As the conflict in the Middle East and disruption to the Strait of Hormuz continues into its 12th week, our team of international experts (i) examine the legal implications for affected businesses of a prolongation of the crisis and (ii) discuss how they are seeing businesses react to the disruption.
The conflict in the Middle East remains ongoing with no clear end in sight. As at the date of this article, the US-Iran ceasefire is fragile and passage through the Strait of Hormuz is precarious. Those businesses that rely on the free flow of trade through the Strait of Hormuz face severe disruption to their operations and stark financial implications. When the Strait does reopen, disruption is likely to continue following damage to infrastructure in the region and the undermining of the security of and confidence in the waterway.
The prolongation of this conflict will have implications for the global economy and on global trade that, for businesses, requires careful management. In these circumstances, parties to affected contracts will have been reviewing their rights and obligations and considering how to mitigate disruption and risk. This is not a regional problem; the ramifications are being felt across the globe. This article examines the key considerations for businesses that are facing ongoing disruption, with a particular focus on the energy sector, and from an English law and Middle East perspective.
The events of the past 12 weeks highlight the vulnerability of global trade to unforeseen events in a key energy hub. These events have had both immediate and ongoing impacts on international energy markets.
In the Gulf region, supply of LNG and oil (and other key materials) has been disrupted as a result of reduced transit through the Strait and damage to upstream facilities. This has impacted production, supply and offtake agreements, and had knock on impacts on logistics and transportation contracts. As prices have increased across global markets, upstream businesses will have been considering how to manage non-performance of supply, while mid and downstream businesses and buyers will have been managing delay and consequential impacts.
Likewise, renewable projects in the Gulf region and beyond are feeling the impact of disruption to supply chains for the materials they require and delays in manufacturing as a result of energy market disruption. Renewable projects are typically carefully priced, with government tariffs locked in, and certain levels of capital expenditure planned for. If such agreements and tariffs are unable to be revisited, this will have a serious impact on the value of those investments.
The longer-term impact of the conflict remains to be seen. Market commentors have suggested that prolonged disruption could accelerate a structural shift in global energy systems, as countries look to prioritise energy security. Events such as this conflict are predicted to increase the focus on prioritising energy security through a shift towards electrification and renewable energy sources. Within Europe, the Iranian conflict has deepened existing concerns already aggravated by the Ukrainian conflict regarding the continent’s dependency on external energy suppliers.
Within the Middle East itself, whilst the lure of Gulf states for energy infrastructure and investments may have been temporarily impacted, commercial sentiment remains positive. In the transactional space, overseas investors appear to be taking a cautious and patient approach, and we have not seen a flurry of deal cancellations or investors walking away from the negotiating table. And whilst project financing may have somewhat cooled compared to its pre-war levels, our finance teams have been kept busy as the banks have shown a willingness to continue to provide liquidity. Gulf state governments have also demonstrated an eagerness to get deals done within the region in a signal of confidence to the market.
Businesses that are affected by the current conflict are well advised to consider their rights as part of the management of fallout on their operations, if they have not done so already. For those businesses that have undertaken this exercise already, the continuation of the conflict gives rise to different considerations and the need to revisit the analysis that has already been undertaken. The situation is not static, such that new rights may be triggered as the circumstances change.
Unlike English law where concepts like “force majeure” are essentially a creature of contract, the civil transactional laws of the GCC states have provisions which, in substance, import such concepts by statute. The governing law of affected contracts will therefore be the starting point for a business to understand its rights and obligations.
Contractual parties will naturally wish to examine (or re-examine) expressly provided for force majeure clauses in their contracts to see if such clauses can provide relief. The circumstances of the conflict may neatly fit within such a clause and a number of entities, including state-owned energy companies in the region, have already declared ‘force majeure’ under supply and offtake contracts.
