John Samms

Introduction

Much ink has been spilled on the controversial 1969 power contract between Hydro-Quebec and CFLCo (the contract) and last week the Quebec Court of Appeal added to the pile with its decision in Churchill Falls (Labrador) Corp. v Hydro-Quebec, 2019 QCCA 1072. The contract at issue in the decision allowed Hydro-Quebec to purchase most of the power produced at the Upper Churchill hydroelectric facility at a very low fixed price, save for the Recapture block of 300 MW and the TwinCo block of 225 MW.¹ The recent decision of the Quebec Court of Appeal makes clear Hydro-Quebec is now subject to an annual energy cap and that some additional energy is available to CFLCo as of 2016, though not as much as they had argued for.

The precise inequity of the contract is unclear, but it has frequently been reported Hydro-Quebec garners 14 times the benefit of the Upper Churchill Hydroelectric facility than CFLCo does, with an estimated $28 Billion having flowed to Hydro-Quebec with just $2 billion having flowed to Newfoundland and Labrador.² The Supreme Court of Canada rejected multiple attempts on the part of CFLCo and the government of Newfoundland and Labrador to vary the terms or the effect of the contract over the years.³

In the June 20, 2019 decision released last week, the issues facing the Quebec Court of Appeal had a different flavour as compared to other disputes, as they concerned the interpretation of the contract as opposed to whether the contract’s effects should be varied or whether Hydro-Quebec ought to be forced to renegotiate.⁴

This litigation began as Hydro-Quebec sought a declaration from the Superior Court of Quebec effectively protecting its rights of “operational flexibility” as defined under the contract and that the changes in the 2016 renewal did not have the effects CFLCo contended they did; those are, (1) by virtue of the Continuous Energy concept added in the 2016 renewal contract, Hydro-Quebec would be limited to specific capped quantities of electrical energy (monthly and yearly) equivalent to the Annual Energy Base under the contract and would not have the exclusive right to all energy and power from the Churchill Falls power plant; and (2) CFLCo would be entitled to sell power to third parties on an interruptible basis both before and after September 1, 2016.

The effect of these propositions are significant. If CFLCo were successful at trial, Hydro-Quebec would be limited to its annual entitlements of energy under the contract in 12 monthly blocks instead of whenever it required it. This would mean, as compared to the 1969-2016 arrangement, the 2016-2041 arrangement would see Hydro-Quebec with a surplus of energy available in summer months of low demand and a shortfall of energy in the winter months of high demand. Coupled with CFLCo’s apparent right to sell surplus energy to third parties, the effect of these propositions would mean a significant bundle of value transferred to CFLCo from Hydro-Quebec by virtue of the differences between the original and renewal contracts.

After a 31 day trial, the trial judge decided in favour of Hydro-Quebec, rejecting those propositions CFLCo had brought forward.

The Quebec Court of Appeal overturned parts of that decision, leaving CFLCo partially successful in the result. The Quebec Court of Appeal agreed with CFLCo in finding the contract is really two contracts with two specific terms, the original contract with a term spanning from 1969 to 2016 and the renewal contract with different language starting at Schedule III of the document, with a term spanning from 2016 to 2041. The Court of Appeal concluded Hydro-Quebec has the right to purchase and receive, annually, a specific quantity of energy equivalent to the value of the Annual Energy Base as defined in the contract, which is then allocated monthly pursuant to the concept of Continuous Energy, according to a mathematical formula that provides for the calculation of the monthly payments owed by Hydro-Quebec. However, Hydro-Quebec’s rights under the Operational Flexibility provisions of the contract allows it to schedule and plan its energy from one month to another, the whole without being limited to a quantitative cap established pursuant to the concept of Continuous Energy on a monthly basis. Thus, there effectively is an annual cap on Hydro-Quebec’s entitlement to energy, but not a monthly cap.

The remainder of this article will summarize the Quebec Court of Appeal decision and analyze its effects.

THE DECISION

The issues

The Quebec Court of Appeal answered three central questions on appeal, the first two of which are the focus of this article:

1. Did the trial judge err by concluding that, under the terms and conditions of Schedule III of the contract (the renewal contract), HQ still has the exclusive right to purchase, and to receive, all the available power and all the energy produced at the Churchill Falls plant, with the exception of the power and energy associated with the Twinco and Recapture blocks, without being limited, on a monthly basis, to a quantitative cap established on the basis of the concept of Continuous Energy?

