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Law360 (March 3, 2020, 1:49 PM EST )
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| Rob Patterson |
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| Shu Shu Wong |
Force majeure would have been on their minds, even if they couldn't instantly recall how the (probably heavily negotiated) provisions ended up in the final signed agreements.
By the beginning of 2020, Chinese LNG buyers were already under some pressure. Against the backdrop of expensive long-term LNG SPAs (with prices often linked to the oil price but faced with Asian spot prices at decade lows) and faltering domestic gas demand (caused in part by the impact on industrial activity from the trade war with the United States, but also on a milder-than-usual winter), the emergence of the coronavirus epidemic presented yet another challenge.
It was only a matter of time before a buyer invoked force majeure as a means (or in the hope) of avoiding its contractual purchase commitments. In early February it was reported that China National Offshore Oil Corporation had invoked force majeure under its contracts with Total SA and Royal Dutch Shell PLC, two of Europe's biggest energy companies — claims that were promptly rejected by the sellers.
The likelihood is that many other force majeure notices have been served by Chinese LNG buyers in recent weeks.
What is force majeure?
The underlying broad principle of a force majeure clause is widely accepted commercially, namely that a party should not be held to performance of its contractual obligations if that party is unable to perform as a result of unforeseen events or circumstances outside its control.
However, although the term "force majeure" is well known to lawyers and business people, it has no recognized meaning under English law. Its meaning, and the precise circumstances in which a contracting party may have the benefit of force majeure relief, is a matter for the parties themselves to agree and to set out in their contract. Similarly, if a contract governed by English law is silent as to the effect of force majeure on a party's ability to perform, there are no common law or statutory provisions under which a force majeure clause may be implied.[1]
Are force majeure claims based on COVID-19 valid?
In short, this will depend on the terms of the relevant LNG SPA, the nature of the force majeure event claimed by the buyer and the facts on the ground (usually at the relevant LNG import terminal), which any LNG seller on the receiving end of a force majeure notice will certainly want to verify.
What is almost certain is that a force majeure claim based purely on a change in the buyer's economic circumstances (including the widening differential between most contract prices and prevailing LNG spot prices) or on the reduction in LNG demand in China is unlikely to succeed, as such macro events are typically expressly excluded from the force majeure definition in LNG SPAs.
Subject to that, there will be numerous specific questions to consider, depending on the nature of the force majeure claimed by the buyer. LNG SPAs typically include a nonexhaustive list of events that may constitute force majeure, provided that certain other requirements are satisfied. Does that list include reference to epidemic or other communicable disease emergency? Is the virus or other alleged force majeure event covered by some other catch-all provision?
If the force majeure event claimed is not the coronavirus itself, but rather the impact of unexpected government orders imposed to combat its spread, such as enforced lockdowns and closure of facilities, including the unavailability of skilled workforce at LNG receiving terminals resulting from those orders, then it may be that a buyer has a stronger case for force majeure relief, on the basis that unforeseen government action is often specifically identified as being capable of resulting in force majeure.
However, depending on the terms of the contract, the buyer may still need to show that the government order was applied across the board and not in a discriminatory manner or in a manner that only affected certain sectors.
Once it has been determined that an event has occurred that could constitute a force majeure event, a buyer will also typically need to show that its occurrence was, to some specified degree, outside its control and unavoidable and that its ability to perform its contractual obligations (namely, the obligation to receive LNG) was adversely impacted.
Similarly, the LNG SPA may require the buyer to have taken steps with a view to overcoming or mitigating the force majeure event. Again, the precise terms of the force majeure provision will need to be analyzed.
Does the clause refer specifically to the FM event being outside the buyer's control and not capable of avoidance by the buyer, or does it extend to the buyer's affiliates? If the latter, given that the largest LNG buyers are state-owned, could the Chinese government be regarded as an affiliate? Is there an argument that the spread of the coronavirus, and its impact, could have been avoided (or at least mitigated) if the government had taken swifter action and not — as some reports suggest — tried to censure initial reports of its existence and severity? Possibly a long shot for LNG sellers.
