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International Trade: When Does Force Majeure Apply?

7 September 2009 - In recent years premixers and importers have been subjected to several incidents where Vitamin suppliers have failed to execute contracts on the grounds that they claimed force majeure. Experience has shown that such events have often created market conditions which have severely disadvantaged buyers and forced them to engage in new and much more expensive contracts in order to secure goods on time.

One specific example which has arisen in recent weeks involves a vitamin producer in China who has refused to execute some of their outstanding contracts on time. The supplier has informed the market that they have a production issue but in this specific case it has never been clearly established if force majeure was declared. The subsequent effects of their decision are that the spot market price has increased by more than fivefold as buyers desperately compete for product on the open market. In addition, premixers became extremely frustrated knowing that product was leaked onto the spot market at price levels which were dramatically higher than a few months previously.

In order to get a better view on what the legal background is in cases which involve force majeure, Feedinfo News Service spoke to Diane Galloway, partner at Reed Smith LLP, one of the 15 largest law firms in the world.

What is force majeure?

A force majeure clause is an agreement between the parties that one or both parties are excused from performing a contract where their performance is affected by the occurrence of a force majeure event listed within the clause. If applicable, the force majeure clause allows one party not to perform without being in breach, without paying damages.

Unlike some legal systems, there is no doctrine or concept of force majeure under English law. It must be specifically and expressly included in contracts in order to have effect, as it will not be implied by the English Courts. In general, contracts must be performed: if not, a party is in breach and must pay damages even if not responsible for the problem - hence the need for a suitable force majeure clause, and it is important to realise that it is exactly what is in that clause that counts, not some vague idea of what is "force majeure".

Types of force majeure clause

There are some "off the shelf" ready made clauses, such as the ICC Force Majeure and Hardship clauses, or particular trade clauses such as GAFTA Force Majeure and Prohibition clauses. However, arguably every force majeure clause should be unique - making sense in the business context of the particular contract and making a sensible allocation of the risks which may affect performance. A general rule would be that the longer the term of the contract, the more important the force majeure clause may be. You should try to anticipate events that may occur which would make it difficult or impossible for you to perform the contract, or events which you are not prepared to accept the risk of the occurrence.

There is no standard meaning of the phrase "force majeure" so specific events which may affect the parties' performance under the contract should be listed. Clauses such as "Usual force majeure events to apply" are too uncertain and "force majeure to apply" is not sufficient and may lead to disputes over what it is meant to cover.

In general, a force majeure clause includes:

• definition of the 'problem' or causative events - long or short list (see below) and 'sweep up' provision;

• obligations as to notice to the other party;

• effect of the event e.g. suspension or extension and then termination by one or both parties without liability.

List of Events

Some of the commonly listed events are: "Act of God, war or war like operations, riot, strikes, fire, storm tempest or flood, perils or accidents of the sea, civil commotion, acts of Government, partial or total prohibition of export/import". Wider events would include "restriction, non delivery or delayed delivery from suppliers, shortages of raw materials or transport, requests of governmental authority, adverse weather conditions, breakdown of intended performing vessel". The usual "sweep up" provision is a phrase such as "any other cause beyond a party's control" and "whether or not similar to the foregoing". This will go some way towards including events which were not anticipated.

How much must performance be affected?

Generally, force majeure clauses are drafted in terms of performance being "prevented", "hindered" or "delayed".

• "Prevented" or "unable to perform" indicates that performance is virtually impossible; this is the most usual provision and is very difficult to establish in practice;

• "Hindered" means that performance is made considerably more difficult;

• "Delayed" is the lowest test, and so the lowest hurdle for the claiming party to overcome.

The fact that a contract is now uneconomic or commercially impractical because it has become greatly more expensive (for example, as a result of a huge increase in raw material or production costs) is almost never within a force majeure clause.

Relying on Force Majeure

A party wishing to make use of a force majeure clause to excuse them from performance must prove that they come within the terms of the clause. In our experience, more than 70% of the force majeure claims will fail in practice because the party claiming force majeure (and so hoping to avoid paying damages for not performing) cannot bring himself within the clause and prove that one of the listed events prevented performance. The clause is therefore often invoked as an excuse, but rarely successfully.

