Sanctions and Material Adverse Change Provisions

Craig Shepherd and Arnold Hoong have recently published an article in the Global Arbitration Review's Asia-Pacific Arbitration Review 2023 on the contractual effects of sanctions on construction projects. The article explored the effect of sanctions on contractual obligations within projects in the Asia-Pacific region as well as globally, and discusses what project owners and contractors should look out for.

The article takes another look at force majeure and frustration in light of sanctions, whilst also highlighting the benefits of material adverse change clauses (or hardship provisions) as a customisable way for parties to improve project management, predictability and stability. Below are some of the key takeaways from the discussion.

The last few years have seen an elevated level of strife around many parts of the world including the Asia-Pacific. At the time of the article, extensive sanctions regimes affect Russia, North Korea, Belarus and Myanmar, while long term sanctions impact on businesses from Cuba and Iran.

The implications of sanctions go well beyond projects located in directly sanctioned countries. In recent history, sanctions have shown that the effects on logistics and the overall viability of projects can be global.

In the authors' view, force majeure and frustration provisions are not adequate to deal with the consequences of sanctions in the international project space, and the authors believe that the time may be right for a more widespread adoption of material adverse change protection.

Force Majeure

Force majeure operates as a defence so parties can be excused from performance of their contractual obligations if the occurrence of specified exceptional events prevents them from carrying out the performance.

Most standard form contracts provide for force majeure only as a defence for failing to perform contractual obligations, and rarely as a ground for a claim. In most instances, these force majeure provisions allow parties to be given additional time or even a possible right of termination. It is however relatively rare for force majeure to trigger a right to payment, although the costs incurred in addressing sanctions may be immense.

Such clauses also often require a party to be "prevented" from performing its obligations and, while sanctions may impose additional hurdles on the performance of a contract, performance may not be prevented, particularly where the project is not in a directly affected country and the impact of sanctions is on logistics, material supply or costs.

In the authors' opinion, force majeure will often provide an inadequate remedy for sanctions in the international projects market.  The remedy available under the contract is unlikely to carry with it payment and may not be triggered at all if the consequence of the sanction is merely to cause difficulties, rather than to fully prevent work.

Frustration

Frustration applies where a contract has become impossible, illegal, or drastically different to perform from the original agreement. Where frustration is invoked and established, the contract will be brought to an end, and the contract will be seen as discharged.

Frustration is generally not available where the obligations simply become difficult or onerous to perform. So long as performance is possible, frustration will rarely be allowed.  In the context of sanctions, this means that unless the project or the parties are in a state directly impacted by the sanctions, frustration is unlikely to be relevant. Parties indirectly affected by sanctions may not find remedy in frustration.

Therefore, frustration is also unlikely to be an adequate response. It is difficult to establish and brings a contract to an end rather than providing an appropriate mechanism to address the consequences of sanctions.

Material Adverse Change & Hardship

Less widely incorporated than force majeure clauses, and not existing as a matter of common law like the concept of frustration; a third and far better answer can be found in material adverse change ("MAC") or hardship provisions. MAC clauses are common in some forms of contracts but are not widely used in construction projects outside the common law world.

The key feature of a MAC clause is that it allows parties to pre-negotiate the contractual mechanism for adjustment of the contract in the event of material changes to the circumstances. Perhaps the most significant difference between a MAC and force majeure provision is that a MAC provision does not require performance of the contract to become impossible. Instead, it can be effective where circumstances have made the contract only onerous or impractical to perform.

For instance, if there is a material impact on the project caused by the introduction of sanctions, even though that impact falls well short of preventing performance, a MAC clause allows for adjustments to the contract and allows the parties to continue with their obligations, with the project and with the commercial deal. The risk of sanctions can be shared, and the parties are incentivised to work together, rather than incentivising the contractor to say that performance is prevented as force majeure and frustration do.

Ultimately, the authors believe that MAC clauses are likely a good thing for the parties in almost every case, and would be a smart remedy for parties hoping for certainty when faced in a world where sanctions exist.  To date, however, they are a remedy which is rarely included in construction contracts.

For the complete article, please click here.

For more information, please contact Craig Shepherd or Arnold Hoong.