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Law360 (July 14, 2020, 5:54 PM EDT )
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| Alexandra Farmer |
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| Maddy Foote |
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| Jennie Morawetz |
While some parties may choose to continue to rely on force majeure provisions to address such risk, albeit in a potentially more detailed or expansive form, other parties may seek more bespoke provisions —e.g., climate risk sharing covenants, indemnification provisions and/or termination rights.
Force Majeure Overview
With the COVID-19 crisis wreaking havoc in global markets, some businesses have turned to the doctrine of force majeure to seek potential contractual relief, and in doing so, have come up against its limitations.
Fundamentally, a force majeure provision is intended to release or excuse a party's contractual obligations under circumstances in which an extraordinary event outside the party's reasonable control renders the party's performance of those obligations commercially impracticable.[1] Force majeure clauses will, of course, vary between contracts.
However, a boilerplate clause typically sets out an exhaustive list of possible events that can excuse a party's performance, including, for example, an act of God, natural disaster, government order or law, action by any governmental authority or national or regional emergency. An act of God is generally interpreted as an acute natural event with severe, unpreventable consequences such as a hurricane, tsunami, blizzard landslide or earthquake.
A force majeure provision may be conditional on the unforeseeability of the event. That is, a nonperforming party may not be able to rely on force majeure where the claimed event was foreseeable to the parties at the time of contract.
In certain states, where the clause is silent on foreseeability, the court will impute this test to the entire clause. In other states, foreseeability will only be imputed to catchall provisions (i.e., any other events outside the parties' control), and not to triggering events expressly listed.
Force majeure can be an imperfect defense. Among its limitations is the fact that the likelihood of success is dependent on a court's interpretation of the clause in the context of the supervening event. Courts generally construe force majeure clauses narrowly, and are therefore reluctant to cover events outside those expressly listed.
Even where a listed event occurs, economic hardship alone is generally insufficient to satisfy the requirements of force majeure. Further, to the extent a contract requires unforeseeability, this fact-intensive inquiry can be challenging — requiring, for example, the analysis of historical data. It can be expensive and time-consuming to litigate these issues.
As litigation from COVID-19 ensues, courts will be tested in how they apply force majeure provisions to the pandemic and related governmental orders — e.g., stay-at-home orders. The uncertainty over how COVID-19 force majeure court battles will play out has made clear that parties should pay careful attention to the language of force majeure and other risk allocation provisions in negotiating contracts going forward.
This rethinking is likely to be particularly important in the coming years with respect to climate change, as a proactive review of potential risks may prove very valuable.
Force Majeure and Physical Climate Change Risk
The physical risks of climate change can be generalized as either acute — e.g., hurricanes, wildfires and floods — or chronic — e.g., increased frequency of heat waves, rising sea levels and changes to the frequency and intensity of rainfall events.[2] Acute physical climate risks pose the most immediate, tangible concern for contracting parties, who often list extreme weather as force majeure triggering events.
Given the increasing frequency with which acute physical climate risks are manifesting — e.g., Hurricanes Katrina, Harvey and Irene, the 2019 Midwest floods and the worst California wildfire season on record — as well as the ever-improving accuracy and confidence of climate risk modelling, it is valid to ask whether such risks will be considered sufficiently unforeseeable, or, particularly if not specifically enumerated, sufficiently extreme in the context of force majeure going forward.[3]
Even less certain is the potential application of force majeure provisions to chronic climate risks, such as gradual sea level rise inundating a coastal property. By definition, a chronic climate risk occurs incrementally and, to a certain degree, predictably (within the scope of present climate modelling capability).
A claim of force majeure for such risks would likely be a nonstarter based on foreseeability or, particularly if not specifically enumerated, the damage being not so extreme as to render performance commercially impracticable. Such risks are particularly likely to manifest in the context of longer-term contracts, such as supply agreements, leases and maintenance contracts.
Force Majeure and Transition Climate Change Risk
In addition to physical risks, climate change poses transition risks — i.e., policy, legal, technological and market changes that may impact a business in the transition to a lower-carbon economy.
One of the hallmarks of the COVID-19 crisis is the startling speed and impact of government action on business operations, supply chains and financial markets. While it might be a fiction to imagine similar shutdown measures introduced in response to climate change, having endured the consequences of failing to implement adequate risk management and preventative measures for a global pandemic, certain governments may now be more likely to take strong action to improve climate change resiliency.
Indeed, the World Economic Forum urged, in its statement on stakeholder principles in the COVID-19 era, that achieving long-term sustainability goals, including the Paris climate agreement goals and the United Nations Sustainable Development Agenda, must run parallel to the response to the COVID-19 crisis.
And without preemptive action, climate transition risks could ultimately come into play in a much more disorderly and/or sudden fashion, since governments would be attempting to mitigate damage once the climate horse has left the stable, similar to COVID-19.
Examples of climate-responsive government directives include:
- Restrictions on indirect (in addition to direct) greenhouse gas emissions, mirroring recent commitments made by certain multinational mining corporations to monitor and curb indirect carbon emissions both up and down their supply chains; this may ultimately shift corporate procurement away from regions that have carbon-heavy power supplies;
- Governmental buyouts of commercial properties in flood-prone or wildfire-prone regions, a regime sometimes referred to as "managed retreat," and undertaken in instances in which the cost of withdrawing individuals and businesses from high-risk areas is less than the cost of constantly rebuilding after successive flood or wildfire events;
- Community-scale curtailment of energy production (i.e., preemptive blackouts) to avoid energizing power lines during severe-risk wildfire conditions, as observed during the most recent wildfire season in California; and
- Extensive insurance obligations, rendering certain properties or business lines uninsurable; legislation currently proposed in certain states seeks to require business interruption policy underwriters to cover such losses incurred during the COVID-19 pandemic.
