As the COVID-19 outbreak intensifies, and construction project supply chains continue to be disrupted, many parties are left wondering whether force majeure disruptions further along the supply chain will excuse performance under their own contract.
The impact of COVID-19 on construction project supply chains
As the COVID-19 outbreak continues, the principal focus remains on the human impact and global efforts to slow the spread of the virus. However, the scale of the economic impact of the virus is also becoming clear.
International construction projects depend on the flow of equipment, materials and labour along chains of supply. A disruption to any link in that chain has the potential to delay delivery and increase costs. Parties routinely allocate the risk of unforeseen events which are beyond their control through contractual force majeure provisions (see here). In addition, many legal systems, principally those based on a civil code, have legislation which deals with parties' rights and obligations following the occurrence of a force majeure event.
The question of whether a party is entitled to relief for non-performance becomes more complex when that non-performance has originated further along the supply chain. We have been receiving an increasing number of enquiries concerning the transfer of force majeure risk from party to party. This note briefly considers a common area of complexity, namely where parties in a supply chain are subject to different standards for force majeure when assessing whether non-performance is excused.
Differing standards for force majeure
If all parties along a supply chain are subject to the same terms and conditions in respect of force majeure, then a disruption to any party will likely also excuse non-performance up the chain. So if, for example, a factory closure in one country delays delivery of equipment required to complete a project in another, the parties in between, up to and including the main contractor, would be excused from liability for the resulting delay. However, asymmetries of force majeure treatment frequently arise. These inconsistencies arise from two main sources: (1) differing contractual treatment of force majeure; and (2) differing governing laws.
A. Differing contractual provisions
When passing risk down a supply chain, it is good practice to ensure that risks are addressed on a back-to-back basis. This applies to force majeure risk as much as any other. However, for various reasons, parties may end up with subcontracts or supply agreements which provide for different treatment of force majeure events.
It may be that one contract provides for a broad, "beyond the parties' control", test as to whether there has been a force majeure event, whilst another agreement in the chain allows for relief only upon occurrence of one of a closed and exhaustive set of qualifying circumstances. Alternatively, where one contract simply extends entitlement to relief without pre-condition, another in the chain may include detailed and rigorous notification and reporting requirements as pre-conditions. Failure to comply may mean that the party is not entitled to relief.
Force majeure clauses in many standard form and bespoke EPC contracts address this potential for disparity head on by specifying that a main contractor seeking relief on the basis of a subcontractor's inability to perform due to force majeure, will only be entitled to relief insofar as the event in question would qualify as force majeure under the terms of the main contract.1 However, if a main contractor has been obliged to accept more generous force majeure terms with one of its key suppliers than it was able to secure itself under the main contract, this could leave the main contractor exposed to liability for delay under its contract and without recourse against its delayed supplier.
In the reverse scenario, where the main contract terms provide relief, but the terms of a subcontract do not, some difficult questions arise. From the main contractor's perspective, its ability to perform is being impacted by a force majeure occurrence. However, as its defaulting subcontractor is not excused from delayed performance, a question arises as to whether it is the subcontractor's breach, or the force majeure event which is the cause of the main contractor's delay. Whether the main contractor would still be entitled to rely on its force majeure provisions to claim an extension of time, will depend on the precise terms of the applicable clause and close examination of causation issues.
From the subcontractor's perspective in this scenario, the fact that its counter-party may be entitled to relief under the main contract will most likely not assist. The subcontractor would remain liable for any delay and, if it has agreed to pay liquidated damages under its contract, could still face this liability.
B. Differing governing law
The second way in which an inconsistency of entitlement can arise is where contracts in a chain have different governing laws.
In many common law jurisdictions, the scope and effect of force majeure is not defined as a matter of law, and express clauses are interpreted strictly. By contrast, most civil law systems provide force majeure mechanisms. Thus, there may be asymmetrical force majeure relief entitlements arising in a contractual chain via different governing laws.
By way of example, in the absence of a force majeure clause in either the main contract or subcontract, or if the impact of the current pandemic falls outside the scope of the clauses, parties may nonetheless be entitled to relief under the governing law. In a scenario where a subcontract or supply contract is governed by French law, for example, and the main contract by English law, the main contractor would not be entitled to force majeure relief,2 while the subcontractor or supplier may be. As with an asymmetry arising from drafting, this could leave the main contractor exposed.
Moreover, where parties do include a force majeure clause in a contract governed by a legal system which legislates for such unforeseen events, questions may arise as to interaction between the clause and the provisions of the governing law. For example, in an ICC arbitration concerning disruption to performance of a contract in Libya, the Tribunal found that whilst the parties had intended to modify the definition of force majeure provided under the Libyan Civil Code, the clause included in their contract did not, on its terms, exclude the fundamental requirement under Libyan law that the event must have rendered performance definitively or temporarily impossible.3
When passing risk down a supply chain, it is good practice to ensure that risks are addressed on a back-to-back basis. This applies to force majeure risk as much as any other. At risk of dispensing unhelpful advice after the fact, one consequence of this pandemic is likely to be that parties will pay closer attention to the scope of their own force majeure provisions as well as those in contracts below them in the supply chain.
Fundamental to achieving back-to-back pass-through of risk is ensuring the contracts along a chain have the same governing law although commercial realities mean that this cannot always be achieved. Where the risks under a contract are significant, this may encourage parties to take advice on the scope of force majeure relief under whichever governing law they are agreeing to and, if possible, seek to achieve symmetry of risk allocation through drafting bespoke force majeure clauses.
Where parties find themselves in this current crisis facing an asymmetry of force majeure relief entitlement, it is important to move quickly to address the potential risks. This should be approached in the same way as any assessment and application of a force majeure clause, namely via a careful reading of the scope and requirements of the relevant clauses and a detailed and frank assessment of causation issues.
1 See for example Clause 19.5 of the FIDIC Conditions of Contract for EPC/Turnkey Project (1999 Edition).
2 There may still be an argument that the contract is discharged through frustration, but this is a much stricter test to satisfy than that typically included in a force majeure clause: "[a] contract may be discharged on the ground of frustration when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract"; Chitty on Contracts (Sweet & Maxwell, 31st edition, 2012), paragraph 23-001. See Suspending contractual performance in response to the coronavirus outbreak
3 National Oil Company v. Sun Oil Company of Libya (ICC Case No. 4462/AS, Award dated May 31, 1985) – see excerpt here.
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