Wednesday, February 22, 2017

How to Modify Your Contracts to Reallocate Risks When Quixotic Presidential Orders Strike

In last week's blog post, I reviewed how “force majeure” issues  might excuse a contractual party’s non-performance and ways in which they might be addressed to avoid this problem.  The focus was on President Trump’s executive orders and legislative changes that could act like a hurricane to destroy predictability in international business.   Perhaps they might be merely lofty and chivalrous but impulsive and impractical, as Miguel Cervantes’ 1600’s story of Don Quixote.

This blog post looks at ways in which restructuring your contract can aid buyers and sellers under state laws for sale of goods.

The sale of goods is governed by the Uniform Commercial Code (UCC) in the 50 states.  The UCC sets forth minimum “obligations of good faith, diligence, reasonableness, and care” that “may not be disclaimed by agreement.”  UCC Section 1-302(b).  Contingency planning thus needs to consider the UCC legal framework for escaping or mitigating the impact of a new presidential executive order, law or regulation.

Pre-Contract Planning.  Risk mitigation planning starts with contract design and limitation of liability under the contract.

1. Negotiated Limitation of Liability.   Be specific and state all limitations of liability, indemnifications and non-performance scenarios (such as liquidated damages).

2. “Irrevocable” Firm Offers.  Sellers should shorten the duration of any “irrevocable” or “firm” offer  and set a reasonably early date for the expiration of the offer (See UCC 2-205), given the unpredictability of the current economic climate.  In any event, the UCC limits such “firm offers” to a maximum of three months.

Contract Restructuring.  There are several UCC rules on contract revisions. If neglected, they could result in unforeseen liability and costs.

1. Commercial Impracticability.  The UCC allows parties to be excused from performance due to “commercial impracticability.”  In other words, a contingency happened that wasn't supposed to or ordinarily would rarely happen.

2. How to Wiggle out of your Contract?   What’s necessary for modification, rescission or waiver of a contract?  If you want to wiggle out, wiggle carefully!  To modify a signed contract for the sale of goods, the changes must be in writing (except “as between merchants”).  UCC 2-209. By requesting modification or rescission, the party seeking the change may be deemed to have waived any non-performance by the other party.  To avoid this risk, the request for modification or rescission should be carefully written.  If the other party has waived a clause, the waiving party may retract the waiver by reasonable notification that strict performance will henceforth be required for any term waived.  However, such a retraction of waiver is invalid if “the retraction would be unjust in view of a material change of position in reliance on the waiver.”  So, once you waive a breach (such as for force majeure), you can’t retract it if your counterparty detrimentally relied in a material manner.

3. Kicking Your Own Bad Habits.  Similarly, have you been too lenient with your supplier by putting the contract in the drawer and forgetting the performance standards and service level agreements?  it may be time to disrupt any “course of dealing” or “course of performance” (or even “usage of trade”).  Kick your “bad habits” by expressly re-affirming that strict compliance with contract terms is required (if you are the buyer) or by proposing a modification or waiver (if you are the seller).  UCC 2—208 holds the parties to an implied contractual provision where the contract for sale involves “repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection.” If you don’t object, you’re stuck with the practical construction of the contract by course of performance, you’re committed to it.

4. Play the Game.  Don’t forget your duty to cooperate, particularly as a buyer.  UCC 2-311 allows one party to a sale contract to treat non-cooperation by the other party relating to delivery or acceptance of the goods as either (i) an excuse for his own delay, (ii) a breach, or (iii) an opportunity to proceed in a reasonable manner.

5. How Bad Must it Be Before You Can Invalidate the Deal?  Was the contract “unconscionable” at inception?  If so, the UCC 2-302 allows a court to invalidate the entire contract or just the provisions that are unconscionable.  This rule generally applies only to the sale of consumer goods.

6. Feeling Insecure about the Contractor’s Performance?  What if President Trump’s executive orders give a buyer or seller reasonable grounds to feel insecure about the future performance of its counterparty?  The UCC resolves this by allowing a party to demand “adequate assurances” and, if it does not receive them, to suspend or cancel the contract.  Under UCC 2—609, each party has a right to adequate assurance of performance by the other.  If there is no “assurance of due performance” within a reasonable time (not more than 30 days) of a receipt of a justified demand, failure to provide adequate assurances can be treated as a repudiation of the contract.

7. Launch a Pre-emptive Strike.   Whether or not a party requests and gets “adequate assurances” of performance, a contract may be canceled if one party acts in “anticipatory repudiation” under UCC 2—610.  This could be a defensive tactic used when either party can foresee that its performance may not be up to par in accordance to their contract.  Of course, a repudiating party can retract his repudiation “with due excuse and allowance to the aggrieved party for any delay occasioned by the repudiation.” UCC 2-611.

In conclusion, when force majeure clause or “commercial impracticability” under UCC 2-615 is not available as an excuse for non-performance, principles of contract restructuring may be available. However, care should be taken to avoid inadvertent technical breach by anticipatory repudiation or inadvertent waiver.

Wiggle carefully!

Thursday, February 16, 2017

Legal Escapes from Disasters: Force Majeure and other Excuses for Contractual Non-Performance under Sudden Changes in Presidential Executive Orders

What’s the difference between a hurricane and a presidential order of Donald Trump? Legally, maybe not much.

