The blockage of the Suez Canal, international sanctions, trade tariffs and now the Iran war and the closure of the Strait of Hormuz, have demonstrated how interconnected the business world is.
It does not take long for disruption to global supply chains to be tangibly felt by UK businesses of all sizes, whether by delays, shortages or rising costs (eg energy, shipping, materials).
This begs the question: what happens when contracts can no longer be fulfilled as a result of the unexpected disruption?
Jared Martin, Solicitor in Thrings’ Commercial Dispute Resolution team looks at how the legal concepts of force majeure, frustration and termination rights can potentially play an important role in protecting businesses from events outside of their control.
Force majeure
Many commercial supply contracts have what are commonly known as a ‘force majeure’ clause. Such a clause will usually allow a party a contractual right to suspend or avoid performance of its obligations, without being liable for a breach of contract, where an unforeseen event outside the parties’ control prevents it from doing so.
The specific wording of the “force majeure” clause will determine when and how it can apply. The event typically needs to be:
- outside the party’s reasonable control
- not reasonably foreseeable at the time the parties entered into the contract
- not capable of being mitigated
- the direct cause of the failure to perform.
Examples often include war, civil unrest and natural disasters, as well as government action, labour disruption and infrastructure failure.
Force majeure clauses are usually applied restrictively by the courts, with the party seeking to rely on them needing to show that the clause clearly covers the event that it has a direct impact on performance, and that they have complied with the procedural requirements of the clause (eg giving proper notice of it to the other party in time).
The force majeure clause will then often set out what happens if force majeure applies – for example, the suspension of obligations, extensions of time, or a right to terminate if the disruption continues for a specified period.
If there is no force majeure clause, then a party will need to consider alternative potential solutions under English law.
Frustration of contract
Where a contract does not contain an applicable force majeure clause, the common law doctrine of frustration may be relevant.
This potentially applies where, due to no fault by either party, an unforeseen event occurs after the contract has been formed, which makes performance impossible, illegal, or significantly different to what was originally agreed or contemplated.
If established, the contract is automatically ended from the date of the frustrating event.
However, it is not easily relied upon, with the courts often taking a narrow view to when it will be applied.
Importantly, it cannot be used where the contract already deals with the risk in question (eg through a force majeure clause), nor where the event simply makes performance of the contract more expensive for one party, nor where an alternative way of performing the contractual obligation is possible. It is therefore often seen as a last resort, and should not be invoked without first taking legal advice, as if a party wrongly asserts that the contract has been “frustrated” and that it has been discharged from performing it, it could be in repudiatory breach of contract.
Termination rights
Many commercial contracts include express rights allowing a party to terminate in certain circumstances – prolonged force majeure events, failure to supply or perform and material breaches of contract being common examples.
Termination clauses typically set out the process that must be followed (e.g. strict notice period requirements) and the consequences of termination – such as on payment obligations or the return of goods.
Where there are no express termination rights, a party may need to consider whether there is an implied termination right or whether one party is in repudiatory breach of the contract which may allow the other to terminate.
In a disrupted supply chain, termination may appear an attractive option. However, it is rarely without risk. Bringing a contract to an end may create further operational challenges, particularly where alternative suppliers are limited.
Exclusions in insurance contracts
Your business interruption and other insurance policies should also not be overlooked. However, many standard policies include exclusions which may limit or exclude cover for losses connected to war, conflict or political unrest and even state-sponsored cyberattacks, although specialised policies are potentially available to cover specific risks.
Coverage, exclusions and conditions in these type of policies vary from policy to policy, and need to be considered carefully. Such policies usually require prompt notification of claims or circumstances that might give rise to a claim.
Practical steps for businesses
Disruption in one part of a supply chain can quickly have wider consequences, delaying production, impacting delivery commitments and straining customer relationships.
When negotiating and entering into supply contracts, particularly where you are exposed to key external factors that will be outside your control, consider the principal areas of risk for your business and then how such risks can be effectively managed in the contract (eg a force majeure clause, right of suspension, termination rights, pricing adjustments).
If you find yourself in the unfortunate position of having to deal with such issues, check your insurance policies for cover (notice of a covered event will usually need to be given to your insurer promptly) and take legal advice with a view to understanding your position and your options.
The Thrings Commercial Dispute Resolution team has an outstanding track record in achieving success in court, also offering expertise in mediation, pre-action work, settlement negotiations and arbitration to deliver commercially focused solutions to minimise disruption to your business. Contact us to find out more.
