Good Deals Gone Bad: Managing Contracts Affected By The Low Oil Price

The plummeting oil price has serious implications for many companies bound by contracts entered into on the basis of a high crude oil price. While the most direct effects are felt by oil and gas companies who may need to abandon projects or asset acquisitions which are not economically viable while the current price trend continues, a wider impact is also felt by other parties, such as contractors and offtakers.

This briefing sets out the headline points to consider if a party wishes to renegotiate or exit an unprofitable or otherwise unfavourable contract, or suspects that its counterparty may wish to do so.

1. What is the governing law of the contract?

• English law doesn't recognise any general principle of good faith in the performance of contractual obligations which might require a party to alleviate the consequences of strict compliance with a contract, so as to enable their counterparty to obtain relief from onerous obligations. Despite the stirrings of a doctrine of good faith in some recent cases, this remains the case. As a result, the courts are generally reluctant to allow parties to escape from bad bargains in the absence of express contractual provisions.
• Civil law jurisdictions generally take a more flexible approach, allowing renegotiation in the event of economic hardship. They are also more willing to require parties to act in good faith in performing their contractual bargain.

2. Is there a hardship clause?

• The contract may include a "hardship clause", or an express provision designed to accommodate changed circumstances, such as a price review clause.
• However, the provisions will need to be clearly defined and sufficiently certain for the clause to be enforceable as a matter of English law. For example, a price review clause will need to define when the review will take place and how the revised price will be calculated, and set out the consequences if an agreement cannot be reached between the parties (for example, referral of the matter to a court or tribunal to determine the revised price).

3. What are the force majeure provisions?

• The contract may include force majeure provisions, which generally operate to suspend contractual rights and obligations on the occurrence of a force majeure event. A force majeure event is typically defined as an unforeseeable event outside the control of the parties which prevents or delays the affected party's performance of its obligations, but the definition will need to be checked carefully. In contrast to certain civil law jurisdictions, under English law there is no general principle of force majeure, and therefore the availability of force majeure relief will depend on the interpretation of the force majeure clause in the specific contract.
• It is highly unlikely that a decline in oil prices (or the consequences of this) would constitute a force majeure event under most contracts, and often events such as these are specifically excluded from the definition of force majeure.
• However, if these do fall within the definition, careful attention will need to be paid to how the clause works. Often, the contract will provide that the parties' obligations are suspended for as long as the force majeure event is continuing, but sometimes clauses incorporate time limits after which, if the force majeure event is still ongoing, one or both parties may have the right to terminate the contract.
• The clause is also likely to impose obligations on the affected party to mitigate the effects of the force majeure event while it is continuing: if this applies, the affected party will need to ensure that it complies with such obligation. Mitigation may involve, for example, seeking to obtain alternative supplies elsewhere.

4. Can the contract be terminated?

Express provisions

• The contract may give one or both parties the right to terminate in certain circumstances. These are often straightforward: for example, the contract may provide that the parties may terminate after a certain date, or, for example, in the context of an oil supply contract, when the seller has delivered the contract quantity to the buyer. If one of these "deadlines" is approaching, it may provide an opportunity for a party to exit the contract. A party exercising any contractual rights to terminate will need to ensure that it complies with the appropriate formalities (e.g. notice provisions).
• In addition, contracts often include a right of termination on breach, which may be restricted to "material breach" or "substantial breach", or simply "any breach". If a party is seeking to exit a contract because it is no longer economic, it may be worth checking to see whether its counterparty has breached the contract in any way and whether that breach gives rise to a contractual right to terminate. Parties should take care, however, to ensure that a breach by their counterparty is sufficient to trigger the right of termination, particularly if the term is not defined in the contract.

At common law

• As well as any express contractual terms dealing with termination, the parties have rights to terminate at common law where there has been a repudiatory breach of contract (unless these have been expressly excluded in the contract).
• A breach of a condition of the contract (a fundamental "breach" term), or of an innominate term (a term which is not expressed to be either a condition or a warranty) which goes "to the root" of the contract, will be a repudiatory breach. This will entitle the other party to terminate with immediate effect if it elects to do so. Alternatively, the innocent party may "affirm" the contract and keep it in existence. If a counterparty has committed a repudiatory breach of contract, careful consideration is required before terminating: it may ultimately be in both parties' best interests to continue with the contract (see section 6 below).
• As with the exercise of contractual termination rights, it is very important to ensure that the other party's breach does in fact constitute a repudiatory breach before the termination right is exercised. This is because, if a party terminates a contract in the absence of a repudiatory breach, it will have wrongfully terminated the contract, which will in itself constitute a repudiatory breach and mean that the terminating party may be liable for damages.
• A related point to be aware of is that any perceived intention by a party to not be bound by the contract's terms could be deemed by the other party to be a repudiatory breach of contract. Therefore, parties should take care if seeking to renegotiate terms to ensure that the desire to renegotiate is not viewed by the other party as evidence of a lack of intention to be bound by the contract, as this may expose the party seeking to renegotiate to termination for repudiatory breach.