THE OIL & GAS “CONTRACTING COMPASS”

5 – POINTING THE COMPASS TOWARD FRUSTRATION & FORCE MAJEURE

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INTRODUCTION

Welcome to the fifth white paper of the “Contracting Compass” seminar series – a Brodies oil and gas initiative to provide insight on issues of English law relevant to oil and gas contracts. Recognising that the landscape of the contract is sometimes difficult to navigate, the “Contracting Compass” provides a continuing commentary on English law by highlighting key clauses from the contract and focusing on particular points of law and practice most relevant to each clause in a way which heightens awareness of the whole of the landscape.

As shown in the image below, we have changed the directional points of the compass.

The compass is labelled in this way because navigating the landscape of a contract requires knowledge of the law, an understanding of how language should be drafted in light of the law, and recognition of how that language will work in practice – whether it relates to contract performance, the ultimate commercial concern of payment or, if a breach has occurred, damages or other remedies.

For each seminar in the series, we will present a white paper dedicated to a single topic. This paper covers the topic of Frustration and Force Majeure.

Frustration and Force Majeure can be characterised as two sides of the same coin when performance of a contract is prevented by the unexpected. In the case of Frustration, the parties rely upon the common law doctrine to cope with commercial consequences not contemplated when the contract was created. In the case of Force Majeure, the parties rely upon contract language to attempt to predict the unpredictable and manage the commercial relationship if the unpredictable occurs.

The conundrum of attempting to predict the unpredictable and know the unknown is reminiscent of an amusing historical quote from the White House – before Twitter.

“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.”

Donald Rumsfeld

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Rumsfeld’s words date back to 2002 when he was acting as Secretary of Defence and responding to questions about what was known, or not known about weapons of mass destruction. Decisions in our day jobs are never as momentous as war in the Middle East, but the quote is topical because there are distinct advantages to “knowing what you don’t know” when negotiating and drafting a contract.

The vast majority of oil & gas contracts have substantial value, have exposure to significant risk, and have sensitivity to many factors which a party cannot, in all circumstances, know, control or predict – such as weather, war, terrorism, volcanic ash and many others more specifically mentioned later in this paper.

When performance of a single contract is vital to project success, when the value is so high (often in the order of hundreds of millions of dollars in the oil & gas industry), when the consequences are so significant, and when there is figuratively so much to play for, it is imperative for parties to anticipate, at the outset of the contract, any remote contingencies that could prevent performance. It is also imperative to understand what rules may be appropriate, or necessary to regulate the commercial relationship in the event of such contingencies.

In this paper, we have considered many of these contingencies, and also the relevant rules, from two perspectives:

• Part 1 – Frustration and the rules that apply at law; and

• Part 2 – Force Majeure, which if properly considered and drafted in the contract, can protect the parties where the law would otherwise not.

We hope you find this paper to be of use and if you are interested in attending any of our accompanying seminar series, please do not hesitate to contact us directly.

GREG MAY KEN MACDONALD PARTNER, OIL & GAS PARTNER, LITIGATION greg.may@brodies.com ken.macdonald@brodies.com 01224 392 255 01224 392 170

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PART 1 – FRUSTRATION

BACKGROUND

As a general proposition, English law requires parties to a contract to perform all terms and conditions in order to discharge their obligations. As explained in more detail in the “Looking at the Law” section below, this requirement can result in harsh and unintended consequences when an event occurs which is misaligned with the commercial intent of the parties when the contract was formed. The doctrine of frustration has been recognised by the English courts as a limited means to protect a party from such consequences. It is “limited” because there are very narrow parameters recognised under English law for applying the doctrine. This is also explained in more detail in the “Looking at the Law” section.

The Purpose

The purpose of the doctrine of frustration is, from a practical and commercial perspective, to bring a contract to an end automatically when something unexpected happens which makes performance impossible or which changes the nature of the outstanding contractual rights and obligations so significantly that it would be unjust to hold the parties to the contract.

The purpose of the doctrine is not to relieve contracting parties from the normal consequences of imprudent commercial bargains. A contract will not be frustrated under English law just because it has become more difficult or expensive to perform. Freedom of contract is a cornerstone of English commercial law and, for this reason, the courts have long been predisposed to refrain from interfering with the basis of any commercial bargain.

Connected to the philosophy of freedom of contract is the reality that risks are intrinsic to any commercial relationship and where they are contemplated by the parties when entering into a contract, the doctrine of frustration will not be entertained by the courts as a means of mitigating or avoiding such risks.

The Principles

As mentioned more fully in the “Looking at the Law” section, a frustrating event is, in principle, one which:

• Occurs after the contract has been formed;

• Is so fundamental as to be regarded by the law both as striking at the root of the contract and as entirely beyond what was contemplated by the parties when they entered into the contract;

• Is not due to the fault of either party; and

• Renders further performance impossible, illegal or makes it radically different from that contemplated by the parties at the time of the contract.

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LOOKING AT THE CONTRACT

Principles-To-Practice

Does It Matter?

If the doctrine has limited and narrow application, the corollary question is - why does it matter, in practice, and why is it relevant to the Contracting Compass? The answer is, stated simply, that when working in-house, it is imperative to know your business and to know each contract in terms of its potential. However, you cannot fully understand what can be achieved from a commercial relationship without also understanding any limiting factors.

If the doctrine of frustration does have narrow application, it is important to understand in advance what those limits may be and, if possible, proactively consider what alternatives may be available in lieu of the boundaries.

We therefore clarify the limits of the doctrine in the following section “Looking at the Law”. Later in the paper, we turn to some drafting tips to highlight certain alternatives to consider in the contract in order to transcend the boundaries of the law. Force Majeure is the most noteworthy alternative and it is covered at length in Part 2; but there are others.

LOOKING AT THE LAW

Common Law

To understand the doctrine of frustration, it is useful to understand why it was first established.

The common law required literal performance of absolute promises. This is what came to be known historically as the rule of “absolute contracts”. The case of Paradine v Jane (1646) Aleyn 26 is an interesting illustration of this rule. In this case a tenant of a farm was found liable for rent arrears for a period of two years despite having been evicted and kept out of possession of the property during that time. Great significance was placed upon a party making good an obligation it had assumed and, in any event, it was thought that parties could provide for supervening events in their contract. Clearly, to the modern lawyer, the decision in this case seems completely unjust and the idea that parties can provide for all supervening events is wholly unrealistic, even if you have a brilliantly drafted force majeure clause!

