Supply Chain Disruption – Again

Businesses affected by the Strait of Hormuz crisis are likely to be navigating both sides of the contractual liability equation: seeking to enforce protections while simultaneously trying to limit their own exposure. This balancing act will feel familiar to those who managed supply chain disruptions during the Covid pandemic or in response to Russian sanctions. But the scale of uncertainty and the severity of the current situation make it particularly challenging to chart a clear path forward. This note provides an overview of the English-law issues that have arisen in this current crisis and is relevant for companies and legal counsel seeking to understand and mitigate contractual risk in their supply chains, including for shipping, energy, commodities, and construction.

Force Majeure

At its essence, the principle of force majeure excuses a party from performing its contractual obligations when an extraordinary event beyond the party’s control occurs. War, conflict, and the events in the Strait of Hormuz are likely to be considered as force majeure events.

However, under English law there is no implied or automatic right of force majeure — the clause must exist in the contract, and its scope is defined entirely by the contractual language. One must not assume that the right to claim force majeure exists or that the right automatically or entirely excuses a party’s performance. Each force majeure clause must be read on its own terms.

Typical language in force majeure clauses may include:

• Foreseeability. Some clauses require that the event was unforeseeable at the time of contracting. Hormuz tensions were visibly escalating before 28 February, and the analysis may be more challenging for contracts that were entered into closer to that date.
• Prevention or hindrance. Clauses may require that the event “prevents” performance, not merely that it makes performance harder or more expensive. A party that can perform its obligations by an alternative means may struggle to establish prevention. Some clauses use the lower threshold of “hinders” or “impedes,” for which the analysis may be more nuanced.
• Mitigation. Most clauses require the affected party to take reasonable steps to mitigate the impact of the force majeure event. A party that takes no steps to explore alternatives before invoking the clause or throughout the duration of the force majeure event may be challenged.
• Notice. Most clauses require prompt written notice to the counterparty. Failure to give timely notice can extinguish the right to invoke the clause entirely. After issuing notice, the notifying party will typically need to update its counterparty on any changes to the force majeure event and its effect on the non-performing party’s ability to fulfil its contractual obligations.
• Suspension or termination. Some force majeure clauses enable the counterparty to terminate the contract if the force majeure event persists beyond a certain time frame. Before issuing any notice, a party should understand its counterparty’s rights, as well as its own.  
• Reasonable endeavours. Some force majeure clauses require that a force majeure event must be “that which cannot be overcome by reasonable endeavours.” However, the UK Supreme Court recently found that a reasonable endeavours proviso does not obligate the parties to carry out the contract by alternative, non-contractual means.^[1] That principle may come into play in the current situation where purchasers, relying on force majeure, may seek to reject alternative or delayed delivery of goods purchased.

War Risk

Shipping contracts typically contain a war risk clause that allows the shipowner or master to divert the ship away from ports, seas, and other geographic areas considered to be under war risk or otherwise cancel the charterparty entirely. As with force majeure provisions, under English law there is no implied or automatic right of war risk; the parties must include the clause in the contract and its scope is determined by the language of the clause.

Typical provisions of a war risk clause include:

• Insurance. The parties may need to comply with orders or directions from any war risk insurer.
• Additional Freight. If, to avoid the war risk, the master adopts an alternative, longer route, that additional freight is normally charged to the charterer.
• Notice. Typically, clauses require the shipowner or master to provide the charterer notice, and in turn, the charterer to promptly nominate alternative safe ports.

Importantly, where a contract is part of a supply chain or matrix of contracts, care should be taken to understand liability across the transaction, especially if the contracts have inconsistent provisions or are governed by different laws.

Frustration

Where a contract contains no force majeure clause — or where the clause does not provide relief — parties sometimes turn to the English law doctrine of frustration. This is understandable, but the doctrine has a high bar that parties often struggle to meet.

Generally, frustration arises where an unforeseen event outside the parties’ control has made the contract impossible to perform. Typical scenarios of where frustration can take effect include the delivery of goods, where the ship carrying those goods has sunk, or renovation of a building, when the building itself has collapsed. The doctrine exists to address genuine impossibility, not hardship. For example:

• Expense and inconvenience are not enough. The fact that performance has become dramatically more expensive or delayed does not frustrate a contract.
• Alternative performance defeats the claim. If the contract can still be performed — even at greater cost or delay — frustration will not apply.
• Foreseen or foreseeable events typically cannot frustrate. Where a party could have anticipated the risk and chose not to provide for it contractually, courts will typically not provide relief through frustration.

For example, and pertinent to the current situation, the House of Lords held that the 1956 Suez Crisis did not frustrate a CIF sale of Sudanese groundnuts, because the goods could still be shipped via the Cape of Good Hope at greater cost.^[2]

For more information about understanding and mitigating supply chain legal risk, reach out to our International Disputes Resolution team.

Crowell would like to thank Phoebe Kinsman for her contribution to this alert.