During a war crisis, what must you check for in your commercial contracts?

During a war crisis, what must you check for in your commercial contracts?

1. Existing Repercussions

After the Russian invasion of Ukraine on 24 February 2022, international businesses are concerned not only on interruption of the production and supply chain but also on financial and economic sanctions of the international community which is imposing sanctions on Russia and its businesses on an almost daily basis.

For instance, Ukraine exports 10% of the global wheat requirements. It is also the fourth in the world for exporting corn and the invasion disrupts the grain flow from Black sea territory. Also, Russia is undoubtedly the prime supplier of one-third of the gas to the EU countries. These cross-border business relationships are surely beginning to feel the pressure amidst Russia’s invasion of Ukraine. The European Union has heavily sanctioned Russia given the war and expressed their condemnation against such an unwarranted attack on a sovereign nation. Additionally, the European Council of the European Union has pressed several strict measures against Russia in recent times such as transactions with state-owned enterprises being halted, restrictions on credit rating services to Russian entities or individuals, and no new investments in the Russian energy sector, etc. Accordingly, keeping up with the constantly changing economic environment and legal requirements is a challenge that requires a review of all commercial contracts.

Almost every commercial contract contains a force majeure clause, in the event of which the other party may terminate the performance of the contract and its obligations without any legal consequences. In the light of the global events caused by the situation in Ukraine, the question arises as to when this force majeure clause can be applied, because war and financial sanctions are not always considered a force majeure situation and a failure to fulfill contractual obligations can always be justified by this circumstance.

1.1. Could such circumstances have been foreseen at the time of the conclusion of the contract?

Circumstances of force majeure are considered to be extremely unusual and rare situations that could not have been predicted. In a business relationship, such circumstances could be specified as circumstances that did not exist at the time of the conclusion of the contract and their occurrence could not be reasonably foreseen and neither the parties to the contract could control or prevent these circumstances. In the current geopolitical situation, it is necessary to assess the moment when the relevant commercial contract and its obligations were made – whether the sanctions were already planned and war in Ukraine had already started at that time and whether it could have been foreseen.

It is also important to analyze whether the circumstances have made it impossible to fulfill the contractual obligation. This means that the sanctions and war in Ukraine must be directly linked to the inability to fulfill a specific contractual obligation.

1.2. Possible difficulties implementing force majeure clause in commercial contracts

Rarely commercial contracts include specific circumstances which would specify what situation could be treated as force majeure in light of the inability to fulfill contractual obligations of the contract. Even if your contract would include a force majeure clause with a reference to “war” it could be a possibility that another party or a court, according to the current invasion of Ukraine, could be hesitant considered that in the current situation, there has been no declaration of war by Russia and a question could arise as to whether such wording in a contract would be sufficient when the broader word “conflict” could be available.

The imposition of economic sanctions in a contract as a force majeure situation is an even more difficult issue. There are a lot of different sanctions imposed by different institutions and it could be extremely difficult to insert a detailed definition of sanctions that could justify the unfulfillment of contractual obligations. For example, such a clause would require that it would be impossible to perform contractual obligations, but at most times sanctions regime permits an authorization to be obtained from a specific institution to perform the contract, then such clause could not be satisfied.

2. Proactive Solutions

2.1. War Risk Insurance 

Insurance is being valued and reached out, for now, more than ever, the COVID-19 pandemic has been a catastrophic event of the century, disrupting many lives and livelihood. According to reliable sources, the Lithuanian insurance market has seen a rapid growth of 3.4% in the past year due to pandemic fear. As the COVID-19 fear remains fresh, the Russia-Ukraine war has raised new concerns and questions regarding trade risks and legal implications.

Given the sudden economic restrictions due to the Russian Invasion, many legal repercussions can be observed, given breakage of the supply chain, alternative sourcing of gas and coal, lack of wheat supply,  individuals & companies are being affected due to disruption of shipping activities (navigation routes being in war risk zones) and so on. Insurance sure does come in handy in such circumstances. The war risk insurance is the insurance that covers damage, “due to acts of war, including invasion, insurrection, rebellion, and hijacking”. Some policies even extend to cover damages incurred due to weapons and mass destruction. These insurances are specifically used in the shipping and aviation industry where the risk of facing a war crisis is high. War risk insurance comprises two elements. Firstly, the liability that covers individuals and items in the craft, and secondly, the war risk hull which covers the entire craft in itself. The calculation for the liability is based on the indemnity amount and for the hull, it is calculated based on the value of the craft. The wake of this war by Russia along the Back Sea Region helps us understand the importance of war risk insurance.

As far as the commercial contracts are concerned, the parties must bear in mind that even though their region is not directly affected by the war or is not a war risk zone, they might still be subjected to several shipping-related problems. In the case of maritime laws and regulations, it is a general practice that all risks pass on to the buyer once the goods are delivered to the board of the vessel as per FOB (Free on Board) delivery terms. The buyers are also not commonly protected under the Incoterms 2020 CFR or CIF (Cost Insurance and Freight) delivery terms during the war as they only regulate freight and insurance costs. For the buyers to be shielded from the uncertainty of war risks, they should look into the DAP (Delivery At Place) method or “door to door”, in such terms the buyers are protected even through war risks.

2.2. Checklist of requirements

There are certain clauses that one must pay attention to specifically during the wartime crisis,  Firstly, being the “Force Majeure clause”, if this clause for instance covers for war risks and damages that may arise out of the war risks and the rights reserved for the parties to exercise during war crisis or tension. The contract should be structured with clauses to address such risks in carefully drafted termination provisions as well as a clear arbitration clause defining a convenient arbitration seat and choice of law. Such decisions can be decisive to avoid rerouting of the dispute, under certain circumstances – to the local courts of one of the parties. Secondly, under the contract of insurance, it must be specifically stated that the goods subjected to be carried are protected under the war risks along with the P&I Hull and Machinery Insurance for the vessel (if it pertains to shipping matters). Thirdly, it is vital that in the present-day war crisis, parties make a mention of the Lloyd’s Market Insurance Contracts (LMA), an association of underwriters declared on 15 February 2022 that the “Ukrainian and Russian waters in the Black Sea and the Sea of Azov are added to the Hull War, Piracy, Terrorism, and Related Peril Areas.” Finally,  the parties must also check if the war risk insurance covers extensively the war risk zone as well as the damages and consequences of the war actions. Hence, parties must check for these clauses and indicate them while drafting their commercial contracts or contracts with their insurance company.

Published by “Glimstedt” Associate Pooja Damodaran.

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