Understanding Force Majeure Clauses of Contracts
The
term “force majeure” literally means "greater force". It is a term
often found in contracts. Generally it allows one or both parties to a
contract to walk away from their contractual duties should a force
beyond their control occur that makes them unable to perform their
duties as required under the contract.
I
have heard of a number of first hand accounts of companies that were
affected by force majeure in contracts or that used the clause to
renegotiate the terms of a contract.
In
one case I know of a mid-sized company was operating services for small
and mid-sized municipalities around the United States. The company was
in a contract written by the municipality that fixed the rate the
municipality would pay the company for every gallon of diesel the company had to buy to operate vehicles used in the service of the contract. When the
contract was written, the price of diesel fuel had been stable for
several years.
About
a year into the 5 year contract diesel prices spiked to a level such
that the company could not operate the contract profitably. The city
refused to renegotiate the amount it reimbursed the company for fuel. The
company had no alternative than to send a letter to the city
advising them that it was no longer going to be able to service the
contract. In its letter to the city the company invoked the force
majeure provisions of the contract as the reason for termination. The
city sued the company for breach of contract and a court held that the
dramatic increase in the cost of fuel to the company was a justifiable reason for the company to invoke the force majeure provisions of the contract.
Courts
across the country have interpreted force majure differently but in
general when an act of God, war, or the failure of third parties--such
as suppliers and subcontractors--to perform their obligations to the
contracting party, force majeure can be invoked.
Another
example I recently heard about took place after Hurricane Katrina
devastated New Orleans. I suspect many companies that were based in New
Orleans or that were directly affected by the storm were able to use
force majeure as a valid reason for not being able to fulfill contracts.
The case I learned about was slightly more indirectly related to the hurricane
that displaced millions of people along the Mississippi, Louisiana, and
Alabama gulf coast.
Many
displaced residents fled to neighboring states with nothing but the
clothes on their back. The Federal Emergency and Management Agency
(FEMA) began buying mattresses and bedding in huge quantities to provide to displaced people. Most modern mattresses are made of high density
foam. The sudden and unexpected demand for mattress foam made it nearly
impossible for foam suppliers to keep up with their orders from mattress
manufacturers. Foam manufacturers raised their prices as much as 80%
during the shortage and claimed the force majeure provisions of their
contracts as the reason for the huge increase. I am not aware of any
litigation that arose out of this event, but it caused mattress
manufacturers great grief at a time they were operating their plants 24
hours a day to produce products to provide to FEMA.
The
most important thing that a business owner should remember about force
majeure is that it is not just a boilerplate provision in a contract.
It
is very real and often invoked in difficult times. For that reason
business owners should make sure that any force majeure provisions be
bilateral and that any third party (downstream) contracts also have a
force majeure provision. So in the case of the mattress manufacturers
that I referenced above, they should have (and probably did) make sure
that they had provisions in their contract that allowed for the passing
on of additional costs or missed delivery dates if circumstances and
forces beyond their control forced them to.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
His direct email address is sam@lesliethacker.com
Twitter: @SMBFinance