Does the clause require that the buyer's performance be prevented by the force majeure event (effectively rendered illegal or physically impossible), or is it enough that it be hindered or delayed, a much wider concept? Does the LNG SPA require that the receiving facilities must have been damaged or otherwise rendered inoperable by the force majeure event? Just what has been the impact of the alleged force majeure event, such as the lack of available workforce, on the buyer's ability to receive LNG? Causation will be a key factor.
According to reports, the China Council for the Promotion of International Trade has issued more than 1,600 force majeure certificates to "exonerate companies from not performing or partially performing contractual duties by proving they are suffering from circumstances beyond their control."[2] Although this may provide some comfort to LNG buyers, for LNG SPAs that are governed by English law, there is no guarantee that such a certificate will provide any assistance as it seeks to obtain force majeure relief under its LNG SPA.
What are the consequences of a successful force majeure claim under an LNG SPA?
The consequences of a successful force majeure claim will vary from contract to contract, but in broad terms the typical result is that the affected party is relieved of its obligations to the extent impacted by the force majeure event and that the contract may be terminated if the force majeure event continues for a prescribed period.
Under LNG SPAs, there may be restrictions on the duration or the quantities of LNG for which a buyer may claim force majeure relief, especially where the contract allows for more than one delivery location. As far as the treatment of the force majeure quantities (i.e. the quantities of LNG that are affected by the force majeure event) are concerned, there are a variety of possible approaches.
For example, the buyer may be required to make up for the force majeure quantities (or, at least, to use reasonable endeavors to do so) by taking these deliveries at a later date instead — generally at the contract price at the time of delivery, rather than at the time of the force majeure event.
Alternatively, some LNG SPAs simply deduct the force majeure quantities from the contracted quantity completely, releasing the buyer from any contractual penalties that would otherwise apply and leaving the seller free to market the quantities to third parties — arguably not an attractive position in the current market. As noted above, many LNG SPAs allow for the termination of the contract in the event of a prolonged force majeure.
What is the outlook for the Chinese LNG sector?
We are still at the early stages of understanding the full impact of the coronavirus outbreak on the Chinese and the global economy. With over 90,000 reported cases and over 3,000 deaths at the time of publication,[3] the outlook for global supply chains looks increasingly bearish, with analysts slashing growth forecasts for the Chinese economy to around 3% for the first quarter of 2020.[4]
This will have knock-on effects not just inside China but also across the rest of the world — and comes at a particularly bad time for export-dependent economies such as Germany, Japan and South Korea.
As far as the LNG market is concerned, the economic slowdown may well push back the time at which China surpasses Japan as the world's largest importer of LNG. Up until late 2019, that scenario was being penciled in for just a few years away, which may still be feasible in the event of Chinese government stimulus and a strong economic rebound once the coronavirus is brought under control.
The coronavirus will inevitably force a greater dialogue between the parties to LNG SPAs. In addition to potential force majeure claims, buyers will be analyzing their contracts for other means of mitigating the impact of the sudden decline in LNG demand. These might include contractual rights to revise the LNG delivery program, reducing the annual or quarterly delivery quantities through the exercise of downward quantity tolerance, or to cancel or redirect LNG deliveries.
Given that China will remain a key player in the global LNG market for years to come, notwithstanding the short-term impact of COVID-19, LNG sellers are going to find themselves under increasing pressure to show some flexibility in their response to what is quickly becoming a global problem.
Rob Patterson is a partner and Shu Shu Wong is an associate at Haynes and Boone LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] The concept of force majeure is similar to, but distinct from, the common law doctrine of frustration, which may apply in limited circumstances, such as where the physical subject matter of a contract has perished.
[2] https://www.chinadaily.com.cn/a/202002/17/WS5e4a38eaa31012821727818d.html.
[3] https://experience.arcgis.com/experience/685d0ace521648f8a5beeeee1b9125cd.
[4] https://www.ft.com/content/473b1eeb-72a9-3da4-96bf-3f2e7e1e7b23.
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