The question in the mind of every enterprise engaged in long term Oil & Gas industry contracts, “Is Covid-19 Pandemic a Force Majeure Event?” Who decides it and whether it is provided in the contract? Contracts are considered as the sole governing mechanism or agreed legal authority for governing relationships between the parties, under the principle of pacta sunt servanda or sanctity of contracts. Thus, contracts once executed cannot be changed due to post-contract events, except by an agreement between the parties. Therefore, if a pandemic like Covid-19 is not an identified event of an FME clause, then the current crisis raises serious questions and shakes the jurisprudence of international contract laws.

Force Majeure Events (“FME”) a French term, represents Unknown, Unprecedented, Unexpected and Unavoidable events, having a negative impact on obligations and responsibilities under the contracts between the parties. In Chinese Contracts Law, it is noted that “force majeure means any objective circumstances which are unforeseeable, unavoidable and insurmountable.” In common law jurisdiction there is no specific definition of force majeure but is interpreted from the clauses provided in a contract and arguments based on the doctrine of frustration. The frustration may or may not be the direct outcome of a force majeure event.

Mr. Justice Bailhache; as he then was, in 1915, explained in Matsoukis v. Priestman: “The words force majeure are not words we generally find in English contracts. They are taken from the Code Napoleon …. In my construction of the words … I am influenced to some extent by the fact that they were inserted by this foreign gentleman”. He further expanded on the meaning of force majeure as:

“I cannot accept the argument that the words are interchangeable with vis major or Act of God. I am not going to attempt to give any definition of the words force majeure, but I am satisfied that I ought to give them a more extensive meaning than Act of God or vis major. The difficulty is to say how much more extensive … I think that the complete dislocation of business … as a consequence of the universal coal strike, did come within the reasonable meaning of the words force majeure …. As to delay due to breakdown of machinery it comes within the words force majeure which certainly covers accidents to machinery. The term force majeure cannot, however, in my view be extended to cover bad weather, football matches or a funeral”.

(Matsoukis v. Priestman [1915] 1 K.B. 681, and McKendrick, Evan, “Force Majeure and Frustration of Contract”, London: Lloyds of London Press, 1991. pp. 213.)

The contracts in Oil & Gas industry, whether for construction of infrastructure, field development or sales and purchase of hydrocarbons (Oil, Gas and Coal) are generally of longer durations, ranging from 1 to 25 years or more.

The first three questions to be answered in determining the consequences of an FME like Covid-19 are:

  1. Is a pandemic included in the list of FMEs in the Force Majeure Clause of the Contract?
  2. What is the maximum duration of an FME provided for before the contract is terminated by default?
  3. What are the statutory provisions under the applicable law of the contract, in addressing long term pandemics like Covid-19?

 

Provisions of a Typical FME Clause

The FME clause is a risk sharing strategy between the parties and lists out the events which were in the contemplation of the parties at the time drafting a contract. The risks or event which could not be foreseen or imagined, are generally left under the phrase of any unforeseen and unavoidable events, provided not caused by either of the parties directly or indirectly. FME clause normally provides Emergency Escape Routes or Exit Strategies, in time of trouble.

Sample from LNG Sales Purchase Agreement (AIPN Model Contract)

… By way of illustration and subject to satisfaction of the conditions specified in Clause 18.1.2, Force Majeure may include circumstances of the following kind:

  • fire, flood, atmospheric disturbance, lightning, storm, hurricane, cyclone, typhoon, tidal wave, tornado, earthquake, volcanic eruption, landslide, soil erosion, subsidence, washout, epidemic, or other natural disaster or act of God;

  • any change in Law after the date hereof, or a change in the interpretation or application of existing Law after the date hereof, subject to Clause 1.4(d); and
  • acts or omissions of a Governmental Authority, subject to Clause 1.4(d).

In the above sample epidemic is included but what if the country or geographical location of the project is not affected by Covid-19, then this clause may not apply. However, change in law and lockdown measures announced through decrees of various governments, would be within the ambit of this FME Clause. This is an arguable case and not an automatic or default application of the FME clause.

