Russia’s invasion of Ukraine and Western sanctions have had a significant impact on supply chains for commodities with prices for crude oil, nickel, wheat and other grains surging sharply.
The prices for such commodities have skyrocketed as Russia and Ukraine are major suppliers of these commodities across the globe. Ukraine and Russia produce and export much of the world’s wheat and other grains whilst Russia is a major producer of crude oil and nickel.
On 8 March 2022, U.S. President Joe Biden announced a ban on U.S. imports of Russian oil and gas to target the “main artery of Russia’s economy”. Crude oil hit its highest price in more than 7 years with the price of Brent crude rising from US$70 per barrel several months ago to more than US$129 per barrel after the announcement. Also on 8 March 2022, following a 250 per cent rise in the nickel price within 24 hours, the London Metal Exchange suspended trading of nickel on the exchange due to a systemic risk to the market and in an unprecedented move cancelled all trades that took place that morning effectively rewinding the market to its closing position on 7 March 2022.
In addition to surging prices, many reports indicate that a drop in the supply of essential commodities such as crude oil, nickel and agricultural products will lead to market shortages. Commodity markets will be volatile for months to come.
Many businesses are finding it increasingly difficult to fulfil contractual obligations and are concerned about their liability for non-performance given the disruptions to supply and rising prices.
Most international commodity contracts are governed by a common law legal system such as English law. There are two primary avenues for contractual relief due to circumstances beyond the control of a party – a force majeure clause and the doctrine of frustration. We discuss below whether current market circumstances may constitute a force majeure event or a frustrating event or allow you to terminate the contract early (and the risks of doing so wrongly).
A. Force majeure
Parties to a contract may specifically excuse non-performance of a contract upon the occurrence of certain events in the form of a ‘force majeure’ clause. Relief under a force majeure clause in a common law contract will depend on the content of the clause itself. Such a clause may excuse or suspend the performance of contractual obligations while the force majeure event persists. If the non-performance is extended or becomes permanent, the force majeure clause may provide for a right to terminate the contract. In the absence of a force majeure clause, parties to common law contracts cannot obtain force majeure relief and have to rely on the narrower doctrine of frustration, which is discussed below.
A change in the profitability of the contract or increase in cost of performance is not enough to amount to force majeure. To invoke force majeure relief, the non-performing party would need to show that the relevant force majeure clause has been triggered which will depend on the precise language and intent of the force majeure clause.
Typically, a force majeure clause will:
- list a series of events which are beyond the parties’ control that constitute force majeure events;
- specify the effect on a party’s performance which the event must have in order for the clause to apply (for example prevent, hinder or delay);
- provide whether reasonable measures have to be undertaken to mitigate the effect of the event; and
- set out the consequences on the parties’ contractual responsibility when a force majeure event occurs.
Below we look at how these may apply in current market circumstances:
- Force majeure events beyond the parties’ control: Usually rising prices or market shortage in themselves would not be defined as force majeure events. Nevertheless, “war”, “hostilities” or “sanctions” are common force majeure events. A party to the contract may be able to invoke force majeure protection if its performance is affected as a consequence of Russia’s invasion of Ukraine or sanctions. Contracting parties and Courts may ask themselves, was it the war or the sanction that prevented, hindered or disrupted performance or some consequential, indirect or flow on effect? How direct the link between the invasion or sanctions and the effect on performance will depend on how the clause is worded. The present situation may also fall within a catch-all provision typically included in force majeure clauses: “events, circumstances or causes beyond the reasonable control of the parties”.
- The force majeure event has prevented, hindered or disrupted the performance of its contractual obligations. Simply because a contract has become more expensive to perform does not mean that a party has been prevented, hindered or disrupted in its performance. English and other common law courts have drawn a distinction between “prevent” and “hinder”. Events which do not literally prevent the performance of a contract but render continued performance commercially impractical or more difficult may be considered a “hindrance”.
- There were no reasonable steps the party could have taken to avoid the effects of the force majeure event. A force majeure clause will typically impose an obligation on the affected party to take all reasonable steps to avoid or mitigate the force majeure event or its consequences such as sourcing from alternative suppliers. Force majeure can only be invoked if it is not possible to avoid the effects. This does not mean though that a party is required to sacrifice its own contractual rights. An English Court recently held that a reasonable endeavours obligation in a force majeure clause did not require a contractual party to accept payment in a different currency when the contract required payment in US dollars, payment in US dollars being prevented due to sanctions.[1]
- The consequences. Usually, a force majeure clause will suspend performance for a certain time period but then allow either party to terminate the agreement. Given that the war in the Ukraine and sanctions may continue for some time, the possibility of termination is an important factor to weigh up when choosing to invoke force majeure.
