Force majeure revisited - the gas crisis of 2022

During the COVID-19 pandemic and following the outbreak of the Ukraine crisis, legal practitioners consistently poured cold water over attempts by commercial parties to rely on force majeure clauses (and the doctrine of frustration). Now, as the hot water really does begin to turn off in Europe, it is looking increasingly likely that commercial parties may finally be in a position to invoke force majeure.

As Europe edges towards rationing gas supplies over the winter months commercial parties are likely to face the challenge of how best to allocate increasingly scarce resources to comply with their contractual obligations.

In this article, Sohail Ali (partner, UK), Khaled Dadi (partner, Amsterdam) and Victor Sampson (associate, UK) consider, from an English and Dutch law perspective, the potential availability of force majeure to businesses facing this challenge and the likely position of the courts on allocating resources where a force majeure clause applies.

Key takeaways

Commercial entities will be facing difficult choices as gas resources deplete over the winter and allocation of resources becomes an inevitable reality. When faced with such choices, we recommend the following:

• Identify contracts which contain an FM clause and those that do not.

• Where a contract does not contain an FM clause and a party is seeking to rely on the doctrine of frustration under English law or unforeseen circumstances under Dutch law, care must be taken that the frustration or unforeseen circumstance is not deemed to be “self-induced,” ie having been caused by a party as a result of prioritising other customers, or has otherwise been catered for in the contract.

• Where a contract contains an FM clause (assuming it applies), parties must behave “reasonably” to determine any allocation of resources. This may mean considering allocating on a pro-rata basis, or in chronological order or on some other basis depending on the specific facts.

• To demonstrate “reasonableness” parties are encouraged to keep an audit trail of any decisions taken (eg minutes/attendance notes explaining why and how any decision on allocation has been reached).

These are, however, difficult and complex questions which will inevitably give rise to dispute(s). Commercial parties are therefore strongly encouraged to take early legal advice when faced with such issues.

Background

Nord Stream 1, Russia’s largest gas pipeline to Europe has been cutting gas supply in recent months. On 27 July 2022, Russia cut gas flows to Europe to 20% capacity (previously already operating at just 40% capacity) and on 30 August 2022 Russia further reduced gas deliveries to France in relation to a dispute over contracts.

To prepare for the looming winter crisis, the European Commission has proposed that EU Member States voluntarily reduce gas consumption by 15% from August 2022 to March 2023. On 29 July 2022, the German city of Hanover cut off hot water in public buildings in response to the expected gas shortage.

As the crisis firmly takes hold and gas supplies into Europe constrict, commercial parties are now facing increasingly difficult questions in relation to their ability to comply with all of their contractual obligations where gas is a necessary, and sometimes the only, source of energy.

Force majeure

As noted in previous articles¹, English law does not provide a statutory concept of force majeure. In contrast, Dutch law does provide a statutory concept of force majeure. However, given the high threshold for invoking Dutch statutory force majeure, parties typically include force majeure provisions which deviate from statutory provisions.

Whether or not a party can rely on an agreed force majeure clause will be a matter of contractual interpretation under both English and Dutch law. Specifically, courts will scrutinise whether a force majeure event (FM event) in the contract has occurred, and if so, whether it has caused the consequences set out in the contract, eg has the FM event “prevented” or “hindered” (depending on the relevant contractual wording) performance of a party’s contractual obligations.

Previously, parties unsuccessfully sought to rely on economic hardship (which is not a valid basis to invoke an FM clause under English or Dutch law unless the force majeure clause includes express wording to that effect). In contrast, FM clauses which list shortages in (energy) supplies, changes in law, or contain more generic wording such as “unforeseen events beyond the reasonable control of the parties” may now (or soon) be potentially applicable to enable a party to suspend or terminate performance under one or more of its contracts.

Allocation of resources under English law (where an FM clause applies)

As the EU considers rationing and/or the supply of gas is either reduced or stops, the question suppliers are likely to face is how to allocate a reduction in resources to comply with all of their contractual obligations, whilst relying on FM clauses under one or more of their contracts to excuse reduced, failed or delayed performance.

There is a lack of case law on allocation of resources under English law, however, generally the courts have been sympathetic to commercial parties who are facing often “insoluble difficulties” but have sought to behave reasonably.

A pro-rata approach?

In Tennants (Lancashire) Ltd v CS Wilson & Co Ltd [1917] AC 495, which concerned a shortage of supply of magnesium chloride as a result of wartime conditions, the court gave some useful guidance as to what might have happened if all of the defendant’s customers had insisted on their right to deliveries (though the question of allocation did not specifically arise).

The court held “probably it would be held in such a case that the deliveries would fall to be made in the order of priority as they fell due, and that, in the event of delivery being due under several contracts at the same time, the amount which it was possible to obtain to implement the contracts would fall to be divided among them pro rata, and that as regards any balance remaining undelivered there would be a prevention within the meaning of the clause.”

The court went on to say “I do not see how the appellants could have lawfully delivered to the respondents without also delivering proportionately to the other firms with whom they had entered into similar contracts. They were either bound to all their customers equally or they were not bound to any of them.”

