Global trade and market instability: Impact on contractual arrangements

Given the dramatic ongoing global trade instability, many international commercial parties may be looking again at their contractual arrangements. In some cases, it may be possible to renegotiate terms to address the changed circumstances, or parties may be able to rely on express contractual rights to deal with increased costs or to terminate agreements that have become uneconomic.

In other cases, parties may want to consider whether they can invoke contractual provisions, such as a force majeure or material adverse change (MAC) clause, to suspend or avoid their obligations– or whether they may be able to rely on the doctrine of frustration to bring the contract to an end. The availability of these provisions and doctrines will depend on the drafting and the governing law of your contracts. While these concepts are well known in common law jurisdictions, they are also recognised in civil law and other legal systems, albeit with different terminology. 

Force majeure

A force majeure clause is a term found in many contracts which excuses one or both parties from performing their obligations if they are prevented (or hindered or delayed) from doing so by circumstances outside their control.

Under English law, the application and effect of a force majeure clause depends on the language used. A typical clause will excuse one or more parties from performing their obligations if they are prevented (or, depending on the scope of the clause, if they are hindered or delayed) from doing so by an event or circumstances outside their control.

However, while all will depend on the construction of the clause, a change in economic or market circumstances which makes the contract less profitable is not generally considered to be sufficient to trigger a force majeure clause. This may present a challenge for parties seeking to invoke a force majeure clause as a result of the imposition of tariffs.

The concept of force majeure exists in many civil law jurisdictions as well. In some legal systems, force majeure may be defined by statutory provisions, and its application can differ based on the specific language of the contract and the relevant legal framework. Civil law countries tend to have specific codes that outline the circumstances under which parties may be excused from performance due to unforeseen events.

Material adverse change (MAC) clauses

Also referred to as "material adverse effect" clauses, a typical MAC clause will allow a party to refuse to proceed with a transaction if a MAC occurs after the contract date. They are most commonly agreed in favour of the buyer in an agreement for the sale of a company or business, or the lender in a loan agreement. MAC clauses are utilised in both common law and civil law contexts. The interpretation of these clauses can vary depending on the governing law of the contract and the courts or tribunals enforcing them. 

Such clauses may be drafted narrowly to specify particular events that will qualify as a MAC or may be drafted more widely but made subject to specific carve-outs. Depending on the construction of the particular clause and the surrounding circumstances, it is possible that a change to tariffs could trigger a MAC clause, if for example it had a significant negative effect on a target company or business.

Frustration

Frustration is a common law doctrine that applies where an event occurs after the contract has been entered into, which is not due to the fault of either party, and which makes further performance impossible or illegal, or renders the obligations radically different from those contemplated by the parties at the time of contracting.

The effect of frustration is to bring the contract to an end immediately and automatically. However, the question of whether a contract has been frustrated will often be a contentious point, and so a party may be required to take legal action to obtain a declaration that the contract has been frustrated.

In determining whether frustration applies, the court will consider multiple factors including the parties’ (objectively determined) expectations at the time of contracting. Frustration tends to be applied narrowly, and events which simply make the contract more onerous or less profitable will not necessarily be sufficient. However, given the dramatic impact recent events may have in some cases, it would not be surprising if arguments of frustration are raised.

The doctrine of frustration is primarily a common law principle; however, similar concepts exist in civil law jurisdictions, such as imprevisión or doctrines centred on impossibility or on unforeseen or changed circumstances. These doctrines serve a similar purpose of allowing parties to seek relief when an unforeseen event makes contractual performance excessively burdensome or impossible.

Other issues to consider

In light of the ongoing global market instability, parties may also want to consider the implications of possible change of law clauses, contractual stabilization regimes, and earn-out or leakage clauses in M&A transactions. Change of law clauses can provide a mechanism for parties to renegotiate terms or terminate agreements if new laws or regulations significantly impact the contract's performance. Contractual stabilization regimes, often used in long-term contracts, aim to protect parties from adverse changes in law by freezing the applicable legal framework at the time of contracting. In M&A transactions, earn-out clauses can help bridge valuation gaps by tying part of the purchase price to the future performance of the target company, while leakage clauses prevent the seller from extracting value from the target company before completion. Additionally, the impacts of insolvency events should be considered carefully, as they can trigger termination rights, accelerate payment obligations, or affect the enforceability of certain contractual provisions. 

Parties are well-advised to review their contractual arrangements and identify the clauses that may benefit or disadvantage them, so they are better prepared to navigate the current uncertainties and mitigate potential risks.

For further information, please contact Charlie Morgan, Christian Leathley, Marco de Sousa, Maura McIntosh, Vanessa Naish, or your usual Herbert Smith Freehills contact.