Introduction
The escalating Middle East conflict - with its near-closure of the Strait of Hormuz, surging oil prices and increasing disruptions to global shipping - is already affecting businesses across Australia.
These events may already be rippling through your contractual arrangements. Prices have risen sharply. Delivery timelines are under pressure. Shipping routes have been disrupted. So, somewhere in the background of every affected contract sits a question that is rapidly becoming urgent: “Does our force majeure clause apply?”
Many might be tempted to use the crisis as a justification for excusing delays or non-performance on the grounds of ‘force majeure’. But be wary! Relying on a force majeure clause is not necessarily straight forward and, if not done carefully, it can lead to significant legal risks.
What does ‘force majeure’ actually mean?
In a commercial contract, a force majeure clause can temporarily excuse or suspend one or both parties from performing their obligations when an extraordinary event ( i.e. beyond their control and not of their making) prevents or significantly impedes performance. The phrase ‘force majeure’ comes from French civil law and translates loosely as ‘superior force’.
Unlike some other countries, in Australia there is no statute that defines what ‘force majeure’ means. Instead, it is a doctrine based on ‘common law’, which means it is a principle that has developed through case law in the Courts. It also means a force majeure clause has no effect beyond what the parties have specifically agreed in writing. If the contract does not contain a force majeure clause, you cannot rely on it. But if it does contain a clause, the specific language in the clause governs everything.
Usually, a force majeure clause could cover unforeseen events such as natural disasters, terrorism, regulatory changes… and war.
Hardship is usually not a force majeure event
There is a common misconception that economic hardship can be grounds for termination of a contract on the basis of force majeure. However, it is well established that economic hardship, such as higher fuel costs, freight costs, raw material costs and so on, does not entitle a party to trigger a force majeure clause to get out of their obligations. Even if these costs mean you will be fulfilling the contract at a loss or reduced profit level, the contract remains legally binding.
Unless your contract contains a separate hardship or price-escalation clause, rising costs alone will not excuse non-performance. Force majeure clauses exist to fairly allocate risk, not to escape unprofitable commitments.
So what is a valid force majeure event?
While the precise test depends on the wording of each contract, the Courts consistently look for three essential elements before allowing a force majeure claim to succeed:
1. The event must be covered by the clause
The first question is whether the Middle East conflict and its downstream effects fall within the definition of a “force majeure event” in your contract. Common listed events include “war,” “acts of war,” “armed conflict” and similar.
The current crisis may qualify under “war” or “armed conflict”, but there could be a technical argument about whether a “war” is actually occurring. As at the date of writing this article, the US has not actually declared war on Iran, as that would require Congressional approval.
Some contracts also include broad catch-all language such as “any event beyond a party’s reasonable control”. But be careful. Courts apply the doctrine of eiusdem generis (meaning ‘of the same kind’) to catch-all clauses. In other words, a general phrase following a specific list will typically be read to cover only events of a similar type to those listed. A clause listing “fire, flood, storm or any other event” is unlikely to extend to geopolitical conflict.
2. The event must have caused the non-performance
It is not enough just to show that a force majeure event has occurred somewhere in the world. The party seeking to rely on the clause must show a direct causal link between the event and their inability to perform the specific contractual obligation. A manufacturer who cannot ship goods because of Strait of Hormuz closures stands on very different legal ground from one who simply faces higher production costs - even if those costs stem from the same conflict.
A party that was already struggling to fulfil the contract before the crisis could find it very difficult to shelter behind a force majeure claim.
3. Reasonable steps to mitigate must have been taken
Almost every well-drafted force majeure clause - and every Court considering them - requires the party invoking the clause to demonstrate they have taken reasonable steps to mitigate the effects of the event. This might include sourcing alternative suppliers, trying to identify different shipping routes or stockpiling key materials. A failure to mitigate can defeat an otherwise valid claim, or reduce the period for which relief is available.
The Risks of Getting It Wrong
If a party invokes force majeure without a valid legal basis, the other party may treat that as a repudiation of the contract and elect to terminate themselves. This could make the party who issued the notice liable for damages for wrongful termination, including lost profits. Over-reaching on a force majeure claim can therefore place you in a far worse position than simply performing at a loss.
Foreseeability can also be an issue. Tensions in the Middle East are not new. They have been a well-documented feature of global risk for decades. Contracts signed before the current crisis could face the argument that the type of disruption now occurring was foreseeable at signing - which can defeat a force majeure claim even where the specific trigger was unexpected.
Practical Steps for Both Sides
What if there is no force majeure clause, or it can’t be used?
There is a related, but different, common law doctrine of ‘frustration’ which might provide some relief – but usually only in extreme cases where performance of the contract becomes truly impossible. For example, if the physical materials needed to fulfil the contract are destroyed. However, there is a high threshold for establishing a successful frustration argument and it applies only in narrow circumstances. Further, it automatically terminates the entire contract rather than temporarily suspending it. That isn’t always a desirable outcome.
Depending on the circumstances, there might also be other ways of trying to terminate the contract – check out our article here about terminating contracts.
What to do now
Now is a good time to review your current contracts and be extra cautious when entering into new ones. Map your significant contracts against the current risk environment: identify which contain force majeure clauses, how those events are defined, what procedural obligations apply, and what a valid invocation would mean for your business in a commercial sense. For new contracts, review any template force majeure clauses and consider including specific triggers that recognise the current crisis (e.g. armed conflict, sanctions, closure of international shipping routes), a separate hardship or price-escalation mechanism to help you deal with rising costs, and clear notice and consequence provisions.
If you are already in a situation where this is a live issue, take extra care. Courts read force majeure clauses narrowly and enforce their procedural requirements strictly. This article covers some of the most common issues, but there are also many other potential legal traps to be careful of. And, in many cases, a commercially negotiated solution can serve both parties far better than formal legal action. But that conversation is best had before notices are exchanged, not after.
How Sharrock Pitman Legal can help
Finding some certainty in uncertain times is not easy. For business owners focussed on protecting their business operations and managing contractual arrangements, it is iimportant to seek expert legal advice sooner than later.
Managing Principal Mitchell Zadow is an Accredited Specialist in Commercial Law with extensive experience advising businesses, whether large and small, shipping out or shipping in. Please do not hesitate to contact us on 1300 205 506 or contact Mitchell directly at mitchell@sharrockpitman.com.au.
The information contained in this article is intended to be of a general nature only and should not be relied upon as legal advice. Any legal matters should be discussed specifically with one of our lawyers.
Liability limited by a scheme approved under Professional Standards Legislation.
Mitchell is the Managing Principal of our law practice.
He is an Accredited Specialist in Commercial Law (accredited by the Law Institute of Victoria). He also deals with areas of Employment Law, Wills & Estate Planning and Probate. For further information, contact Mitchell on his direct line (03) 8561 3318.