Importance of commercial reality

However, English courts have recognised that pro-rata division is not always or the only appropriate method of allocation.

In Intertradex v Lesieur-Tourteaux [1977], Mr Justice Donaldson held that “my own view is that if the seller appropriates the goods in a way which the trade would consider to be proper and reasonable - whether the basis or appropriation is pro-rata, chronological order of contracts or some other basis – the effective cause [of non-delivery] is not the sellers’ appropriation, but whatever caused the shortage.”

Indeed, in Bremer Handels GmbH v Vanden-Avenne Izegem PVBA [1978], the court held that pro-rata allocation in some cases may make no commercial sense. In Bremer, the court held that faced with deciding how to allocate a 90-tonne shipment of soya bean when faced with commitments for 44,000 tonnes, the seller was faced with “insoluble difficulties.” Allocating on a pro-rata basis created a de minimis situation where the purchasers would have been entitled to 0.204% of their purchase. To impose an obligation to pro-rata would “introduce into this commercial field an exercise in logic which would be destructive of commercial reality.” Lord Russell therefore held that “a question in the application of the law in a commercial field must surely be whether it would work sensibly.”

What happens when there is no FM clause or a party seeks to rely on frustration?

The biggest difficulty when it comes to allocation of resources is where a party does not have an FM clause in a contract and/or is seeking to rely on the common law doctrine of frustration (ie to argue that an unforeseen event has occurred which renders the performance of a contract impossible, illegal or radically different to that contemplated at the outset of the contract). In those circumstances, the courts have shown far less sympathy to suppliers who set about allocating limited resources.

Professor Treitel in his book on the Law of Contract considered the situation where a party has entered into a number of contracts with other parties and an unexpected event prevents him from satisfying all those contracts. According to Treitel, that party can elect to use such means as remains available to him to perform some of the contract, provided he acts reasonably in making his election. The other contracts, which he does not perform, will have been frustrated by the supervening event.

Treitel's analysis was rejected in the “Super Servant Two” case (J Lauritzen v Lauritzen v Wijsmuller BV [1990]). Lord Justice Bingham held that whilst he had “no doubt that force majeure clauses are, where their terms permit, to be construed and applied as in the commodity cases…it is in my view inconsistent with the doctrine of frustration…that its application should depend on any decision, however reasonable and commercial, of the party seeking to rely on it.” He held that the essence of frustration was that it should not be due to the act or election of a party – the concept of self-inducement and frustration were “simply opposite sides of the same coin.” Rather, that frustration must “bring the contract to an end forthwith, without more ado automatically.”

Allocation of resources under Dutch law (where an FM clause applies)

In contrast to English law, Dutch law does not have a body of case law or give clear guidance in terms of a preferred approach towards allocation in cases of scarcity.

Potential support for chronological allocation

The District Court of Arnhem ruling in summary proceedings was asked to assess whether a company trading in road salt was allowed to allocate its stock amongst its customers during an unusually harsh winter. Although the court did not allow for such an allocation outright, it did seem to imply that such a right to allocate amongst customers could exist on a chronological basis² .

Other mechanisms provided for under Dutch law

Dutch law does provide for other mechanisms to change the balance in a contract if maintaining the contractual status quo would be deemed to be unreasonable or disproportionate. In Vodafone v. ECT [2007], the Dutch Supreme Court held that principles of reasonableness and fairness could mean that parties, including commercial parties, must consider each other’s legitimate interests when performing contracts. Many legal scholars have taken the position that this could, in turn, imply a duty to renegotiate the contract parameters and an obligation to accept a reasonable proposal to accept a contract amendment (eg in the form of a pro-rated lower volume of products being delivered).

In Oosterhuis v Unigro [1976], the Dutch Supreme Court held that the right to enforce contractual performance may not be honoured by a court where performance would require disproportionate efforts having to be taken by a party.

In addition, one can always petition the court to amend the terms and conditions based on unforeseen circumstances. This could be relevant where an unforeseen change in circumstances has affected the monetary equilibrium of the contract meaning that performance has become excessively expensive for the seller or the value of the bargain has diminished entirely.

In the past, the general tendency of the Dutch courts was to stick to the contract terms when confronted with claims of excessive increases of energy prices or supply shortages. This typically meant that a failure to perform (fully) remained for the account of the defaulting party. In the wake of COVID-19, courts have become more amenable to changing the contractual equilibrium by sometimes applying a "share the pain" principle. We have also seen some recent (lower court) decisions where courts have held that the unprecedented energy price increases or delayed deliveries due to the war in Ukraine and renewed COVID-19 shutdowns in China cannot remain fully for the account of the defaulting party.

Although court verdicts dealing with allocation of capacity are still scarce, it is very well imaginable that Dutch courts will – when applying principles of reasonableness and fairness – end up applying principles which are similar to those applied by English courts as set out above.

The collapse in oil prices: force majeure and other strategies (27 May 2020)
² District Court of Arnhem (vzr.) 05-02-2010, ECLI:NL:RBARN:2010:BL3723