The escalating tensions in the Middle East and Ukraine together with disruption to supplies, shipping lines and damage to energy facilities has prompted affected parties to establish what contractual rights they might have. Whether driven by war, sanctions regimes, raw material shortages, inflationary pressures, or unexpected market shocks, “turbulent times” expose contractual assumptions that may no longer hold. Well drafted and negotiated commercial clauses and swift response to trigger events can preserve value. We consider the English legal position of some contractual areas that typically come under particular scrutiny in uncertain times, and where UK businesses might concentrate a review of their commercial contracts.
Some common commercial areas include:
- pricing review provisions – cost plus, fixed or indices such as fuel, CPI or RPI;
- suspension or termination rights;
- minimum volume commitments and how they are impacted;
- exclusivity provisions – can the customer go elsewhere or dual source?
Some legal implications involve the following:
Governing law
Identify which law governs the contractual relationship and consider local law advice where necessary. Legal concepts for managing contractual performance operate differently depending on the governing law and local mandatory overriding laws. For example, while force majeure (as discussed below) is a purely contractual concept under English law, certain jurisdictions effectively provide force majeure relief in statute.
Force majeure (FM)
An FM clause typically excuses one or both parties from performance of the contract in some way following the occurrence of certain events. Its underlying principle is that on the occurrence of certain events which are outside a party's control, that party is excused from, or entitled to suspend performance of, all or part of its obligations. Close scrutiny of the clause and the events that it covers together with the outcomes such as if it triggers a suspension or termination right will need to be considered.
Material adverse change clause (MAC clauses)
MAC clauses are usually subject of detailed negotiation between parties. They are intended to provide protection from unforeseen events or circumstances which have a detrimental impact on the parties to a contract. This may trigger a right to require the parties to renegotiate specific aspects of the contract or even a right permitting a party to terminate the contract in its entirety. Most MAC clauses contain two elements: a "trigger event" which activates the clause in the first place, followed by a requirement for that trigger event to have a material adverse effect. Short-term price volatility or other disruptions may not in themselves qualify. Reliance on a MAC clause therefore requires careful consideration about the scope of the trigger event and the approach taken by courts to MAC clauses will always depend on how they are drafted.
Frustration
If a contract does not contain an FM or MAC clause, the law of frustration is an English common law principle which exists independently of the contractual terms. The effect of frustration is to discharge the parties from their obligations to perform the contract further, i.e. it is forward-looking and does not have the effect of invalidating the agreement from the outset. Frustration is a high bar to establish, and, broadly, neither commercial inconvenience nor the fact of additional costs of performance may be sufficient to frustrate a contract. The mere fact that performance has become more difficult or expensive due to the use of an alternative transport route or increased insurance costs is unlikely to suffice. The Law Reform (Frustrated Contracts) Act 1943 (LRA) applies to most commercial contracts governed by English law (unless they exclude its effect) and there are exclusions for certain shipping contracts, insurance contracts and contracts for specific goods which have perished. The LRA applies where a contract governed by English law has become impossible to perform or otherwise frustrated (and the parties are therefore discharged from the further performance of the contract) and provides that:
- monies paid out before frustration are recoverable afterwards;
- monies due before frustration are no longer due afterwards;
- a party who has obtained a valuable benefit under the contract may have to pay for it if the court considers it just; and
- a party who has incurred expenses in respect of the contract before the frustrating event may recover such expenses from the other party if the court considers it just.
Sanctions
Under an English law governed contract, sanctions present both a legal compliance risk and a potential trigger for suspension or termination where performance becomes unlawful or exposes a party to enforcement action. The rapid expansion of global sanctions regimes has elevated sanctions clauses with contracts now including express negotiated provisions for sanctions. Other contractual terms and rules which apply to contracts may assist a party if a sanctions issue arises during the course of a contract (e.g. force majeure, frustration, supervening illegality).
