In 2009 in the wake of the Great Recession we coauthored Contract Enforceability During Economic Crisis: Legal Principles and Drafting Solutions [i] (“Article”).The broad thesis of the Article was that the “law” would rarely provide relief to a contracting party adversely affected by fundamental market changes. In reaching this conclusion we examined a wide range of “law”: common law as reflected in the doctrines of impracticability; force majeure and economic duress; the Restatement (Second) of Contracts and the Uniform Commercial Code; international contract law as expressed in the UNIDROIT Principles and the Convention for the International Sale of Goods (“CISG”). In the article we recognized that well-drafted contract provisions might enable a party to obtain protection from market risks.
Exactly two years ago, we published Contractual Enforceability During the Coronavirus Crisis in which we applied the principles and conclusions of our article to the Covid-19 crisis.
Two years later (almost to the day), we are here once again analyzing those same principles in light of a new high-impact event that is shaking the world order, the Ukrainian war. On February 24, 2022, Russia launched a war on Ukraine which, in the opinion of many, was to be a blitzkrieg with Russia quickly taking control of Ukraine, instead the war is still raging on after one month a half, thanks to the Ukrainian heroic resilience and the determination of the West to offer a united front to this unprovoked infringement of a country sovereignty.
How the situation is going to develop is unclear. “For Russia’s stalled, bloody military campaign, there appears to be no imminent possibility for a dignified retreat or a peace deal that could be sold as victory, but also no clear route to a military victory either, except perhaps through an intensification of aerial bombardment to destroy Ukraine rather than subdue it.” Shaun Walker, One month on: how a tragedy has unfolded in Ukraine.
What it seems clear is that besides the horror of this invasion and the significant repercussions at international levels which might bring political and economic mayhem, some contractual issues could emerge which could be greater than the issues caused by the pandemic (with its lockdown/stay-at-home orders and supply chain problems), possibly greater than the Great Recession of 2007/2008 and perhaps could resemble some of the contractual issues that emerged after some major war conflictsof the last century.
We will distinguish between current contracts and future contracts and contracts in the making.
A) Future contracts and contracts in the making
Well drafted contracts post Ukrainian crisis can and should deal specifically with it. Indeed, it could well be considered professional malpractice not to do so.
i) MAC (or MAE) clauses. Our Article provides models of clauses that could easily be adapted to the current crisis. One could wonder whether MAC (Material Adverse Condition) (also known as MAE – Material Adverse Effect) clauses could be well suited to the current crisis. We noticed in our Article that “market change is expressly excluded as a material adverse condition. Moreover, courts tend to narrowly construe MAC clauses.[iii] In our knowledge, there are no instances in which a court has found a MAC has occurred as a consequence of 2008 financial crisis (or the 9/11 for that matter).
The same problem should not exist today because the Ukrainian war is not merely a market change. However, it is possible that the seller/supplier might want to include a specific carve-out for wars, in which case, the Ukrainian war could be excluded and no relief would be offered by a MAC clause (interpretative issues should be considered; for example, Russia calls the invasion “special operation”). The scope and limitation of the MAC clause depend on the bargaining power of the parties. We noticed in our Article, however, that these clauses typically are not intended to address changes affecting entire industries/the economy as a whole. So, perhaps these clauses are not the best to deal with the Ukrainian war.
ii) Force majeure.Force majeure clauses should also be considered to fence the repercussions of the Ukrainian war but drafting should be careful.. In our Article, we noticed that
Contracts often contain force majeure clauses. The purpose of such clauses is to allow a party to avoid a contract even when doctrines such as impossibility or impracticability do not provide relief. The typical clause specifies various events, such as war, acts of God, or strikes, as grounds for contractual excuse. If a force majeure clause is narrowly drafted, a court is almost certain not to apply it to market change. Reference was made to several cases in which changes in the market had disproportionally affected one of the parties.[iv] Even with broadly-drafted force majeure clauses, courts have refused to given relief for failure of the market.[v]As Judge Posner wrote in 1988: “A force majeure clause is not intended to buffer a party against the normal risks of a contract. The normal risk of a fixed-price contract is that the market price will change.”[vi]
Consider that force majeure clause generally excuses performance only temporarily, while event lasts. An idea would to insert the possibility for aggrieve party to cancel the contract if the event lasts for more than a specified time.
The current situation, however, is different because the Ukrainian war goes beyond a market crisis.
However, there are at least two problems for broad MAC clauses and force majeure clauses as a possible remedy to the repercussions of Ukrainian war.