Thus, the doctrine of frustration was first introduced into English law to mitigate the harsh effects of the rule as to absolute contracts.

“It is really a device, by which the rules as to absolute contracts are reconciled with a special exception which justice demands" - Lord Sumner in Hirji Mulji and Others, Appellants v Cheong Yue Steamship Company Limited, Respondents [1926] A.C. 497 at 510.

Initially the doctrine was established to deal with situations where the physical subject matter of the contract had perished (Taylor v Caldwell (1863) 3 B & S 826). In such circumstances it was considered that there was, in the words of Blackburn J. “an implied condition that the parties shall be excused in case, before breach, performance becomes impossible from the perishing of the thing without default…”.

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The doctrine of frustration has since been extended beyond cases where the subject matter had perished to cases where, despite no physical destruction of the subject-matter, the “commercial adventure” envisaged by the parties was frustrated. The court has also since moved away from the “implied term” test because it was deemed artificial as it was unlikely that there would ever be a genuine common intent to terminate a contract upon the occurrence of a particular event. In most cases parties would not say “it is all over between us”; they would seek to include reservations and qualifications to protect their respective positions. With that in mind, the now favoured test is a “radical change in the obligation”. Lord Radcliffe in Davis Contractors Ltd v. Fareham Urban District Council [1956] AC 696 stated:

“...frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non haec in foedera veni. It was not this that I promised to do.”

The common law principle is that if a contract is found to have been frustrated, both parties are released from further performance and neither is entitled to sue the other for breach.

Details of the Doctrine

Given that the effect of frustration is to terminate the contract and discharge the parties from further liability under it, the courts are unwilling to invoke the doctrine lightly. There are strict limits which the courts are loathe to extend.

In National Carriers Ltd v Panalpina (Northern ) Ltd [1981] A.C. 675, Lord Simon set out the strict limits of the doctrine:

“Frustration of a contract takes place when there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged from further performance.”

Lord Simon’s description of the limits of the doctrine helpfully sets out what is required before a court will consider a contract to have been frustrated:-

• Firstly, there must be a supervening event;

• Secondly, the supervening event must not be caused by the default of either party;

• Thirdly, the contract must not make provision for the supervening event; and

• Finally, the event must have so significantly changed the nature of the obligations from what was considered when the contract was entered into that it would be unjust to force the parties to perform.

Let’s look at each in turn.

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Supervening event

The crux of this is that the event must not have been foreseen or be foreseeable for frustration to apply. If an event is foreseen or foreseeable then it is considered to have been within the contemplation of the parties at the time of entering the contract and will not therefore frustrate the contract. The rationale for this is that the risk arising from the event falls on the party which bears it under the contract. Parties choosing not to alter the allocation of risk in their contract in circumstances where they had the risk in mind at the time of contracting (i.e. by using a force majeure clause) are taken to be content with the harsh effects of the rule as to absolute obligations.

If parties consider a particular event to be foreseeable, but ultimately do not make provision for it, the contract is unlikely to be considered frustrated if the event actually occurs. In Ocean Tramp Tankers Corporation v. V/O Sovfracht, The Eugenia [1964] 2 QB 226, Lord Denning held that where parties who had chartered a vessel for a trip to India via the Black Sea were aware of the possibility that the Suez Canal might be closed as a result of military activity, but did not make provision for it in their contract, the effect of the closure of the canal did not frustrate the contract.

The lesson here is, if you’ve thought about the possibility of an event happening, draft a clause to cover it, lest you be exposed!

Default of either party

A supervening event is considered to be one which is altogether out with the control of the parties. Therefore a party who is at fault or whose act was deliberate will generally be unable to invoke frustration because of the difficulty that party will face in showing the existence of a supervening event out with its control. This is known as “self-induced frustration”. Lord Justice Bingham considered this issue in J Lauritzen AS v Wijsmuller BV (The ‘Super Servant Two’) [1990] 1 Lloyd’s Rep 1 –

“…whether the frustrating event relied upon is truly an outside event or extraneous change of situation or whether it is an event which the party seeking to rely on it had the means and opportunity to prevent but nevertheless caused or permitted to come about. A fine test of legal duty is inappropriate; what is needed is a pragmatic judgment whether a party seeking to rely on an event as discharging him from a contractual promise was himself responsible for the occurrence of that event.”

In circumstances where a party proves that there was a supervening event which, on the face of it could frustrate the contract, it is for the other party to prove that the frustration was self-induced.

Contractual Provisions

If a provision within the contract seeks to deal with the occurrence of an event then such event will not frustrate the contract. Thus the effect of a force majeure clause may be to eliminate the possibility of invoking the doctrine of frustration because the contract will be held to have covered the event which has occurred. This is not an absolute rule however as force majeure clauses are intended to cover events which are capable of being resolved relatively quickly whereas the doctrine of frustration covers events which render further performance impossible. This will be covered in further detail later in this paper – see force majeure.

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Radical change in obligations

The starting point in considering whether there has been a radical change in obligations is to look at the terms of the contract itself to establish what the extent of the contractual obligations are in order to decide whether the supervening event satisfies the test.

Below are a few examples of events which will radically change the obligations and frustrate a contract:-

• IMPOSSIBILITY

The archetypal case of a frustrated contract is where the subject matter of the contract is destroyed or a party is unavailable due to illness, death or some other exceptional circumstance.

Taylor v Caldwell (1863) 3 B & S 826 is an example of frustration due to impossibility. The parties entered into a contract to let The Surrey Gardens and Musical Hall over four days for the purpose of holding various concerts and fetes. After execution of the contract but before the first concert, the Music Hall was destroyed by fire. The Court held that the parties had contracted on the basis of the continued existence of the Music Hall at the time when the concerts were to be given; that being essential to their performance and that the destruction of same, without fault of either party, resulted in the contract being frustrated and the parties were thus excused from their obligations under the contract.

