Member Article

The recent volcanic cloud and flight bans in Europe remind us of the damaging impact that mother nature can have on businesses. Even after the ash has cleared and flights are fully operational again, the extent of the disruption caused by the ash clouds may linger for many years in the form of contractual disputes.

The impact of flight delays on ordinary people's lives has been widely reported in the media, yet it may take weeks or even months before we can start to evaluate the impact on businesses around the world. Food shipments have perished, production lines have been suspended and sporting events have been cancelled or postponed. The costs associated with these incidents are significant. The knock-on effects, including delivery delays down the supply chain, revenue losses and rescheduling costs for postponed events (e.g. revised marketing materials) are even more significant. This begs the obvious question – who is going to pay?

Clearly, a volcanic eruption in Iceland is the furthest thing from anyone's mind when drafting a contract. There are, however, a number of contractual and legal mechanisms that may be of assistance to manage exposure in these most unforeseen circumstances.

Contractual Force Majeure

In common law jurisdictions such as Hong Kong, a force majeure clause (if your contract has one) is your most likely saviour. While each clause will be different, they usually have the following elements that will need to be established if they are to be relied on:

(a) the first step is to establish that a 'force majeure event' has occurred. What constitutes an event is always different, but generally speaking events that are beyond your reasonable control will be covered. Therefore, flight delays caused by a volcanic eruption are likely to be force majeure events. If your definition of a force majeure event references 'acts of God', a volcanic eruption is likely to fall within this definition

(b) it is not enough that a force majeure event has occurred. You must prove that the event has prevented, hindered or delayed your ability to perform, either partly or wholly, your obligations under the contract, e.g. the flight delays caused by the ash cloud have delayed delivery of key components in a production line, which can not be obtained from alternative sources. You must be able to show that performance of the contract has become physically or legally impossible and not merely difficult or unprofitable

(c) you will need to prove that your non-performance is due to circumstances beyond your control. While in this case no one can be expected to have controlled the volcano, relief may not be available if a 'reasonable and prudent person/operator' would have taken pre-emptive steps that would have avoided the impact of the force majeure event. It is important to note that ordinarily you will not be relieved for events brought about by your own negligence or wilful default

(d) it is important that you follow through with the mechanics of the force majeure clause, such as giving the proper notice of the occurrence of a force majeure event to your counterparty

(e) another important factor is ensuring that you take reasonable steps to mitigate the consequences of a force majeure event. If this obligation is not expressly stated in the contract, it is likely to be implied by a court of law, and

(f) force majeure clauses will generally grant you relief from your obligations under a contract only to the extent that performance has been prevented or delayed by the force majeure event. Obligations not affected will need to continue to be complied with as required by the contract.

While the above elements are common to many clauses, it is necessary to consider the exact terms of each clause to determine whether force majeure relief is available under a particular contract.

Other protection

Apart from contractual force majeure, the following options are also worth considering when unpredictable circumstances arise:

(a) taking advantage of any other contractual provisions, e.g. specific termination rights, termination for convenience clauses and rights to delay satisfaction of unsatisfied conditions precedent

(b) does the jurisdiction in which you are operating or the governing law of your contract provide any form of statutory relief? For example, the PRC and other civil law jurisdictions (e.g. France) have statutory force majeure regimes that may provide relief even if your contract does not protect you

(c) common law relief such as frustration of contract. Frustration will only serve to terminate the contract and will only be applicable where a contractual obligation has become incapable of being performed, not just delayed or more difficult or expensive, and

(d) whether your insurance coverage will provide protection against costs and losses suffered by you or your customers as a result of your inability to perform your contractual obligations.

Moving forward

When the ash settles, the events of the last month or so will bring into sharp focus the terms of companies' standard form contracts and law firms' precedents, as unfortunately many force majeure clauses and other contractual provisions will be found wanting in these unpredictable but financially damaging circumstances.

Against this backdrop, we recommend that clients and law firms alike pay greater attention to force majeure clauses when drafting and negotiating contracts. In the most extraordinary of circumstances, the force majeure clause is likely to be your greatest tool when managing risk, losses and costs. In particular:

(a) give careful consideration to the definition of a force majeure event and what should and should not fall within this definition. This definition should always be tailored to the particular circumstances of each transaction and particular consideration needs to be given as to whether a force majeure event affecting another person in your supply chain should constitute force majeure in your contract

(b) consider the extent to which a party must have taken appropriate pre-emptive measures to protect against the force majeure event, in order to be able to rely on the clause

(c) discuss with your counterparty what happens in the event of a force majeure event and include these consequences in the force majeure clause, including the circumstances in which you can terminate the contract

(d) if you are the 'middleman' in a transaction, it is particularly important to ensure that the terms of the force majeure clause negotiated with your supplier is adequately reflected in the force majeure clause that is negotiated with your customer, otherwise known as 'back to back' obligations. If this is not the case, you may find that your supplier is excused from performance of its obligations but that you cannot invoke the force majeure provisions of your contract with your customer. In this situation, you will be liable to your customer as a result of circumstances beyond your control and without recourse to your supplier

(e) if you are sourcing goods from a particular supplier to satisfy a contractual obligation, we recommend that your contract specify that you are only required to source the goods from that supplier. In the absence of such a clause, if your source of supply fails, your force majeure clause is unlikely to protect you. In these circumstances, you may be required to source the goods from a different source, even if this is on unfavourable terms, e.g. at an increased price

(f) in the context of supply of goods contracts, include an allocation clause. It is inevitable that when the force majeure event is resolved a supplier's immediate ability to supply will be limited and it will have multiple customer obligations to fulfil. An allocation clause will provide a clear and transparent mechanism (e.g. pro-rata or priority treatment for valued customers) in which to rationalise limited supply between each customer, and

(g) ensure that there are proper notification provisions included in your force majeure clause. The last thing you need when a force majeure event has disrupted your business is to be trying to determine how and when you should give notice to your counterparty or, worse still, to lose the force majeure protection because you don't comply with the formalities.

The Icelandic volcanic eruption caught many people off-guard. While this article discusses some of the legal options available and the importance of obtaining proper contractual protection moving forward, people and companies should not lose sight of the importance of maintaining commercial relationships. In these difficult circumstances, it is those relationships that will inspire the individuals involved to try as best they can to reach acceptable outcomes for all parties involved.