As a matter of English law, the scope of a force majeure clause is a matter of contractual construction. It will be necessary to check whether specific, relevant events, such as outbreaks of war and blockades of waterways are included in the list of force majeure events. In the present circumstances, the need to establish the existence of a “war” may be more challenging than demonstrating “hostilities”, with debate over whether an undeclared “war” gives rise to a force majeure. In our experience, in circumstances where contracting parties accept that the Iran conflict falls within the meaning of “war” in a force majeure clause, the point of dispute is on whether the conflict has “prevented” performance.
It is therefore important to analyse the causative link between the event and the failure to perform. The requirement that performance is “prevented” has a higher threshold than the requirement that performance is “hindered” or “delayed”. Depending on the specific language used in the relevant force majeure provisions, there may be a risk for the affected party that there is no causative link in cases where the conflict has merely increased the technical or commercial costs of performance but has fallen short of “preventing” the party from performing its obligations.
If a force majeure clause is triggered, the requirement to conform with the clause will be important. It is often necessary to issue a notice that meets certain strict formalities. The party relying on force majeure may then need to issue prescribed updates. It will often be a requirement that the party claiming force majeure mitigates the disruptive impact of the event. How far a party must go in mitigating the effects of the event is a fact specific question that will often require consideration of the reasonable options available to that party, unless the clause provides a more burdensome standard of mitigation.
The effect of such a clause will typically be that non-performance of contractual obligations is excused. If the event is prolonged, there may be a right to terminate the contract. However, if a force majeure clause is relied upon illegitimately (to excuse performance or to terminate the contract), there is a risk that the affected party will be subject to a claim for breach or repudiation of the contract.
In contrast, under most GCC laws, force majeure is a statutory concept. In essence, if force majeure supervenes and renders performance of an obligation impossible, the corresponding obligations shall lapse, and the contract shall be automatically dissolved. The provisions typically distinguish between partial impossibility and temporary impossibility (in continuing contracts) where contracts are not automatically dissolved – parties can seek to terminate specific obligations or apply to court to dissolve the whole contract. To the extent contracts are governed by laws of the GCC countries (e.g., UAE, Qatar, KSA), parties should be aware of the statutory framework of force majeure which might sit alongside contractual force majeure provisions – albeit similar principles may apply such as unforeseeability of the event and causal link to impossibility of performance.
Alternatively, a party that is not protected by a force majeure clause may wish to consider (or reconsider) whether it can find recourse in the doctrine of frustration. The doctrine exists as a matter of English common law and has a high threshold. The doctrine will not apply where the allocation of risk in relation to such matters has been provided for in the contract.
Frustration may apply where a party’s obligations cannot be performed due to impossibility, illegality or because performance has become something radically different to that which was originally intended. It is not enough that obligations become more difficult or more expensive to perform. Where the doctrine is able to be relied upon, like force majeure, it will excuse performance. But, as with the exercise of rights under a force majeure clause, care must be taken not to improperly rely upon the doctrine.
Under most GCC laws, there is a similar provision relating to hardship of performance albeit with a critical difference to English law – an obligation that becomes more expensive to perform can be adjusted. For example, in the UAE, the civil code permits a court/tribunal to adjust a party’s obligation that has become more onerous (but not impossible) to perform due to exceptional unforeseeable events and where the party is threatened with grave loss, and it is not possible to contract out of this provision. In practice, this provision (if triggered) could allow parties to have commercial discussions with counterparties on issues like cost sharing of obligations that can still be performed but at a much higher price (e.g., transport by air rather than by sea).
Consideration ought also to be given to the wider contractual rights and obligations of the affected party. There will be various further clauses to consider, including the following.
A material adverse change (MAC) clause may allow a party that is involved in an ongoing transaction to withdraw from the transaction when an unforeseen event occurs that materially impacts the value of the transaction. As with a force majeure clause, the triggering of a MAC will depend on the terms of the clause; such clauses often exclude changes affecting the wider market. MAC clauses tend to be heavily negotiated and will not be pervasive across all affected contracts.
Change in law provisions may be available to address legislative action and the impact that it has had on the contract. Such clauses are typically seen in long term contracts as may arise in the energy sector. Where new laws or regulatory measures are introduced and impact the terms of an affected contract, the relevant party may have some recourse for its losses. Similarly, in contracts between private actors and state entities, a stabilisation clause may similarly provide the affected party with recourse for measures introduced by the government that impact the party.
