‘Force majeure’ clauses in commodity sale agreements – what should you be thinking about?

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We have written previously about force majeure clauses in the context of market disruption events that have occurred or were anticipated (See previous alerts, 11-027, 11-00710-189 and 09-005, on force majeure). Lawyers spend a great deal of time analysing the impact of such events on their clients’ contractual arrangements. This article seeks to suggest some ways in which in-house legal and business teams might treat force majeure as a moving issue that merits regular evaluation of what a contract should say, in anticipation of the unanticipated. In particular, it seeks to identify some guidance points as to what a review of a force majeure regime should focus on, including factors relating to the parties themselves, the nature of the trade and the jurisdiction that will determine its application. We focus here on the laws commonly chosen to govern transactions made in three key trading centres namely London/Geneva, Singapore and Houston.

The importance of tailoring

Some events are clearly easier to predict than others. Following the return of major flooding to Queensland’s coal transportation network in January this year – the second time in two years – those buying or selling coal from the eastern Australian ports will no doubt be thinking carefully about how their contracts react to such interruptions. The developing infrastructure in Indonesia and seasonal rains combine to make disruptions a regular and predictable event. Political tensions in West African countries make disruption to oil exports and "declarations" of force majeure at export terminals somewhat commonplace, whilst socio-economic factors in South America have led to restrictions on the flow of agricultural commodities that have become the norm over the past few years. When considering how these types of events impact business flows we recommend that clients consider some of the less-visible considerations.

1. The nature of the contract

The form of a force majeure clause included in a contract for the sale of goods may often be based, at least in part, on template wording derived from the standard conditions of sale of one of the parties or an industry standard trading agreement. That wording may be intended to apply across a spectrum of transactions envisaged by those who prepared the templates at the time that the templates were drafted. Whilst a clause that is drafted in this way may be a good starting point, it should not obviate the need to think critically about the clause’s application in the transaction at hand. In particular, we recommend that you consider the following:

The subject-matter of the transaction.

For instance, whether it is a spot or long-term sale contract or a contract involving participation in internal market aspects of production or transportation. Where you are selling in a contractual chain, are the force majeure provisions consistently worded? Often, the wording may operate strongly in the seller’s interest at the top of the chain but be considerably looser at the bottom, potentially leaving intermediate traders open to unexpected exposures. Conversely, a well-worded clause can put a party in a chain in a strong negotiating position should a pre-identified event occur.

The risk appetite of your business in relation to the particular transaction.

For instance, is it a new business line or a business that is currently expanding or contracting? Unforeseen events and their consequences have the potential to dramatically affect both the profitability of a transaction and how operationally intensive it becomes, thereby influencing decisions about whether to invest in further transactions. The concept of force majeure has the potential to mitigate some of the consequences of these events, so attention should be increased where there is high sensitivity about a transaction.

The location(s)

in which performance is to take place and the anticipated circumstances in those locations at the time that performance is expected. Is the location where performance is to take place associated with risks that are not currently provided for in the force majeure provision?

2. The party’s role and identity

A party’s interest in negotiating the force majeure regime should vary depending on whether it is the buyer/seller under a sale contract; the producer or consumer of that commodity; and/or the party responsible for the transportation of the commodity. In addition, factors relating to the identity of the contractual counterparty or pool of potential counterparties are important and should bear upon the intentions of the force majeure clause. The following may be relevant questions to ask:

  • Is one of the parties a government authority, or connected to a government authority? If so, should alterations be made to "government intervention" type events, which might give such parties some control over the occurrence of the event?
  • Likewise, is one of the parties connected with, or does it have influence over, the relevant labour force, potentially affecting the operation of the clause regarding "strike" and "lockout" events?
  • Is one of the parties susceptible to sudden changes in market conditions, such that it may be incentivised to "declare" force majeure where it stands to suffer a financial loss? Would an express exclusion of events constituting economic or financial circumstances be worth including in the clause?
  • In a situation where a party has similar obligations under a series of contracts, would it be appropriate to provide for a discretion regarding the priority of performance of those contracts – sometimes referred to as a "most favoured nation" clause? As we will see below the courts have developed certain rules regarding whether and how a party may prioritise its deliveries.

3. Jurisdictional considerations

Whilst the concept of force majeure is broadly understood across the world, its recognition and application by the courts differs significantly across jurisdictions. We identify below some jurisdiction-specific issues that should inform drafting and negotiation priorities.

English law.

English courts will not imply a force majeure clause or particular events within it. It must therefore cover all of the potential sources of disruption. The use of the word "whatsoever" in a catch-all provision is more likely to convince the English courts not to restrict the application of the catch-all provision to the general nature of the specific events which precede it. Where the force majeure clause requires performance to be "prevented" then the party seeking to invoke force majeure must demonstrate that performance is physically or legally impossible

This is a very high burden to discharge compared to clauses that become operative where performance is "hindered," "delayed," "disrupted," "impaired," "impeded" or "interfered with." For instance, case law indicates that the burden may be satisfied in circumstances where a seller would, as a result of the event, still be able to perform its obligations under a contract, but to do so would result in the dislocation of that seller’s entire business.

Singapore law.

While the jurisprudence generally accords with the approach of English law to force majeure, recent judicial analysis gives some further guidance on determining the meaning of "disruption" to a seller’s performance. The Singapore Court of Appeal found that a test of commercial practicability should be used, such that where it has become "commercially impracticable" for that party to perform, a disruption will have occurred. On the basis of that decision, a mere increase in price of supplies of goods which would be used to supply the buyer is unlikely to cause commercial impracticability, but the inability of the seller to negotiate a price for those supplies may cause such impracticability. In relation to clauses that require events to be beyond the control of the party relying on the force majeure clause, the decision proposed a general principle that the party seeking to rely on the clause must take all reasonable steps to avoid relying on the clause, before doing so. These findings introduce significant differences in the application of force majeure clauses governed by Singapore law.

Texan law.

Like in England and Singapore, the terms of the contract strictly determine what will constitute force majeure. If a contract does not include a force majeure clause, then the obligation to perform under the contract is absolute and a court will not imply one. Texan courts will not require impossibility of performance, or for an event to be outside a party’s control, in order for there to be a valid force majeure event. So long as the contract specifically identifies an event as a force majeure event, it will be treated as such. Unlike under Singapore an English law, there is no implied duty to mitigate one’s losses. Therefore, clauses should be drafted specifically to provide for that duty, where, for example an English law governed clause is to be used in a Texan law governed contract and equivalence of application is sought.

Conclusion

Unforeseen events are not easy to predict or define. Force majeure clauses continue to be an active source of disputes, particularly in trade in emerging markets. Since force majeure is effectively a contractual exceptions mechanism, it will often be construed against the party seeking to rely on it. Identifying the potential sources of disruption and providing for the consequences, cognisant of the relevant law, can prevent exposures and lead to a quick resolution of a non-performance issue. Regular evaluation and re-evaluation of force majeure regimes is recommended.

Topics:  Commodity Sale Agreements, Contract Drafting, Force Majeure Clause, Jurisdiction

Published In: Civil Procedure Updates, General Business Updates, Finance & Banking Updates, International Trade Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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