MPLP PPA Dispute

fyi
----- Forwarded by Elizabeth Sager/HOU/ECT on 02/20/2001 02:20 PM -----

"JOHN G KLAUBERG" <JKLAUBER@LLGM.COM<
02/18/2001 05:46 PM

To: Elizabeth.Sager@enron.com
cc:
Subject: MPLP PPA Dispute

PRIVILEGED AND CONFIDENTIAL: ATTORNEY WORK PRODUCT
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Elizabeth:

I looked through the CMS PPA on my return flight to NY. While I think we
should walk through the various contractual provisions over the phone, I
nonetheless thought it might be of some help to set forth a few preliminary
focal points for those discussions, particularly if you don't get to this for
a few days. I thought it made sense to contemporaneously record some
comments as I was thinking through some of the issues/positions. Also, I'll
have to run down the conflict issue when I get back into the office, but I
thought I could generally review the PPA in any event.

In addition, I did not know whether it was ENA's or Dynegy's obligation to
work on a response to CMS, but I thought it made some sense to see what one
might look like on paper. (See attached). At this point, however, I'm not
sure whether MPLP should furnish any specific contract-based rationale in
writing to CMS as to MPLP's position that the capacity charges should be
adjusted on a calendar year basis. You will note that the draft letter
focuses on the language dealing with the adjustment formula to the Contract
Capacity Factor (which clearly is done on a calendar year basis), rather than
the scheduled changes to the stated capacity charges set forth on Exhibit D.
As noted below, there are some issues underlying this position.

Preliminary Overall Assessment

The PPA essentially is inconsistent on the capacity charge adjustment issue.
While many of the relevant computations are done on a calendar year
basis--which generally supports MPLP's position--the effect of adjusting the
stated capacity charges on a calendar year basis results in two anomalies:
namely, the stated capacity charge (on Exhibit D) for "Year 1" only would
apply for 3 months, but even more importantly, the capacity charge (on
Exhibit D) for "Year 35" would apply for the last 21 months of the Contract
Term. The anomaly "running in the other direction" is that, under CMS's
interpretation, various computations would be made on a calendar year basis
(e.g., Contract Capacity Factor), and adjustments resulting therefrom would
be applied "mid-stream" (i.e., after 3 months of the alleged "contract year"
). My overall concern is that an arbitrator may focus on the anomaly
(described above) that results by applying Exhibit D using a calendar year
concept (i.e., the 21 month "Year 35" issue) since that is a fairly easy
concept to get your arms around..

More Information/Diligence/Research

Before a definitive conclusion on the issue can be made, we likely would want
to review or undertake, as the case may be, some additional
information/diligence/research, such as (which I assume we could generally
obtain from the Michigan regulatory counsel referenced in the e-mail you
forwarded):

--The Michigan PUC presumably approved the PPA (prior to the first amendment)
in a published Order. Was there anything in that Order or the submissions
(or exhibits thereto, including financial projections) that might provide
some guidance?

--My guess is that there must be other CMS QF PPAs with the same type of
pricing structure since this issue essentially would arise in every instance
where the COD was not a Jan.1. Do we (or local counsel) know whether this
may be a "global" attack by CMS on these types of PPAs?

--While not directly relevant to the contract interpretation question,
confirm with local counsel that CMS would have recovered the "excess"
capacity payments from its customers--so that it presumably would have to
issue a customer refund if it were to prevail on its claims.

--CMS "self bills" itself under the PPA. Has the statute of limitations run
on any of its claims for refunds for prior years? Can CMS's prior course of
dealing be used to support MPLP's contractual interpretation, or is there
otherwise an equitable argument that CMS should not be able to recover prior
"overpayments" (as opposed to prospectively adjusting the capacity
payments)? (This could be particularly helpful to try to settle out the
dispute on the basis that MPLP would concede the issue on a prospective basis
only).

