Legal development

The Red Sea crisis – managing the impact on contractual performance

The Red Sea crisis – managing the impact on contractual performance

    The continuing crisis in the Red Sea which has seen attacks on international shipping by Houthi rebels continues to disrupt supply chains globally and across industry sectors. The re-routing of shipping around the Cape rather than using the Suez Canal causes major delays and substantially increases costs. This brings into focus again the need for parties to think about their rights and responsibilities when faced with such events and the resulting disruptions.

    What should impacted parties be thinking about?

    The availability of redress will depend on the specific wording of the relevant contract(s) and the applicable governing law. While common law often requires contractual force majeure (FM) provisions for effective remedies, in many civil law jurisdictions FM and hardship considerations also exist as substantive legal doctrines codified in their civil codes.

    Contractual FM provisions

    If a contract contains a FM clause, a party may be relieved from performance of its obligations if the express requirements of that clause are met. Parties need to pay keen attention to how the FM clause is drafted, and in particular consider:

    1.  Does the event which has caused non-performance fall within the contractual definition of FM? 

    Whether the event is a FM event under the contract will depend largely upon the drafting of the clause. In relation to the Red Sea crisis, attention might be paid to definitions that include "war" or "conflict". Or, falling short of that, parties might seek to rely on references to "circumstance not within the reasonable control of the parties" or the like.

    Consider what event has impacted performance of the contract, for instance is it an attack on a particular vessel or is it an ancillary event such as the continuing diversions of commercial shipping routes, sanctions, legislation or other acts of government. These actions may fall within the definition of FM under the particular clause. Particular attention may need to be paid to insurance cover issues.

    2. Is the impact of the FM event sufficient to trigger suspension or termination?

    Consider whether the FM event has, in fact, impacted the performance of the contract (and how this might be proved). Check to see whether performance of the contract must be rendered impossible or whether it suffices that performance is merely hindered. If performance is suspended, check whether related payment obligations are also similarly suspended. 

    3.  Time limits and notice periods – beware of potential pre-conditions

    Adherence to any time limits and notice requirements is key; they may operate as pre-conditions to relief (be conservative with "prompt" notification obligations). The contract may also contain an obligation to report periodically by the party giving notice; this requirement too may constitute a pre-condition.

    Failure to respond to FM notices runs the risk of acquiescence/waiver/estoppel; even if the FM clause does not expressly require a response, a clear rejection should be sent where FM is not accepted, including a reservation of rights. 

    4.  Mitigation requirements

    Check to see whether there is any express or implied obligation to mitigate, as failure to do so may prevent reliance on a FM clause. 

    5.  Consequences of invoking an FM clause

    Careful thought must be given to contractual termination rights which might be triggered by a FM notice; sometimes these arise soon after a declaration of FM. We have seen these triggered after a period as short as 20 days. In such circumstances invoking a FM clause may be undesirable.

    English law doctrine of frustration 

    The English law doctrine of frustration may apply where performance is rendered impossible, illegal or radically different. The bar for relying on such doctrine is generally high – it will not apply where performance is merely more expensive or more onerous. If frustration is successfully claimed then obligations to perform are discharged and the contract is automatically brought to an end which may or may not be a desirable commercial outcome. Complicated issues arise where value needs to be given for partial performance of frustrated contracts.

    Force majeure and hardship considerations under civil law 

    Where a contract is governed by a civil law, separate codified legal doctrines reflecting FM and hardship considerations may operate in addition to a contractual FM provision, or provide for relief where such a contractual provision does not exist. These doctrines are often based on the notion of impossibility of performance and will require case-specific analysis to assess whether they can be invoked. In some jurisdictions they may also extend to situations where changed circumstances have rendered performance financially not viable and/or it would otherwise impose hardship to insist on the original bargain terms despite unforeseen changes of fundamental circumstances (e.g. delay). 

    In such cases, relief may take various different forms, including voiding performance obligations, compensation of damages suffered, or adjustment of relevant terms by the court or arbitral tribunal to restore an equitable balance. Questions may nevertheless arise as to recourse to such doctrine in sophisticated commercial agreements where the parties have had full opportunity to allocate risk contractually. Close attention should be paid to the perils of delay in seeking hardship relief.

    Other contractual flexibility mechanisms

    Some contracts provide for liquidated damages and/or liability caps to remedy particular breaches. These are commonly seen in supply agreements to address non-supply or partial supply of goods. These provisions might be utilised in situations where a supplier chooses non-performance in favour of keeping particular goods to on-sell elsewhere in more favourable circumstances. For example, in certain circumstances, it might be advantageous for the seller to pay a fixed amount for non-performance under one contract and make a profit by selling the same goods under another contract, particularly where those goods have increased significantly in value. Whether liability caps and provisions for liquidated damages will apply in case of deliberate breach of contract will however require close analysis and depend upon the factual matrix.

    Final thought

    The Red Sea crisis is just the latest geopolitical event to have an impact upon international trade, rendering performance of contractual obligations more difficult, or perhaps impossible. In recent times, the COVID-19 pandemic and Russia's invasion of Ukraine led to similar challenges. Experience of the impact on international trade of these events has shown how important it is to proceed carefully where relief is sought under FM or similar mechanisms.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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