- The effects of the COVID-19 pandemic on the oil market have been remarkable. It was estimated that oil consumption might fall by more than 30 million barrels per day in April – a figure which equates to around a third of the daily oil consumption. That estimate has proved to be about right. On 20 April, West Texas Intermediate, the US oil price benchmark, temporarily fell below $0, heralding the novelty of a negative price for the sale of goods whereby sellers would in effect have to pay buyers to receive the goods.
- The drop in consumer demand has caused refineries to reduce their processing operations. In turn, storage tanks into which arriving tankers would ordinarily discharge their cargoes lack capacity to receive them. It was reported that, as of 27 April, nearly 90% of the global volume of crude oil storage was full and that the rest could fill up in as few as three weeks. Market participants seeking to deliver/receive cargoes have encountered severe delays.
- Force majeure notices have been tendered under contracts for sale and purchase in large numbers. This bulletin seeks to outline legal issues relating to the topic of frustration and force majeure.
The test for frustration and its applicability
- The common law doctrine of frustration applies to all contracts governed by English law, but only to the extent the contract does not make provision for the particular event, usually in a force majeure or exceptions clause. Some contracts seek nevertheless to preserve the application of the doctrine. Taking as an example the widely used BP General Terms & Conditions 2015 these state that the doctrine of frustration is not excluded or limited by its express provisions relating to force majeure. Whether such a provision will be effective to preserve the application of the doctrine of frustration might be questioned.
- The classic statement of the test remains that of Lord Reid in Davis Contractors v Fareham. Frustration occurs when, without default of either party, a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. In that case, the parties will forthwith, automatically and without more be discharged from any further obligation to perform.
- The doctrine is widely viewed as imposing a high threshold, which is no doubt correct. It is nevertheless possible to invoke the doctrine when goods simply cannot be discharged at the nominated port of delivery. Such an argument was, for instance, raised by a charterer at the time of the 2009 economic crisis in defence of a claim for non-performance of a contract for the carriage of iron ore. As the steel plant was no longer processing ore, it was alleged that the (specially reinforced) storage yards at the nominated discharge ports were full and that it was simply impossible to discharge the ore ashore anywhere else.
- Where contracts for sale and purchase of crude oil are on FOB terms – whereby the seller’s obligation to deliver will be fulfilled once the cargo is pumped onboard a vessel at the port of loading – such arguments will not arise in quite the same way. In such instances, the goods can be delivered by the seller; it will then be for the buyer to discharge the cargo at a place of its choosing. But if global storage facilities are in fact exhausted – or to such an extent that performance of the contract becomes radically different from the perspective of the buyer – it is conceivable that the doctrine of frustration may be invoked. It might also apply where the terms of sale are not FOB, but ex ship at the agreed discharge terminal, depending of course on the relevant terms and the other facts that are present.
The test for force majeure and its applicability
- Unlike the doctrine of frustration, the concept of force majeure does not apply by operation of law, but instead depends on the terms of the contract. The terms of force majeure clauses vary, and any such clause must be construed carefully, in accordance with its terms. Invocation of force majeure will produce the result prescribed by the clause, which may not be full discharge but can instead be a temporary suspension.
- To invoke a force majeure clause, the party relying on it must prove the facts bringing the case within the clause. Depending on the wording, it must therefore prove that it was prevented, hindered or delayed, as the case may be, from performing the contact by reason of that event. It must usually also prove that its non-performance was due to circumstances beyond its control; and that there were no reasonable steps that it could have taken to mitigate the event or its consequences.
- One issue which has recently come under judicial scrutiny is whether force majeure clauses require the invoking party to prove that, but for the event relied on as having caused its failure to perform, it could and would have performed the contract. Although parties are free to draft a force majeure clause that does not require this, proof of such causation may be required. This might be thought to be fair enough: why should a defaulting party be released from liability because an event occurred that would have prevented performance when in fact he was never going to perform anyway? But in some cases it may seem harsh that a party is liable in damages for not doing that which was in any event impossible for reasons beyond his control.
- To give an example of a typical clause, the BP General Terms and Conditions provide that “[n]either the Seller nor the Buyer shall be liable for a failure to perform any of its obligations under the Agreement insofar as that party proves that the failure was due to an impediment beyond its control”. Various examples of an “impediment” are then given, although it is expressly stated that the enumeration is not to be treated as exhaustive. Pandemic is not expressly referred to. The clause goes on to state that, in case of an impediment which renders performance of the delivery obligations impossible, the party relying on the clause shall be discharged of those obligations. Where, however, the impediment merely delays performance of the delivery obligations, the delivery obligations shall be postponed – but only until the laydays should expire, whereupon a right of cancellation will arise.
- Variations of this clause have recently been insisted upon. It is understood that one such version makes it clear that COVID-19 is indeed an impediment, and also provides for a right of cancellation after a 30 day suspension period, whether or not the effect of the pandemic on the obligations was foreseeable. The need for variations suggests some uncertainty as to the effect of the standard form contract. It may, for instance, be in dispute whether performance was truly impossible for the purpose of the clause, or else only delayed.
- Care must be taken to ensure that any head and sub contracts are on back-to-back terms, or else there is the risk of a supply contract on BP terms being terminable without recourse, without an equivalent right arising under an on-sale contract, leaving the middleman with an exposure to damages for non-performance.
- There are extensive challenges facing the oil trading sector which are likely to give rise to substantial litigation. The sheer number of FM notices that have been tendered suggests that there will be litigation upon their efficacy. This bulletin has sought to address only some of the issues likely to arise.
Richard Southern QC
The contents of this bulletin, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
 According to Rystad Energy, a research firm, as reported on www.businessinsider.com
 See Cl. 65.5.
  AC 696 at 729
 Classic Maritime Inc v Lion Diversified Holdings  1 Lloyd’s Rep. 59. See  ff. The argument was raised on a summary judgment application, and was allowed to proceed to trial. No trial of the issue subsequently took place.
 Depending on the situation, it may be necessary to examine whether the cargo could not be delivered without the incurring of such delay as would frustrate the commercial object of the contract; the duration of frustrating delay is notoriously difficult to judge.
 See e.g. Hoecheong Products Co Ltd v Cargill Hong Kong Ltd  1 WLR 404 at 409; Mamidoil-Jetoil Greek Petroleum Co SA v Okta Crude Oil Refinery AD (No. 2)  2 Lloyd’s Rep 635 at 
 Classic Maritime Inc v Limbungan  1 Lloyd’s Rep. 349;  1 Lloyd’s Rep 178 (CA)
 See Clause 65.1 ff. Shell International Trading and Shipping Company Limited GT&Cs are in similar terms.