--The cover letter from CMS suggests that the alleged payment error resulted
in payments in excess of the avoided cost rate authorized by the PUC. Isn't
this determination to be made over the life of the PPA, rather than for any
particular period? Assuming CMS's statement is correct, I assume it does not
affect the validity of the PPA, but only whether CMS can recover the "excess"
amount in rates?

--Do we have any leverage in the event we were to raise this dispute with the
PUC? If so, can this be used in the context of trying to work out an overall
restructuring of the PPA?

Certain Points in Support of MPLP's Position

--The definition of "Contract Capacity Factor" provides for a calendar year
determination and, most importantly, provides for a partial year calculation
for the year in which the COD occurs that ends at the end of that calendar
year. If the capacity charge should be adjusted as of the anniversary of the
COD date, it arguably would not make sense to have a partial year calculation.

--Sec. 10(a) provides that if in any calendar year the Contract Capacity
Factor is less than 60%, then the capacity charges set forth on Exhibit D
"shall be adjusted for the next calendar year as follows.... The capacity
charges for the following calendar year shall then be determined....
(Emphasis added). This section makes specific reference to Exhibit D and
makes the adjustment effective for the next calendar year, not on the next
anniversary of the COD. It arguably would not appear to make any sense to
apply the Contract Capacity Factor adjustment on a calendar basis, but
determine the capacity charges on a COD anniversary basis if no adjustments
thereto are required because the Contract Capacity Factor levels do not
require an adjustment.

--NOTE: The counter-argument, however, is that the foregoing language only
pertains to the computation of a percentage "haircut" or adjustment that is
applied to the stated capacity charges on Exhibit D, whatever those may be,
rather than to when the annual stated capacity charges are effective. That
is, making this adjustment on a calendar year basis, even though the
scheduled capacity rates change each October 1, is not necessarily in
conflict with the rest of the PPA.

--Sec. 2(b) (Effective Date and Term) provides that the Agreement runs for 35
years "and thereafter from year to year," unless a party gives at least one
year's notice to terminate which termination shall be effective "at the end
of the 35 years or any calendar year thereafter." (Emphasis added). Thus,
for example, if one month after the end of the 35 year term--i.e., October
31, 2030--a party gave notice to terminate, such termination would be
effective December 31, 2031, not September 30, 2031 or September 30, 2032
(i.e., not on the anniversary dates of the COD). Thus, the PPA contemplates
in certain respects certain "stub" years and certain "long" years, a
contractual scheme that is at least analogous to MPLP's position on the stub
and long years for the timing of the scheduled changes in the stated capacity
charges on Exhibit D.

--There are other calendar year based obligations--for e.g., Sec. 13 (and
Exhibit B) reflect termination payments that, again, are calculated on a
calendar year basis. (We should discuss with the commercial people the
economic rationale underlying the termination payments to see if there may be
additional support in that respect). (Note that some other calendar year
based calculations were eliminated by the First Amendment to the PPA, but can
still be used to reflect the underlying "calendar year" flavor of the PPA
since the issue at hand existed even prior to the First Amendment).

A Few Additional Points to Note

--The PPA is devoid of default language, LDs, etc.; however, MPLP could bring
a claim against CMS to arbitration (Sec. 18) for what it believes it is owed
when CMS does not pay the full capacity charges in 2001 (plus interest as
provided at Sec. 20) and keep performing under the PPA.

--Although I do not see a significant issue here, let's briefly discuss the
potential for CMS to try to affirmatively use an "indication" of a regulatory
disallowance pursuant to Sec. 10© as a way to attempt to force its
"contract year" interpretation of Exhibit D. While Sec. 10© is one of
those "old school" one way regulatory outs, MPLP would undoubtedly use Sec.
10(e) [requiring CMS to defend the PPA) to prevent CMS's affirmatively use of
the PUC to support its contract claim. (In Pennsylvania, PECO, in an
analogous circumstance, attempted to use a PUC determination as justification
to attempt to break a PPA with a QF).

Let me know when you wish to follow up.

John

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John Klauberg
LeBoeuf, Lamb, Greene & MacRae, L.L.P.
212 424-8125
jklauber@llgm.com
- sager-2.doc