Contracting in the context of the new geopolitical landscape

These geopolitical developments present challenges for commercial parties, who are, in principle, obliged to comply with the contracts they have made. To avoid being exposed to unexpected risks or burdens, parties must anticipate geopolitical changes when entering into contracts.

The interests of the parties will vary. For example, a buyer might seek to avoid any changes to the purchase price, terms, or obligations under a purchase agreement as a result of increased import or export tariffs. On the other hand, a seller might want to avoid being required to fulfil its original obligations if circumstances change significantly.

One of the ways parties can adapt to uncertain environments is by including specific provisions in their contracts. Such contractual clauses may include force majeure, hardship, termination and price adjustment provisions, Incoterms, and clauses on alternative dispute resolution.

Force majeure

Force majeure clauses remove liability for unforeseeable and unavoidable events that prevent parties from fulfilling their contractual obligations. These clauses typically cover natural disasters and human-made catastrophes and usually permit non-performance, withdrawal, or termination of contracts.

The interpretation, limitations, and impact of force majeure contractual clauses vary depending on the applicable law and the specific wording of the provision. Force majeure provisions typically apply only to unforeseeable events, and so may not cover challenges which are generally now seen as foreseeable, like the current trade war. There is a required causal link between the force majeure event and the fulfilment of the contract. Many systems and provisions require the event to be a significant obstacle, sometimes interpreted as "impossibility", but the exact threshold depends on the applicable law and the wording of the clause.  For example, export bans and other government actions that make performance impossible could qualify as force majeure events, while increased challenges like higher tariffs, may not meet the necessary threshold of impossibility.

Hardship

Hardship provisions can be used when circumstances change, and are intended to cover cases where unforeseen events fundamentally change the balance of a contract, with an excessive burden being placed on one of the parties. Generally, these clauses require the parties to negotiate in good faith to reach a reasonable amendment to the contract. If the parties cannot agree, a third party, such as an arbitrator, is often appointed to resolve the issue.

Unless explicitly agreed on, the right to renegotiate is not the right to unilaterally change or terminate the contract. Parties may also agree in advance on the consequences of hardship by requiring price reductions or partial release from obligations.

It is important to note that, even if there is no hardship provision in the contract, in some legal systems an obligation to renegotiate may arise from general principles of reasonableness and fairness or good faith, like in the Netherlands and Italy.

Termination provisions

Since geopolitical changes may lead a party to want to terminate the contract, it is often wise to specify in a termination clause the specific circumstances under which termination is allowed. For example, the imposition of certain tariffs could be expressly included as a condition allowing termination (force majeure events and hardship situations may also be listed among the circumstances). It could be  specified that such situations must go on for a certain period of time before termination is allowed.

Price adjustment

Parties have various options to reduce the risk of unexpected price increases by allocating or sharing the risk of price fluctuations. A common approach is to include price adjustment provisions in their contracts.

Examples of price adjustment provisions include: cost-based adjustment provisions, where the price is adjusted in line with changes in the cost of raw materials, labour, and similar factors; index-based adjustment clauses, which allow price adjustments in accordance with an economic index to reflect economic trends; and time-based provisions, which provide for price adjustments at specified time intervals.

Incoterms

In contracts concerning the delivery of goods, parties could include Incoterms rules, which are a set of eleven internationally recognised standards published by the International Chamber of Commerce (ICC). These rules are designed to minimise misunderstandings by clearly defining the responsibilities, costs, and risks associated with the transportation of goods.

Incoterms specify which party is responsible for arranging and paying for transport, which party bears the risk of loss or damage during transport, which party must provide insurance, and which party is responsible for handling import and export formalities. In times of geopolitical change, parties can strategically use Incoterms to allocate according to their needs in response to threats, such as increased tariffs. For example, by opting for Ex Works (EXW) instead of Delivered Duty Paid (DDP), a seller can avoid exposure to unpredictable export and import duties and tariffs.

Alternative dispute resolution

Geopolitical changes can increase the risk of disputes between parties, such as disagreements over the use of force majeure or hardship provisions. In some cases, it may be beneficial to include contractual clauses for alternative dispute resolution methods, such as mediation or arbitration. Various factors (e.g. cost, enforceability, and speed) can make alternative dispute resolution more advantageous than litigation. Whether alternative dispute resolution is preferable, however, depends on the specific circumstances and the relevant jurisdiction.

