What does the Coronavirus mean for supply contracts, and is it possible for parties to avoid contractual obligations due to low demand?
- Under English law, force majeure clauses in contracts may allow parties to avoid their performance obligations in certain extreme circumstances, as defined by the contract.
- It is unlikely that a low demand for LNG in China would reach the level of extreme circumstances required to invoke a force majeure clause of the type we are used to seeing in long term LNG supply contracts under English law.
- Force majeure provisions usually contain requirements to use reasonable endeavours to avoid the effects of the extreme circumstance.
In the last fortnight there has been news in the press that CNOOC and PetroChina have invoked force majeure clauses in their long-term LNG supply contracts and that Sinopec and China National Petroleum Corporation are considering doing likewise. In the case of PetroChina, it has been reported that this is due to an inability to get enough workers to its terminals to run them at full capacity. In the case of CNOOC, it is reported that force majeure has been invoked because of lower demand for LNG in China due to factories and other industry being temporarily suspended and a lower need for aviation and motor fuel. Shell and Total have rejected the force majeure notices and are threatening compensation claims. But what is the legal position?
Under English law, force majeure clauses are included in long-term contracts as a way for the parties to take a break in their performance obligations or to terminate the contract in extreme circumstances, typically a natural disaster, war or "act of God", which would legitimately excuse their performance of the contract.
A force majeure provision is never implied under English law and will only arise in contracts where the parties have specifically agreed to it and on the terms that they have negotiated. So, if a contract included a force majeure provision excusing the performance by the parties of their obligations due to "failure of demand for the product relating to the outbreak of a disease or virus in China", that would likely be invoked in the current circumstances. However, if the clause excused performance because of "natural disaster, flood, war and other acts of God" or even of "worldwide epidemics" generally, it is less clear that the outbreak would fall within the contemplated use of the clause.
Furthermore, most force majeure clauses will require that the event was unforeseeable at the time the contract was entered into, leading some commentators to suggest that if a contract with this type of clause was entered into after the SARS outbreak, it may have been foreseeable that a similar virus could occur again and the parties may not be entitled to relief.
A further factor that will need to be borne in mind is that a party claiming force majeure must show that it was the force majeure event (and not some other factor) that caused the party to be unable to fulfil its obligations. A force majeure clause also generally requires the party invoking the clause to use reasonable endeavours to avoid the effects of force majeure to the extent possible. These aspects can be seen in the case of Seadrill Ghana Operations Ltd v Tullow Ghana Ltd, where Tullow was not entitled to invoke a force majeure clause. Tullow had entered into a hire contract for a drilling rig with Seadrill which it intended to use in two fields and later in a wider field it planned to develop. A moratorium imposed by the Ghanaian government stopped Tullow from drilling, which Tullow claimed made it impossible to provide a drilling programme. The government had also refused to approve the plan for the wider oil field for other reasons. The Judge held that Tullow was not entitled to rely on the force majeure provision to terminate the agreement because, although the moratorium was a force majeure event, the refusal to approve the new field was not force majeure and was an effective cause (and, in fact, the greater cause) of Tullow not being able to provide a drilling programme. The Judge also stated that Tullow had a contractual duty to use its reasonable endeavours to avoid the moratorium stopping it performing its obligations to provide drilling instructions, and Tullow had the opportunity to provide drilling instructions in different locations. Not doing so would have meant that Tullow was unable to utilise the force majeure clause because it had not used its reasonable endeavours to avoid the effects of the event.
The decision and obiter discussion from Seadrill Ghana Operations Ltd v Tullow Ghana Ltd show that the force majeure event or circumstance must be causative to the contractual breach and that a party must have used reasonable endeavours to avoid the effects of the force majeure (assuming that a clause does not say otherwise) in an English law contract. It is unlikely, for example, that low demand for LNG would be sufficient cause to not accept the shipments because acceptance is still physically possible. Parties seeking to rely on force majeure clauses would have difficulty establishing that they had used reasonable endeavours to avoid the effects of low demand. (For example, they could have shipped LNG supplies to other distributors or processors.)
An example of an event not being causative to the breach of contractual obligations is seen in the decision in Thames Valley Power Ltd v Total Gas & Power Ltd in which, the parties had entered into an agreement for Total to provide gas to Thames Valley Power. The market price of gas rose sharply and Total sought to rely on a force majeure clause to cease supplying until prices fell. The Judge held that a party could not be relieved from its contractual obligations on the grounds of force majeure merely because the contract had become more expensive, or less profitable, to perform.
We would suggest that it would follow that if a similar contract with a similarly worded force majeure clause was disputed in the current circumstances, low demand for LNG would not preclude purchasers from accepting shipments of LNG, or accepting shipments and then selling the LNG on to other distributors or processors. It may become more expensive for them to accept shipments, but that would not allow them to be relieved from their obligations on the grounds of force majeure. If it became impossible to accept shipments because a port specified in the contract is closed or because the purchaser could not possibly make alternative arrangements to accept the LNG, that would more likely be interpreted as a force majeure event.
The wording of the clause in question also determines the remedies available to the parties, as the consequences of a force majeure event will differ between contracts, depending on what has been negotiated. Some allow for a temporary suspension of the parties' obligations, possibly including a set time period after which the contract may be terminated for a long-term force majeure event. Some will allow for termination of the contract because of the force majeure event from the outset. Others will only allow for certain obligations to be suspended (so payment obligations may still continue in a force majeure event). What such clauses are likely to have in common is that they will set out a process to be followed. For example, the party claiming exemption from their obligations may have to issue a notice and provide evidence of the force majeure event or both parties may have to agree that a force majeure event is occurring.
In a further development, at the end of January the China Council for the Promotion of International Trade confirmed that China would offer force majeure certificates to local companies which were not able to fulfil contractual obligations because of the outbreak of coronavirus as a means of evidencing their inability to perform the contract. Such certificates may be helpful for parties which have to provide evidence of their inability to perform to invoke a force majeure clause and may be of significant value in contracts governed by the laws of the PRC. However, in an international context, while a certificate may lend weight to the suggestion that a contract cannot be performed, unless an English law contract contains a specific force majeure clause excusing performance which is drafted widely enough to cover the circumstances which are stopping the party performing the contract, a certificate is unlikely to mean much.
Even where there is no force majeure clause, it is also worth noting that the English law doctrine of frustration may apply. The doctrine of frustration states that if a contract becomes impossible to perform through no fault of either of the parties it may be automatically terminated. Impossibility of performance is a high bar to establish, and the English courts have stated that increased costs or difficulty of performance is not the same as impossibility, but there may be circumstances in which frustration becomes relevant if supply chains collapse.
As the outbreak of coronavirus continues we can see that it is likely that imports to and exports from China will continue to be affected, not only because of the unavailability of ports but also because factory workers have been asked to stay at home to avoid the spread of the virus. How the situation develops remains to be seen. The Jiangnan shipyard has now recommenced work after invoking force majeure clauses to delay deliveries and certain private shipyards are still suspending their normal operations. Fiat Chrysler has warned that one of its plants in Serbia will be forced to halt production because it is struggling to obtain parts from China. Hyundai and Kia paused production in South Korea due to shortages of components from China. Manufacturers of technology products may similarly be affected by parts not leaving China, and Apple has warned that it will miss sales targets due to disruption related to coronavirus. Soybeans are a significant import to China, and Brazilian and U.S. suppliers are concerned that demand will be much lower than expected. Aside from the tragic human impact of the virus, the consequences are being seen throughout the business and legal world, and we expect that force majeure clauses in contracts governed by English law will continue to be invoked both within and outside of China as the outbreak continues.
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