Impossibility must however be distinguished from commercial impracticability. In Davis Contractors Ltd v. Fareham Urban District Council [1956] AC 696, building work took some 14 months longer than expected and cost around £20,000 more than the contract price. In the circumstances, as the work had been completed, albeit late and over-budget, it was clearly not impossible for Davis to carry out their contractual obligations. Lord Radcliffe said “To my mind, it is useless to pretend that the contractor is not at risk if delay does occur, even serious delay. And I think it a misuse of legal terms to call in frustration to get him out of his unfortunate predicament.”

Therefore parties must be careful not to confuse impossibility and commercial impracticability as the latter does not result in a contract being frustrated under English Law. Some jurisdictions, such as the USA, do however recognise the doctrine of commercial impracticability in certain circumstances.

• SUPERVENING ILLEGALITY

This concerns contracts which were valid when formed but become illegal to perform as a result of the occurrence of events subsequent to the making of the contract. For example, a contract to provide services in Russia may have been deemed to be frustrated as a result of EU sanctions imposed in 2014. This is to be distinguished from contracts which are affected by illegality from the outset.

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• FRUSTRATION OF PURPOSE

There is also the possibility of frustration of the purpose of a contract. The courts are keen to avoid this concept becoming an easy escape for parties to bad bargains. However, as a result of a narrow interpretation, the law in this area is confusing and unclear.

In Krell v Hutton [1903] 2 KB 740, Krell entered into a contract with Henry to allow Henry to occupy his flat on Pall Mall during the days of the King’s coronation procession. Henry paid Krell a deposit and agreed to pay the balance at a later date. The King later became seriously ill and the procession was cancelled. Henry refused to pay the balance and Krell sued. Ultimately the Court of Appeal held that Krell was not entitled to demand the balance on the ground that the contract between the parties had been frustrated.

However, somewhat confusingly, in Herne Bay Steam Boat Company v. Hutton [1903] 2 KB 683, Court of Appeal, in circumstances where Hutton chartered a steamboat to carry passengers to see a Royal Navy review and cruise round the fleet and the review was subsequently cancelled, the contract was not deemed to have been frustrated.

The main difference between these two cases is that in Krell, the common purpose of both parties was that facilities for viewing the processions should be provided and the cancellation of the procession prevented the achievement of that common purpose, whereas in Herne Bay, the common purpose was not wholly defeated as the fleet was still present and could provide entertainment for spectators.

Effect of Frustration

At common law, the effect of frustration is that the contract is brought automatically to an end on the occurrence of the frustrating event and both parties are released from further performance of their obligations. Termination is not retrospective and the contract is not rescinded ab initio (from the outset).

The law of contract does not regulate the financial consequences of a contract being discharged as a result of frustration. The common law lets the loss lie where it falls. This, much like the rule as to absolute contracts has resulted in extremely harsh decisions. Ultimately Parliament was compelled to intervene in the form of the enactment of the Law Reform (Frustrated Contracts) Act 1943 (the “Act”).

The Act applies only to a contract which is governed by English law and which has become “impossible of performance or been otherwise frustrated”.

The Act adjusts the rights and liabilities of parties who have been discharged from further performance of the contract as a result of a frustrating event.

s.1(2) provides that all sums paid before the time of discharge are recoverable and all sums payable before the time of discharge, cease to be payable. Therefore if a buyer has paid the purchase price for goods before the frustrating event occurs, the buyer is entitled to repayment and if the buyer has not paid the purchase price but it became payable before the frustrating event occurs, then it ceases to be payable.

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s.1(2) further provides that if the party to whom sums were paid or payable, incurred expenses before the time of discharge in, or for the purpose of, the performance of the contract, the court may, if it considers it just, allow that party to retain or recover the whole or any part of the sums paid or payable, not exceeding the amount of the expenses incurred. Therefore if a seller incurs expenses in manufacturing or packaging goods before the frustrating event occurs, the seller may, if the court considers it just to do so, set off those expenses against the sums paid or payable by the buyer before the frustrating event occurred.

s.1(3) deals with situations where one party obtains a valuable benefit (other than a payment of money) by virtue of something done by the other party to the contract in or for the purpose of the performance of the contract. The court may require the party who gained the valuable benefit to pay a “just sum” for it.

The concept of a “just sum” was explored in BP Exploration Co (Libya) Ltd v. Hunt (No 2) [1979] 1 WLR 783.

Mr Hunt owned an oil concession in Libya but did not have the resources to exploit it. He entered into a joint venture with BP to carry out exploration and development. The joint venture contract stated that (i) Mr Hunt would transfer to BP half the concession (ii) BP would transfer Mr Hunt’s ‘farm in’ contributions in cash and oil and (iii) 3/8ths of Mr Hunt’s share of the oil produced from the field would go to BP until 125% of the ‘farm in’ contributions and half of BP’s costs were repaid. A huge oil reserve was discovered in 1967 and substantial quantities of oil were produced from the field but in 1971 BP’s interest in the oil field was expropriated by the Libyan government and then in 1973, Mr Hunt’s interest was also expropriated.

BP claimed that the contract had been frustrated and claimed for a just sum to be awarded under s.1(3) of the Law Reform (Frustrated Contracts) Act 1943.

It was clear to the court that the contract had been frustrated as a result of the expropriation of the concession and that Mr Hunt had obtained a valuable benefit from BP before the contract was discharged. The difficulty faced was valuing that benefit.

Ultimately Robert Goff J concluded that the ‘valuable benefit’ which Mr Hunt had obtained as a result of the work done by BP before the frustration of the contract was the ‘end product’ of BP’s services. BP was awarded $35.4m plus interest.

It is important to note that the Act does not apply to certain shipping contracts, insurance contracts and contracts for specific goods which have perished. In relation to these contracts, parties must rely on the common law. This provides that sums paid before the frustrating event are recoverable only if there is a total failure of consideration. If the failure of consideration is only partial then the sums are not recoverable. Any expenses incurred in performing the contract are also not recoverable.

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PART 2 – FORCE MAJEURE

PURPOSE

Frustration is invoked at law, but force majeure is conversely a creature of contract. As explained more fully when “Looking at the Law” below, any protection provided by force majeure is wholly dependent on the parties making provision for it in the contract. Under English law, it is not a term of art, it is not a legal concept standing separate from the contract, and it is not a right or remedy enjoyed by either party independent of the contract.