Finally, it is important for the non-performing party to comply with any notice or other requirements imposed by the force majeure clause. Often, a party is required to invoke force majeure immediately or within a certain number of days of its performance being affected and not doing so may result in a party losing the ability to claim force majeure. One of the benefits of a force majeure clause is to improve certainty around when a force majeure event is taking place. If a party does not give notice, that certainty is lost. Conciliatory parties may prefer to negotiate over whether a force majeure event has, in fact, taken place rather than issue a notice but such an approach can destroy the benefit of the force majeure clause. It may be better to issue notice of a force majeure event and negotiate afterwards. Otherwise, if litigation later ensues, a court properly interpreting the contract will find that the force majeure clause was never triggered and the doctrine of frustration – which the parties had sought to avoid – is all that is available. However, the appropriateness of giving notice will depend on the clause and circumstances in question.
B. Frustration under common law
An alternative ground for contract relief in the absence of a force majeure clause is the doctrine of frustration which brings a contract to an end automatically, without either party’s act or election, and the parties are discharged from further liability under it.
Unlike force majeure which determines how outstanding obligations should be resolved in the event of a foreseeable event, the doctrine of frustration concerns the treatment of contractual obligations in the event of an unforeseeable event which makes the performance of contractual obligations impossible or “radically different” from what had been agreed in the contract such that it would be unjust to hold the parties to the strict contractual obligations.[2] Upon the occurrence of such an event, the contract is frustrated and the result is that both parties are automatically discharged from their contract by operation of law.[3] The precise relief available will depend on the governing law of the contract and the relevant statutory provisions under the applicable law.
The English and other common law courts apply the doctrine of frustration within narrow limits and it may only be relied on under exceptional circumstances. A mere change in the profitability of a contract or increase in cost to perform the contract will not result in a frustrating event, although it might if the increase is astronomical.[4] Further, the doctrine of frustration does not apply where the matters relied on are the fault of one or both parties or where the risk has been expressly allocated under the contract e.g., it will not apply where a clause of the contract (i.e., a force majeure clause) deals fully and completely with an event that would otherwise, absent the clause, frustrate the contract.[5]
For frustration to apply, the non-performing party will be required to show that:
- An unforeseeable event has occurred i.e., the particular event was not provided for by the parties in the contract. Whether an event was unforeseeable is determined by the date at which the contract was entered into by the parties. Prior to 24 February 2022, Russia’s invasion of Ukraine or the imposition of new sanctions on Russia were arguably unforeseeable. However, if the contract contains a force majeure clause that deals with the otherwise frustrating event, such as “war”, “hostility” or “sanctions”, the non-performing party may not be able to rely on the doctrine of frustration.
- The unforeseeable event has rendered performance under the contract impossible or radically different from what was agreed. For instance, a supply contract may be impossible to perform if the seller is not able to obtain the relevant products itself or raw materials to produce the products. However, a contract will not be frustrated where there is an alternative method of performance and no fundamental difference between the original and alternative method of performance. For instance, if a supplier under a supply contract is no longer able to obtain crude oil from Russia but is able to obtain crude oil with the same specifications from the U.S., even if the supplier’s obligations are more difficult or expensive to perform, the contract will likely not be frustrated.
As frustration brings a contract to an end automatically, it is desirable for parties who do not wish to continue their contract or maintain their commercial relationships. For parties who do want to maintain their commercial relationships, invoking a force majeure clause would be preferrable if the clause provides for an extension of time or suspension of the performance of contractual obligations rather than bringing the contract to an automatic end.
C. Other termination or suspension provisions or entitlements
If force majeure and frustration do not apply, there may be specific provisions in the contract which entitle you to terminate or suspend the contract which should be considered. For instance, some modern contracts may have a specific sanctions or compliance provision, which allows a party to suspend or terminate if the other party becomes sanctioned. Similarly, a sale contract may provide that the seller is entitled to review the sale price if the cost of raw materials increases by a certain percentage and failing agreement on the reviewed price a termination right applies. Conversely, it may be the case that any non-performance by one party of its contractual obligations due to the market shortage and/or rising prices constitutes an event which entitles the other party to terminate the contract under a termination clause. In this case, the innocent party may terminate the contract and exercise the right to claim damages against the non-performing party.
