Frustration of contracts – emerging markets,

civil unrest and political change

Mark Davenport, Partner, Head of International Commercial Disputes

Richard Little, Partner, Commercial Dispute Resolution

Eversheds LLP

30 January 2014

Frustration of contracts

Today’s speakers

Richard Little Partner Commercial Dispute Resolution

Mark Davenport Partner Head of International Commercial Disputes

• Frustration of contracts in emerging markets

– Emerging markets hold opportunities but carry greater risk

• Political change

• Civil unrest/instability

• Supply chain/contractor issues

• Sanctions

• Immature/unreliable legal system

• How does contract law deal with these issues?

• Doctrine of frustration

• Force majeure clauses

• How can you minimise these risks at the contract drafting stage?

– Investment structuring

– Drafting of contractual provisions

Agenda

• Political Change

– Risk of change of government and/or prevailing policies

• Nationalisation of industry

• Export bans

– Eg Indonesia’s recent ban on nickel and bauxite exports

• Restrictions on repatriation of profits

• Removal of government incentives and subsidies

– New regimes (and their State companies and organisations) may seek to rewrite existing deals and contracts

Emerging Markets Risks

• Political Change

– Case Study: Egypt from 2011

• New government re-evaluated many contracts and arrangements agreed to by the previous regime

• 12 publicly disclosed investment treaty claims have been commenced against Egypt following resignation of Mubarak in February 2011 – as against 11 claims against Egypt commenced in total across all years up to 2011

– Be aware of:

• What is a strict contractual right and what is an understanding or arrangement

• The forum for enforcing rights

Emerging Markets Risks

• Civil Unrest

– Civil unrest may result from political or economic instability – and itself lead to difficulties in performing and/or enforcing contracts during period of unrest

• Government entities may not be operating or operating normally

• Private counterparties may be unable or unwilling to operate due to safety concerns

– Can also cause or act as a catalyst for other risks – for example, a change in government policy or in the behaviour of a government controlled counterparty

Emerging Markets Risks

• Civil Unrest

– In extreme cases – for example the Arab Spring – performance of contracts may grind to a standstill

– Whether this will amount to frustration (or fall within a force majeure clause) will depend on the contract.

Emerging Markets Risks

• Supply chain / contractor issues

– Conditions in emerging markets differ from home jurisdiction

• Security restrictions preventing or delaying movement of people and parts

• Geographic remoteness

• Extreme weather conditions and reduced capacity to deal with natural disasters

• Local labour requirements

Emerging Markets Risks

• Supply chain / contractor issues

– Lack of readily available alternative suppliers and contractors

– Case Study: Contractor in Kurdistan, Iraq

• Ordinarily simple tasks – repair of broken machinery or replacement of staff - can take months rather than days

Emerging Markets Risks

• Immature/Unreliable legal remedies

• Availability of formal remedies

– Local courts may apply local law provisions or have different powers to those available in UK courts

– Counterparties may have privileges or immunities before local courts

• Availability of effective remedies

– Extreme delay (eg India)

– Lack of effective enforcement of judgments of domestic courts in place of performance, or of foreign judgments within place of performance

Emerging Markets Risks

• Immature/Unreliable legal remedies

• Jurisdiction or Arbitration clauses are a separate topic – but important to factor in efficacy of enforcement measures into business contingency planning

• Case Study: Enforcement of Injunction

Emerging Markets Risks

• Sanctions

– Used to combat terrorism and discourage regimes/individuals from acting in ways condemned by the international community

– Seek to prevent targeted individuals/entities from dealing with their funds and accessing financial services

– For example:

• making a payment to a targeted entity

• dealing with funds owned or controlled by a targeted entity

– Backed by civil and criminal penalties

Emerging Markets Risks

The sanctions life cycle

Stage 2

Sanctions imposed and implemented

Stage 3

The crisis deepens and

sanctions evolve

Stage 4

The lifting of sanctions

Stage 1

Crisis in the making

Sanctioned jurisdictions

Myanmar

The Ivory Coast

Egypt Iraq

Liberia

The Republic of

Guinea

Somalia Tunisia

Sudan

Zimbabwe Cuba

Iran North Korea Syria

Congo

Afghanistan

• Sanctions

– Sanctions levied against many emerging markets – particularly in the Middle East and Africa

– Removal or relaxation of sanctions allows increased opportunities for investment

– Targets and nature of sanctions may evolve – in both directions - over life of contracts

– Lessons for Myanmar?

Emerging Markets Risks

Risks and contract law

Poll

How does your business deal with risk in emerging markets?

A. Considering these risks as part of the overall cost-benefit analysis of any dealing in that jurisdiction

B. Insurance policies covering these risks

C. Adapting our payment and supply terms – e.g. requiring payment in advance

D. Adapting contracts so that we avoid or vary our obligations in the event that certain events come to pass

• Frustration

– Depending on its severity, incidents may invoke the legal doctrine of frustration

– Under English law, a contract is frustrated where circumstances change in such a significant way that it is physically or commercially impossible to perform the contract, or that contractual performance would be radically different from the obligations that were originally agreed to

– The frustrating event must have occurred without the fault of the party seeking to rely on it

– Doctrine operates within narrow confines

Risks and contract law

• Frustration

– Matters which have led to the frustration of contract have included a change in law which makes contractual performance illegal, the destruction or government appropriation of the subject matter of a contract

– If an event was foreseen at the time of contracting, this generally excludes the operation of the doctrine of frustration

Risks and contract law

• Frustration

– Effect of frustration is that once a contract is frustrated, it is discharged finally and automatically

• No requirement for a ‘frustration notice’

• Loss lies where it falls – subject to statutory changes which can lead to a reallocation of progress payments

• Contract cannot be frustrated (in this strict legal sense) only for a period of time – this can lead to significant uncertainty when a contract falls dormant

Risks and contract law

Force Majeure

• No inherent meaning to force majeure under English law – will depend on wording of contract.