As highlighted in Part I above, the principles of English law are rigid – i.e. a contractual obligation is recognised as absolute and “frustration” will only apply as an exception in exceptional circumstances. Where the law is inflexible or inadequate, commercial practice is often the only way to address gaps and redress deficiencies – not only where the law is absent but also where it does apply and does not, in practice, sufficiently serve the commercial relationship.

From a practical perspective, it is therefore imperative for the parties to remain vigilant of the limits of the law and, where recognised, to attempt to create a comprehensive framework in the contract in order to fully and effectively regulate the contractual relationship in a way which is consistent with commercial intent. As mentioned in Part 1, a force majeure clause does not stand alone as the singular solution. It is one clause, among many, that should be considered as a means for protecting the parties beyond the boundaries of the law. All of these types of clauses are of a class we refer to collectively as “alternatives to the law”

The Drafting Tips at the end of Part 2 provide a summary reference to specimen language for other clauses. The focus herein is force majeure – therefore, detailed consideration of the other alternatives is beyond the scope of this paper. However, reference to each is relevant and the specimen language shown at the end will be a continuing point of reference in this Part 2. A force majeure clause can only be properly drafted in the context of the whole of the contract. If there are other clauses also existing as “alternatives to the law”, the interplay between them and the force majeure clause must be well understood. If similar risks or concerns are covered by other clauses, the force majeure clause must be tailored to avoid conflict and complement the whole.

The following paragraphs highlight the preferred structure of a force majeure clause. Within that structure, we describe the key components which comprise it. In respect of each of the components, we refer to detailed “specimen” language and consider how such language will work in practice. Likewise, where language of the “force majeure framework” interrelates with other provisions of the contract, we highlight this interplay against the whole of the “contractual framework”.

First principles are, however, the cornerstone of the structure. For that reason, we initially provide an outline of these principles as context. Against this backdrop, we set forth the structure of a typical clause, consider the component parts, and focus on the language therein. A final layer of context is the law. Any framework created in the contract must be (i) interpreted, (ii) applied and (iii) enforced at law.

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First Principles –

• CREATE IT: Force majeure is not, by nature, a legal concept. It must be created by contract.

• DEFINE IT: Recognising force majeure as a concept is not enough, it must be clearly defined.

As more fully explained in “Looking at the Law”, English courts will generally give the language a narrow construction. Boilerplate provisions may be a trap for the unwary and general language may not be adequate to address certain risks particular to the parties, the jurisdiction, the area of operations, the environment, and the commercial relationship

When defining it, is descriptive language enough, is a list required; are both required?

• PROVE IT (THE EVENT IS NOT ENOUGH): If an event is clearly defined as force majeure and it has occurred, the happening of the event will, alone, typically not be enough to trigger protection. What is the additional burden of proof? Who bears the burden?

• IF YOU PROVE IT, WHAT ELSE: A clause may also provide other evidentiary hurdles and additional points of process may apply - such as written notice, reasonable steps to mitigate, a continuing duty to cooperate, an ongoing responsibility to confer with the other party in respect of contingencies, and a continuing commitment to communicate relevant information.

• IF “FIRST PRINCIPLES” ARE FULFILLED, WHAT NEXT: This last question is addressed in the details of drafting. It is largely left to the parties to agree the parameters of protection, how long the protection applies, how it affects other provisions of the contract, when, or if it escalates to termination after a specified period, and how it relates to other commercial/contractual consequences that may arise from non-performance.

LOOKING AT THE CONTRACT

From Principles-To-Practice

The Structure

In terms of structure, a force majeure clause will typically create a framework for the parties to manage their commercial relationship, at least for an interim period, in the wake of a serious event beyond the control of a party which prevents that party’s performance of one or more obligations. The framework will typically attempt to manage the relationship in a way which will avoid a dispute regarding breach and will attempt to forestall the contract being terminated for long enough for the parties to consider the commercial practicalities of continuing the relationship, or not.

A typical force majeure clause will therefore have a suspensory effect on all or part of the contract. The framework of a typical clause will be centred, in essence, on fulfilling this fundamental purpose – i.e. putting the relationship on pause. This is broadly reflected in Clause 12.1 from the below language extracted from LOGIC On-Offshore Services, Ed. 3.

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Looking at LOGIC

LOGIC On-Offshore Services, Ed.3 - Clause 12:

12.1

Neither PARTY shall be responsible for any failure to fulfil any term or condition of the CONTRACT if and to the extent that fulfilment has been delayed or temporarily prevented by a force majeure occurrence, as hereunder defined, which has been notified in accordance with this Clause and which is beyond the control and without the fault or negligence of the PARTY affected and which, by the exercise of reasonable diligence, the said PARTY is unable to provide against.

12.2

For the purposes of this CONTRACT only the following occurrences shall be force majeure.

(a) Riot, war, invasion, act of foreign enemies, hostilities (whether war be declared or not), acts of terrorism, civil war, rebellion, revolution, insurrection of military or usurped power;

(b) Ionising radiations or contamination by radioactivity from any nuclear fuel or from any nuclear waste from the combustion of nuclear fuel or radioactive, toxic, explosive or other hazardous properties of any explosive nuclear assembly or nuclear component thereof;

(c) Pressure waves caused by aircraft or other aerial devices travelling at sonic or supersonic speeds;

(d) Earthquake, flood, fire, explosion and/or other natural physical disaster, but excluding weather conditions as such, regardless of severity;

(e) Strikes at a national or regional level or industrial disputes at a national or regional level, or strikes or industrial disputes by labour not employed by the affected PARTY its subcontractors or its suppliers and which affect a substantial or essential portion of the WORK;

(f) Maritime or aviation disasters;

(g) Changes to any general or local Statute, Ordinance, Decree, or other Law, or any regulation or bye-law of any local or other duly constituted authority or the introduction of any such Statute, Ordinance, Decree, Law, regulation or bye-law.

12.3

In the event of a force majeure occurrence, the PARTY that is or may be delayed in performing the CONTRACT shall notify the other PARTY without delay giving the full particulars thereof and shall use all reasonable endeavours to remedy the situation without delay.

