Ukraine - Impact of Russian invasion and sanctions on English law contracts: frustration, illegality, force majeure & MAC
22 March 2022
I. Does the contract include an illegality / force majeure / material adverse change clause and, if so, has it been triggered?
This is a question of interpretation so the usual rules apply: a close analysis of the relevant events and the language of the clause will be needed. Specifically:
What, exactly, is the relevant event?
The event may be a legal one (eg whether payment would be a criminal offence) or a factual one (supplies cannot get through, there is no electricity, the factory has been shelled).
Is the event within the scope of the clause, either expressly or by implication?
- Most force majeure clauses contain a list of events which will constitute force majeure. An illegality clause may specify the laws under which performance must have become illegal. Material adverse change clauses often do not list out what is in scope, relying instead on the general meaning of the words. Work out whether the event being relied upon as the basis for invoking the clause is caught.
- Where there are lists of events, you can get into arguments about whether the event you are relying on needs to be of the same type.
- It may be more difficult to show that an event is force majeure or that a change is material if it was foreseeable.
Has the event affected the ability to perform in the way required by the clause?
- Most force majeure clauses require a party to show that, as a result of the event, performance has become physically or legally impossible, and not just more difficult or unprofitable. This is a high bar. A change in the market conditions that renders performance more expensive is not likely to be a force majeure event where impossibility is required. For a MAC clause, you will want to focus on the specific and not the general; “material” is also a high bar and the event will need to be on a more than temporary basis. Similarly, to rely on an illegality clause, it may be necessary to show the illegality makes performance impossible.
- Some clauses may have lesser requirements (eg that performance has become “impracticable” or been “hindered”).
- The devil will be in the detail. In some cases the position will be clear but in others it may be difficult to say whether the event has had the effect on the ability to perform that is required by the clause.
What are the mechanics for invoking the clause and what are the consequences of doing so?
- A failure to follow the mechanics for invoking a clause—for example by not complying strictly with notice requirements—could prevent reliance on it.
- Understanding the consequences of triggering the clause is also key. Does it allow you to terminate the contract or suspend obligations? Does it explain how the relationship is unwound (if indeed it is)? Are these consequences consistent with public policy (see the discussion on frustration below)?
- Insured parties may find their insurers requesting that they invoke certain clauses if that would result in any loss being mitigated.
Is it lawful to invoke the clause?
- In some cases, the steps involved in invoking a clause, or the consequences that flow from doing so, may themselves amount to a breach of sanctions. For example, if the effect of invoking the clause is to “alter” funds or economic resources owned, held or controlled by a sanctioned counterparty.
- As always, before taking any step in relation to a contract where sanctions may be in play, it is critical that you stop and check whether taking the step is lawful under all applicable laws.
II. Has my agreement been frustrated?
Before taking a decision on whether to invoke express provisions of an agreement, it is important to consider whether your agreement may have been frustrated.
Has performance become impossible or radically different?
- A contract may be frustrated when something occurs, after the contract was entered into, which makes it physically or legally impossible to perform or which means it can only be performed in a way that is radically different from what was agreed.
- If performance under an English law agreement has become illegal under English law—in other words, if performance has clearly been prohibited or would be criminal—the contract may be frustrated.
- This will be a question of careful interpretation of the law giving rise to the alleged illegality and the contractual provision with the potentially problematic obligation to perform.
- Relevant factors to this assessment include: the existence of a licensing regime, the availability of a licence, the permanence of the illegality, whether the illegality pervades the entire contract etc.
- The fact that performance has become illegal under laws other than English law will in most circumstances not be sufficient, save in some cases where performance has become illegal under the law of the place where the contract is required to be performed.
- It is possible that the disruption caused by the invasion and legislative response may cause a contract to be frustrated even where performance has not become illegal. The threshold for establishing frustration is high, however. It will not be sufficient that performance has been hindered or has become more costly or inconvenient.
Does your agreement deal with the consequences of the event such that frustration may not arise?
- If your contract contains a clause that deals fully and completely with the event that would otherwise frustrate the contract, this generally means that your agreement cannot be frustrated.
- Given the prevalence of force majeure clauses in commercial contracts in many markets, this normally means that frustration is rarely invoked.
- Importantly in this context, however, an express provision will not exclude frustration for illegality where this would be against public policy.
What are the consequences of frustration?
- Frustration brings the contract to an end, automatically, and discharges the parties from further liability under it.
- A statutory regime—the Law Reform (Frustrated Contracts) Act 1943—deals with what happens following frustration. Broadly, sums paid prior to the contract being discharged will be recoverable unless the obligations in question have been wholly performed by the time of discharge. Sums subsequently payable cease to be payable (subject to certain provisos).
III. Do you benefit from statutory protection?
The UK legislation—the Sanctions and Anti-Money Laundering Act 2018— provides that where someone does (or does not do) something “in the reasonable belief that it is in compliance with” UK sanctions, that person “is not liable to any civil proceedings” to which that person would otherwise have been liable for doing or not doing that thing (section 44).
This provision is not an easy read, but it is similar to so-called “no claims” and/or “no liability” provisions that you find in EU and UN sanctions. In the words of the UK Government’s explanatory notes, “It aims to protect people from any adverse results generated by compliance (for example, a breach of a contract to supply goods that are prohibited from export by sanctions).”
In practice this provision is likely to offer significant protection against liability for non-performance (even if it turns out, for example, a contract was not frustrated due to illegality).