Oil: Force Majeure in the Era of Coronavirus – Challenging Times for Common Sense?

By Ruchdi Maalouf, solicitor, De Gaulle Fleurance & Associés, and advisor to the Global Gas Centre

The new coronavirus pandemic (which we will refer to as “the coronavirus” here, rather than the unattractive “covid 19”) upset global activity on a scale comparable to the worst calamities in contemporary times. The initial reaction of some businesses (including in the oil & gas industry) was to minimize the severity of the crisis, including -according to the specialized press- to reject some of the early force majeure (FM) notifications from Chinese LNG buyers. Given the scale of the disruption caused by the coronavirus, denying that the current circumstances support FM notices would fly in the face of common sense. But the existence of FM circumstances does not mean that contracts can be suspended or terminated. This is not how FM operates.

What is force majeure?

FM means something different depending on the legal system. In civil law systems, contract law defines FM and that definition applies to all contracts. FM is a statutory right that can be invoked to relieve a party from liability when it fails to perform. In French law for example, it is defined in the civil code and allows a party in a contract to escape liability when it is unable to perform an obligation because of (i) an event outside its control, (ii) which could not be reasonably foreseen when the contract was concluded, and (iii) which cannot be avoided.

Common law systems tend not to codify contract law and often do not have a concept of FM. It is given force of law because parties include it in their contracts and, as a result, each contract contains its own definition of FM. There may be instead a concept of frustration which allows the contract to be cancelled in certain circumstances (it is relevant, but it is not FM). In English law for example, FM is not a term of art, but FM clauses are popular in international business contracts.

A legal definition of force majeure in contracts

There is no standard FM clause in international contracts. If we look at the precedents of the LNG industry, a well drafted FM clause in a sale and purchase agreement (usually subject to English law) will contain the following features:

– A definition of FM, typically stating that events beyond the control of a party (which is expected to act as a reasonable and prudent operator

– a legal standard) that prevented or delayed the performance of an obligation will constitute FM – A list of events presumed to be FM

– A list of events excluded from FM – A rule excluding liability for failure or delay in the performance of an obligation because of FM

– Rules on how and when FM should be notified and finish – Rules on the effects of FM (exclusion of liability for failure or delay, possible termination)

To summarize, FM means that specific circumstances caused the intended performance of a specific obligation to fail. That failure would normally result in a breach of contract but instead FM relieves the attendant liability and suspends the obligation or in some cases allow a termination of the contract.

Applying force majeure to an existing contract

In my legal practice, I have noticed that FM has taken a central place in many discussions in recent weeks. All are affected and will sooner or later face an FM notice from a counterparty, or have to issue one. Most likely both.

The following is relevant to contracts governed by English law. The starting point of FM is not the FM situation, but the likely failure to perform an obligation under a contract. Consider an LNG sales agreement. If a party fails to perform the contract, it will be liable, but FM can relieve its liability for failure. How? the contract must include an FM clause there must be an obligation, the performance of which is impeded by the claimed FM events the specific events causing the failure to perform must be qualified as FM the FM clause must not exclude expressly these specific events the party claiming FM has done everything required by the contract to prevent FM a proper and timely FM notification has been made to the other party.

It should be noted that FM clauses do apply to the obligation to pay money when due. FM does not relieve the liability nor the obligation.

The importance of the force majeure notification

Very often, FM disputes revolve around the notification of FM. If FM is not notified properly, the relief it offers may not be available.

The FM notice is sometimes misunderstood. It is not merely a duty to inform that performance will not take place because of FM. The party claiming FM bears the burden of proof and should demonstrate that performance is not possible. That party must identify the circumstances constituting FM, explain which contractual obligation they affect, demonstrate that the circumstances prevent performance of that contractual obligation, and demonstrate that the party affected by FM acted in accordance with the standards set in the contract.

A common sense approach

 It is quite extraordinary that we should debate if the most dramatic global events since World War 2 can constitute FM. When FM only affected some Asian buyers, it was tempting to argue that the epidemic did not stop operations and merely represented an ordinary economic setback, something FM clauses traditionally exclude from their scope. At this stage, FM affects the oil & gas industry from wellhead to final consumer, it should be clear to all that minimizing or underestimating the impact of FM would be a miscalculation and ultimately everybody and every industry will be affected.

It is true that there is a misunderstanding in parts of the public on the nature of FM. Some may think that FM is a status that applies to all circumstances within a defined space and time. FM would be equivalent to a declaration of a state of emergency, or for that matter a declaration of a pandemic by the World Health Organization. It is not the case. We are not in a state of FM and there is no such thing. The FM clause only kicks in when you cannot perform, and your liability can only be relieved if the events preventing you from performing can be qualified as FM in the contract, and the process set out in the contract was followed. In other words, the right approach is to start from a contractual obligation that cannot be performed, analyze the events causing the failure, and then take a view on whether these allow the liability to be relieved. FM defines the nature of specific circumstances applying to a specific obligation in a specific contract.

It is therefore a fallacy to query whether the coronavirus or the pandemic are FM events. Your starting point should not be to qualify the events as FM or not. This coronavirus crisis also illustrates this: it is not the nature of the pandemic that matters, it is the response. Similarly, in a contract, it is not the nature of the events that matters, but the fact that they interfere with performance. And the disturbance here is not caused by the coronavirus, but by the governmental responses. A pandemic has forced most of the world to take measures stopping non-essential activities and putting in lockdown more than half of the human population. That triggered a global economic crisis on an unprecedented scale.

In conclusion, if you are not able to perform an obligation under a contract, and this is caused by something that relates to the current global crisis, it is very likely that your liability is relieved by FM, provided the contract allows it and you notify it properly (except if it relates to pay money due). However, that does not mean that everyone should run for cover by raising the FM umbrella. Taking the example of the LNG industry, some producers may need to reduce production for various reasons (reduced shipping capacity, failure of various supply chains causing the closure of some of their facilities), while buyers may face a reduced demand (which is not a market event but a global failure of the economy and the supply chains – not a customary exclusion in contracts). If each side makes FM notifications without consulting each other, all sides will suffer avoidable damage. Common sense also dictates that all sides in all industries talk openly to each other and work towards a common goal: survive this crisis.

The article was published in the World Energy Weekly (April 20 issue), a publication of Petrostrategies, A French think-tank specializing in the oil and gas problems.