The Court of Appeal concluded Hydro-Quebec has the right to purchase and receive, annually, a specific quantity of energy equivalent to the value of the Annual Energy Base  as defined in the contract, which is then allocated monthly pursuant to the concept of Continuous Energy, according to a mathematical formula that provides for the calculation of the monthly payments owed by Hydro-Quebec, but that Hydro-Quebec’s rights under the Operational Flexibility provisions of the contract allow it to schedule and plan its energy from one month to another, the whole without being limited to a quantitative cap established pursuant to the concept of Continuous Energy on a monthly basis.

2. Did the trial judge err by concluding that, under the terms and conditions of said Schedule III (the renewal contract), CFLCo cannot, until August 31, 2041, sell to anyone quantity whatsoever of power or energy over and above the quantities associated with the Twinco and Recapture blocks, whether such sales are made on a firm or interruptible basis?

The Court of Appeal concluded there is nothing preventing CFLCo from disposing power associated not only with the Recapture and Twinco blocks, but also with the energy produced over and above the energy contemplated by the concept of Annual Energy Base, provided, however, that CFLCo satisfies its commitments to Hydro-Quebec. By virtue of deciding Hydro-Quebec’s right to operational flexibility means they are not limited to monthly limits of energy as prescribed under the concept of continuous energy, presumably there will not be as much excess power available to CFLCo as they had argued for.

3. Do the conclusions of the judgment go beyond what the trial judge was entitled to decide?

The Court of Appeal concluded the conclusions did not go beyond the relief claimed and that in other aspects, the trial judge declined to decide certain issues and justified why he did so.

These questions are of mixed fact and law therefore the standard of review was palpable and overriding error. The main factors affecting the decision were: the characterization of the contract, whether there was ambiguity in the contract, Hydro-Quebec’s rights to power and energy, CFLCo’s right to sell available power, and the impact of the absence of any sales of power.

Characterization of the contract

The trial judge concluded the contract and renewal contract constitute an inseparable contractual whole, which he found to be mixed contract containing a joint venture and a sales component. This was contrary to the recent finding by the Supreme Court of Canada, which concluded the contract is neither a joint venture contract nor a relational contract.⁵ This amounted to an error that came with significant consequences. In particular, the Court of Appeal stated at paragraph 45 that (emphasis in the decision)⁶:

“With all due respect for the trial judge, his error regarding the characterization of the contract is not without its consequences. Viewing the document as an inseparable contractual whole created the risk of comingling the terms and conditions applicable to one period with those applicable to the other, together with all aspects of their negotiation, contrary to the clear wording of the third paragraph of section 3.2 of the Contract:

3.2 Renewal of Contract

This Power Contract shall be renewed on the basis stated in this Section, for a further term of 25 years from the expiry date hereof.

The renewed Power Contract shall be that set forth in Schedule III hereof, which shall come into force automatically without any further signature being required.

Any or all Articles or Sections of this Power Contract, other than this Section 3.2, as well as any or all undertakings or promises not specifically contained in Schedule III shall have no force and effect beyond the expiry date hereof and shall not thereafter be binding upon the parties to the renewed Power Contract.

Remarkably, the trial judge had decided the original contract and renewal contract constituted an inseparable whole, which minimized section 3.2 above and other language differences between the original contract and the renewal contract to the point they might as well not have existed. On this, the Court of Appeal concluded, “it is clearly wrong to say that the agreement relating to the first 40 years and the agreement relating to the following 25 years form an indivisible whole, when section 3.2 states the opposite in no uncertain terms.”⁷

To further emphasize the effect of this error, observe the striking differences between the “Object” provisions in the original contract and the renewal contract (emphasis added):

Original Contract

2.1 Object

During the existence of the present Power Contract Hydro-Quebec agrees to purchase from CFLCo and CFLCo agrees to sell to Hydro-Quebec each month (i) prior to the Effective Date at least the amount of energy indicated in Column 7 of Schedule II hereof as available during the stage of construction applying to such month and the Firm Capacity and (ii) from and after the Effective Date, the Energy Payable, and the Firm Capacity; all at the prices, on the terms and conditions, and in accordance with the provisions set forth herein.

Renewal Contract

2.1 Object

During the entire term hereof, Hydro-Quebec agrees to purchase from CFLCo and CFLCo agrees to sell to Hydro-Quebec each month the Continuous Energy and the Firm Capacity, at the price, on the terms and conditions, and in accordance with the provisions, set forth herein.