Notice provisions and time limits

Force majeure clauses usually have provisions regarding the notices, which must be given under the clause when an event occurs. A failure to comply with the notice requirements may lead to the loss of the right to claim force majeure (whether it does so will depend on the wording of the clause). It is always better, if you do want to invoke a force majeure clause, to watch and comply with all time limits carefully.

What should you do at the time of the Force Majeure incident?

If a party fails to mention force majeure at the time of an incident, it becomes much harder in practice to rely on the force majeure clause at a later date. Messages at the time of the force majeure event should clearly set out that it is a force majeure event, or a party may "waive" or lose your right to claim force majeure. Even if a party is unsure, it may be better to invoke the clause at the earliest opportunity and then collect evidence and clarify e.g. "On the information presently available to us, it appears that the situation is one of force majeure within clause [ ]. We therefore as a precaution hereby give notice of force majeure as required by clause [ ]. We are, however, making further inquiries and will revert".

Take care to look carefully at the clause to see what happens next. The norm is an extended period for performance and then a right of one or both parties to cancel the contract.

When a Force Majeure event affects more than one contract

Where a seller has sufficient goods to fulfill some, but not all, of his contracts due to a force majeure event, he should (if there is nothing express in the force majeure clause) allocate the goods in the way in which the trade would consider reasonable and proper, whether this is by dividing them equally amongst his counterparties, or by allocating them in the order in which the contracts were concluded. It is very clear that he cannot allocate his supplies to new contracts concluded after the force majeure event to take advantage of a rise in price, nor simply choose the highest price contracts to perform. A Buyer with proof that the Seller is still offering similar goods for sale will usually defeat any force majeure claim.

Conclusion

Force majeure clauses arise frequently in commercial contracts and they are often the cause of disputes or litigation. Parties increasingly attempt to rely on force majeure to excuse themselves from liability. Careful attention needs to be paid to exactly what is within the clause in terms of proof, timing, alternative methods of performance. In our experience, the hurdles for a party claiming force majeure successfully are substantial, most cases do not succeed and the non-performing party has to pay damages in court/arbitration proceedings for breach.

Checklist

• Look at all relevant contract clauses (Law, Force Majeure, Prohibition, Hardship, Strikes, Limitation of Liability etc);

• Look at the exact wording of the clause;

• Check time limits/notices;

• Check what happens next (extension/cancellation/by whom?);

• Consider legal advice;

• Consider alternative methods of performance permitted by the contract;

• Collect all available evidence both of what happened AND what other performance was possible; and

• Consider how to allocate available supplies.

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Representative Matters:

Advised grain companies on issues resulting from recent Ukraine export problems

Acted for the successful foreign claimant in a number of Chinese CIETAC commodity arbitrations

Advised Brazilian grain company in relation to arbitration arising out of non-payment under a letter of credit and bank insolvency

Advised coal company on potential illegality issues concerning their Turkish buyer

Advised in relation to contamination found in Chinese honey and Indian Chilli powder

Advised metal trading company on exposure and security issues on back-to-back sales contracts, including advice on performance bond issues.

Advised trading companies in relation to contract terms on pesticides, futures trading, warehousing in Egypt, Retention of Title clauses and foreign security

Involved in ad hoc multi-party commodities arbitration in 2004 through 2005 involving fraudulent bills of lading/ship arrest/FOB sales contracts/court intervention under s44 Arbitration Act

Involved with 12 ongoing commodity arbitrations 2006/2007 in GAFTA and FOSFA

Diane Galloway may be contacted at:

Telephone : +44 20 3116 2934 (London)

E-mail : dgalloway@reedsmith.com

About Reed Smith LLP

Reed Smith represents many of the world's leading companies in complex litigation and other high-stakes disputes, cross-border and other strategic transactions, and crucial regulatory matters.

With lawyers from coast-to-coast in the United States, as well as in the United Kingdom, continental Europe, Asia and the Middle East, our firm is known for its experience across a broad array of industry sectors. We counsel 28 of the top 30 U.S. banks and 10 of the world's 12 largest pharmaceutical companies. Our shipping practice has been designated among the most preeminent in the world, and our advertising law practice is regarded as among the legal industry's finest.

Reed Smith has grown in large part because of its uncommon commitment to delivering high-quality service and developing long-term client relationships. Our approach to service begins by understanding our clients' business goals. We then work to develop the resources necessary to help achieve them.

www.reedsmith.com
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