By Deborah Slattery-Pereira

The business community is closely following the ongoing international arbitration proceedings between Shell and other buyers against Venture Global, in the London Court of International Arbitration.[1] The multi-billion dollar arbitrations are happening in a heated oil and gas market, affected by the Ukraine War.[2] These arbitrations will impact other market players, including lenders and equity providers involved in this long-term project finance.[3]

Venture Global contracted to supply Shell and others with Liquified Natural Gas (“LNG”) at the Calcasieu Pass LNG export facility in Louisiana.[4] In their arbitrations, the buyers claim that Venture Global did not perform its obligations and sold LNG to third parties for the higher prices that have prevailed since the outbreak of the Ukraine War.[5] The buyers argue that Venture Global made a lot of money by breaching their contract.[6] Shell presents a study showing that Venture Global earned U$3.5 billion by selling LNG on spot markets.[7] Venture Global alleges that force majeure delayed the company from starting full operations and thereby from fulfilling the obligations.[8]

In common-law jurisdictions, contracts are binding promises that govern private relations.[9] When parties make a covenant, non-performance is in itself as unjust as a broken promise.[10] However, a contract does not entitle parties to specific performance, only to compensatory damages.[11] More precisely, expectation interest is the measure of damages.[12] Expectation interest places the creditor in as good a position as he would have been in if the debtor had kept his promise.[13]

If the expectation interest is the measure of damages in breach-related termination of contracts, the buyer’s loss matters, not the seller’s gain.[14] In assessing damages, the arbitral tribunal should not define how much money Venture Global made by not performing. Only the buyers’ expected gain from trade matters; or how much money would be necessary to place Shell and others in the position that they would have been in if Venture Global had performed.[15]

Courts generally cannot enforce performance if the contractbreaker intentionally decides to not perform.[16] For law-and-economics scholars, if the seller can get a better price by transferring the same good to a third party, this more efficient allocation of community resources will increase social welfare.[17] Courts should define the buyer’s compensatory damages reflecting the buyer’s own gain of trade, which represents the expectation interest.[18]

The Delaware Supreme Court held that the efficient breach theory does not modify damage calculations for an injured party.[19] In this case, an investor sued an energy developer for breaching the consent provision.[20] This provision prohibited the developer from selling the company’s assets without the investor’s consent.[21] Alternatively, the contract provided the developer could pay a premium to the investor.[22] The court concluded the developer had to pay the premium to the investor since the developer did not perform.[23] The court reasoned that efficient breaches allow two paths for the breaching party: “perform the contract or fully compensate the promisee for non-performance.”[24] Efficient breach does not change the method of calculating expectation damages.[25]

The efficient breach theory has a similar application to international contracts, though parties can adopt a different substantive law to govern their deviation from commitments.[26] Although not much information is publicly available, Shell and others asked the U.S. Federal Energy Regulatory Commission to investigate why Venture Global was not operating at full capacity at Calcasieu Pass. [27] Their conduct indicates the law from a U.S. jurisdiction applies to their arbitration proceedings as Venture Global operates under the U.S. regulatory power.[28] Moreover, Venture Global alleges force majeure in these arbitrations, but Venture Global does not argue the company efficiently breached the contract.[29]

In an efficient breach scenario, the net-gains from non-performance will stay with the breaching party, increasing profits.[30] The non-breaching party will question this gain allocation as these gains consist in a wealth-transfer between the contracting parties.[31] Courts (or arbitral tribunals) will decide who deserves to keep the surplus, especially in long-term incomplete contracts.[32] Law-and-economics scholars agree that, in the absence of full compensation to the buyer, enough to cover expected damages, the seller acts immorally by efficiently breaching the contract.[33] The seller acts immorally because he obtains a benefit that exceeds the value of his contractual bargain without meeting the buyer’s expectations regarding performance.[34]

In their arbitrations, Venture Global may make a case for force majeure.[35] But if the buyers win, the assessment of damages becomes central, and assuming that common-law governs the contract, the buyers will receive expectation interest.[36] Shell and other buyers should be awarded enough money to place them in the same position that they would have been if Venture Global had timely performed its obligations.[37] That includes the buyers’ lost profits, according to the contract-market deferential.[38] The compensatory damages are calculated based on the difference between what the buyers have been paying to Venture Global and what they would have resold for those volumes on the spot market, considering the increased prices from the Ukraine War.[39]

[1] See Mark Rashad & Curtis Williams, Exclusive: Shell, BP pursue arbitration claims against Venture Global LNG, Reuters (July 12, 2023), https://www.reuters.com/business/energy/shell-bp-pursue-arbitration-claims-against-venture-global-lng-2023-07-12/.

[2] See James Smyth & Shotaro Tani, Shell claims LNG Group “wrongfully earned $3.5 bn on shipment arbitrage, Fin. Times (Sept. 5, 2024), https://www.ft.com/content/e092e2b0-da76-458c-80e9-6a3e1c5db0f1.

