Force majeure and the resources industry - managing the impact of COVID-19

9 minute read 20.04.2020 Evan Goldman, Jordan Phillips, Kathryn Finlayson

The ripple effects of COVID-19 will continue to be felt in the Australian resources industry as contracting parties make ongoing commercial and operational decisions in uncertain and evolving circumstances. This article gives resources operators a framework within which to consider these issues and strategies to protect their interests.

The shut-downs caused by the pandemic are unprecedented, particularly as the global supply chain has become more internationalised, interlinked and reliant on lower stockpile levels. At this stage, it is uncertain whether and how commonly used 'Force Majeure' clauses will apply to excuse obligations under goods and services contracts in the resources industry. For some high value critical supplies, disputes over force majeure clauses will arise and may not be settled for some time.

To mitigate against this uncertainty, contracting parties can put in place systems and strategies now to protect their interests and improve their chances of success in any such dispute, while allowing flexibility to negotiate mutually acceptable alternative solutions now.

Emerging risks and the introduction of force majeure

The impacts of the COVID-19 pandemic on the resources sector have been significant and will continue to evolve as responses by Australian and international governments unfold and change over time.

We have seen effects ranging from the cessation of exploration and drilling operations to more subtle but widespread impacts on major Australian resources operations such as delays in supply of essential inputs. Emerging risks for the sector include:

Cancellation of LNG deliveries by buyers in the face of steep reductions in demand due to restrictions on local industry;
Delays and shortages in internationally (particularly Chinese) sourced equipment, spares and construction materials caused by pressure on supply chains, nation-wide restrictions on vessels that berth within 14 days from their last international port of call. In Queensland and New South Wales, there are more stringent restrictions preventing the berthing of vessels that have within the last 14 days visited China and South Korea (Qld and NSW), and Italy and Iran (NSW only);
Health risks caused by the close proximity of workers performing certain functions within mines;
Restrictions on FIFO workers, and industrial action by workers concerned that they are exposed to risk of infection from FIFO workers exempt from restrictions;
Issues caused by the location and spread of operations activities within areas subject to travel and quarantine restrictions, in particular the comprehensive travel bans between regions within Western Australia and further restrictions on travel within the Kimberley region.

We are already seeing declarations of force majeure under major LNG export contracts and in long term coal supply contracts to domestic energy generators. We expect this trend to continue and for force majeure notices to also be delivered on a range of lower-value procurement, services and transportation contracts.

Whether the parties' particular agreed force majeure clauses responds to any scenario is often highly contested, and will be even more so in this novel and ever-changing COVID-19 pandemic. This article gives resources operators a framework within which to consider these issues as they arise and to implement strategies to protect their interests without restricting communication and cooperation with counterparties.

What is a force majeure clause?

A force majeure clause provides an agreed contractual mechanism to deal with unexpected events beyond the parties' control, usually by suspending the obligations of a party if the event impedes, prevents or delays performance. As a contractual construct in Australian law, force majeure is as wide or as narrow protection as the parties have agreed and its operation depends critically on the words used in the clause.

Force majeure is distinct from frustration, which is a common law doctrine that is triggered if the contract is incapable of being performed because the circumstances in which performance is required are radically changed. Frustration is a blunt instrument which results in automatic termination of the contract. Frustration offers no relief where an event delays performance or makes performance more onerous.

Force majeure provisions are common in the resources sector, in particular in long term supply agreements, marketing agreements, transportation agreements, and other contracts which require regular performance of services or delivery of goods from a particular source (noting that they are relatively uncommon but not unheard of in joint venture agreements).

Does the force majeure clause relieve non-performance caused by COVID-19?

Has an event of force majeure occurred?

The expression used in the force majeure clause will determine whether COVID-19 or its effects trigger the clause, but common trends can assist a party's consideration. Definitions of a 'Force Majeure Event' usually fall into one of these categories:

A broad definition of a qualifying event;
An inclusive or 'illustrative' list of events;
An exhaustive list of events; or
An inclusive list of events plus a broad 'catch all' definition.

A party is more likely to be able to rely directly on the COVID 19 pandemic as an event of force majeure if the force majeure clause contains a broad definition or, failing that, an inclusive list.

For any list-based definition the terms specified in the list are critical.

Unless expressions like 'infectious disease', 'epidemic' or 'pandemic' are listed, parties will need to carefully consider if it can rely on COVID-19 directly as an event of force majeure, or indirectly on an event of response to COVID-19. In the resources sector, that may include the personnel effects of federal or state government restrictions on movement (or an inability for personnel to operate at safe social distance), port and shipping restrictions, access to other freight or delivery infrastructure, or shortages in necessary materials. In these cases, expressions to look for include 'government action', 'emergency', 'national emergency', 'labour shortages' or descriptions of particular products or services that the parties have agreed are necessary for that transaction.