In either case, the party seeking to rely on termination or suspension needs to adhere strictly to the notice requirements in the contract. Any failure to comply with those requirements may render the notice invalid.
Under common law, even if not expressly provided for, a party will generally have the right to terminate a contract for a repudiatory breach namely if:[6]
- the defaulting party by words or conduct or silence informs the other party that he or she will not perform his or her contractual obligations;
- the breach is of a condition of the contract; or
- the breach deprives the innocent party of substantially the whole benefit which it was intended to obtain from the contract.
When faced with any of the above repudiatory breaches, the non-defaulting party is entitled to exercise a right to terminate the contract and claim damages for the breach. The non-defaulting party is not obliged to exercise its right to terminate and may elect to affirm the contract (i.e., to treat it as ongoing) and claim damages for any breaches of the contract. A party will be found to have affirmed the contract if it has acted in a manner which evidences an intention to continue with its contractual obligations. Once a contract has been affirmed, with knowledge of the breach, the non-defaulting party is no longer entitled to terminate the contract for that specific breach, but it may be entitled to terminate at a subsequent date if the breach continues or the defaulting party commits another breach of the contract.
Before terminating a contract, it is important for the terminating party to consider carefully the legal basis on which it is seeking to terminate the contract. There are serious consequences for terminating a contract on the mistaken belief that there is a right to do so. This could be construed as a repudiatory breach of the contract which would entitle the other party to accept the repudiation, terminate the contract and claim damages. If the non-defaulting party affirms the contract and loses its right to terminate, any belated attempt to terminate will be considered a repudiatory breach thereby entitling the other party to terminate the contract and claim damages.
Conclusion
The market shortages and rising prices of commodities potentially give rise to defaults in performance. It is important to:
- review any force majeure clause contained in the contract and take advice on its scope under the governing law of the contract. If the current circumstances fall within an event provided for in the force majeure clause, carry on contractual obligations to the greatest extent possible and undertake any reasonable steps to mitigate the effect of the force majeure event on contractual performance. Inform the other party of the force majeure event in accordance with any notice or other requirements stipulated in the force majeure clause. Consider what relief is provided for in the force majeure clause such as suspension of contractual obligations or extensions of time for the performance of contractual obligations;
- take advice on whether the doctrine of frustration applies under the governing law of the contract and the consequences (e.g., automatic termination of the contract) if the doctrine applies. Consider whether it is desirable to invoke the doctrine of frustration given such consequences and if so, notify the other party at the address in the notice provision. Mitigate the effects of any frustrating event and potential losses sustained by the other party;
- review the termination or suspension provisions in the contract and take advice on whether there exists a ground for terminating or suspending the contract. Ensure that any notice requirements are met and notices sent to the correct address when exercising a right to terminate or suspend;
- keep records of any non-performance or breach of the contract, including the timing of non-performance, mitigation efforts and losses sustained; and
- actively negotiate with the other party for possible waivers, time extensions and mutually beneficial alternatives to fulfil contractual obligations – a front-foot approach is typically the best.
References
[1] MUR Shipping BV v RTI LTD [2022] EWHC 467 (Comm)
[2] National Carriers Ltd v Panalpina (Northern) Ltd [1981] A.C. 675 at 700; Notcutt v Universal Equipment Co (London) Ltd [1986] 1 W.L.R. 641 at 4; Alliance Concrete Singapore Pte Ltd v Sato Kogyo (S) Pte Ltd [2014] 3 SLR 857 at [33]-[36]; Wong Lai-ying v Chinachem Investment Co Ltd [1980] HKCU 1 at 6-7.
[3] National Carriers Ltd v Panalpina (Northern) Ltd [1981] A.C. 675 at 712; Dathena Science Pte Ltd v Justco (Singapore) Pte Ltd [2021] SGHC 219 at [184].
[4] Tsakiroglou & Co Ltd v Noblee Thorl GmbH [1962] A.C. 93 at 118, 128-129; Alliance Concrete Singapore Pte Ltd v Sato Kogyo (S) Pte Ltd [2014] 3 SLR 857 at [39].
[5] Select Commodities Ltd v Valdo SA [2006] EWHC 1137 (Comm) at [6].
[6] Grand China Logistics Holding (Group) Co. Ltd. v Spar Shipping AS [2016] EWCA Civ 982 at [21].
