The wonderful world of force majeure

August 6, 2010

Russia’s decision to ban grain exports will be welcomed by some physical grain traders because it allows them to declare “force majeure”, walking away from wheat supply contracts that had become increasingly uneconomic to perform.

Force majeure was originally developed as a doctrine under civil law systems. There is no automatic or general right to invoke force majeure in the common laws of England and New York that govern most international commodity supply contracts.

The common law equivalent is “frustration”. Lawyers have spent many happy and profitable hours arguing what does and does not constitute frustration. It is a narrower definition than force majeure — and much harder to prove.

But something similar to force majeure can be incorporated into a contract by the specific agreement of the parties. Lawyers advising commodity traders will always ensure that a carefully worded force majeure (FM) clause is included in every commodity supply agreement to enable the supplier to walk away if the contract becomes too onerous to perform.

The first step is to define the goods to be supplied very carefully. Assume Trader A has contracted to supply wheat to Country B that it intends to source from Country C. If the contract is merely for the supply of “wheat” meeting certain quality standards, an export ban would not enable an FM clause to be invoked.

If Trader A can no longer obtain the wheat as planned from Country C because of an export ban, the court would hold it to the requirement to deliver the wheat, even if that means sourcing from another country D at greater expense, incurring losses, or pay compensation for the failure to perform.

But if the contract defines the goods as “wheat from Country C”, then an export ban renders it impossible to fulfil. Wheat from Country D is no longer an effective substitute for the wheat from County C no longer available.

The second step is to set out precisely circumstances that enable the supplier to declare force majeure. These are normally set out at length and in detail but on a non-exclusive basis. Any well-drafted FM clause will cite export bans, sanctions and other government actions as discharging the party from liability to perform.

This is why some physical trading houses with contracts to supply Russian grain to overseas markets seem paradoxically to have lobbied for an export ban.

The ban was the only way they could activate the FM clauses in their contracts (and also possibly invoke frustration if necessary).

Without it they would have been forced to pay whatever it took to obtain scarce Russian grain supplies, even if the cost was far more than they could recover from the buyers under the contract. The fact a contract is no longer economic perform does not (automatically) excuse performance.

Crucially, because the affected contracts will all have referenced Russian wheat, the trading houses are under no obligation to source wheat from other countries to meet their obligations.

Freed of their obligation to perform or pay compensation under the original contracts for Russian wheat, they can now negotiate new contracts (at better prices) for the supply of wheat from other sources.

The lesson: commodity buyers should read their contracts very carefully and understand the circumstances in which sellers can just walk away.


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