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12.4

Save as otherwise expressly provided in the CONTRACT, no payments of whatever nature shall be made in respect of a force majeure occurrence.

12.5

Following notification of a force majeure occurrence in accordance with Clause 12.3, the PARTIES shall meet without delay with a view to agreeing a mutually acceptable course of action to minimise any effects of such occurrence.

Key components

The above LOGIC language shows the structure, but it also contains the detail of various key components which comprise a typical force majeure clause. In summary, a typical clause is comprised of the following parts and each of these parts is logically linked to a corresponding first principle.

• The event – how it is defined?

• What is the trigger for protection under the clause? More than the event is required?

• What additional burden of proof is required?

• What other formalities or procedures apply?

• If protection is triggered, what are the parameters? In other words, how does protection apply in practice and what is the scope?

• If scope is limited, what is covered in practice, what is not?

• If risk is not covered by force majeure, is it covered elsewhere? Is so, what is the interplay with other provisions?

Looking at the language

Referring to the above listed key components, each is a helpful context for looking in more detail at the language.

In this regard, we turn to the first key component – defining the event.

The above LOGIC language creates an exhaustive and exclusive list of those occurrences that will constitute a force majeure event. Referring to Clause 12.2, it provides in relevant part that “For purposes of this CONTRACT only the following occurrences shall be force majeure”.

From the perspective of commercial practice, there are two competing concerns to balance in determining whether to create a list of specific events and in deciding whether the list should be exhaustive and exclusive, or merely illustrative.

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The first concern is narrow construction of language by the courts. Given this general attitude under English law, if the parties have some degree of appreciation of the potential for an event of significance to occur and prevent performance, it will invariably be best practice to identify it explicitly as a listed event. The second concern is that even the most experienced of parties to a contract will have limited powers to predict all events which may arise in the course of the commercial relationship and rise to the level of interfering with performance. Contracts may be long term and degrees of exposure to particular types of risk may change. Likewise, the commercial relationships within a contract will evolve. For these reasons, there is a persuasive point that an exhaustive list may prove over time to be too limiting.

However, the countervailing concern is that general language may be the subject of dispute. Likewise, it may give a party too much latitude to be protected from an event that leads to a breach. There may be a commercial view that absolving a party of liability for breach for any period should only be afforded in the most exceptional circumstances and such circumstances will always be more precisely identified in an explicit list, not general language.

In Looking at the Law, we consider in more detail the principles of interpretation that may apply to any list that is created (whether exhaustive or non-exhaustive).

The second key component is the trigger for protection.

The happening of an event is not, alone, enough. The primary purpose of a force majeure clause is to protect a party from the occurrence of an event when such event interferes with performance. Therefore, the event (by list or otherwise) must be coupled with additional language regarding interference with performance, i.e. the trigger.

From a drafting perspective, why is it relevant to highlight such additional language as a separate second component? Referring to LOGIC, Clause 12.1 describes the interference as “delayed or temporarily prevented”. As explained in more detail in Looking at the Law, the protection provided by this language may arguably be interpreted as broader than merely the word “prevent”. Likewise, adding the word “hindered” to “delayed or prevented” may make the protection even more broad in the eyes of a court.

The third key component is the additional burden of proof.

There will typically be an additional burden of proof in a force majeure clause. Referring to LOGIC, this additional burden is described in Clause 12.1 as “without the fault or negligence of the party affected and which, by the exercise of reasonable diligence the said party is unable to provide against.” This type of wording will vary from contract-to-contract and the particular language used will, of course, determine the height of evidentiary hurdles to be cleared by a party. For example, a force majeure clause may have alternative language such as “unforeseeable, beyond the control and not attributable to an act or omission and by exercise of all reasonable endeavours, the said party is unable to provide against.” Adding the language “unforeseeable” does of course impose an additional burden of proof. It arguably introduces uncertainty as to what may or may not be foreseeable and from what point and time foreseeable will be determined. Also, “act or omission” is broader than “fault or negligence”. Likewise, “all reasonable endeavours” may be construed as a more onerous burden that “reasonable diligence.”

As a final note, the party seeking to rely upon the protection will bear the burden of proof.

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The fourth key component is other formalities that apply.

Other evidentiary hurdles and points of process may apply, such as written notice, continuing cooperation and responsibility to mitigate. For example, LOGIC provides in Clause 12.3 that “the PARTY that is or may be delayed in performing the CONTRACT shall notify the other PARTY without delay giving the full particulars thereof and use all reasonable endeavours to remedy the situation without delay”. This language may be assumed to be a mere formality, but in Looking at the Law we highlight the recent case in the oil and gas industry that considered the question of whether a notice obligation could be construed as a condition precedent to receiving force majeure protection.

The fifth key component is the scope of protection and how it applies in practice.

As mentioned above, by agreeing a force majeure clause the parties are creating a contractual framework for managing the relationship in the wake of an “event”. Therefore, the mechanics of how that framework will operate, how long it will continue to operate and how much protection it provides will be at the commercial discretion of the parties when drafting the terms of the contract. Referring to LOGIC On/Offshore Service Edition 3, it is clear from the language of Clause 12.1 and 12.4 that the contract will remain in suspense for the whole of any period of force majeure and during that period no payments of whatever nature shall be made unless expressly provided in the contract to the contrary.

By operation of this language the contract may remain in suspense indefinitely without either party having a right to terminate. If neither party will incur any additional costs during the period of force majeure it may be commercially acceptable for the parties to remain in suspense indefinitely. However if costs will be incurred it is less likely to be commercially acceptable or indeed equitable and a party may require a right to terminate or as a minimum a right to be compensated for any period where that party is required to stand-by. Such costs may be incurred for the purpose of either remaining on stand-by, discharging the obligation to use reasonable endeavours to remedy the situation, or performing any course of action to minimise the effects of the “event”. It also cannot be overlooked that an indefinite suspension of the contract will result in a party forgoing any other commercial opportunities. Again, all of these contingencies and the particular language relating to these contingencies will be within the contemplation and commercial discretion of the parties when drafting the clause.

The sixth key component is risk beyond force majeure.