– Force majeure does have a common meaning in other jurisdictions and the UNIDROIT Principles of International Commercial Contracts, (which has some similarities to the English law doctrine of frustration)

• As there is no fixed meaning, it is therefore critical that the events or circumstances which constitute force majeure are defined in the contract

• The wording of a force majeure clause is an important part of the allocation of risk in a contract, and should be drafted and negotiated as part of that framework – there is no one boilerplate ‘force majeure clause’

Risks and contract law

FIDIC:

Force majeure means an exceptional event or circumstance:

a) “which is beyond a Party's control”, b) “which such Party could not reasonably have provided against before entering into the Contract”, c) “which, having arisen, such Party could not reasonably have avoided or overcome”, and d) “which is not substantially attributable to the other Party."

Risks and contract law

FIDIC:

Under FIDIC, force majeure must include the above four elements, and may include, but is not limited to:

– “war, hostilities…invasion, act of foreign enemies”,

– "rebellion, terrorism, revolution, military or usurped power or civil war,"

– "riot, commotion, disorder, strike or lockout by persons other than the Contractor's personnel and other employees of the Contractor and Sub-contractors“; and

– “natural catastrophes such as earthquake, hurricane, typhoon or volcanic activity”

Risks and contract law

Risks and contract law

Poll

Which of the below is a potential effect of a force majeure clause?

A. A suspension of contractual obligations

B. A variation of contractual obligations

C. Termination of the contract

D. All of the above

• Effect of force majeure situation under the wording of contract

– Answer is D – the effect of a force majeure contract is governed by the terms of contract

– A situation of force majeure may lead:

• to a temporary suspension of contractual obligations on behalf of one or both parties;

• a variation of other contractual obligations – for example, a deferral or reduction in payments, or a variation in otherwise applicable exclusivity terms;

• after a defined period of time, termination rights.

– A situation of force majeure will mean that a party cannot make a breach of contract claim that it would otherwise be able to make against a supplier.

Risks and contract law

• Effect of force majeure situation under the wording of contract

– Remember, a force majeure clause is an allocation of risks between the parties.

Risks and contract law

• Emerging markets can carry increased political and business risk

• To manage this risk, investments are commonly structured in a manner that maximises protection under international investment treaties

• These investment treaties – often referred to as ‘BITs’ (bilateral investment treaties) or ‘MITs’ (multilateral investment treaties)- are agreements between States, which enable foreign investors with a properly structured investment to be protected against unlawful State interference with their investment

Drafting contracts – investment structuring

• Under these treaties, each State commits to various obligations in relation to foreign investors or investments – for example, to provide fair and equitable treatment to foreign investors and compensation to them in the event of expropriation of their investment

– Provides rights and protections to investing companies which are actionable directly against the State

– Often signed by States with emerging economies to incentivise economic development

• To maximise the protections available to them, investors must consider the investment treaty framework before investing in a foreign State

Drafting contracts – investment structuring

• Tips

– Consider whether a force majeure clause is desirable and, if so, its scope

– Invoking a force majeure clause is rarely a ‘trump card’ – many will only provide for a temporary suspension of contractual obligations, will offer corresponding variations to the counterparty, and may refer to obligations to prepare and implement a business continuity plan

– Consider interaction with insurance policies

• Is your counterparty likely to be (or easily able) to insure against these risks?

• What are the limitations of your own insurance?

Drafting contracts – force majeure clauses

• Will not discuss sanctions compliance per se – but effect on contracts

• Introduction of sanctions may make contractual performance illegal or impossible

• Particular difficulties may arise where sanctions are imposed in one jurisdiction (e.g. UK or US) with extraterritorial effect, but not enforced in another jurisdiction (State where contract is performed or home State of counterparty)

– Addressed through appropriate sanctions clause

• Go beyond FM/frustration clauses

• Wording of clause will vary depending on nature of contract

Drafting contracts - Sanctions clauses

• Emerging markets hold opportunities but carry greater risk

– These risks can change dramatically over the life of a contract

• The legal effect of emerging markets risks upon contracts can be uncertain

• The starting point is the contract - the best way of reducing risk and uncertainty is at the contract drafting stage, when making the initial investment

• Consider:

– investment structuring to access investment treaty protections

– force majeure and/or sanctions clauses to reduce uncertainty

– what sort of force majeure clause you want – it may not be the other side’s boilerplate!

Summary

Frustration of contracts

Mark Davenport

DD: 0845 497 4996

Intl: +44 20 7919 4996

markdavenport@eversheds.com

Richard Little

DD: 0845 497 0602

Intl: +44 20 7919 0602

richardlittle@eversheds.com

Contact

Shine Webinars

• Please find below the details on our website for:

• Past webinar recordings:

• http://www.eversheds.com/global/en/what/services/in-house-counsel/webinars.page

• Future webinar sessions:

• http://www.eversheds.com/global/en/what/training/showevent.page?Events=en/SHINE_webinar_updates

• Other events in the SHINE series:

• http://www.eversheds.com/global/en/what/services/in-house-counsel/index.page

Past and future events