Affected parties should also consider if contractual provisions other than the force majeure clause may be more responsive to the change in circumstances. Depending on their terms, a 'change in law' or 'change event' clause may be more applicable to COVID-19 and may impose more wide-ranging obligations requiring the parties to amend the affected terms of their agreement. Where one or more of these other mechanisms are present, their terms may also affect the objective construction of the force majeure clause, i.e. the force majeure clause may be read to exclude any event where the change event clause applies.

Did the force majeure event cause the non-performance?

The affected party will need to establish a causal link between the event (or its consequences) and the failure to perform its obligations. Common clauses contain a spectrum of requirements for this causal link (from hardest for the affected party to satisfy to easiest) – being whether the event: 'prevents'; 'hinders'; or 'delays' performance.

Most force majeure provisions also contain a positive obligation to seek to 'mitigate', 'prevent', 'remedy' or 'overcome' the force majeure event. A party who does not take advantage of an available reasonable alternative method of performance cannot generally rely on a force majeure clause.

What are the notice requirements?

It is common for force majeure clauses to include notice provisions, but the precise trigger for the notice may be unclear, especially in the current circumstances. For example, an obligation may have been able to be performed when COVID-19 was declared a pandemic by the World Health Organisation, but may now be impossible due to government restrictions on travel or shipping. Some clauses set out further steps an affected party must take (which might include regular reporting to the other party).

Whether a failure to comply with notice provisions or other contractual steps will invalidate a party's right to rely on the clause, will depend on whether the procedure is expressed in permissive or mandatory terms. Where the language is mandatory, the agreement will likely be construed more strictly (although a technical non-compliance will not always invalidate a notice even in these cases).

Preparing for and managing potential force majeure declarations as a result of COVID-19

The application of any particular force majeure provision to this unprecedented and evolving situation is likely to be unclear. Force majeure declarations will be ripe for dispute and those disputes are unlikely to resolved in time for effective operational decision-making.

The priority for resources companies should be to take steps now to protect their position and manage that uncertainty, while retaining open lines of communication and exploiting opportunities for cooperation with counterparties.

Strategies for affected parties

Parties at risk of non-performance need to promptly identify if it is reasonably arguable that their non-performance is excused by an force majeure and, if so, strictly comply with any notice provisions within required timelines to protect their position.

They also need to implement scalable strategies within business operations to establish and document the causal link between events of force majeure and the delay or non-performance ('scalable' because the effort justified will differ between volume force majeure notices on low value procurement contracts, and long-term supply contracts with core customers that represent a significant input or revenue stream). Affected parties should:

Identify sources of information that will assist them to demonstrate the effects of COVID-19 on operations, e.g. notifications and updates from suppliers, shippers or port authorities, GPS equipment and location data, daily and weekly ops reports, human resources records, WHS and medical updates (a 'pre-force majeure' baseline will also be required for comparison);
Establish clear internal reporting lines and systems to continuously collect, update and preserve evidence from different departments or units within the business;
Use information collected to document the effects of the force majeure event and the link between those effects and non-performance (to make reports to the counterparty and preserve the affected party's position in any dispute);
Document mitigation measures (and any measures investigated but not judged feasible) e.g. diversifying the supply chain for materials and consumables, securing alternative port and corresponding rail capacity, procurement of local or on-site accommodation for FIFO workers, automation options, changes to shift and crew numbers and rotations to avoid contact.

Strategies for non-affected parties

Parties in receipt of force majeure notices should implement corresponding systems to test force majeure claims. Parties should review force majeure notices for contractual compliance and promptly reserve their position if a notice may be invalid or does not sufficiently demonstrate the causal link between an alleged force majeure event and the non-performance. They should also make requests for the affected party to provide detailed information regarding:

How the force majeure event has affected its operations; and
Details of the actions taken to prevent or mitigate the effects of the force majeure event;
In addition, they should document the effects of the non-performance. In certain circumstances it might also be appropriate to keep the affected party informed of these effects, to flag potential damages.

Maintaining relationships and exploring alternatives

The steps set out above are not mutually exclusive with taking an open and cooperative approach with a counterparty. A mutually acceptable negotiated solution is almost always preferable to reliance on, or a dispute about, strict contractual rights. That is even more so in response to a pandemic with such far-reaching economic effects.

Parties should try to preserve and promote their commercial relationship with counterparties in a force majeure dynamic. Be cognisant of the effect that strictly worded notices (or responses questioning those notices and requesting information) can have on the reader and keep other communication lines open. If handled carefully the steps required to protect a party's position can also:

Reduce the need to enter into a formal dispute to resolve the position while operational effects are ongoing, instead allowing the parties to keep engaging and performing as best they are willing and able;
Promote open dialogue between the parties about the effects of the COVID-19 pandemic and steps being taken to mitigate them; and
Facilitate agreement or the negotiation of alternative arrangements on commercial terms, which may be a preferable outcome for all parties.