As the COVID-19 crisis and its economic fallout intensify, contractual parties have increasingly invoked force majeure provisions to excuse performance of contracts. This article is a follow up to Schiffer Hicks Johnson’s earlier article on COVID-19 and force majeure clauses, and offers an update on emerging global trends in force majeure and the evolving considerations businesses should apply in evaluating force majeure provisions found in existing as well as new contracts. For more information, contact Logan Johnson at ljohnson@shjlawfirm.com or 713-357-5161.

Update on Force Majeure Conflicts in the Energy Sector

Extremely low oil prices and disruptions in demand due to COVID-19-related restrictions have led to a number of force majeure declarations in connection with oil and gas purchase agreements. Force majeure declarations have been particularly prevalent in emerging markets. If current economic conditions persist, it is likely that an increasing number of buyers will seek force majeure declarations to excuse performance of purchase agreements negotiated prior to the recent drop in oil prices and global proliferation of COVID-19 lockdown measures.

So-called “force majeure certificates” issued by Chinese international trade promotion authorities to Chinese companies in the wake of that country’s COVID-19 outbreak remain a source of potential conflict. In February 2020, Shell and Total rejected a force majeure notice from a liquefied natural gas (LNG) buyer in China which sought to back out of an existing supply contract. Because these force majeure certificates issued by Chinese authorities would generally not be recognized as providing legal validation for a force majeure declaration outside of China, they may become a basis for future legal disputes.

While Chinese gas imports have risen in recent days, India has increasingly become an epicenter for force majeure activity in international energy contracts. In response to depressed demand, Indian importers have invoked force majeure to repudiate purchase contracts for liquified natural gas[1] and multiple Indian refineries have issued force majeure notices seeking to cancel  delivery of oil cargoes in response to depressed demand for fuel due to lockdown measures.[2] [3]

Within the United States, an increasing number of downstream purchasers may also seek to repudiate contracts on the basis of force majeure. For example, on March 31, 2020 Kansas-based pipeline and refinery operator Flint Hills Resources, which operates two refineries in Corpus Christi, invoked a force majeure clause to repudiate its April crude oil purchase commitments.[4] As oil storage capacity becomes increasingly scarce,[5] more downstream purchasers may become inclined to follow suit and make force majeure declarations.

Emerging Considerations in Force Majeure Contracts

As the COVID-19 continues, a number of critical legal considerations have emerged which may affect force majeure disputes arising from the present crisis.

To invoke force majeure or impossibility performance must be objectively impossible, merely difficult or uneconomical performance is not sufficient.

When evaluating force majeure clauses, it is important to remember that a force majeure provision only excuses nonperformance when the specified event has made performance impossible. Likewise, the closely related common law doctrine of impossibility excuses performance when it has been prevented by an unforeseeable event that could not have been guarded against. However, both force majeure and impossibility require that performance be objectively impossible.[6] If performance of a contract is merely difficult or uneconomical this will not suffice.[7]

Whether events render buyer performance factually impossible may become a major source of conflict in disputes over force majeure provisions. For example, a downstream oil purchaser that has exhausted its storage capacity might argue that accepting delivery under a purchase agreement is factually impossible, while a seller would argue that this is not sufficient to invoke impossibility or force majeure because the buyer could have mitigated its lack of storage by selling its existing stockpile even if it finds the current market price unpalatable. In cases like this, ultimately, whether force majeure applies will likely come down to a factual determination as to whether a loss was foreseeable and whether a party could have taken action to prevent it. 

Be mindful of costs and benefits when negotiating COVID-19-related force majeure.

Despite the rapid and unprecedented economic disruption which COVID-19 has caused in a few short months, businesses should remember that the current crisis likely remains in its early days. Planning by the federal government has been predicated on the assumption that the pandemic could last for 18 months or longer.[8] Indeed, multiple waves of outbreaks and subsidence may occur before a sufficient proportion of the population develops immunity (through infection or vaccination), eliminating the disease’s ability to spread within society. In the ensuing period, the severity of outbreaks and resulting economic disruption at any given time or in any particular country or region may vary and cannot easily be predicted. Because of this, COVID-19 will remain a continuing source of uncertainty for businesses. Therefore, it is important for businesses to see the worldwide coronavirus pandemic not as an isolated event, but rather as an ongoing risk to be managed when drafting new contracts or evaluating existing ones.

Force majeure clauses function as a means for distributing risk between contracting parties. Effectively, a force majeure is an agreement by one or both parties that they will bear the risk of losses that may result if a stated condition prevents its counterparty from performing. In this respect, when a party agrees to a force majeure clause it is effectively insuring its counterparty against contractual liability arising from a specified event. Even when a force majeure provision is bilateral and excuses nonperformance by either party, it may favor one side more than the other if either the buyer or seller’s performance is more likely to be disrupted by the force majeure event.