In addition, s44 of the Sanctions and Anti-Money Laundering Act 2018 provides statutory protection where a contract is breached in the reasonable belief that this is to comply with UK sanctions law; in many cases none of the these will provide bulletproof protection to a party looking to suspend performance or terminate a contract due to a sanctions issue. Bespoke clauses can therefore offer valuable protection, particularly for high-value cross-border contracts. These might include indemnity-backed warranties on the counterparty’s compliance with sanctions, and specific termination rights linked to sanctions issues. Bespoke sanctions provisions should not however be an alternative to due diligence before contracting and businesses should monitor sanctions developments and understand how restrictions might result in increased exposure either directly or indirectly through suppliers.
Hardship
Long-term supply agreements, particularly contracts for the supply of energy and natural resources, may contain a hardship clause. A typical hardship clause provides that if, during the term of the contract, there are changes to, or movements in, the market affecting the contract price which result in hardship to either party, the parties will meet to consider and agree any adjustment to the contract terms necessary to offset or alleviate the hardship. If no adjustment is agreed within a defined period, the clause may allow the following: give the party affected by the hardship the option to terminate the contract; give either party the right to refer determination of what (if any) adjustment is necessary to an independent expert or arbitral tribunal. Whether such a clause can be invoked when a crisis has caused supply chain disruption, and the meaning of "hardship", depends entirely on the drafting of the clause.
Termination and suspension rights
In uncertain geopolitical times, parties should carefully review not only express termination triggers (as described above, for example, force majeure, sanctions compliance, MAC events etc) but also suspension rights. The procedural mechanics governing termination, can be key as failure to comply precisely with notice requirements or timing provisions can invalidate the right to terminate or give rise to improper termination and breach. Particular attention should be paid to the notices clause and whether termination is automatic or discretionary, whether it is exercisable for anticipated events (such as risk of sanctions exposure), and the consequences of termination for example payments due. Given that wrongful termination itself constitutes a repudiatory breach, exercising termination rights defensively and with a clear evidential basis is critical where external geopolitical developments are rapidly evolving.
Supply chain disruption
Where there is disruption to transport routes, supply chains or energy supplies, businesses that depend on the transit of goods through affected areas face the prospect of delays, increased costs and interruption to their operations. Where contracts contain a liquidated damages clause (to quantify the damages payable for a specified breach in a commercial agreement such as late or defective performance) or strict compliance with time provisions, parties may face significant liability for delays that are ultimately attributable to these disruptions. These clauses should be reviewed to understand where liability is apportioned.
Insurance
Contractual provisions around insurance are always a focus in uncertain times; a review of whether the businesses insurance cover responds to war risks, sanctions, or supply chain disruption is prudent. Understanding the material terms of a contract of insurance and how it impacts the main commercial agreement is important and should prompt an understanding of: the definition of the risk to be covered; the duration of cover; the amount and mode of payment of the premium; and the amount payable by the insurer in the event of an insured loss. Standard property and business interruption policies frequently contain war exclusions, which may limit or eliminate cover for losses arising from the conflict. Businesses should review their policies urgently to understand the scope of any exclusions and to determine whether separate war risk, political risk, or terrorism insurance is in place or available.
Next steps
Businesses acting swiftly to understand their legal position, actively engaging with counterparties, and taking proactive steps to mitigate risk will be best placed to navigate uncertain geo-political circumstances. Contractual protection and risk allocation will turn on drafting precision and procedural compliance with proactive contract management key to protecting commercial interests. For businesses, “dusting down” contracts in uncertain times might involve the following:
- reviewing contractual protections and understanding the key risks particularly on minimum volume commitments, exclusivity and pricing mechanisms;
- engagement with contractual counterparties early to plan how to manage situations;
- consideration of whether FM clauses in existing and future contracts clearly and expressly allocate force majeure risk;
- undertaking robust supply chain due diligence;
- where transactions remain under negotiation, reassess valuations and negotiate appropriate contractual protections to allocate the risks arising from the crisis;
- review of insurance policies and checking robustness of any insurance provider and ensuring prompt notification of claims to insurers; and
- staying alert to sanctions to understand implications, investigate whether current customer and supplier due diligence procedures account for sanctions risk and are robust.