In the same way the scope of protection will be in the commercial discretion of the parties when drafting a force majeure clause, it will also be in the commercial discretion of the parties to consider whether any protection beyond force majeure is required, and if so, what type of additional clause(s) will be required to provide such protection. It is important to acknowledge that force majeure does, in essence, only protect a party from being in breach and it does not typically contemplate that an affected party will be entitled to any other rights or remedies, other than potentially being kept whole during the standby period and being entitled to terminate after an extended period. Referring to Clause 12.2(g) if a force majeure event such as change of law results in escalation of a party’s costs, such party will not be protected within the four corners of the force majeure clause. If this risk is anticipated by the parties, a separate cost escalation or hardship clause will be required. Likewise, if a force majeure event puts a party’s property in peril in the event of war risk, for example, the parties may require a separate expropriation clause as referred to in the Drafting Tips. In short, if any of the drafting tips are adopted, the parties must also consider, in any event, the potential interplay between additional clauses in this regard and the existing force majeure provisions.

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LOOKING AT THE LAW

Creature of the contract, not common law

Force majeure (or vis major in Latin) literally translates to ‘superior force’. It is unsurprisingly a term derived from French law. As mentioned in the introduction, it is not a common law concept, but something created by contract.

In the absence of a force majeure clause, contracts can become frustrated. However, as we have covered in the previous section, the doctrine of frustration is applied reluctantly by the courts, is very limited in scope and results in automatic termination of the contract, irrespective of the parties’ wishes. The best course of action is (so far as possible) to avoid having to rely upon it at all. If a contract makes provision for a particular event occurring, then the event will be dealt with in accordance with the contract and the doctrine of frustration will not apply. A force majeure clause seeks to address the occurrence of certain events which are out with the parties’ control.

If force majeure is created by contract, how is it interpreted by the courts?

• The language of force majeure clauses varies greatly, with some requiring the performance of the contract to have been prevented by the event, while others only require performance to be hindered or delayed. Often a prescribed length of time must pass before a particular event can be considered as force majeure.

First Key Component - Creating definition

If you use a force majeure clause, you should define it. If you do not do so, the consequences could be that you do not have force majeure protection in your contract. You need to consider whether or not to use lists of scenarios that are to be treated (or not) as force majeure events. You need to decide if the list is exhaustive or otherwise. Consideration should be given to whether or not you expressly disapply certain default rules of contractual interpretation.

• Reference to force majeure only

In British Electrical and Associated Industries (Cardiff) Ld. v Patley Pressings Ltd. [1953] 1 W.L.R. 280 the terms of a contract note in relation to a sale of steel contained the following clause:

“Subject to force majeure conditions that the government restricts the export of the material at the time of delivery.”

The result was that the entire contract was held as void because the words of the force majeure clause were too obscure to be capable of any definite or precise meaning. The word “conditions” was held to mean “clauses” or “stipulations”. Given that there were a variety of force majeure conditions in the trade, and no evidence that any particular one had been agreed upon, it was held that there was no consensus ad idem, and therefore no concluded contract.

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• Exhaustive list of what is included

Creating an exhaustive list of force majeure events is not only an exhausting task, but may lead to unintended consequences. Courts do not like reading things into contracts which are clear and unambiguous. The rule of contractual interpretation known as expressio unius est exclusio alterius (latin for ‘the express mention of one thing excludes all others’) may mean that the exhaustive list, is exactly that, exhaustive! The benefit of an exhaustive list is certainty – both parties know what constitutes a force majeure event and there is no ambiguity (at least, in theory).

• Non-exhaustive list of what included

Often a general sweep up phrase will be included at the end of a force majeure clause to avoid it being considered as containing an exhaustive list. This can, however, result in unanticipated outcomes. Another rule of contractual interpretation is ejusdem generis (latin for ‘of the same kind’). The effect of this rule is that a general word is assumed to be qualified by preceding examples which are of a common category. In a commercial context there is no requirement to interpret contracts ejusdem generis and general words are to be construed as having their natural and wider meaning. However, in Tandrin Aviation Holdings Limited v Aero Toy Store LLC and another [2010] EWHC 40 (Comm), Aero Toy Store LLC contended that the financial crash triggered the force majeure clause and prevented it from completing its purchase of an aircraft. The court held that the catch all phrase “any other cause beyond the Seller’s reasonable control” had to be read in the context of the entire clause and it was telling that nothing in the list of examples was at all connected with economic downturn.

• List of what is not included

This is of most benefit to customers. Events such as industrial action or supplier default can be specifically excluded from the definition of force majeure so that such events do not trigger force majeure and the supplier can be found in breach (and liable in damages).

Regardless of how you approach the drafting of your force majeure clause it is important to remember that the interpretation of force majeure clauses will be governed by the usual rules of contractual construction. Force majeure provisions will be construed strictly and in the event of any ambiguity the contra proferentem (latin for "against the party putting forward”) rule will apply. The effect of this rule is that the clause will be interpreted against the interests of the party that relies upon it.

• Events already existing/foreseeable at date of contract

The courts have held that there is no justification for limiting the ordinary meaning of words in a force majeure clause to events which were not in existence at the date of the contract. Equally there does not appear to be any decision preventing the inclusion of events which were foreseeable at the date of the contract.

In Great Elephant Corp v Trafigura Beheer BV (The Crudesky) [2013] EWCA Civ 905, the contract included a force majeure clause which specifically referred to an “unforeseeable act or event which is beyond the reasonable control of either party”. The court considered that the word “unforeseeable” did not add to the concept of “within reasonable control” as presumably any event within a party’s reasonable control is also very likely to be foreseeable.

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• Economic changes

These are not regarded as force majeure events under English law. In Thames Valley Power Limited v Total Gas & Power Limited [2005] EWHC 2208 (Comm) Mr Justice Clarke said: “No case has been cited to me in which a clause such as the present has been interpreted as relieving a party from its obligation to perform because the performance of the contract has become economically more burdensome. If a company as familiar with the effect of fluctuations as Total wished to secure that result, it would need to do so in much more explicit terms.”.

It therefore seems to be the case that if a party wishes to include a specific economic change (such as the introduction of a new currency) as a force majeure event then that event should be specifically set out within the force majeure clause (with sufficient clarity).

