The Texas energy industry is no stranger to turbulent times, as a commodity-driven industry subject to boycotts, cartels, price volatility, sudden political turmoil and other events.
However, after a major shock in oil and gas prices just weeks ago, the industry and related service sectors were suddenly hit by the global COVID-19 pandemic. As a result, contracts in place and long-term supply and demand have been hit by circumstances that may be characterized as “force majeure” events – conditions neither anticipated nor contracted for in many deals.
This rarely invoked principle of force majeure, often imbedded in commercial contracts by way of boilerplate language, excuses a party’s nonperformance due to unforeseen events outside the party’s control. Refineries, pipelines, oil and gas rigs, both onshore and offshore, and all energy and petrochemical production facilities are suddenly subject to suspension or shutdown.
This raises questions: How will these events impact current contracts and customer relationships, and how will the unthinkable onslaught of a global virus be treated when parties negotiate, litigate or arbitrate disputes over these shutdowns?
While the law on these events is yet to be made, a quick review of the law on force majeure and on how parties’ contracts allocate risks will provide some guidance for businesses struggling with these issues.
General considerations for evaluating whether force majeure may apply
Under established law, the doctrine of force majeure, if included in a commercial contract, potentially excuses a party’s failure to perform in circumstances outside the party’s reasonable control that caused the nonperformance. There is no standard legal definition of force majeure, and therefore the scope and application of a force majeure clause depends on the particular terms of the contract in which it is used.
In most jurisdictions, the law assumes that sophisticated contracting parties can allocate risk, accounting for events that may interrupt performance and remedies – including damages – that may result and that may be used to mitigate the risk. This applies even to the most drastic events, such as force majeure circumstances, in which performance is made impossible due to an event outside a party’s control.
Parties may try to mitigate that risk by including force majeure clauses that exculpate an impacted party from a claim of breach for nonperformance, by extending deadlines, allowing alternate performance, removing liquidated damages or penalties or, in extreme cases, providing for termination of the contract. However, the contract language that speaks to this type of event governs the parties’ agreed allocation of risk and, if such a clause exists, either excuses performance, allocates the risk of such an event or possibly remains silent on certain occurrences.
But it will be likely as energy businesses review their contracts in place that few will speak to the havoc wreaked by the COVID-19 pandemic. Many, however, will address severe market price swings or government orders or shutdowns.
Contracting parties may define events of force majeure in whatever manner they prefer. Under most contractual definitions and in accord with the common law defense of impossibility, a force majeure event must be something unexpected and outside the reasonable control of the party invoking the clause. Under Texas law, for example, force majeure is an affirmative defense and so the party invoking a force majeure clause bears the burden of proof to establish that it applies.
Given the wide range of sophisticated commercial contracts utilized in the energy industry, a force majeure clause is more common in the energy sector than in other commercial relationships. The type of event that qualifies may vary – whether it be a labor strike, government order, act of god, natural disaster or even a pandemic or epidemic.
Whatever the language, most clauses have similar characteristics: a list of triggering events and often a catch-all clause, a notice requirement with a set deadline, a remedy specified for the duration of the event and possibly a termination clause.
When a contract has no force majeure clause, an immediate question arises as to whether a party can still claim force majeure to be excused from performance. In Texas, like in many other common law jurisdictions, force majeure rights are implied by law. Force majeure is a creature of contract; therefore, if the contract is silent, a party claiming force majeure must rely on other doctrines, such as impossibility of performance. Each contract will be different, and it is by necessity hard to make too many hard and fast rules about when an event like COVID-19 lets a party cancel, delay or terminate a contract under force majeure.
With respect to the energy industry, Texas courts have held in the past that market downturns do not generally constitute force majeure events, concluding in TEC Olmos, LLC v. ConocoPhillips Co., a Texas Court of Appeals case that states “fluctuations in the oil and gas market are foreseeable as a matter of law.” In addition, some force majeure clauses are drafted to expressly exclude “economic hardship” and “changes in market conditions” as force majeure events.
On the other hand, certain government actions and the destruction of gas production platforms and pipelines by hurricanes have been deemed force majeure events excusing performance. For example, a pipeline was excused from performance because of a change in federal regulatory orders that was deemed an event of “force majeure” in an opinion issued by the Houston Court of Appeals in Atl. Richfield Co. v. ANR Pipeline Co. And events of the last two decades, including storms such as Rita, Ike and Harvey, have led the courts to expand on reasonable grounds to allow parties to assert force majeure. Most of the cases have a common theme: The courts let sophisticated parties allocate risk, potential remedies and even damages for nonperformance as they see fit.
How is COVID-19 unique as an event for the energy industry?
The circumstances presented by the COVID-19 pandemic are undoubtedly unique. While energy contracts contemplate every event from market price shifts to political turmoil to government actions to natural disasters, the notion of a massive shutdown of the energy business from a pandemic is a rarity.
Although force majeure may apply with respect to certain contracts under these circumstances, each contract and force majeure notice should be carefully scrutinized to determine whether (1) the cited event constitutes a force majeure event as defined by the parties in their agreement, and (2) the cited event caused the invoking party’s nonperformance. In short, whether force majeure is a viable defense to contractual nonperformance will heavily depend on the breadth and precise wording of the clause at issue.
- How have the parties enumerated qualifying events of force majeure in the clause at issue? Whether the parties included (or omitted) the terms “pandemic,” “epidemic” or “quarantine” in the laundry list of specified force majeure events does not necessarily end the inquiry. Parties on both sides of the force majeure issue must also consider applicable knock-on effects prompted by COVID-19, which may or may not constitute events of force majeure in their own right under the contract language negotiated by the parties.