[3] See Ed Hirs, Did Venture Global LNG break contracts with Shell, Edison, and BP?, Forbes (Sept. 6, 2023, 10:14 PM), https://www.forbes.com/sites/edhirs/2023/09/06/did-venture-global-lng-break-contracts-with-shell-edison-and-bp/.

[4] See id.

[5] Rashad & Williams, supra note 1.

[6] Smyth & Shotaro, supra note 2.

[7] Id.

[8] Id.

[9] Charles Fried. Contract as promise: a theory of contractual obligation 16 (2015) (“An individual is morally bound to keep his promises because he has intentionally invoked a convention whose function it is to give grounds—moral grounds—for another to expect the promised performance.”).

[10] See Thomas Hobbes, Leviathan, ch. 15.

[11] See Oliver Wendell Holmes, The Path of the Law, Bos. L. Sch. Mag. Feb. 1897, at 5, (“The duty to keep a contract at common law means a prediction that you must pay damages if you do not keep it, and nothing else.”).

[12] Fried, supra note 9 at 19.

[13] Id. (stating that the contracting party is bound to perform what she promised to the other party, or, alternatively, to put the other party in as good position as if the contracting party had done so).

[14] Daniel Markovits & Alan Schwartz, The Myth of Efficiency Breach: New Defenses of the Expectation Interest, 97 Va. L. Rev. 1939, 1942–43 (2011).

[15] Id. at 1943 (emphasizing that “promisors’ obligations [should] be set according to promisees’ gains from trade,” not the promisors’ gain).

[16] See Richard A. Posner, Let Us Never Blame a Contract Breaker, 107 Mich. L. Rev. 1349, 1350 (2009) (stating that, as long as the non-performing party pays damages to the other party, no blame can catch to that party, even if the party did not perform deliberately. The party can choose to not perform because a third party offered more money for the same service or product that the party had promised to supply in the original contract. The non-performing party should not be blamed because no real breach of contract occurred as the promise was “either-or”: performance or compensation for non-performance); see also Robert L. Birmingham, Breach of Contract, Damage Measures, and Economic Efficiency, 24 Rutgers L. Rev. 273, 284 (1970) (“Repudiation of contract should be encouraged where the promisor is able to profit from his default after placing the promisee in as good position as he would have occupied had performance been rendered.”); Charles J. Goetz & Robert E. Scott, Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Breach, 77 Colum. L. Rev. 554, 558 (1977) (affirming that efficient breach overcomes performance as long as compensation to the promisee mirrors the value of performance, thusthe promisee will receive the value of performance and the promisor will be able to increase his profits).

[17] See Birmingham, supra note 16 at 284–85 (stating that efficient breach encourages the efficient reallocation of community resources, because otherwise forcing the party to fulfill his contractual obligation would “limit[] the factor and product mobility essential to proper functioning of the market mechanism.”).

[18] See id. at 285.

[19] See Leaf Invenergy Co. v. Invenergy Renewables LLC, 210 A.3d 688, 703 (Del. 2019).

[20] See id. at 690.

[21] See id.

[22] Id.

[23] Id. at 700.

[24] Id. at 703.

[25] Id.

[26] See Eric A. Posner & Alan O. Sykes, Efficient Breach of International Law: Optimal Remedies, Legalized Noncompliance, and Related Issues, 110 Mich. L. Rev. 243, 253 (2011).

[27] See Ruth Liao, Shell Joins BP in Ramping Up Dispute With Key US LNG Seller, Bloomberg (Jan. 3, 2024, 12:40 PM), https://www.bloomberg.com/news/articles/2024-01-03/shell-joins-bp-in-ramping-up-dispute-with-key-us-gas-exporter.

[28] See id.

[29] Smyth & Shotaro, supra note 2.

[30] See Goetz & Scott, supra note 16 at 558.

[31] See id. at 559.

[32] Steven Shavell, Is Breach of Contract Immoral?, 531 John M. Olin Cent. for L, Econs., and Bus. Discussion Paper 13 (2005), http://www.law.harvard.edu/programs/olin_center/papers/pdf/Shavell_531.pdf.

[33] See id. at 15–16.

[34] Id. at 14.

[35] Smyth & Shotaro, supra note 2.

[36] Fried, supra note 9 at 19.

[37] Id.

[38] See Goetz & Scott, supra note 16 at 559 (stating the non-performing party should provide a monetary compensation reflecting the damages based on contract-market differential, which means the sum enough to equalize the performance based on an objective market evaluation).

[39] See Hirs, supra note 3; see also Goetz & Scott, supra note 16 at 559, n.44 (arguing that the contract-market differential is the appropriate measure of expectation damages because it translates the contractual allocation of risk regarding a shift in the market price which was allocated to the non-performing party).

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