President Trump’s unexpected executive order in January 2017, which banned any nationals from 7 countries from entering the U.S. for 90 days, surprised not only the would-be terrorists but also the law-abiding business community. More disruption may be foreseeable. NAFTA could be terminated or restructured. Business visas could be curtailed. Imported goods and services could be subject to a new “border adjustment tax,” while exports would be exonerated. Other disruptions to the global supply chain are clearly foreseeable, but the parameters remain to be seen.

Plan Ahead Now. Every buyer or seller of goods or services across borders should be making plans to deal with potential sudden changes in U.S. law or policy. Let’s consider “force majeure” and other legal excuses for contractual non-performance under the Uniform Commercial Code ["UCC"] (applicable in all 50 states). Possible action steps include contingency planning, review and renegotiation of contracts, repricing, workforce redeployment or restructuring, hedging contracts, business interruption insurance, business continuity planning, disaster recovery procedures, diversification of risk portfolio by sourcing from backup suppliers, and internal and external audits of procedures.

What is “Force Majeure”?   “Force majeure” is a common law concept of equity that excuses non-performance by a seller. Typically, “force majeure” clauses in a contract define the types of events: natural disaster or regulatory prohibition. Less obvious is whether the “force majeure” concept gives a valid excuse not to deliver due to a sudden increase in the price of components or commodities, and, if so, whether such an excuse depends on whether the new shortages in global supply arise from speculators seeking to corner the market, hoarding by merchants to hedge against future risks, uncertainty or a other sudden increase in demand for the item in the marketplace. Even less obvious is whether a sudden new regulation qualifies as a force majeure if it merely increases the cost of doing business, adds a new tax to a type of transaction (such as a tax on imports of products or components needed for manufacturing), or imposes a new requirement for a governmental license. 

Drafting (or Reviewing) Force Majeure Clauses. It’s time to review your contracts and perhaps seek modification to your “force majeure” clauses.

1. Definition.  What is a “force majeure” event for purpose of this contract? The contract should define it by including specific examples and excluding cases that might be recurring, predictable and thus “ordinary” risks to be allocated expressly by contract. Must the event be unforeseeable, or merely overwhelming?

2. Impossibility?  or Mere Change in Costs of Delivery? Must the impact make performance impossible, or will the contract be changed if there is merely an extreme difficulty or higher cost? Where possible, the parties should allocate risks by specifying outcomes of predictable contingencies, such as (i) sudden shortages in the marketplace, (ii) changes in pricing or exchange rates, (iii) regulatory changes that affect the normal supply chains for labor and goods.

3. Required Mitigation?  What actions must the affected party take before the impact of the force majeure event can validly excuse non-performance or delay performance? At a minimum, one might ask the affected party to take reasonable measures using reasonable effort to overcome the adverse impact.

4. Option to Pay to Cure?  May the unaffected party insist on the right to pay extra to get a “cure” and thus enjoy the benefit of the bargain, albeit at a higher cost?

5. Notice and Other Conditions for Being Excused.  Must the affected party give notice of inability to perform due to a “force majeure” event? And how soon, to be “timely”? What kind of notice is needed? What are the consequences of not giving timely notice? Is the giving of notice excused when the unaffected party has actual or constructive notice (such as by reading newspapers or watching a TV journalist’s nightly critiques of Trump’s operations)?

6. Duty of Cooperation?  What level of cooperation (and effort and payment of money to overcome the force majeure’s impact) is required from the un-affected party?

7. Cancellation.  How long must the parties wait before treating the contract as cancelled?

8. Practical Risk Management Solutions.  What alternative solutions exist when both parties refuse to accept a risk?
    a.  Insurance.  Either party can purchase business interruption insurance and thus quantify the allocation of risk. Insurance also can cover loss of the goods. What conditions are necessary to have such insurance coverage? When does the insured acquire an insurable interest?
    b.  Disaster Preparedness.  Procurement officers normally insist on the seller’s or service provider’s having a business continuity plan and disaster recovery procedures, which would be audited under SOC II or SSAE 16 Type II audit processes.
    c.  Resiliency in the Global Supply Chain.  Potentially, goods or services could be provided from centers located in geographies with different disaster profiles. A portfolio approach could be used to mitigate risks (political, technical, economic, pricing, regulatory, etc.) that are related to any one particular supplier.
Force Majeure in the Sale of Goods: "Commercial Impracticability" and Legal Prohibition.   In two scenarios, a seller of goods is excused from non-performance under UCC 2-615 (with caveats):
  • “if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made. “ In other words, a contingency happened that wasn't supposed to happen or ordinarily would rarely happen. Or

  • “by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.”
Few contracts identify the “basic assumptions” that underlie the commercial reasonableness. Hence, the “commercial impracticability” defense under UCC 2-615 is so vague that it invites mediation, negotiation and settlement. Once it applies, though, the supplier must allocate resources in a fair and reasonable manner.

In this Trump era, unexpected and sudden changes in U.S. laws, regulations and policy may be the order of things to come. Service providers, supply chain managers (from CEO’s, CFO’s and CIO's all the way down to procurement officers) and e-commerce merchants need to rethink contingency planning, including redefining Force Majeure clauses.

More on this in my next blog.