- Did the parties include catch-all language to excuse performance based on unforeseen events that are not specifically identified? Even those catch-all clauses are not created equal. For instance, does the catch-all language account for the legal principle of ejusdem generis, by attempting to also include events dissimilar to those specifically enumerated? (Language such as “or any other events or circumstances not within the reasonable control of the party invoking this provision, whether or not similar to any of the foregoing events of force majeure.”) And is the event similar in nature to those that have been enumerated?
- What is the prescribed period, if any, for sending a notice of force majeure under the contract? Many clauses include a relatively short window (such as 10 or 15 days) for providing notice of nonperformance due to a claimed event of force majeure, and failure to timely comply may waive the claim.
- Has the identified force majeure event caused the invoking party’s nonperformance? As set out above, current events will not necessarily trigger every contractual force majeure clause. Even where the circumstances constitute an event of force majeure under a contract, in theory force majeure only excuses nonperformance actually caused by the identified event.
These guiding principles should be considered when making or responding to a force majeure notice in any segment of the energy industry.
Notice and the burdens imposed in asserting force majeure claims
The key to evaluating a force majeure claim lies not only in the parties’ contract but also in the notice provisions and burden of proof required to prove the force majeure event. Whatever the conditions, the party asserting force majeure bears the burden to prove both the factual and legal grounds establishing the event as force majeure in accordance with the contractual terms.
Most standard form contracts, such as those used in construction industry groups, including energy projects, have a 21-day notice provision or similar period for the delayed party to assert an event of force majeure. As a result, this type of notice provision has made its way into many energy contracts, including all segments: upstream, midstream and downstream.
The time for notice and the documentation required varies from one contract to the next. A refinery supply agreement for deliveries of product likely contains provisions different from a construction contract for an offshore rig or a petrochemical plant. While every segment of the energy industry is unique in this regard, there are certain common provisions that must be taken into account in determining how to respond to the COVID-19 crisis.
Across all segments of the energy industry, a contractual force majeure clause will likely include its own notice requirement or key to a notice provision governing the contract as a whole. If a clause is invoked, there are several critical factors that must be considered in evaluating the force majeure notice and its impact: (1) the timeliness of the notice, (2) the adequacy of identification of the force majeure event (pandemic or government shutdown, for example), (3) the supporting evidence of the event, its duration, and its impact on performance of the contract, (4) the remedy sought by the party asserting force majeure and (5) whether the receiving party timely issues its response to the force majeure notice. A failure to meet any of these requirements risks a later finding of waiver under the contract or failure to satisfy the applicable burden of proof, whether with respect to the event, its impact or the remedy sought.
Importantly, each contract will vary and will call for different remedies. For example, the AIA form contract provides only for an extension of time. The plain intention of such a provision is to extend the performance time so that there are no liquidated damages, penalties or cost overruns. And for the party receiving the force majeure notice, there may be a costly loss of time, equipment and even lost revenues and other consequential damages.
That is why the details of a force majeure claim must be set forth in writing – to ensure clear communication of the force majeure event, its duration, its impact on performance under the contract and the remedy sought. In any jurisdiction, it is equally important to evaluate the response and position taken by the party receiving a force majeure notice.
Most courts and arbitral tribunals assume that the parties to a large transaction are sophisticated and capable in their negotiations of appropriately assuming and allocating risk, and thus assume that the parties set the contract terms and pricing on that basis. In short, a party will be held to the contract as agreed.
Through that lens, together with principles of “gap-filling law” that may apply under the Uniform Commercial Code or at common law, a court or tribunal will determine the legal validity of a force majeure claim both on its merits and with consideration to the timely and proper issuance of notices and documentation required by the contract.
Conclusion: Evaluating whether an energy contract is subject to force majeure
Due to the multifaceted, highly nuanced issues raised by potential claims of force majeure, a party faced with managing force majeure clauses across a number of different agreements and agreement types should take immediate steps to ensure a consistent approach, prioritizing value and risk assessments, is in place.
A combination of careful review of the force majeure provisions, damage and remedy provisions and notice provisions is required with respect to any assertion of force majeure and the response to such a claim. The outbreak of COVID-19 and the resulting shutdown of facilities and disruption in the energy industry supply chain is unprecedented. One might assume that the virus outbreak and the resulting federal, state, county and city orders will ultimately excuse all performance for impacted parties to an energy contract.
However, the petroleum, chemicals and electric power sectors are among the essential critical infrastructure allowed to remain open even during government shutdown orders in accordance with the Department of Homeland Security CISA guidelines. These guidelines have become familiar to almost every energy industry in-house counsel and executive since issued weeks ago in March.
While the energy industry continues on in Texas, every business from upstream to downstream is wondering how to deal with the myriad impacts of closures, shutdowns and the national emergency declaration. Key to working through this question will be an evaluation of the contracts in place, the federal and state regulations and negotiation of temporary measures with suppliers and customers to put a stop to the immediate damage caused to all businesses in Texas.
Later, there will likely be two competing lines of thought as energy business shutdowns occur: (1) Whether the existing threat of a pandemic and the resulting government shutdowns caused an event of force majeure, or (2) if the exclusion from government shutdowns should allow contracts to be performed and workers to continue to proceed given those energy sectors named as “critical infrastructure.”
To many, the answer to either question may seem obvious, but the real question will always remain: “Did the parties to the contract expect the unexpected?” These issues will drive the state of the law and decisions on contracts arising from the COVID-19 crisis.
This publication originally appeared in the April 2, 2020 issue of the Texas Lawbook.