Taken together with section 3.2 of the original contract, which effectively states the language of the renewal contract is operative beyond the expiry of the original contract, the trial judge was able to escape the fact that “continuous energy” is the package that Hydro-Quebec is purchasing in the renewal contract, which CFLCo argued set monthly energy ceilings available to Hydro-Quebec for purchase. The Court of Appeal remarked upon this at paragraph 62, saying the trial judge “was so focused on seeking out what the parties had wanted to say that he minimized the importance of what they had written.” The court continued, “the text should not be treated as if it did not exist”.⁸

The ambiguity of the contract

Having found the trial judge had erred in the characterization of the contract, the Court of Appeal next analyzed his findings in relation to the ambiguity of the contract. The trial judge concluded the renewal contract was ambiguous and that he therefore had to interpret it.

The Court of Appeal was not convinced the trial judge had committed a palpable and overriding error by concluding that the contractual texts were ambiguous, but they did point out the wording within the renewal contract was “vitally important”. The Court of Appeal stressed the “prudence with which one must proceed” in a case where the persons involved in the negotiation did not testify and the existence of the “unambiguous” section 3.2, reproduced above. In light of these qualifying statements, one wonders what the Court of Appeal would have done on this issue had the standard of review been that of correctness.

Having concluded the trial judge erred on the characterization of the contract and having emphasized the language in the renewal contract in the ambiguity discussion, the Court of Appeal had set the stage to decide whether Hydro-Quebec had a right to all the power and energy.

Hydro-Quebec’s right to all the power and energy

The trial judge concluded that Hydro-Quebec has the right to all the energy produced by the plant and to reach this conclusion, he considered he was justified to go beyond the wording of Schedule III (the renewal contract) because of its supposed ambiguity.⁹ The Court of Appeal found the trial judge “committed a manifest error in his interpretation and terms and conditions” of the renewal contract, primarily through two flaws: first, the trial judge minimized the importance of the text in the renewal clause and second, the trial judge found that operational flexibility as defined in the contract is meaningless unless Hydro-Quebec had access to all the energy produced at the plant, as it did before September 1, 2016. ¹⁰

The Court of Appeal went on to say that Hydro-Quebec’s right to the energy produced by the Churchill Falls plant is now limited but that Hydro-Quebec still has an operational flexibility very similar to that both parties acknowledged it had prior to September 1, 2016. The Court continued on by comparing the original contract and renewal contract, specifically the differences in the “Object” provisions (produced above) and the absence in the renewal contract of section 6.2 in the original contract, which stated CFLCo shall deliver to Hydro-Quebec […] such power and energy as Hydro-Quebec may request.¹¹

This led the court to conclude the Annual Energy Base in the renewal contract establishes the annual quantity of energy to which Hydro-Quebec is entitled under the renewal contract, while Continuous Energy allocates this quantity from month to month, on a purely mathematical basis, essentially to ensure CFLCo has a regular and stable flow of revenue throughout the year.¹²

Does this mean then that Hydro-Quebec are entitled only to monthly blocks of energy? The Court of Appeal decided no, as operational flexibility under section 4.1.1. and its power requirements under section 5.3 grant scheduling of its requests for the delivery of energy.

The court then went on to say the trial judge erred in determining the Annual Energy Base includes all the energy produced by the Churchill Falls hydroelectric project, putting a fine point on the analysis with the following statement at paragraph 89: “As a matter of fact, why would this dispute have arisen if both parties did not believe in the existence of a certain quantity of energy over and above the value of the Annual Energy Base?¹³

What then is the function of Continuous Energy in the renewal contract? Here, the Court of Appeal found it is “both a payment term intended to ensure regular and steady revenue for CFLCo and a monthly allocation of the energy that Hydro Quebec binds itself to purchase, and CFLCo binds itself to sell it to, annually.”¹⁴ This means what Hydro-Quebec gets under the renewal contract is predetermined by that formula, rather than solely on Hydro-Quebec’s needs, explaining the removal of section 6.2 (the provision mandating that CFLCo shall deliver such power that Hydro-Quebec requests), which was in the original contract but not the renewal contract.