• Acts of agent

In Great Elephant Corp v Trafigura Beheer BV (The Crudesky) [2013] EWCA Civ 905, the Court of Appeal held that reference to acts or events beyond the reasonable control of “either party” extended to parties who had been delegated performance of the obligations under the contract.

Second Key Component – Trigger for Protection

It is not enough to demonstrate that a pre-defined event that could qualify as force majeure has occurred. You need more – the trigger should be pulled. The trigger is not a manual step for the party claiming force majeure to take. Such steps are covered in the fourth key component. The trigger is that the event impacts performance of the contractual obligations. The event prevents performance or, where your force majeure clause so permits, hinders or delays performance.

• Burden of proof

It is for a party relying upon a force majeure clause to prove the facts which bring the event within the ambit of the clause. In Channel Island Ferries Limited v Sealink UK Limited 1988 WL 622867 Lord Justice Parker held “…(1) that it is for the party relying on a Force Majeure clause to bring himself squarely within that clause; (2) that in most cases that can only be done by showing either legal or physical impossibility;…”.

• Interpretation of the trigger

The Court of Appeal held in Coastal (Bermuda) Petroleum Ltd. v VTT Vulcan Petroleum SA (No 2) (The Marine Star) [1996] 2 Lloyd’s Rep 383 that a force majeure clause should be interpreted by reference to the words that the parties used in the clause, rather than their general intention. This is in keeping with general rules of contractual interpretation. Courts are loathe to go beyond the four walls of the contract. The Contract is sovereign.

The result of this is that if an event must “prevent” performance then the party seeking to rely on the clause must show that performance is impossible, not just more difficult or costly. If an event is merely required to “hinder” or “delay” then that will generally be satisfied if performance is considerably more onerous. It is unlikely that an increase in cost of performance alone would trigger a clause with this wording.

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Third Key Component – Additional Burden of Proof

The third key component requires consideration of the force majeure clause in the contract. The additional burden of proof is contract-specific. In the LOGIC example there is (a) the need to demonstrate that fulfilment of the contract is impaired without the fault of negligence of the party claiming force majeure and (b) the exercise of reasonable diligence by the party claiming force majeure cannot address the adverse impact of the event on contract performance. Additional burdens of proof take many forms – is the obligation to respond to the force majeure event one of taking reasonable endeavours or all reasonable endeavours? Some examples of additional burdens are discussed below.

• Reasonable steps to mitigate

In Channel Island Ferries Limited v Sealink UK Limited 1988 WL 622867 the court held that Sealink were in breach of contract and could not rely upon the force majeure clause because it had not taken reasonable steps to avoid its operation or mitigate its results. Channel Island Ferries and Sealink entered into a joint venture agreement for the operation of ferry services. The announcement of the joint venture (and corresponding redundancies) resulted in Sealink employees striking and taking occupation of Sealink vessels. This resulted in Sealink being in breach of the joint venture agreement because Sealink was unable to provide vessels for operation. Sealink sought to rely upon the force majeure clause in the joint venture agreement but the court at first instance and ultimately the Court of Appeal held that Sealink had not taken all reasonable steps to avoid the operation of the force majeure clause. Sealink had not communicated with the unions before the announcement of the joint venture agreement and unsurprisingly the reaction from the unions was severe.

Lord Justice Parker stated that it is important to bear in mind that “a party must not only bring himself within the clause but must show that he has taken all reasonable steps to avoid its operation, or mitigate its results.”

• Compliance with government requests

In Okta Crude Oil Refinery AD v Mamidoil-Jetoil Greek Petroleum Co SA [2003] EWCA 1031 a government authority’s request to Okta not to perform the contract did not fall within the force majeure clause in the contract because Okta had instigated the procurement of the request from the authority. The force majeure clause included “acts or compliance with requests of any governmental authority…beyond the control of the party affected”. The decision of the court refers back to the Channel Island Ferries case in which it was held that a party relying upon a force majeure clause has an obligation to show that there were no reasonable steps they could have taken to avoid or mitigate the force majeure event and its consequences. In this case Okta had initiated discussions with the government concerning its performance of the contract and Okta’s lawyers had produced a draft letter for approval by the Prime Minister, which was used by the government when formulating the final version requesting Okta to cease performance. It was therefore not an act beyond the control of Okta and did not fall within the ambit of the force majeure clause.

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Fourth Key Component – Other Formalities

The force majeure clause may provide for automatic application of force majeure where a qualifying event occurs which prevents contract performance (or hinders or delays same where the contract so provides). However, many force majeure clauses require notification by the party claiming force majeure in order to trigger the start of a force majeure period. In such cases, the failure to serve such a notice could result in the loss of opportunity to seek the relief that force majeure provides. In any event, prompt and decisive notification where force majeure is applicable will better place the party in establishing that the force majeure provisions are activated. Delay in serving such notification, even where not fatal, could seriously undermine the evidential basis for establishing force majeure.

In Scottish Power UK Plc v BP Exploration Operating Company Ltd and others 2015 EWHC 2658 (Comm), the Commercial Court considered whether a contractual notification requirement in a force majeure clause was a condition precedent or an intermediate term. The court considered the prior (but differing) authorities relating to force majeure provisions but concluded they were of limited assistance to interpreting the clause in question. This highlights the fact that force majeure clauses, like other clauses in a contract, must be interpreted on their own terms in the context in which they were used and other contracts with the same or similar provisions are of limited assistance in guiding the court. The Court held that the clause was not a condition precedent and failure to comply with the notice provision did not result in the force majeure claim failing. The second issue of whether the notice provision was an intermediate term to which non-compliance might prevent force majeure being claimed was resolved by the Court determining that the notice provisions was not an intermediate term.

The point to underline here is that compliance with notice provisions is not only desirable (if you wish to avoid unnecessary litigation) but essential where the notice is a condition precedent or where breach of it would be construed as a material breach of contract.

When created by contract, how is it recognised by the courts?

Is it an exemption clause?