Because force majeure provisions shift the risk of losses, as a general matter, a favorable force majeure provision will lead to a higher contract price to compensate the greater risk faced by a counterparty. While parties’ first instinct might be to seek force majeure provisions that cover any and all possible COVID-19-related risk, this may not be appropriate for every transaction. As with any kind of insurance, the more extensive a provision’s coverage, the higher the contractual term’s cost. In certain transactions this maximalist approach could cause a party to purchase a greater hedge against risk than is necessary or useful for its purposes. When negotiating COVID-19-related force majeure provisions, parties must be mindful of several factors in deciding what scope and specificity of force majeure language is appropriate, these include:

• Tolerance for economic risk.
• Counterparties’ tolerance for economic risk.
• How long the party expects COVID-19-related disruptions to continue in the relevant market.
• Governmental policies in the relevant market and governmental responses to prior outbreaks.
• Market dynamics within a particular line of business or sector of the economy.
• The likely availability of alternative buyers or sellers for the good or service that is the subject of your transaction.

As discussed above, force majeure provisions distribute risk of loss due to extraneous events between contracting parties. However, the insurance offered by a force majeure clause will almost always come at a cost. To appropriately determine their exposure to COVID-19-related risk, it is now more important than ever that parties thoughtfully review the scope and verbiage of force majeure provisions in both new and existing contracts.

Catchall provisions and common law impossibility are unlikely to excuse COVID-19-related nonperformance under new contracts.

Clear and specific language delineating COVID-19-related disruptions that will trigger a force majeure clause will be more essential than ever when drafting any new agreement. This is because catchall provisions and the contractual doctrine of impossibility which could potentially protected parties to pre-outbreak contracts from liability even where force majeure provision did not specifically cover disease or government actions will likely be unavailable in relation to any contracts agreed to after COVID-19 became a foreseeable risk.

New contracts will be products of a world where COVID-19-related disruptions are an eminently foreseeable business risk. Because of this, many COVID-19-related disruptions such as lockdowns, port restrictions, and other measures will likely not fall within the scope of either the catchall provisions that backstop many force majeure provisions or the general contractual doctrine of impossibility.

Catchall provisions typically extend the coverage of force majeure clauses to not just enumerated events, but also “other causes beyond the reasonable control of the party.” However, under American law, when a nonperforming party claims force majeure based on a catchall provision rather than an event explicitly contemplated in the contract, courts “extend [force majeure] only to those situations that were demonstrably unforeseeable at the time of contracting.”[9] While English law, which governs most international trade contracts, does not require the event triggering the force majeure clause be unforeseeable, even under English law, a force majeure clause is more likely to be enforceable if an event is not foreseeable. This is because lack of foreseeability reduces the possibility that application of the force majeure doctrine would be barred by a party’s own negligence or failure to mitigate the consequences of the event. English law does not permit parties to invoke a force majeure clause in response to their own deliberate default or a failure to perform caused by their own negligence. Under both English and American law, invoking the common law doctrine of impossibility similarly requires that an event be unforeseeable.

As social and economic disruptions caused by COVID-19 become foreseeable risks in new contracts, whether operating within the US or internationally, catchall provisions and impossibility cannot be depended on to excuse nonperformance relating to COVID-19 in contracts agreed to after the risks posed by COVID-19 became clear.

Conclusion

Both internationally and within the United States, as long as energy demand and prices remain low, attempts by buyers to discharge liabilities under pre-COVID-19 contracts on the basis of force majeure will remain an ongoing risk. Because of this, an awareness of the legal doctrines surrounding force majeure and impossibility is essential for any company that seeks to intelligently navigate the present economic instability.

[1] https://www.reuters.com/article/india-lng-imports/update-3-indian-lng-importers-issue-force-majeure-notices-as-gas-demand-slumps-sources-idUSL4N2BI2YF

[2] https://www.reuters.com/article/us-health-coronavirus-india-refineries-e/exclusive-two-indian-refiners-declare-force-majeure-to-curb-mideast-oil-supply-idUSKBN21E2W5

[3] https://www.reuters.com/article/health-coronavirus-india-hpcl/update-1-indias-hpcl-invokes-force-majeure-on-iraqi-oil-industry-source-idUSL4N2BN3QH

[4] https://www.houstonchronicle.com/business/energy/article/Flint-Hills-Resources-invokes-force-majeure-on-15169368.php

[5] https://www.forbes.com/sites/gauravsharma/2020/03/31/oil-storage-may-run-out-in-6-weeks-as-crude-futures-endure-worst-ever-quarter/#307c7df66ed8

[6] Kel Kim Corp. v. Cent. Markets, Inc., 70 N.Y.2d 900, 902, 519 N.E.2d 295, 296 (1987).

[7] See, e.g., N. Illinois Gas Co. v. Energy Co-op., Inc., 122 Ill. App. 3d 940, 952, 461 N.E.2d 1049, 1059 (1984); Warner v. Kaplan, 71 A.D.3d 1, 5, 892 N.Y.S.2d 311, 314 (2009).

[8] https://www.nytimes.com/2020/03/17/us/politics/trump-coronavirus-plan.html

[9] URI Cogeneration Partners, L.P. v. Bd. of Governors for Higher Educ., 915 F. Supp. 1267, 1287 (D.R.I. 1996); see also Clean Unif. Co. St. Louis v. Magic Touch Cleaning, Inc., 300 S.W.3d 602, 610 (Mo. Ct. App. 2009) (“The purpose of a general, catch-all phrase, such as ‘causes beyond [the parties’] control’ in a force majeure or escape clause is to relieve a party of liability when the parties’ expectations are frustrated due to an ‘unforeseeable occurrence’ beyond the parties’ control.”).