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Will an ‘Act of God’ offer a way out of a contract?

Contract with magnifying glass and pen Print publication

01/08/2019

In times of economic decline or uncertainty, parties often seek to extricate themselves from contractual commitments which, perhaps for reasons outside their control, are no longer commercially favourable. One strategy in such cases is to invoke the contract’s force majeure clause.

What is a force majeure clause?

A force majeure clause typically excuses one or both parties from performance of the contract in some way, following the occurrence of certain events. Its underlying principle is that, on the occurrence of certain events which are outside a party’s control, that party is excused from, or entitled to suspend performance of all or part of, its obligations. The term ‘force majeure’ has no recognised meaning in English law and should therefore be expressly defined in the contract.  Commercial contracts typically define exceptional events such as ‘acts of God’, natural disasters, terrorism, strikes, government acts, building collapse, fire, and the like as force majeure events.

Why is Classic Maritime Inc v Limbungan Makmur of interest?

In this recent case [1], the Court of Appeal gave important guidance as to the nature and operation of force majeure clauses.  In particular, the court highlighted that, regardless of the occurrence of a force majeure event, a party cannot rely on such a clause if it would not have been ready, willing and able to perform its contractual duties even if the exceptional event had not occurred.

What practical advice arises?

Parties should pay careful attention, both at the point of drafting and if/when a party seeks to renege on a deal, as to what is required before an exceptional event may excuse them from performance under any particular contract.

Parties should also note that the occurrence of an exceptional event will not be enough to excuse a party from its obligations if the party would have been unable to perform in any event.

The following practical tips therefore represent general good practice when it comes to anticipating, and attempting to cater for, an uncertain and ever-changing commercial marketplace.

  • Parties should always seek to specify the kind of events that they consider to be within the scope of force majeure. They should be defined precisely so as to capture industry-specific risks [2].
  • The English courts do not look favourably on reliance on force majeure clauses to escape contractual obligations that have simply become more expensive or difficult to perform. Parties can, however, negotiate and expressly provide for a clause of this kind.
  • To offer flexibility, parties should consider including within the contract a specified time period after which the contract terminates automatically; or providing for the parties to have an option to terminate; or both.
  • Parties should consider providing for the terminating party to have some form of redress, for example if goods or services have already been paid for at the time of the force majeure event.
  • Parties should note that what appears, on the face of it, to be a force majeure clause, may in fact be an ‘exception’ (or an ‘exclusion’) clause; or it may be a clause which covers contractual ‘frustration’. Each of these types of provision has different legal and practical implications, and specialist advice will be needed.
  • Finally, without a carefully drafted clause that expressly refers to Brexit, an English court is unlikely to regard Brexit as a force majeure event [3].

What happened in this case?

In Classic Maritime Inc v Limbungan Makmur, the appellant was a ship-owner under a long-term contract which provided for shipments of iron ore from Brazil to Malaysia. The respondent (the charterer) had an absolute obligation under the contract to perform, subject to a clause of general exceptions such as would typically be found in a force majeure clause.

A dam burst at the mine where the iron ore was being sourced, preventing any shipment from taking place. The ship-owner claimed for lost shipping revenue. When the charterer argued that it was protected from any liability for breach of the contract on the basis of force majeure, the ship-owner contended that, for the clause to apply, it was incumbent upon the charterer to demonstrate that but for the dam burst, it would have performed its contractual duties.

Much of the debate before the High Court comprised technical legal argument as to whether the clause was a ‘contractual frustration clause’ that automatically cancelled future contractual obligations; an ‘exception’/’exclusion’ clause that excluded or limited liability for breach; or a ‘force majeure clause’ per se. Each of those can have different legal and practical ramifications.  The Court of Appeal decided that what mattered was “not the label but the content” of the clause.

On the facts of this case, the Court of Appeal found that the clause in question was not, in fact, a force majeure clause. Rather, it was an exception/exclusion clause which required the charterer, if it was to escape liability, to establish that its failure to fulfil the contract resulted directly from the dam burst.  As the demand for iron ore in the Malaysian market had drastically decreased during the course of the contract, it could not be said that the dam burst had directly affected the charterer’s performance – the charterer would not have performed in any event.

The implications of the Court of Appeal’s decision were significant. On the question of damages, the compensatory principle required the court to place the ship-owner in the position it would have been in had the contract been performed.  Because the obligation on the charterer was absolute, the value of that performance was what the ship-owner would have made from the cargo if it was supplied, less the ship-owner’s costs. The Court of Appeal awarded $19 million in damages.

Contrast that with what the position would have been if the charterer had been able to establish that, but for the dam burst, it would have performed… In the latter scenario damages would have been nominal only. The importance of drafting such a clause correctly is therefore abundantly clear.

WM comment

Relying on a purported force majeure or similar clause is not an easy, nor by any means a guaranteed, ‘get out’ for contracting parties when times get tough.  By far the better advice is to try to anticipate, at the point of drafting, the types of circumstances in which the parties may wish to extricate themselves entirely from the arrangements and/or to avoid or limit liability for any breach or non-performance; and then to cater for that correctly in the contract.

Following on from that, this case highlights that there are subtle differences between a force majeure, frustration and an exemption clause and those differences will be determined by the specific wording used in each clause, regardless of the label attributed to it by the parties.

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[1] [2019] EWCA Civ 1102
[2] For example, a clause stating that the “usual ‘force majeure’ clauses shall apply” has been held to be void for uncertainty (British Electrical and Associated Industries (Cardiff) Ltd v Patley Pressings Ltd [1953] 1 WLR. 280).
[3] although recent case law suggests that, depending on the circumstances, Brexit may be regarded as an event which gives rise to termination of a contract by ‘frustration’. (See Walker Morris’ earlier briefing.)

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