As it has been correctly pointed out 1) “overly broad ‘force majeure’ and ‘MAC’ clauses may create an illusory contract that amounts to an option by the party benefited thereby. (Jose Sariego, The Wrath of God and its Impact on Contracts – “Force Majeure” and “MAC” Clauses, available here) and 2) if one party claims that a MAC event or a force majeure event occurred and the other disagree, the only solution is going to court or arbitration (and often there is “a race to the courthouse” or arbitration Id.)
iii) Condition clauses. Another way of dealing with the uncertainty of the Ukrainian war could be condition clauses, i.e., the parties could expressly agree “that the duty of one party (or, perhaps, both of them) should depend on the happening of one or more specified events.”[vii] The Restatement (Second) §224 defines a condition as “an event, not certain to occur, which must occur . . . before performance under a contract becomes due.” There is plenty of uncertainty in the Ukrainian war and it could be the natural realm of conditions (precedent or subsequent)[viii]. Of course, the event in question could be identified in a “negative” one (for example: “delivery by June 15 if by that date, the Russians have retired from Ukraine”).
The event in question would be connected to the Ukrainian war. Let’s imagine that one of the many Western department stores currently closed in Russia wants to place an order for 10,000 items from a manufacturer. Being unsure about if and when the department stores “will re-open” and not being available to risk to purchase items that are useless passed the season, the department store could insist that its obligation to receive delivery and pay for the items is conditioned on the department store’s re-opening by June 1. This would be a “condition precedent”. Another way of doing it, would be to phrase the term as “a condition subsequent”, i.e. the department store has an obligation to accept delivery of the items and to pay for them but, if by June 1, the chain has not decided to reopen in Russia, then the department store is released from the obligation to accept delivery and pay.
Provided that the manufacturer is available to accept such terms, particular attention should be paid to correctly phrase the condition clause.
Courts are typically emphatic that an “express condition” must be stated in unambiguous language because express conditions must be literally performed or satisfied; substantial performance will not suffice. See, e.g., MHR Capital Partners LP v. Presstek, Inc. 912 N.E.2d 43 (N.Y. 2009) (noting that courts have recognized that the use of terms such as “if,” “unless,” and “until” constitutes “unmistakable language of condition”). Id. at 813.
If conditions are not properly phrase, they would offer very little protection to the department store. However even with proper drafting, a condition clause would not completely protect the department store. In fact, several doctrines can be used by the seller to avoid the effect of condition. First, in case the Western chain is still closed in Russia on June 1, but in the meantime the department store has decided to serve the Russian market online, the seller could try and avoid the effect of the condition (i.e., could insist on buyer’s performance) using the “excuse due to immateriality” doctrine:
almost all modern courts … would actually insist on strict performance of conditions only when the conditioning events are material to the agreement of the parties. Conditions that are merely ‘technical’ ..[are] generally excused under various theories such as adverse interpretation, waiver, prevention, or avoidance of forfeiture. Id. at 817.
The success of such an excuse is uncertain but the claim would be viable.
Second, waiver and estoppel could also be excuses to a condition. An obligor whose duty is expressly dependent on a condition may be under a duty to perform despite the nonoccurrence of that condition, if a court finds that he has, by word or conduct, “waived” the right to insist on fulfillment of the condition before performing the duty.” Id at 817. This could happen if the buyer indicates in correspondence with the manufacturer that the chain is about to start to serve the Russian market online it and confirming that it is still interested in the items.
Depending on the circumstance, other doctrines might apply to excuse the condition, so that the use of condition to protect a party from the uncertainty of the Ukrainian war is not fool-proof. In other words, ultimately, parties enter into a contract at their own risk in a time of crisis.
Nor the aggrieved party is likely to easily obtain damages through insurance. For example, underwriters of representation and warranty insurance (RWI) policies (which are policies designed to cover the unforeseen cost of seller’s breach of rep&warranties in an M&A) are likely to exclude from their coverage, business downturns due to the Ukrainian war .[ix]
B. Pre-existent contracts
What about existing contracts executed before the war, particularly contracts without MAC clauses, conditions, or force majeure? Of course, the Ukrainian crisis is having a fundamental effect on markets. While some of these effects are positive for some companies (e.g., an increase of the price of some commodities), the vast majority are negative: inflation, volatility in the stock exchange and turmoil in the supply chain. Also, many international chains have closed down in Russia and Western manufacturers have stopped production in their Russian plants.
In some contracts relief from the war is irrelevant because the contract is either terminable at will or on very short notice or consist of orders for goods that the parties will place or not depending on circumstances. Some long-term contracts instead might be affected. This is the case of supply contracts (example: supply of raw materials to manufactures). For example, what about the situation of an order for the supply of 1000 custom-made leather jackets to a department store of an international chain that is now closed in Russia in retaliation for the Ukrainian war? Could the purchaser renegade on the contract claiming that it cannot receive delivery of the already half-manufactured jackets because of the closure of the department store? What if you don’t have a force major clause in your contract?