A Sample from a Rig Building Contract

“If, at any time before the delivery and acceptance of the Rig, either the construction of the Rig or any performance required under the provisions of this Contract and the Specifications as a prerequisite of delivery of the Rig is delayed due to war, blockade, revolution, insurrections, sabotage, plague or other epidemics, quarantines, or import/export embargoes imposed by any government including the State government; or due to acts of God including, but not limited to, earthquakes, tidal waves, or typhoons; or by destruction of the shipyard or works of Builder or its subcontractors or of the Rig, or any part thereof, by fire, flood or other causes beyond the control of Builder; each of such contingencies shall be deemed to be included in the definition of Force Majeure as used in this Contract, and in the event of delays due to the happening of any of the aforementioned contingencies, the Delivery Date shall be extended for a period of time sufficient and necessary to cover such delay. It is agreed, however, that Builder shall make all reasonable efforts to eliminate, resolve or otherwise minimize the efforts of Force Majeure.”

 

This clause also refers to plague or epidemic within the geographical location of the contract or work site. Pandemics like Covid-19 would have to be argued if a party is genuinely affected by such events.

 

  1. Permissible Duration of an FME

It is common to see a time limitation for an FME to be applicable. FME is a temporary event and projects or contracts are expected to continue after a specified duration provided or agreed between the parties. The situation where an FME like Covid-19 which seems to be continuing for an indefinite period, the FME clauses would provide for termination of a contract.

 A Sample from an OSV Towage Contract

“…

has the right to cancel its performance under this Contract whether the loading has been completed or not, in the event of force majeure, Acts of God, perils or danger and accidents of the sea, acts of war, warlike-operations, acts of public enemies, restraint of princes, rulers or people or seizure under legal process, quarantine restrictions, civil commotions, blockade, strikes, lockout, closure of the Suez or Panama Canal, congestion of harbours or any other circumstances whatsoever, causing extraordinary periods of delay and similar events and/or circumstances, abnormal increases in prices and wages, scarcity of fuel and similar events, which reasonably may impede, prevent or delay the performance of this contract.

The event “quarantine restrictions” is an extremely broad term and would encompass Covid-19 restrictions, resulting is a serious loss to the rig owner waiting for a rig to be transported. The right to cancel the contract is immediate without waiting for a period after an FME has occurred.

 A Sample from Drilling Rig Charter Party

“…

should any circumstance of force majeure continue for more than 30 days then, unless Charterer chose to extend its well drilling programme for a period equal to the period of the delay, Charterer might “terminate this contract as provided in Clause 28.”

A Sample from OSV Charter Party

“…

if a force majeure condition prevents or hinders the performance of the Charter Party for a period exceeding 15 consecutive days from the time at which the impediment causes the failure to perform if notice is given without delay or, if notice is not given without delay, from the time at which notice thereof reaches the other party.”

 

In above examples and several other similar circumstances, the duration of an FME will be shorter than 30 days. Given the circumstances around the world due to Covid-19 Pandemic, it will be hard to say which contracts are not affected either due to quarantines or due to breakdown in supply chain and mobility of humans, an essential resource in every contract.

 

  1. What are the statutory provisions under the applicable law of the contract?

Given the current scenario and uncertainty surrounding every business, especially with downward steep fall of oil prices, it may be an opportune moment to exit from long term contracts and avoid unprecedented losses. For some oil trading companies, it was too late to mitigate or were too slow to react and avoid bankruptcy proceedings.

Contractual clauses may appear to be too harsh in context of Covid-19 and renegotiations in good faith will depend on the willingness and commercial bargaining position of the parties. The statutory provisions in some civil law countries, like France, do provide for termination of contracts if FME is of permanent nature, however infectious diseases are foreseeable and not considered as FME. The position taken by emergency decrees by governments and temporary Laws passed by legislative assemblies, may provide for some reprieve but it is yet to be tested.

Recommendations

No one should take comfort that Covid-19 is a global FME, so our contract is secure. it is time to review the commercial situations, market dynamics and conditions of the contracting partners. Terminating contracts or breaching contracts under the pretext of Covid-19 as an FME, may prove to be a wrong and expensive move. In any relationship whether contractual or otherwise, there is no harm in establishing lines of close communications and working together to mitigate the impacts. It may also require renegotiating the contracts and avoid unnecessary litigation in courts or arbitration. Mediation through an independent neutral, could also help in exploring options and finding a win-win strategy.

For assistance in contract reviews and renegotiation or advise on dealing with current projects, feel free to contact customerdesk.tmc@tiberiasmc.com