War, Coups and Hurricanes – Exiting long-term services contracts when conditions change
When entering a long-term services contract, the prospect of future political or environmental changes affecting performance will not be the parties’ primary focus. However, circumstances can change quickly and without warning, particularly in what may be regarded as more challenging jurisdictions. Whether due to regime change, civil unrest, military action, extreme weather events or the imposition of sanctions, the ability to provide contracted services may become fundamentally compromised.
The impact of such changes may be so severe that continuing operations would give rise to safety/security concerns or reputational risk, or be contrary to the supplier's public environmental, social and governance commitments. In such circumstances, service providers may be forced to consider ways to cease supply and to exit the jurisdiction. This will often involve exiting the underlying contract, even though provision of the services is still possible.
In the event of war, coup, hurricane or other dramatic changes in circumstance, exiting a long-term services contract and the jurisdiction in which those services are provided can be complex and risks attracting liability. In this article we consider the key considerations if change necessitating exit occurs, and how to prepare for that at the point of entering into contracts.
Commonly used contractual provisions
Termination, force majeure and material adverse change provisions can assist, but only if and to the extent that they are carefully drafted to deal with the relevant circumstances and they expressly provide termination rights in those circumstances.
Express termination provisions: Clauses titled "termination" are common in long-term agreements. However, this does not necessarily mean the road to termination will be clear.
- Given the impact of termination, in many cases these provisions will have been heavily negotiated. It is not uncommon to see termination rights in favour of one party but not the other. Where express rights to terminate do exist, they often arise only if certain narrowly defined conditions are met, or at a certain point in time during the life of the contract. Where termination at will is permitted, this will usually be only upon the expiry of a prolonged notice period, which is not conducive to a swift and expedient exit.
- Terminating with no proper basis exposes a party to the risk of being in repudiatory breach and giving the counterparty a right to terminate and claim damages.
To avoid these issues, consider including a mutual right to terminate on little or no notice should certain defined events occur. For example, if a change to the prevailing political regime conflicts with a party's human rights policies or exposes that party to breach of its public ESG commitments.
Force Majeure (FM) clauses: An FM clause may assist where the change in circumstance that has occurred falls within the (often narrow) wording of the clause. However, a typically drafted FM clause will not help exit an entire service contract if some elements of the service can still physically be provided, even if at extra cost. Neither would it help a supplier exit an entire country if the service can still be performed in some regions of that country. Purporting to terminate a contract under an FM clause which has not been properly triggered is likely to be a repudiatory breach.
- Issues that may arise include:
- establishing that the relevant event is an FM event as defined by the contract;
- establishing that the alleged FM event has caused impossibility or non-performance. An FM clause will not provide a route to termination if the relevant event simply makes performance more difficult or economically unprofitable than it was before. If performance is still legally or physically possible, even a broadly drafted FM clause is unlikely to assist;
- ensuring that notice is given in accordance with the contractual requirements (and as soon as reasonably practicable following the FM event);
- establishing that the occurrence of an FM event:
- affects the entirety of the contract, rather than certain individual obligations; and
- permits a party to terminate the contract. This may seem obvious but is not a given. In many contracts, the occurrence of an FM event merely permits the temporary suspension of performance for the duration of the event, with the parties obligated to recommence performance once it has ended.
- To ensure an FM clause can provide an effective route to termination:
- define an FM event widely to cover all possible scenarios. Where a particular concern exists (such as where regime change is likely or the safety of workers is threatened), include it expressly in the definition of force majeure; and
- ensure the clause provides a termination right in appropriate circumstances. For example, provide that a party may terminate the entire contract where an FM event continues for a certain period of time, or where a certain number of isolated FM events affecting individual obligations under the contract have occurred in a defined period of time.
Material Adverse Change (MAC) provisions: MAC clauses are less common in service contracts than in the context of M&A and facility agreements. However, they may serve a purpose in volatile countries or regions, particularly in long term agreements. If properly implemented, such a clause may allow a service provider to walk away from its obligations if relevant circumstances can be said to amount to an MAC.
- For a MAC clause to assist, the events that have occurred must fall within the precise scope of the contractual provision (which may have been heavily negotiated), failing which there is again the risk that reliance on it will be a repudiatory breach.
- In negotiations, consider which entities in a counterparty's corporate structure should be subject to the MAC clause, particularly if there is a risk that the complexity of that structure may be used to obfuscate unattractive control changes.
Can the common law assist?
In the absence of effective contractual mechanisms, a party wishing to exit after a dramatic change of circumstance will be left with the limited protections offered by the common law.
