Just as the coronavirus pandemic left countless companies unable to perform contractual obligations, escalating geopolitical tensions in the Middle East now force companies and their counsel to ask a familiar question: does our contract excuse nonperformance when the world turns upside down?
Force majeure, and the related common law doctrines of impossibility and frustration of purpose, are poised to once again become a focus of business litigation as the Iran conflict generates oil shortages, energy price shocks and global market disruption. Companies that experienced COVID-19 disputes know better than to assume their contracts will protect them, and those lessons are more relevant than ever.
Force Majeure
Once a party to a contract has made a promise to perform, it must fulfill its obligation even where unforeseen circumstances make performance burdensome, difficult or more expensive. If the party fails to perform, it usually is responsible for damages to the counterparty.
But when the contract contains a force majeure provision, as many do, that provision may provide a defense to the failure to perform. Courts, however, narrowly construe these provisions, and the specific language of the applicable force majeure provision in the parties’ contract will govern. The Iran conflict raises at least three categories of disruption that companies are already experiencing or anticipate experiencing in the near term:
- Oil and fuel shortages. The effective closure of the Strait of Hormuz, attacks on oil and gas infrastructure and OPEC supply volatility have already rattled global energy markets. Businesses dependent on petroleum-based inputs, from manufacturers to farmers to shippers to logistics providers, face materially increased costs and, in some cases, outright supply failures.
- Energy disruption. Electricity and natural gas prices are closely correlated with oil markets. Data centers, industrial manufacturers and other companies with energy-intensive operations may find that performance becomes economically impossible, not merely more expensive, if energy costs spike to levels that were genuinely unforeseeable at the time of contracting.
- Withdrawal of venture capital. Investors in US and European businesses, themselves affected by trickle down impacts, may reconsider existing or future commitments. As reported earlier this month by The Financial Times, the escalating conflict and regional instability have already prompted some oil-rich Gulf economies to review their overseas investments. For startup and growth-stage companies that depend upon funding to meet operational milestones or contractual delivery dates, the downstream effect could be as disruptive as any physical supply chain failure.
A typical force majeure clause includes a list of triggering events that could excuse performance. Whether these disruptions will constitute a valid force majeure event depends entirely on the language of the particular contract. Common triggering events such as “acts of war,” “government actions,” “embargoes,” “civil unrest” and “acts of terrorism” may capture Iran-related disruptions. The more difficult question will arise for energy and supply chain failures that are not directly caused by a war or government-mandated embargo but are instead the downstream economic consequence of regional conflict.
Many force majeure provisions also include “catch-all” language such as “or other similar causes.” Catch-all provisions must be interpreted within the context of the provision as a whole, and the legal maxim of ejusdem generis may apply: the catch-all will be interpreted to include only items of the same kind as those listed. Thus, a provision listing “acts of war, government embargo, and terrorism” followed by “and similar events” may encompass Iran-related disruptions more broadly than one listing only natural disasters.
An applicable triggering event is only the first step. Unless the force majeure provision provides otherwise, courts generally require that performance be rendered impossible, and not merely more difficult or expensive. A party that can still perform, even at a higher cost due to elevated energy prices or replacement capital, will face serious headwinds in asserting a force majeure defense.
Causation is equally important: courts already demonstrated in the COVID-19 context the need to establish direct causation between the force majeure event and the specific performance at issue.
Parties must also carefully consider what performance is actually excused. Force majeure provisions in commercial contexts often exclude payment obligations, or only temporarily suspend payment.
Critically, parties must follow any applicable notice provisions or risk losing the ability to invoke the defense entirely.
Alternatives to Force Majeure
Parties to contracts without force majeure provisions may look to the common law doctrines of impossibility and frustration of purpose to excuse nonperformance. Impossibility could apply when performance is objectively impossible.
Frustration of purpose provides a defense where a change in circumstances makes one party’s performance virtually worthless to the other, frustrating the very purpose for which the contract was made. These doctrines are narrowly construed in every US jurisdiction.
Drafting Considerations Going Forward
Parties currently negotiating or renegotiating contracts should take this moment to reconsider their force majeure language. Drawing on the pandemic experience, consider:
- Defining triggering events expressly to include or exclude events such as “armed conflict,” “acts of war,” “embargo,” “sanctions,” “energy crisis,” “commodity shortage” or “geopolitical instability”;
- Avoiding overreliance upon “act of God” language;
- Being mindful of the doctrine of ejusdem generis and ensuring catch-all language is drafted broadly enough to capture the actual risks the parties intend to address;
- Crafting language that clearly specifies what happens at the end of the force majeure event, including whether the event permits termination or only a temporary suspension of performance; and
- Expressly addressing disruptions to supply chains, energy markets, labor forces and access to financing.
