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.

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