  D. Replacement Products

  The PPSA stipulated that the Plaquemine Facility was to be in operation by May 1, 2003, and that in case this date was not met, AEP would provide TEMI with Replacement Products,*fn6 or AEP would pay TEMI the Replacement Price.*fn7 PPSA §§ 11.4, 11.5. In Spring 2002, AEP informed TEMI that the plant would not be operational by the target date. The following year, AEP attempted to provide TEMI with Replacement Products; however, TEMI refused to accept the Replacement Products and claimed ...


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