Notice provisions may be triggered in the relevant contract, or related contract, as a result of either the relevant event or the non-performance of a party’s obligations. For example, a notice may lead to an extension of time to a party’s obligations or be a requirement under a finance or insurance contract. A notice that is late or that is invalid will have implications on a party’s ability to rely on the outcome of the notice.
More generally, it will be necessary to look at other potentially affected clauses, such as representations and warranties (the underlying premise of which may have shifted since the conflict), termination rights (that may have been triggered by breaches of the contract or related contracts or prolonged force majeure), and other clauses that allocate risk between the parties.
Every international crisis presents its own unique set of facts when it comes to a force majeure assessment. This conflict is no different.
1. Force majeure is an intensely fact specific assessment. It depends on the (i) language of the clause and (ii) how events on the ground apply to that language.
2. We are seeing parties seeking to collaborate in the short to medium term where there is a clear contractual/legal force majeure event or where performance has become more onerous. But parties may not be willing to forego payment obligations where such obligations are not prevented by force majeure.
3. The immediate impact across projects (including construction) is the rising costs of materials and supplies. Whilst parties are cooperating in ongoing projects to, amongst others, share increased costs, in the event issues prolong this will inevitably lead to disputes where the costs escalate to levels that cannot be sustained within acceptable project margins.
4. Where a party is required to meet delivery of goods, but is unable to do so, we are seeing discussion regarding alternative means of performance. Where delivery by another means (such as by air) is much more expensive, the question, under English law, is whether the affected party is “prevented” from performing and/or the standard that must be met to mitigate the event. Under GCC laws, however, the question is more focussed on whether insisting on performance threatens a party with grave loss such that the obligation should be adjusted.
5. Parties are seeking to avoid formal disputes where this is possible, while we wait to see what the full repercussions of the conflict will be. Parties will need to consider how best to protect their positions to avoid undermining their rights. As the conflict extends, and supply chain frustration continues, disputes across the supply chain are inevitable.
There are various steps that impacted businesses would be well advised to take. Many businesses will have already taken steps to consider their rights, but as the position evolves, so will the appropriate assessment.
Clarity on impacted contracts is important. Businesses should prepare lists of those contracts that are affected, with a focus on key contracts. It is necessary to focus beyond contracts that are directly affected, to contracts where there is a secondary impact. A careful audit of affected contracts should then occur to identify the rights and obligations that have been affected by the events and the obligations that are triggered by the events.
Consideration as to how to address the matter with contractual counterparties and interested parties will follow. Once the business knows what its rights and obligations are under the contract, it will need to focus on getting the execution of those rights and obligations correct (e.g. the issuing of relevant notices and mitigating the impact of the event), and avoiding any breaches of contract in so doing. It may also be helpful to consider amicable commercial solutions to the difficulties being faced.
Dealing with insurers is another key aspect. Apart from early notification, it is pertinent to assess if the insurance cover extends to war risks (most standard insurance policies do not and parties typically have purchased additional cover). Even if insurance does cover war risks, parties should assess what is covered and for what duration (e.g. we have seen policies that lapse if the war continues beyond a certain period).
Where disputes may arise, document preservation is vital. It is important to contemporaneously document the impact of the conflict on the business (contractually, operationally and financially) and the actions taken by the business to mitigate the disruption. Clarity as to timelines and actions will assist if a dispute arises, as a means of evidencing the party’s position.
Other considerations that a business should be alive to will include its compliance obligations in light of the changing sanctions landscape, and the resilience of the business and the procedures in place to deal with a further escalation of the situation, including contingency planning.
Ensuring that the business takes advice from legal and other advisers and other service providers at appropriate stages will be key. It can be too late to involve external lawyers after rights have been improperly exercised or contracts terminated.
We are here to help; if you would like to discuss any of the issues raised in this article, please contact our team of specialists.
Partner, Commercial Disputes and Construction & Engineering
UAE
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