Technically speaking, while both common law and civil law jurisdictions contain some principles of excuse in case performance cannot occurred for event outside the control of the parties, the concept of “force majeure” (“superior force” in French) originated in civil law and common law does not traditionally contain that concept. Nowadays, also at Common law, the term force majeure is used as a short-hand label to refer to doctrines that excuse performance where that performance is impacted by events outside the control of the affected party. The reference is to equitable concepts such as “frustration of purpose” or “impossibility of performance”.[x]
While obtaining relief based on these concepts is generally difficult, “courts have been much more willing to grant relief when the event on which the claim of impracticability or frustration rests is on some form of supervening governmental regulation rather than cases in which the event is war, natural disaster, or market change” [xi] However, the “receptiveness to claims of excuse where performance is prevented by supervening governmental action” does not make the path easy to the aggrieved party, in fact “courts will still impose stringent limits on such relief in that category of frustration cases as well as any other … Those limits include the requirement that frustration be quite substantial.” In particular, courts state that “the performance must be rendered ‘virtually worthless’ and the principal purpose of the contract must be substantially undermined.”[i]
In the example of the supply contract for jackets, can it be said that the performance has been rendered “virtually worthless” because of the closing of the department store? Isn’t it the case that the jackets could still be sold in the future when the department store re-open? The following arguments could be made: purchaser could say that it is uncertain if and when the department store will re-open in Russia; purchaser could also say that if and when the department store will re-open, the jackets will be out of fashion (the viability of this argument depend on the specific item; just to remind the high standard of “virtually worthless”, one should remember that even if the jackets are worth a tenth of their value, they would still have same value and those doctrines would not apply) True, the department store will not be able to get an immediate benefit from the delivery and will receive some financial disadvantage from purchasing now products that it will be able to sell only in the future and at a lower price, but perhaps this is not enough to avoid the contract under frustration of purpose. Different would be the situation in which the supply contract is for perishable products that the department store cannot sell because of the closure. The performance of the supplier here would be virtually worthless because if and when the department store re-opens, the products cannot be sold.
For contracts executed before the Ukrainian war, without a force majeure, a condition clause or a MAC clause, a remedy would still be possible but a case-by-case evaluation is necessary.
C. Some general observations
Even if an aggrieved party might have a force majeure defense or an impracticability or frustration of purpose claim, the party might want to consider the long-term commercial implications for its business before invoking these doctrines. First, some of these doctrines, for example force majeure, excuses performance only temporarily, while the event lasts but do not excuse performance any further (for example, unless you have a broad definition of force majeure in your agreement, the financial difficulties following the reopening will unlikely be covered). Second, aggrieved parties might be excused from performing but this does not mean that being excused is necessarily desirable for their business (for example: what if your supplier cuts you out of their customers list in the meantime? Or if you are the supplier, what if your customer finds a substitute supplier). A better strategy sometimes could re-negotiation. For example, the customer of an aggrieved supplier might accept longer delivery terms or an alternative performance. Or, conversely, the supplier of an aggrieved customer (for example the supplier of the jackets in our example, might accept to suspend the contract waiting for the re-opening of the department store or might accept to re-route that delivery to a different department store of the chain). Renegotiation entails some risks that need to be gingerly evaluated possibly (with professional legal advice) but renegotiation should probably always be the first option. Only if renegotiation is off the table, force majeure, frustration of purpose, impracticability or other doctrines might be considered, keeping in mind that are never a “slum dunk”.
For more information, Nathan M. Crystal and Francesca Giannoni-Crystal
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[i] Crystal, Nathan M and Giannoni-Crystal, Francesca. “Contract Enforceability During Economic Crisis: Legal Principles and Drafting Solutions” Global Jurist, vol. 10, no. 3, 2010. https://doi.org/10.2202/1934-2640.1367
[ii] MAC clauses are commonly used in the context of mergers and acquisitions to allocate risk between buyers and sellers in case an adverse business or economic development occurs between signing and closing. MAC clauses are also common in derivative contracts, interest rate swaps, and others. A MAC clause generally refers to a defined term in an agreement delineating what constitutes a material adverse change or a material adverse event/effect. A MAC clause is usually not a basis for immediate termination of a contract unless expressly provided. Normally, only where the affected party has failed to provide adequate performance assurance after receiving a written notice and sufficient opportunity to preserve the integrity of a transaction does a MAC clause entitle the unaffected party to terminate the contract.
However, while mergers, acquisitions and derivative contracts are the usual setting, there is no reason why the MAC clause cannot be used in other contexts, like a sale of goods. In a merger or acquisition contract, a MAC clause enables the acquirer to refuse to complete the acquisition or merger if the target suffers such a material change. In a sale of goods contract the MAC clause could provide the same right that the UNIDROIT Principles allow in case of hardship: renegotiation of terms and in case negotiation is unsuccessful, a right to go to court to adjust or to cancel the contract. Id.
