Managing contract risks in times of turmoil: Leveraging force majeure and balancing insolvency risks

In the current environment of heightened geopolitical tension, including the effective closure of the Strait of Hormuz and impacts on regional oil and gas infrastructure, global supply chain disruption and volatility in energy markets, force majeure provisions are more important than ever.

Australian businesses in the mining, agriculture, transport and industrial sectors who rely on oil fuel and by-products, and other critical imports, are facing unprecedented and unpredictable challenges. Procuring supply and managing shortages and increased costs are critical operational issues and frequently, existential. In these circumstances, obtaining relief from the performance of contractual obligations can be vital.

However, the pace of changes in the market and the complexity and implications associated with calling force majeure can put businesses in financial stress and under extraordinary pressure to make complex, far-reaching decisions in tight timeframes. Businesses therefore need to understand not only how to navigate their contracts to obtain adequate force majeure relief but, if financial viability is an issue, how to protect directors and other stakeholders by early engagement of the ‘safe harbour’ mechanisms as those decisions are made and actioned.

What is a force majeure clause?

Typically, a force majeure clause in a contract operates to provide relief to a party from its obligations to perform under the contract to the extent that the relevant performance is prevented, hindered or delayed due to the occurrence of an event beyond the reasonable control of the party affected.

The right to claim relief from obligations to perform due to the occurrence of such events is not an inherent legal right. It only exists if the relevant contract expressly provides for it.

Where a force majeure event as described in a contract occurs, it typically has three practical effects:

1. Suspension of obligations: The affected contractual obligations of the party impacted suspend for as long as the event continues and cannot be overcome, such that performance of the affected contractual obligation is delayed, hindered or rendered impossible (as distinct from merely more costly).
2. Relief from liability: The affected party is relieved from liability for non‑performance of the affected obligations during that period.
3. Termination rights: If the disruption persists beyond an agreed long‑stop period, the clause may give one or both parties a right to terminate the contract.

What events can trigger force majeure?

Force majeure clauses usually set out a list of qualifying events, supported by a broader definition of events that are beyond the reasonable control of the company. Examples of common triggers include:

• natural events such as floods, cyclones, bushfires or earthquakes
• government action, including changes in law, embargoes, sanctions, export restrictions or regulatory shutdowns
• geopolitical instability, including conflict, sanctions or international tensions that disrupt trade, transport, insurance or energy and commodity supply chains
• industrial disruption, including strikes or labour unrest affecting operations or key suppliers
• supply chain and logistics disruption, such as port closures, shipping delays, fuel shortages or infrastructure failures.

Events by themselves are not enough

The existence of an ‘event’ alone is not enough. Other key principles apply, including:

• The event must fall within the wording of the clause: For example, generic references to ‘war’ or ‘government action’ may leave gaps where disruption arises indirectly.
• The event must prevent, hinder or delay performance, not simply make it more expensive: A sharp increase in freight costs or input prices will rarely qualify unless the clause expressly allows it. Force majeure is concerned with inability to perform, not reduced margins arising from increased costs or the need to procure or replace capital. For example, in derivatives contracts designed to smooth out fuel price movements, the mere fact that supply chain issues (albeit arising from geopolitical factors), result in significantly unexpected exposure to one party does not, of itself, absolve that party from making a payment under that contract.
• Could steps have been taken to avoid the impact of the event: If the impact of the event could have been avoided by steps taken prior to its occurrence, this may jeopardise an affected party’s prospects of obtaining force majeure relief, given the need for that party to establish a direct causal nexus between the force majeure event and the claimed impact on contractual performance.
• Burden of proof: The party claiming force majeure bears the burden of proving that the relevant force majeure event has occurred and had the specific destruction of performance capacity required by the clause. Accordingly, record keeping is critical not only when making the claim but also throughout the continuance of the force majeure relief, to demonstrate that contractual performance could not have been recommenced earlier.

Key questions to ask before triggering force majeure

Because invoking force majeure can have lasting legal and commercial consequences, it should rarely be treated as a reflex response. Before issuing a notice, companies should work through a structured assessment:

• Does the event clearly fall within the force majeure definition or description in the contract? The wording must clearly cover both the event and its consequences.
• Is performance genuinely prevented, hindered or delayed or merely more difficult or costly? If the contract can continue to be performed but is merely more costly, this will generally not be grounds for claiming force majeure. Also, if the clause states that performance must be ‘prevented’ to invoke force majeure, then merely being hindered or delayed in performance will also not be sufficient grounds for a claim.
• Have all notice and timing requirements been strictly complied with? Check deadlines, the form that notice of a claim of force majeure has to take, the required content of the notice and the obligations to provide updates.
• What steps are required to mitigate the impact and resume performance? Most clauses impose an express duty to take reasonable steps to overcome the effects of the event.
• What are the commercial and relationship consequences of invoking force majeure? Calling force majeure may preserve legal rights but can cause damage to long‑term business relationships and general market perception. For example, what will be the impact on other contractual relationships of a party calling force majeure under a key contract e.g., will this impact banking facilities, upstream or downstream contractual obligations, credit ratings and so on?
• Are there alternative contractual mechanisms that may deliver a better outcome? These may include other contractual clauses or negotiated workarounds to manage unexpected events.

In practice, force majeure is a contractual mechanism for allocating the risk of specified disruptive events and operates only in accordance with its agreed terms. Whether it can or should be relied on depends on precise drafting, strict compliance with process requirements and a balanced assessment of legal entitlement against operational, relational and reputational consequences.

How to navigate force majeure complexities when financial viability of the business is an issue

Given that the effects of the current Middle Eastern oil crisis are not yet fully apparent, as events continue to unfold rapidly and unpredictably, it remains to be seen whether oil-exposed Australian businesses (particularly those in the mining, agriculture, transport and industrial sectors), can successfully rely upon force majeure clauses in their respective commercial contracts.

Managing these issues is difficult at the best of times. Businesses in financial stress may need to look for other avenues to secure the time and information to make the best decisions. In these circumstances, companies need to consider the availability and benefit afforded by the safe harbor protections in the Corporations Act.

As is well known, Australian laws impose onerous duties on directors and holding companies, including duties not to incur debts while insolvent. There are numerous examples of directors and holding companies being held personally liable for such debts. The safe harbour restructuring plan mechanism was introduced into Australian law in 2017 and has developed into a common and flexible tool to manage this risk. It should be regarded as a critical component in the toolkit of directors grappling with solvency challenges arising from supply shortages and related force majeure issues.

The safe harbour provisions allow directors and holding companies (via a carveout from insolvent trading liability) to consider, formulate and implement restructuring plans, provided such plans have reasonable prospects of achieving a better outcome than an immediate winding up. This is a relatively low hurdle, and plans may be dynamic and evolving.

Features of restructuring plans in this context may include seeking advice about, and seeking to renegotiate, affected commercial contracts (including obtaining relevant forbearances such as force majeure relief and obtaining waivers of liquidated damages), procuring alternative sources of supply and making other operational adjustments to make the business more resilient to ongoing energy price shocks. Safe harbour protections may be invoked immediately upon taking steps to develop a plan; for example, by engaging an appropriately qualified professional advisor.

Early and proactive engagement by company boards is integral to the viability and effectiveness of these plans as responses to the energy crisis and its successive shockwaves.

If you found this insight article useful and you would like to subscribe to Gadens’ updates, click here.

Authored by:

Michael Joyce, Partner
David O’Farrell, Partner
Amy Kho, Partner
Pravin Aathreya, Partner