Why are Hydro-Quebec entitled to power beyond the monthly limits under the Continuous Energy formula? Again, the Court’s answer is operational flexibility. More specifically, the provisions pertaining to operational flexibility are exactly the same in the original contract and the renewal contract, the effect of the Annual Energy Base/Continuous Energy is not so strong as to completely override the practice the parties have employed for the last 40 years, except that there is an annual cap on energy available to Hydro-Quebec (emphasis added)¹⁵:

[112] Sections 4.2.1 and 6.5 of the Initial Contract gave HQ full operational flexibility allowing it, through its requests for the delivery of energy, to control production and manage water levels in the reservoirs. This allowed HQ to adapt its requests for energy and power based on the seasonal demand for energy in Quebec, reducing its requests in the summer (thereby allowing water to accumulate in the reservoirs) and increasing them in the winter, when demand was higher Given that HQ had access to all the energy produced by the plant, it also adapted its requests for energy on a multi-year basis, by scheduling deliveries above the value of the Annual Energy Base during years of high hydraulicity and below that value during years of weaker hydraulicity.

[113] Sections 4.1.1 and 5.3 of Schedule III [the renewal contract] are identical to sections 4.2.1 and 6.5 of the Initial Contract. …

…

[116] In my view, one must try to reconcile the concept of operational flexibility with the notion that HQ has access to a limited, albeit considerable, quantity of energy. On this point, I agree with HQ. It would be surprising if the parties had intended a purely intra-monthly flexibility (i.e., solely within each month), as CFLCo proposes, despite the fact that HQ enjoyed full operational flexibility for 40 years and that, even after August 31, 2016, HQ still needs to efficiently coordinate the considerable energy contributed by the Churchill Falls plant with the energy from its own network of plants.

…

[118] I see nothing in the terms and conditions applicable as of September 1, 2016 that would prevent HQ from doing as it has always done since the plant was commissioned, which is to adjust its requests for the delivery of energy (and power) based on the seasonal profile of demand for electrical energy in Quebec (higher in winter than in summer) and in perfect harmony with its own network of plants. This, of course, is subject to an additional restriction which did not exist before September 1, 2016, that is, the annual limit on the energy to which HQ is entitled pursuant to Schedule III [the renewal contract] (Annual Energy Base).

[119] Consequently, I see nothing in Schedule III [the renewal contract] that would prevent HQ from postponing (or accelerating) the delivery of energy it has paid for (or will pay for) pursuant to sections 2.1 and 7.1, but of which it has not yet taken delivery (or which it needs sooner), subject, however, to the annual cap represented by the Annual Energy Base.

Going a step further, the Court of Appeal stated CFLCo’s restrictive interpretation would “strip HQ’s right to operational flexibility to any effect.”¹⁶

So what is the effect of all this? Simply, instead of all of the energy it requires excepting the Recapture and TwinCo blocks, Hydro-Quebec is now only entitled to the Annual Energy Base in a given year. At note 53 of the decision, the court noted CFLCo and Hydro-Quebec were in disagreement regarding the value of the Annual Energy Base as of September 1, 2016, although they had agreed, in May 1969, to set it at 31.5 billion kilowatthours (31.5 TWh) at the start of the first 40 –year period. It is unclear whether this dispute has been settled, but it is a necessary piece of data to determine what excess energy may be available to CFLCo at what points of the year.¹⁷

Insofar as power is concerned, at paragraph 109 of the decision, the court explains the Guaranteed Winter Availability Contract, which the parties signed in 1999, increases the power made available to Hydro-Quebec during the winter months (November 1 to March 31) from 4382 MW to 5064 MW.¹⁸ The totality of the plant’s power, according to the evidence before the trial judge, is 5,428 MW (note: the Court of Appeal decision indicates 5428 KW, which misquotes the trial decision at paragraph 483).¹⁹

Where there is excess energy, can CFLCo sell it to third parties?

CFLCo and sales of interruptible power

The trial judge concluded that, until August 31, 2041, CFLCo has no right to the power and energy produced by the plant, except for the 300 MW (Recapture) and 225 MW (Twinco) blocks, and that, accordingly, it will not be entitled to sell to anyone whomsoever (including Newfoundland and Labrador Hydro) any quantity whatsoever of power (and energy) exceeding the quantities associated with those two blocks.²⁰ That conclusion was obviously tied to the trial judge’s conclusions in other areas of the decision.

On appeal, CFLCo argued its obligation would be limited to providing Hydro-Quebec with the Firm Capacity scheduled by Hydro-Quebec, and nothing more. They further argued that insofar as Hydro-Quebec does not use the power available to it under the contract, CFLCo may do with it as it pleases, provided it respects its energy and power commitments to Hydro-Quebec.²¹ Hydro-Quebec replied the basis for this logic is flawed, because unscheduled power is used to build up operating reserves and that the intention of the parties was never to give CFLCo rights to any quantity of power other than the Recapture and TwinCo blocks.

