China's unofficial trade ban on Australian commodities: Does your supply contract provide relief if you can no longer perform?

By Tristan Appleby, Adam Rose, Stuart MacGregor, Samy Mansour and Brett Cohen
23 Dec 2020
As a result of China's official and unofficial trade restrictions, miners, suppliers, commodities trading houses, customers and end users should be checking what contractual protections they may be able to rely on (or may be invoked by counter-parties) and what steps can be taken to mitigate against these risks in negotiating new sale and purchase agreements in a challenging trading environment.

It has been reported that the Chinese Government has issued both official and unofficial directions to private Chinese companies and state-owned enterprises to cease imports of an expanding range of Australian export commodities including thermal and coking coal, copper ore and concentrate, and for port and import control authorities to refuse authority to enter or discharge Australian cargoes.

At the time of writing, more than 60 ships carrying Australian thermal and coking coal have been left waiting off China's coastline to unload cargo for extended periods, with approximately 80% of those vessels waiting four weeks or longer. Chinese customers are also reportedly paying steep premiums for replacement imports from other countries amidst a slump in global coal prices. Together with other disruptive events that have occurred throughout the year (including the Australian bushfires, floods and COVID-19), these trade tensions have brought force majeure clauses and other protections to the fore as businesses consider whether their customers, or they themselves, can continue to comply with their contractual obligations.

For parties now unable to effectively perform their contractual obligations, or who face the uncertainty of Chinese buyers seeking to suspend, delay or cancel cargoes (or, in some cases, terminate supply arrangements altogether), the question is whether an unofficial ban or "clearance restriction", as opposed to legislation, regulation or formal trade restriction such as sanctions enacted by the Chinese Government, have the force of law, and whether compliance with an unofficial direction means a party is "prevented" from performing their obligations.

Force majeure – what to look out for when seeking relief

Force majeure clauses provide temporary relief to a party from performing its contractual obligations where a supervening event has prevented or delayed performance. While the ability for a party to rely on a force majeure provision depends on the terms of the relevant contract, parties should consider the following:

  • Is it force majeure?: Does the relevant event constitute a "force majeure" as defined in the contract? This can range from a list of specified events, through to more generic references to "acts of God", but typically relates to events that are beyond a party's reasonable control. There is generally a distinction between situations which prevent the performance of a party's contractual obligations and those which merely make performance commercially unappealing. Force majeure will ordinarily not arise for the latter (and, as such, you should consider whether an unofficial government direction is sufficient to trigger the clause in your contract).
  • Notices: If the event is "force majeure", the party seeking relief should ensure that it complies with the terms of the contract. Typically, force majeure provisions require notice to be given specifying (to the extent practicable) details of the relevant event, the extent to which relevant obligations are affected and, potentially, the anticipated length of delay that will arise from it.
  • Mitigation: The party affected by the force majeure event is usually expressly required to use its reasonable endeavours to mitigate the effect of that event on its ability to continue to perform its obligations under the agreement.
  • Relief and termination: Relief is typically only available for the duration of the actual delay arising out of the event of the force majeure, with termination rights able to be invoked where a force majeure event subsists for an "extended" period of time (that time period being dependant on the circumstances relevant to the contract).

If your force majeure clause doesn't cover you, what else might you be able to rely on?

Other contractual protections may apply where performance has been impacted by external circumstances. These include:

  • Terms of trade: If performance of the contract has commenced but has been delayed as a consequence of trade restrictions (eg. a carrier vessel has arrived in Chinese waters, but has not been permitted to discharge its cargo), it is relevant to consider the terms of trade the parties have agreed upon. These commonly deal with passage of title to and risk in the goods (eg. who bears the cost if a perishable, evaporating or unstable material or product, such as an agricultural product, liquids, condensates, or certain chemical products, mineral ores or concentrates such as spodumene, diminishes in quality or quantity because of delays during shipping), import clearances and transport costs (eg. who pays for increased tariffs, customs duties or demurrage). In an Australian mining context, coal and mineral products are mostly bought and sold on INCOTERMS® Free on Board (FOB) or Cost and Freight (CFR), or terms based thereon. In each case, the buyer bears the risk of the goods once loaded onto the vessel at the port of shipment and is responsible for import clearances, but if CFR is used (which is more common for Chinese buyers) the seller is responsible for arranging the contract of carriage at its own cost, so bears the risk of increased shipping costs.
  • Change in law: Unlike force majeure clauses (which excuse delayed or non-performance of a contract), a change in law clause allows for a price adjustment (plus or minus) where the cost of a supplier's performance is increased or decreased as a consequence of a change in law, regulation or sometimes the conditions attaching to a government approval. As an example, the various emissions trading and carbon pricing mechanisms proposed, passed and repealed in Australia over the last decade have (understandably) made change in law clauses a standard feature of most corporate power purchase agreements. A change in law clause may also provide that if a party is prevented from performing its contractual obligations because of a change in law, the parties must negotiate changes to the contract. As with force majeure, whether an unofficial policy change or a direction given to a Chinese purchaser of Australian commodities constitutes a "change in law" and what relief is available to a party affected by a change in law will turn on the drafting of the agreement.
  • Frustration: At its most extreme, parties may argue that the contract is frustrated altogether – that is, that without the fault of a party, the contract is incapable of being performed due to an unforeseen event (or events), resulting in the obligations under the contract being radically different from those contemplated by the parties.

Establishing frustration, however, can be difficult as it does not apply to hardship. The fact that the method for performance contemplated by a contract has been affected, or the burden of performance has been increased, by an event or events occurring without fault, does not amount to frustration unless performance in accordance with the contract has become practically impossible. The doctrine of frustration is also applied within very narrow limits. For a party to succeed in claiming frustration, they must show that the parties never agreed to be bound in the fundamentally different situation that has unexpectedly emerged.

What to consider when negotiating contractual protections

In industries that are significantly exposed to natural disasters – for example, resources and transport– the use of force majeure and contractual protections is an important risk mitigation measure. The current trade restrictions introduced by China provide an opportunity for parties to consider what they will, and will not include, in provisions they are currently negotiating, such as:

  • Force majeure: Parties should consider whether the list of force majeure events should be inclusive or exhaustive and – just as importantly – they should consider whether they will make clear when a force majeure event will not apply. For example, typically contracts specify that:
    • no force majeure event will discharge a party from an obligation to pay money (a point to note regarding the payment of money is that it is common, where there are formal State sanctions against a party, that a sanctioned party cannot open or keep a bank account in sanctioned jurisdictions or the relevant currency of the sanctioning country so there may be some events of force majeure that do affect the obligation to pay money); and
    • general economic or trading conditions, and failures to obtain access or accreditation rights, do not constitute force majeure events.

    Another variation of this is to make clear that an event such as a failure of a supplier's equipment or failure to maintain equipment in accordance with best practice will not of itself constitute a force majeure event.

  • Notices: Given it may not always be practical to specify the length of delay caused by a force majeure event at the time the notice is delivered, parties should consider an obligation on the affected party to provide periodic supplemental notices for the duration of the force majeure. Another matter to consider is whether the force majeure notice should specify the extent to which the relevant event is covered by insurance.
  • Mitigation: If express mitigation obligations are included, parties should consider the extent of these. Another matter to consider is whether an obligation on the parties to meet and endeavour to reach agreement as to how to best minimise the impact of a force majeure event is appropriate.
  • Supply interruptions: If the contract involves an obligation for supply of a critical product, consider including mechanisms that require the supplier to treat the customer equitably with other customers if supply of the relevant commodity will be curtailed in a force majeure scenario (eg. a requirement that the supplier supply the commodity that is available pro rata amongst customers with firm supply rights). Without such protections, the supplier in a force majeure situation that can supply some product will always be motivated to supply what is available to customers under contracts with the highest price.
  • Terms of trade: Specific terms addressing title to goods, import clearances and transport costs are an important mechanism to deal with external events occurring during shipment. These will vary depending on the contractual relationship between the parties and the estimated risks and costs associated with delivery.
  • Change in law: Parties should carefully consider whether to provide relief for changes in law and, if so, the scope of the relief and definition of a "change in law", and whether it appropriately addresses all circumstances that parties may wish for the contract to be flexibly adapted to.
  • Termination: In the event of a prolonged force majeure event, in addition to termination rights, parties should consider if express re-negotiation rights should be triggered and whether the supplier should have an obligation to assist a customer with obtaining alternative supply.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.