Key takeaway

Parties should clearly define which situations are covered and not covered by the relevant contract clause. This might involve specifying the events that fall under the provision, and establishing a causal link between these events and any resulting non-performance. However, it’s important to strike a balance, as defining the provision too narrowly could limit its usefulness in unforeseen circumstances. Additionally, the contract should detail when and how notice should be given to invoke the clause and outline the obligations of the invoking party to mitigate the effects of the event.

Several international instruments have been developed to promote uniformity and simplicity. These international instruments can also be used as tools by parties when drafting contracts to anticipate uncertainties and unpredictability arising from geopolitical changes.

Examples of these international instruments include the clauses of the ICC, the UNIDROIT Principles of International Commercial Contracts 2016 (PICC), the Principles of European Contract Law (PECL), and the United Nations Convention on Contracts for the International Sale of Goods (CISG). These instruments offer comprehensive frameworks and model provisions, addressing issues such as force majeure and hardship. Parties may be inspired by the drafting in these instruments. They can also supplement their contracts by stipulating that the contract is governed by these frameworks.

The ICC has drafted, among others, force majeure and hardship clauses. These clauses can be directly included in the contract, incorporated by reference or serve as a basis for drafting tailor-made provisions.

The PICC and PECL also contain clauses on force majeure and hardship. For these to apply, the parties must have agreed that the contract is governed by the PICC or PECL. They may also apply if parties have agreed that their contract is governed by 'general principles of law, lex mercatoria, or the like', or when parties have not chosen any applicable law. The PICC can also be used to interpret or supplement international and domestic law.

The CISG contains a force majeure provision as well.  As the CISG does not have a specific provision dealing with hardship, whether the CISG also covers hardship is debatable. Hardship may, in certain circumstances, be inferred from Article 79 CISG, although this interpretation is not recognised in all jurisdictions. The CISG governs cross-border sales contracts of goods when the parties are domiciled in states that are party to the CISG or when the rules of private international law lead to the application of the law of a state party to the CISG, unless the applicability of the CISG has been excluded.

Applicable law

Domestic law can also supplement contracts and assist parties to anticipate uncertainties arising from geopolitical changes.

As every jurisdiction has its own set of laws and may have different and sometimes mandatory rules for cases of force majeure and hardship, it is important to carefully consider which domestic law should be applied to a contract. The best choice of domestic law depends on the specific needs of the parties.

For example, in the Netherlands, Article 6:258 of the Dutch Civil Code (DCC), which constitutes mandatory law, states that, at the request of one of the parties, the court may modify the consequences of a contract or dissolve it in whole or in part on the grounds of unforeseen circumstances of such a nature that, according to standards of reasonableness and fairness, the other party cannot be expected to maintain the contract unchanged. Such modification or dissolution may even be given retroactive effect. In principle, it is not possible to exclude the application of this legal provision.

In recent years, Article 6:258 DCC has frequently been used in connection with the COVID-19 pandemic. One example is retail business owners who had to close their business due to COVID-19 restrictions have invoked this article to seek relief from paying full rent. In this regard the Dutch Supreme Court has ruled that the COVID-19 pandemic can, in principle, be considered an unforeseen circumstance for rental agreements concluded before 15 March 2020, unless there are specific indications to the contrary. Parties may want to take such national developments into account when choosing the applicable law in their contracts.

Similarly, Article 1467 of the Italian Civil Code states that, at the request of one of the parties, the court may terminate the contract in the event of changed circumstances (e.g. an excessive burden arising). In general, the Italian perspective is that contracts must always be interpreted in good faith. The parties may choose to refer the determination of the subject matter of the contract to a third party. In this case, if the third party's decision is clearly unfair or incorrect, the determination can be requested from the court.

The evolving geopolitical landscape requires parties to carefully consider and address potential uncertainties when drafting contracts. By incorporating tailored contractual provisions (i.e. force majeure, hardship, termination, price adjustment, and alternative dispute resolution provisions and Incoterms) parties can better manage the risks posed by unforeseen events. Inspiration can be drawn from international instruments, like those discussed in this article. It is essential to determine which national law will govern, especially considering potentially overriding mandatory rules, changes in jurisdiction, and the flexibility found in national case law.