In deciding the matter, the Court of Appeal distinguished between three categories of power under the contract²²:

1. The power associated with the 300 MW (Recapture) and 225 MW (Twinco) blocks;
2. The power included in the concept of Firm Capacity found both in Schedule III and in the Initial Contract, as well as the additional power reserved by Hydro-Quebec under the GWAC (682 MW during the winter period); and lastly,
3. The power associated with the excess energy (over and above the Annual Energy Base) to which CFLCo has been and continues to be entitled since September 1, 2016

On the first category, like the trial judge, the Court of Appeal saw nothing that would prevent CFLCo from disposing this power as they saw fit.²³

On the second category, the Court of Appeal agreed with the trial judge, saying CFLCo has no right to this power.²⁴

On the third category, the Court of Appeal saw nothing standing in the way of CFLCo disposing it as it sees fit, provided it satisfies its commitments to Hydro Quebec under the renewal contract as well as under the GWAC.²⁵

Conclusion

The Court of Appeal concluded as follows²⁶:

[175] For all these reasons, I would allow CFLCo’s appeal in part and declare, first, that HQ’s right to energy produced by the plant is limited annually to the value of the Annual Energy Base (but, under sections 4.1.1/Operational Flexibility and 5.3/Firm Capacity Schedules of Schedule III, it has the right to an operational flexibility similar to that it enjoyed until August 31, 2016) and, second, that, since September 1, 2016, there is nothing preventing CFLCo from disposing of the power associated not only with the Recapture and Twinco blocks, but also with the energy produced over and above the energy contemplated by the second concept of Annual Energy Base, provided, however, that CFLCo satisfies its commitments to HQ.

WHAT NEXT?

This is a complex decision and the parties publicly stated they will take their time to analyze its effects. In many ways, the decision is a tie as between the parties given neither received the exact judgment they were looking for. Whether that tips the scales in favour of either party seeking leave to appeal to the Supreme Court of Canada remains to be seen.

¹ At the outset, one should understand the difference between energy and power as stipulated under the contract. At issue in this case was how much “energy” Hydro-Quebec is entitled to under the contract and when it is it so entitled. The Superior Court of Quebec and the Quebec Court of Appeal simplified these concepts nicely, stating “power” or “capacity” as defined in the contract is the rate at which electrical energy is delivered at any point, measured in kilowatts (KW, 1000 watts), megawatts (MW, 1 million watts), gigawatts (GW, one billion watts) and terawatt (TW, one trillion watts). “Energy” is the result of power multiplied by the time during which the power is used, measured, in the case of electrical energy, in kilowatt-hours (KWh). Therefore, 1KWh is 1 KW of power over a period of one hour. At paragraph 1092 of the trial judgment, the trial judge pointed out “power is used to deliver energy”. Energy and power are interrelated but are different products under the contract.

² David Maher, “Quebec Court of Appeal rules in favour of Newfoundland and Labrador” (June 21, 2019)

³ Churchill Falls (Labrador) Corp. v Hydro-Quebec, 2018 SCC 46; Reference re Upper Churchill Water Rights Reversion Act, [1984] 1SCR 297; Newfoundland (Attorney General v Churchill Falls (Labrador) Corp., [1988] 1 SCR 1087.

⁴ Churchill Falls (Labrador) Corp. v Hydro-Quebec, 2019 QCCA 1072

⁵ Churchill Falls (Labrador) Corp. v Hydro-Quebec, 2018 SCC 46

⁶ Churchill Falls (Labrador) Corp. v Hydro-Quebec, 2019 QCCA 1072

⁷ Ibid.

⁸ Ibid.

⁹ Ibid, 60.

¹⁰ Ibid, at 61-63.

¹¹ Ibid, at 72.

¹² Ibid, at 75.

¹³ Ibid

¹⁴ Ibid, at 103.

¹⁵ Ibid.

¹⁶ Ibid, at 126

¹⁷ Ibid, at 66.

¹⁸ Ibid.

¹⁹ Ibid.

²⁰ Ibid, at 151.

²¹ Ibid, at 152-153.

²² Ibid, at 157.

²³ Ibid, at 160.

²⁴ Ibid, at 163.

²⁵ Ibid, at 164.

²⁶ Ibid, at 175.