[iii] In our Article we cited to In Re: IBP, Inc. Shareholders Litigation (789 A.2d. 14 (Del. Ch. 2001), holding that a party seeking to invoke a MAC clause and terminating a deal, faces the high burden of proving that the events claimed to be a MAC substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the MAC should be material when viewed from the longer-term perspective of a reasonable acquirer. After our Article was published, an important decision by the Delaware Court of Chancery, for the first time, determined that a buyer had ever validly terminated a merger agreement pursuant to a MAC clause. Akorn, Inc. v. Fresenius Kabi AG (See more here) which was affirmed by the Delaware Supreme Court (see more here). Akorn, actually is not an exception to the narrow view that courts take on MAC clauses; simply said, the circumstances in Akorn were so extreme (overwhelming evidence of widespread regulatory violations and pervasive compliance problems” as well as the fact that target’s financial performance “dropped off a cliff”, Eric Fidel, Akorn: Establishing a Material Adverse Effect) that it should be read as the exception to the rule, not as a change in the rule.
[iv] For example, we cited, among others to United States v. Panhandle Eastern Corp., 693 F. Supp. 88 (D. Del. 1988), refusing to apply the force majeure clause to cover adverse market or economic conditions and Northern Indiana Public Service Co. v. Carbon County Coal Co, in which the court refused to give relief to the aggrieved party, even with a broad force majeure clause in the contract, and in situation in which the price of the coal had risen from $24 to $44.
[v] See, e.g., Golsen v. ONG Western, Inc. 756 P.2d 1209 (Okla. 1988), holding that the contract must be read as a whole, and the three words in the force majeure clause referring to failure of market could not override the other provisions of the contract, particularly the take-or-pay provision.
[vi] Northern Indiana Public Service Co. v. Carbon County Coal Co., 799 F.2d 265, 275 (7th Cir. 1986).
[vii] (Charles Knapp, Nathan M. Crystal and Harry G. Prince, PROBLEMS IN CONTRACT LAW: CASES AND MATERIALS (Aspen Law & Business, 9th ed. 2019) at 805.
[viii]A condition precedent refers to an event that must exist or occur before a duty to perform will arise. A condition subsequent contemplates that a duty would be owed but subject to discharge on the happening of an event after that duty had originally arisen. Charles Knapp, Nathan M. Crystal and Harry G. Prince, PROBLEMS IN CONTRACT LAW: CASES AND MATERIALS (Aspen Law & Business, 9th ed. 2019) at 816.
The difference between the two types of conditions is that, in a condition precedent, until the conditioning event does occur, the duty does not arise, while in a condition subsequent, the duty arises but the obligor is released from the obligation if the event occurs. Depending on the circumstances, the uncertainty can be built as a condition precedent or a condition subsequent.
[ix]See Invasion of Ukraine: The Impact on Insurance, available at https://www.jdsupra.com/legalnews/invasion-of-ukraine-the-impact-on-6366168/ “The Russian invasion of Ukraine will have an impact on insurance processes and renewals and the events of the last few weeks have immediate repercussions on certain lines of coverage.”
[x] While the doctrines of impracticability of performance and frustration of purpose are separate grounds for relief from a contract, the elements of the doctrines are nearly identical. … The doctrines require the disadvantaged party to show: (1) either an extreme change in the nature of performance (performance is made impracticable) or an extreme reduction in the value of the other party’s performance so as to render it nearly worthless (a party’s principal purpose is frustrated); (2) the occurrence of an event, the nonoccurrence of which was a basic assumption of the contract; (3) without the party’s fault; and (4) the party seeking relief does not bear the risk of that event’s occurrence either under the language of the contract or the surrounding circumstances. Charles Knapp, Nathan M. Crystal and Harry G. Prince, PROBLEMS IN CONTRACT LAW: CASES AND MATERIALS, above, at 752. Internal citation and quotation marks omitted.
[xi] Id. at 766.
Examples are cases in which the Government forbids export to certain countries (e.g., Iran in Harriscom Svenska, AB v. Harris Corp., 3 F.3d 576 (2d Cir. 1993)) or requires additional measures (see, e.g., M.J. Paquet, Inc. v. N.J. DOT, 794 A.2d 141 (N.J. 2002) in which OSHA’s regulation on lead played an important part).
[xii] Charles Knapp, Nathan M. Crystal and Harry G. Prince, PROBLEMS IN CONTRACT LAW: CASES AND MATERIALS at 766 (Internal citation omitted.)
