Force Majeure in a Bear Market

 

Force Majeure Type Clauses

 

There are a number of contractual provisions, such as force majeure, hardship and price review clauses that are currently being examined by the courts, as corporates attempt to find ways of discharging their obligations from burdensome contracts.  For example, Australia's Fortescue Metals Group is relying on a force majeure clause in arbitration proceedings in London after it suspended all of its long-term shipping contracts as a result of the financial crisis, which it says triggered a sharp fall in Chinese steel production and consequently a collapse in iron ore demand.

 

The English courts have interpreted both force majeure and hardship clauses as being of the same category of clauses.  They are considered “boiler plate” clauses and have an effect of contracting out of the common law doctrine of frustration.  Although some jurisdictions vary in the interpretation of the effect of such clauses, the English courts tend to interpret them similarly.

 

Having said this, there is some distinction between them, subject to the specific circumstances arising and the changing landscape of the global financial climate and the court’s interpretation of the law.  I shall discuss them below, applying the relevant law to the agreements.

 

Force Majeure

 

In common law jurisdictions, where the applicable laws are essentially developed through precedent, the effect of a force majeure clause will depend on the construction of the relevant wording of the clause.  To give an example, the English courts apply a series of precedents and have arrived at a narrow construction defined as the "presumption that the expression force majeure is likely to be restricted to supervening events which arise without the fault of either party and for which neither of them has undertaken responsibility"[1]. 

 

The argument that force majeure should cover an event or circumstance that makes the contract seriously uneconomic to perform has been previously pursued[2].

 

In that case, Clarke J held that a force majeure event must have made the party invoking the force majeure event unable to supply, “The fact that a contract has become expensive to perform, even dramatically more expensive, is not a ground to relieve a party on the grounds of force majeure”[3].  There is a distinction between inability and inconvenience.  Allowing the force majeure clause to be invoked where performance is commercially impracticable would add uncertainty and open-ended qualification that would be inconsistent with the rest of the agreement.

 

There has been a case[4] where Singleton LJ and Denning LJ, powerhouses of the English judiciary, stated by way of obiter that a prohibitive price increase might bring a force majeure clause into operation.  Parenthetically, it is interesting to note that this case concerned a 30% price increase directed by the Bank of Brazil.  Having said this, no significant case law that has followed this precedent.  The prevailing position under English law is that the Contractee bears the risk of the availability of supply and if that obligation has not changed, it will be held to its bargain, even if the Contractee's costs have risen dramatically.

 

Even if supply were impossible, the reasons for the impossibility will also be relevant.  It is not possible to rely on self-induced force majeure[5].  The effect of a force majeure would be to suspend and not terminate the obligations of the Contractee.  Therefore, by invoking the force majeure clause, the Contractee would be likely to gain nothing more than postponement of the obligations and not release.

 

​Hardship

 

Hardship clauses can be regarded as a species of force majeure clause that provides for review of terms affecting the party to the contract in the event of substantial hardship.   The hardship should be defined so that it is clear when the clause applies and so that the clause does not fail for uncertainty.  As stated earlier, the contra proferentum rule may well come into play here. 

 

The question of whether a hardship clause can be invoked for economic reasons shall depend on the wording the clause, however, this is the type of clause most likely to engage in the circumstances, in comparison with the force majeure clause.

 

The difficulty with contracts that contain both a hardship and force majeure clause, is that a particular event,  might fall within both clauses.  One clause will be given priority, since the remedy sought for each clause shall differ.

 

The basic position under English law is, as stated above, similar to that of a force majeure clause.  In other words, it arises from the doctrine of impossibility and therefore the mere impracticability does not render the performance of the contract impossible and does not necessarily discharge the burden of the parties.  The position is the same as in Brauer.  The reason why the court did not uphold the hardship was precisely the wording of the clause.

 

In contrast, a more recent case[6] decided that poor economic conditions could allow the parties to renegotiate, by invoking the hardship clause.  In that case, it was the wide drafting of the wording of the clause that gave effect to the judgment.  The precise wording of that clause was “If at any time or from time to time during the contract period there has been any substantial change in the economic circumstances relating to this Agreement […]”[7].

 

Hardship clauses have been interpreted by the International Chamber of Commerce (“ICC”) as imposing on parties an obligation perform their contractual obligations, even if events have rendered performance more onerous than would reasonably have been anticipated at the time of the conclusion of the contract.

 

However, where continued performance has become excessively onerous due to an event beyond a party's reasonable control, which it could not reasonably have been expected to take into account, the clause obligates the parties to negotiate alternative contractual terms, which reasonably allow for the consequences of the event.  Failure to agree to alternative provisions entitles the party invoking the clause to terminate the contract[8].

 

The difference in result suggested by an obligation, on the one hand, to perform a contract that is “more onerous" than anticipated while, on the other hand, avoiding performance of the terms of a contract that are "excessively onerous", might encourage the liberal use of the hardship clause by those who perceive that they made a disadvantageous bargain.  The use of the hardship clause or its incorporation by reference into a contract could result in unanticipated requests for renegotiation with the ultimate threat of contract termination if renegotiation proves futile. 

 

The important feature of a hardship clause is the right to refer the question of any adjustment to an independent arbitrator or adjudicator to determine the issue as to whether, and if so to what extent, the contract price or other terms of the contract, according to the particular wording, adjustment of the contract provides a means of resolving a dispute where the parties cannot negotiate their differences. 

 

Irrespective, any hardship clause in the contract or other renegotiation of terms, where one party is unable to further perform the contract in whole or part or simply chooses to do so, does not necessarily amount to termination or repudiation of that contract.  It is a common misconception that a breach by one party of the contract terminates the contract so that neither party needs to continue to perform his obligations.  An innocent party must continue to perform his side of the bargain unless the breaches of the other party are such as to substantially deprive him of all the benefit of the further performance of the contract and he chooses to accept the repudiation.  Only then are both parties thereby released from further performance of the contract.  The release is of course without prejudice to any accrued rights to payment of damages or as the case may of either party. 

 

Frustration

 

It is very unlikely that a party could successfully argue under English law that a contract had been frustrated by poor economic conditions, as frustration is given very limited scope by the English courts.  Under the doctrine of frustration, relief is only available where performance has become impossible.  The fact that performance may be more difficult or expensive than anticipated is not sufficient.  The key phrase of this advice must be: impracticability does not amount to impossibility.

 

 

[1] Fyffes Group Ltd -v- Reefer Express Lines (The Kriti Rex), [1996] 2 Lloyd's Rep 171

 

[2] Thames Valley Power -v- Total Gas & Power [2005] EWHC 2208

 

[3] Ibid

 

[4] Brauer & Co (Great Britain) Ltd -v- James Clark (Brush Materials) Ltd [1952] 2 Lloyd's Rep 147

 

[5] J Lauritzen AS -v- Wijsmuller BV (the “Super Servant Two”) [1990] 1 Lloyds Rep 1

 

[6] Superior Overseas Development Corporation and Phillips Petroleum (UK) Co Ltd -v- British Gas Corporation [1982] 1 Lloyd's Rep 262

 

[7] Ibid

 

[8] ICC 2003 Hardship Clause (3)

 

 

 

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