A government directive is typically held to constitute a force majeure event when the directive either explicitly prohibits performance, or is so unforeseeable that the parties could not reasonably be expected to have allocated risk for it in their contract. Yet each of the actions described above has precedent in recent history. Therefore, arguing that a climate-driven government directive is a force majeure event may, like certain weather events, also fall down for being insufficiently extreme or unforeseeable.
Climate-Focused Force Majeure Improvements
In light of recent commercial litigation arising from the COVID-19 pandemic, commentators have recognized this time as an opportunity to address the sometimes inadequate and ambiguous drafting of force majeure provisions — noting, in particular, the need to comprehensively consider potential risks and plan for the consequences well in advance.
The following potential improvements have been suggested in a series of recent articles:[4]
- Consider client- and industry-specific definitions of triggering events, as opposed to relying on a list of generic events or an act of God. In the context of climate change, this approach would likely necessitate a detailed discussion of the types of acute and chronic events that would qualify as force majeure, and at what frequency — e.g., intensity or duration of droughts over a specified period of time.
- Specify events that would not constitute force majeure, and describe the consequences should those events occur, with a view to carving out events that the parties may be able to handle or mitigate without excusing performance entirely.
- Explain the impact of force majeure on each specific contractual provision, including payment, liability for damages and termination in addition to performance.
Alternatives to Force Majeure for Climate Risk
While these recommendations go some way to minimizing concerns, the case remains that, in the face of foreseeable climate-driven risks, the force majeure doctrine provides imperfect protection. For one, it creates an all-or-nothing paradigm that may be an imperfect solution for a risk that is best shared.
In light of the COVID-19 crisis, contracting parties may be driven to spend more time carefully considering the potential consequences of pandemics or climate change, and thereafter develop a more deliberate sharing of risk through conditions, covenants or indemnity provisions. An example of such a provision has been presented by The Chancery Lane Project, a pro bono initiative of corporate, in-house and academic lawyers and barristers.
The Chancery Lane Project's most recent publication, "Climate Contract Playbook: Volume 2," presents a model "climate risk sharing" clause for supply contracts, which is designed to encourage contracting parties to reduce the impact of climate change events on contract performance without creating additional adverse climate or social outcomes.
Specifically, during climate change events, (1) the impacted party would be required to provide notice of the disruption, and (2) the parties would be required to work together in good faith to minimize and mitigate the impacts of the disruption, ensure that each party's liquidity ratio is maintained and mitigate wasted embedded carbon (being the carbon emissions produced during the manufacture, supply and use of goods or services).
In the event that a party's liquidity ratio — i.e., its ability to maintain operations and pay its staff — drops below a negotiated threshold, then the parties would be required to renegotiate the terms of the agreement in good faith.
To mitigate the potential waste associated with disrupted supply chains, the model language also allows either party to stop providing its products during the period of disruption without terminating the agreement; offer to sell the products to other customers and provide a payment discount; or reuse, resell or recycle the products and provide a payment discount.
Using this model clause as a starting point, parties may customize the provisions as needed with their own situation-specific terms. Of course, the success of the clause will depend on the parties' interests and commercial priorities, but this risk-sharing approach may be warranted in certain situations.
In particular, businesses party to mid- to long-term supply agreements may identify a need to fill the gap in risk allocation for the threat posed by both physical and transition climate risks. Similar risk-sharing provisions could be adapted to other types of commercial arrangements, such as lease, employment, credit, construction or operations and maintenance agreements.
Of the many lessons learned during this pandemic, one is that business, like life, is unpredictable. Parties should therefore aim, as much as possible, to consider risk allocation early and carefully, as this endeavor can go some way to increasing resiliency to future climate challenges.
Alexandra Farmer is a partner, and Maddy Foote and Jennie Morawetz are associates, at Kirkland & Ellis LLP.
Disclosure: Kirkland & Ellis International is identified as a contributor to the first volume of The Chancery Lane Project's Climate Contract Playbook, but has not been involved in the development of the second volume, which is referenced in this article.
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] While outside the scope of this article, it is also worth noting that, in addition to force majeure provisions, contract parties may also look to the common law doctrines of impossibility, impracticability and frustration of purpose to excuse contractual performance.
[2] Jennie Morawetz, "How Cos., Asset Managers Can Plan for Physical Climate Risk," Law360 (March 19, 2020), available at: https://www.law360.com/articles/1254780/how-cos-asset-managers-can-plan-for-physical-climate-risk.
[3] Even where an event is specifically enumerated, the party claiming force majeure may need to show that the event is sufficiently extreme. For example, where the resultant harm is financial, this will not excuse performance unless there exists "extreme and unreasonable difficulty, expense, injury, or loss involved" (Butler v. Nepple
, 354 P.2d 239 (Cal. 1960)).[4] See Peter Biagetti and Clare Prober, "Fuss Majeure: Lessons from the Early Outbreak of Covid v. Contract Cases" (April 24, 2020), https://www.natlawreview.com/article/fuss-majeure-lessons-early-outbreak-covid-v-contract-cases; see also Abby Sacunas and Nicole Sprinzen, "Contracting to Avoid Force Majeure Litigation in the Midst of the COVID-19 Pandemic" (April 25, 2020), https://www.jdsupra.com/legalnews/contracting-to-avoid-force-majeure-89039/.
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