- Frustration: In the absence of an FM clause, the doctrine of frustration may apply, but only where the performance of the contract has become legally/physically/commercially impossible. The threshold for frustration is high and it is usually unavailable where the contract contains an FM clause covering the event(s) in question.
- Illegality: If performance of the contract becomes illegal under English law (e.g., as a result of English law sanctions), illegality does not justify termination. However, if a decision is taken to cease performance, illegality would be a defence to a subsequent breach of contract claim brought by the counterparty for a failure to perform the illegal obligation. Notably in the context of sanctions, the doctrine of illegality may not assist parties to an English law contract if:
- performance of the contract becomes illegal under foreign law (e.g., following sanctions under US or EU law), unless the contract requires actions to be performed in the country/countries where those actions would be unlawful; or
- performance of the contract has not yet become illegal - for example if it is merely suspected that sanctions may be imposed against the counterparty at some point in the future.
- Termination in breach of contract: A party who ceases to perform its obligations without a contractual or common law right to do so will expose itself to liability for damages or an order for specific performance. Termination in breach would also permit the counterparty to terminate for repudiatory breach (although it may be unlikely to elect to do so given that termination is what the breaching party is seeking to achieve).
If the potential for significant political or environmental change is anticipated, or if the impact of an unlikely change in circumstance would be intolerable, it may be possible to provide for creative solutions to those problems at the outset.
- If regime change or increased state control is a concern, consider including a clause dealing with changes to a counterparty's wider corporate structure or ultimate beneficial owner. For example, a warranty given expressly by the counterparty that it is not, has not been and will not in future be a counterparty which is "unsuitable".
- Unsuitability should be defined carefully. It should extend to direct/indirect parent companies, subsidiaries and other members of the corporate group if a change affecting such an affiliated company would make dealing with the counterparty untenable. It should also set out who determines whether the other party has become "unsuitable" and in what circumstances.
- The contract should contain a right to terminate where unsuitability is established, in breach of warranty.
- Consider the inclusion of a specific clause dealing with the consequences of sanctions, addressing:
- The type of sanctions covered. It may be appropriate to include sanctions under foreign law (such as US or EU law). This will depend on the identity and location of the contracting parties and their parent entities.
- Whether or not sanctions affecting affiliated parties should trigger the clause.
- At what point the clause will be triggered. If proportionate, providing for a right to terminate even if sanctions are not yet in place, but where one party has a reasonable suspicion that sanctions will be imposed or where the exact factual position is unknown, may be crucial to mitigate reputational risk.
- Automatic termination without notice in the event of the imposition of sanctions. This will be necessary to avoid the risk of potential sanctions breach even for a very limited period.
- Where requesting sanctions-specific provisions is not possible in the context of friendly negotiations, ensure the contract contains one or more of the other clauses referred to above. If necessary, strengthen or expand such clause(s) to ensure that (a) they apply in the event of sanctions being imposed (or suspected) and (b) they provide a clear route to termination.
If there is no clear route to termination
Unfortunately, in many situations, particularly if the contract does not contain the types of clauses outlined above, and where the common law cannot assist, the only option will be to seek to agree on the terms of exit. This may involve agreeing to transfer provision of the services to a third party, and may therefore require the continuation of a certain level of service during a handover period. Whether this is attractive or possible will depend on the exiting party's willingness to remain exposed to the very risks they are seeking to escape, even for a limited period.
- Continued performance pending a negotiated exit may not be attractive or possible if there is a risk of imminent sanctions or where employee/worker safety is under threat. In addition, a party who can continue performance while negotiations are ongoing may lose the opportunity to argue later that performance is impossible, as required under an FM clause or to establish common law frustration.
- However, an exiting party may have more leverage where its counterparty's key priority is maintenance of supply. The risk of supplies ceasing (assuming the exiting party is prepared to do so) may encourage them to the table.
If you are permitted to terminate/exit
Upon termination, both parties to the contract are released from their primary obligations (i.e., to deliver goods or supply services, and to pay for such goods or services) for the future. Rights which have accrued up to the date of termination (like the obligation to pay due and outstanding sums) remain valid and enforceable. However, exiting parties should be alive to the risk that recovery of sums owed to them may be difficult or impossible if the counterparty has become a sanctioned individual, entity or state, or is affected by war or civil unrest.
Finally, a sudden termination or exit from a country may cause a party to sustain losses arising from late delivery of goods or supply of services, or late payment for them. Performance bonds/guarantees may assist with transferring that risk to the issuer, such that if a party is forced to terminate or exit a country suddenly, with money still owed to it under the contract, the bonds/guarantees may be called upon to ensure the outstanding sums are paid.