It has been said that a force majeure clause merely defines a party’s obligations so if one party’s performance is prevented, impeded or delayed by a force majeure event then that party is not in breach of contract. In contrast, an exemption clause is based on the occurrence of the breach and seeks to exclude or restrict liability for such. The distinction is often difficult to establish. In Fairclough, Dodd & Jones Ltd. v J. H. Vantol Ltd [1957] 1 W.L.R. 136, the House of Lords, in reversing a Court of Appeal decision, referred to dicta of the Court of Appeal judge, Parker L.J., “Whether viewed as a clause which extends the time for shipment or as an exception clause, it is a clause which operates to prevent what otherwise might be a breach from being a breach. Such a clause would normally, at any rate, not be construed as being operative, unless in its absence the party protected would have been in breach.”

A more decisive view was taken by Lord Justice Longmore in Great Elephant Corp v Trafigura Beheer BV (The Crudesky) [2013] EWCA Civ 905, “It goes without saying that a force majeure clause must be construed in accordance with its own terms; it also hardly needs emphasised (a) that it is an exceptions clause and any ambiguity must be resolved against the party seeking to rely on it…”

This is a reminder of the importance of being aware of the contra proferentem rule of contractual interpretation when drafting force majeure clauses.

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Breach of contract by other party

It is a general principle of English law that a party shall not be advantaged by its own breach. This also applies to reliance on force majeure clauses.

In Ministry of Sound (Ireland) Ltd v World Online Ltd [2003] EWHC 2178 it was held that even if a force majeure clause did cover a case in which one party was prevented from performing its obligations under the contract by the breach of the other party, its only effect would be to excuse the innocent party from its obligation to perform so that it would not be in breach and could not be liable in damages.

Are there statutory controls?

Force majeure clauses may be subject to statutory controls in the same way that other clauses in a contract may be.

In standard form terms of business, a force majeure clause will be governed by section 3(2) of Unfair Contract Terms Act 1977. This requires the clause to satisfy the “reasonableness” test to remain valid. It is likely that if one party classifies events which are in fact within its control as force majeure then this would be considered unreasonable.

In relation to consumer contracts entered on or after 1 October 2015, a supplier’s force majeure clause will need to satisfy the concepts of fairness and transparency within the Consumer Rights Act 2015.

For contracts entered into prior to that day the applicable legislation is the Unfair Terms in Consumer Contracts Regulations 1999. The guidance is much the same as that applicable to the Consumer Rights Act 2015. Clauses should not be contrary to good faith or cause significant imbalance in the parties’ rights and obligations to the detriment of the consumer. Clauses should be drafted in clear language.

Effect of the force majeure clause

The effect of a force majeure clause is contract specific. Party autonomy allows determination of the consequences of its application. Most commonly, these clauses are suspensory. Future performance of the obligations is put on hold whilst force majeure subsists. The obligations are reactivated once force majeure comes to an end. Appropriate adjustment of the contract following the expiry of the force majeure period will apply so as to ensure that the non-performing party’s liability for non-performance or delay in performance is removed. Typically, the clause will provide rights of termination after the expiry of a pre-defined period in which force majeure subsists. Such termination will typically be without liability, except in respect of prior breaches.

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DRAFTING TIPS - METHODS TO MITIGATE THE LAW

Tip One

CHANGE OF LAW PROTECTION

The below language is taken from LOGIC On/Offshore Services Ed 3, Clause 18.3:

Should changes in any applicable laws, rules and regulations, including any change in interpretation of the same by a COMPETENT AUTHORITY, made after the EFFECTIVE DATE OF COMMENCEMENT OF THE CONTRACT, result in increases or decreases in the cost to the CONTRACTOR of performing the WORK, the CONTRACT PRICE shall be adjusted to the extent described in Section III – Remuneration, or as otherwise may be agreed between the PARTIES.

Tip Two

CHANGE OF COSTS PROTECTION

The rates set forth in Clause/Section X shall be revised to reflect increases in the CONTRACTOR’s operating costs from [insert date of extension or other agreed date]. The following operating costs shall be subject to adjustment: (a) labour costs, including actual payroll burdens and benefits, of the CONTRACTOR’s personnel listed in Section X; (b) cost of spare parts and supplies by reference to [insert reference to any relevant price index, if applicable]; (c) cost of insurance; and (d) increase in personnel assigned to the WORKSITE.

Tip Three

EXPROPRIATION

In the event the Contractor reasonably believes that there is a serious and real threat of loss or damage to the Drilling Unit or injury or death of Contractor Personnel due to terrorism, confiscation or war, the Contractor has the right to terminate the Contract on written notice after forty-eight (48) hours and after temporarily plugging and abandoning any well in progress. In such event, the Contractor shall be paid its compensation earned to the date of termination plus the Demobilization Fee.

TIP FOUR

SEVERABILITY CLAUSE

The below language is taken from LOGIC On/Offshore Services Ed 3, Clause 29.10:

If any provision of this CONTRACT shall be found by any court or administrative body of competent jurisdiction to be invalid or unenforceable, the invalidity or unenforceability shall not affect the other provisions of this CONTRACT and all provisions not affected by such invalidity or unenforceability shall remain in full force and effect. The PARTIES agree to attempt to substitute, for any invalid or unenforceable provision, a valid or enforceable provision which achieves to the greatest possible extent, the economic, legal and commercial objectives of the invalid or unenforceable provision.

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CONCLUSION

In summary, when parties agree the terms of a contract they cannot anticipate, predict, and control all risks that may be so serious as to prevent performance.

If performance of the contract is prevented by an event not anticipated, not predicted, and beyond the control of the parties, holding the affected party to an absolute standard of performance, without compromise, will be fundamentally unfair.

Unfortunately, English law is very rigid in this regard. The only avenue for protection, at law, is the doctrine of frustration. However, the doctrine has historically been applied only on limited grounds in exceptional circumstances. Likewise, if the doctrine does apply, it will automatically end the contract.

Where the law is limited, the parties must look to the contract for protection. A properly drafted force majeure clause will provide some protection, within limits. It will also keep the contract alive long enough for the parties to properly consider alternatives for keeping the relationship alive.

Where force majeure is limited, other clauses must also be considered. If properly drafted, force majeure and all other clauses will interact in a way which creates a comprehensive framework for managing the commercial relationship. The future may, at times, be unpredictable and uncontrollable, but it can be manageable with a complete framework of contract terms.

The next seminar of the Contracting Compass will occur on Wednesday 3 May 2017. We hope to see you again at Brodies House for this and other events.