Recently the European Commission has raised concerns regarding the continued dry conditions in south-western Europe. It is reported that the drought might lead to a reduction of the yield potential in the key growing regions in Europe – in particular, Romania, Italy and Hungary. In the circumstances where Ukrainian export experiences unprecedented challenges due to the blockade of the seaports by Russia, the bad weather conditions in Europe might have a significant effect on importers of grain and the performance of their contracts.
The previous experience in such situations shows that bad weather conditions might cause a shortage of goods on the market and lead to a cascade of defaults under forward contracts. No doubt, the defaulting companies will rely on the force majeure clause in their contracts to be released from liability. In these circumstances, it is advisable for the traders to analyze potential risks arising from the drought in Europe and in advance develop legal safeguards to minimize them.
To help you with this matter, AGA Partners will share their recent experience in commodities arbitration involving a largely similar background – the drought in Romania in 2020. In this article, we will elaborate on the legal consequences of the drought and present specific tips which might help traders to indemnify the risks arising from this situation.
Drought in Romania: Back to the Future
The current dry weather is no longer a big surprise for European farmers. In 2018-2020, certain growing regions in Europe also experienced soaring temperatures and intense drought. In particular, the moisture-deficient soil reserve was observed in eastern Romania.
Despite these unfavourable conditions, a Romanian grain trader decided to conclude a forward contract on the sale of a large parcel of ‘Romanian origin corn’ to its partner in Turkey. In July 2020, the parties agreed on the shipment of the goods in September 2020 on a CIF Marmara basis. It is important that the GAFTA force majeure clause was incorporated into their contract.
To perform the agreement with its Turkish customer, the seller contracted the goods from its regular suppliers in the eastern part of Romania. However, in August 2020, farmers in this region faced hot and dry weather which led to a significant reduction in the yield. The reduced amount of the harvested crop naturally triggered a spike in the prices for Romanian corn which prompted the seller’s suppliers to sell the goods to companies paying a higher price for them. As a result, the seller could not procure the necessary amount of corn from its regular suppliers.
For this reason, the seller approached its client with the request to cancel the contract due to unfavourable weather conditions. The buyer, however, was inexorable – he urged the seller to stick to his obligations and procure the goods, despite the price increase. Nevertheless, the seller failed to do so and did not supply even a pound of corn as agreed.
There was nothing left for the Turkish buyer but to declare the Romanian seller in default and initiate arbitration to recover the losses incurred due to the increase in the price of the goods.
Fierce Battle in Arbitration
In arbitration, the seller took the position that the drought in Romania constituted a force majeure which released him from liability for the non-delivery of the goods.
In support of this position, the seller’s counsel submitted the reports of the commissions allegedly appointed by the government. These documents fixed that certain lands in eastern Romania and crops grown on them were damaged by the drought, either totally or partially. In the seller’s view, the reports represented undeniable evidence of force majeure (he even called these reports ‘force majeure certificates’).
Having received the seller’s defence, we have started to vigorously dispute that the seller could be excused from liability because of the drought in Romania. Our position was straightforward: there was no force majeure at all, the seller just refused to procure the goods because of the high acquisition prices. In addition, we argued that the seller was not protected by the force majeure clause as it failed to send a formal notice about the drought to the buyer.
After numerous rounds of the parties’ submissions, the tribunal proceeded to the preparation of the award.
Tribunal’s verdict
In a few months, the tribunal rendered an award which provided a detailed interpretation of the GAFTA force majeure clause. While the award, of course, is not binding for further disputes, it vividly illustrates the possible legal consequences of the drought and thus might serve as a lodestar for the current circumstances.
High Threshold for Force Majeure
From the outset, the arbitrators noted two fundamental rules of English law on force majeure which laid the basis of their award.
First, the tribunal emphasized that force majeure is not ‘a term of art’ under English law. A party is allowed to use it as a defence only within the four corners of the agreed clause. This means that only those events that are expressly specified in the force majeure provision can constitute a ground for releasing a defaulter from liability. Any other ground which is not directly specified in the clause cannot protect a defaulting party from the unfortunate events impeding the contract performance.
It flows from this rule that the wording of the force majeure clause is extremely important as it will serve as a strict guideline for the tribunal. It is, therefore, essential for the traders to revise the contracts carefully in order to avoid undertaking unnecessary risks in this situation.
Second, it was established by the tribunal that the seller bore the burden of proving force majeure which was a rather high one. This is a direct consequence of a traditionally strict attitude of English law to the performance of contracts allowing the release from liability only in exceptional circumstances. The defaulting party must demonstrate that the force majeure event truly prevented the performance of the contract, it does not suffice to show that performance became merely burdensome or unprofitable.
Sympathy Towards the Difficulties
Having established these basic principles, the tribunal proceeded with their application to the facts of the case.
The arbitral panel noted that the drought, in general, could be treated as a force majeure event. In their opinion, the prolonged dry conditions could fall within the notion of ‘Act of God’ or the catch-all phrase ‘any other event comprehended in the term “force majeure”’. As a next step after establishing the event of force majeure, the seller had to prove that this drought directly affected his ability to perform the contract.
Accordingly, the arbitrators proceeded with analyzing the reports which were filed as evidence of force majeure. They acknowledged that these reports showed “catastrophic damage to the corn crop” in the specified farms and the “extremely serious” effect of the drought. Although the reports did not represent a formal force majeure certificate, they were accepted by the tribunal as proper evidence of force majeure. This decision was explained by the fact that the GAFTA clause does not require the tender of formal certificates to prove force majeure (it merely refers to ‘satisfactory evidence’). In this way, the arbitrators have taken a flexible approach making emphasis on the content of evidence rather than its form.
The tribunal also agreed with the seller that the said clause generally does not require a force majeure event to be unforeseeable. They specifically noted that this condition is mentioned only for the event called ‘impediments to transportation and navigation’ and thus evidenced the intention of the draftsmen to exclude the requirement of foreseeability for other events. In the arbitrator’s opinion, the existence of precursors of the drought at the time of the contract conclusion could not prevent the seller from relying on the force majeure defence.
In the light of the above conclusions, it appeared at first glance that the arbitrators were pretty sympathetic towards the difficulties the seller faced due to the bad weather conditions in Romania.
Difficulties ≠ Prevention of Shipment
Despite this sympathy, the tribunal eventually held that the filed evidence did not allow it to excuse the seller from liability for the non-delivery of the goods. In making this decision, the arbitrators relied on the following reasoning.
1. The contract performance was not really prevented
The seller had to demonstrate that corn of Romanian origin was not available for supply to the buyer. The seller’s reports did not prove that as their scope was very limited – these documents related only to the land in five localities in eastern Romania. They merely showed a sharp reduction in the crop in those regions. At the same time, western Romania was not affected by the bad weather at all. These facts led the tribunal to the conclusion that the seller could have procured Romanian corn on the market, albeit at a higher price. The effect of the drought, hence, was not unavoidable for the seller.
2. The seller failed to send a force majeure notice
The tribunal stated in the award that the seller’s obligation to serve a force majeure notice within 7 days after its occurrence represented a condition of the contract. This means that the seller could be released from the liability only if this requirement was strictly complied with. It is essential that the force majeure notice must be served in writing – a mere reference to the drought during the call was not accepted by the arbitrators.
Thus, the timely service of the notice was declared essential for the force majeure defence.
In the case of the drought, the tricky question is when exactly this 7-days period starts and ends. The discussed arbitration is an illustrative example of that: the tribunal was puzzled by this question because drought does not occur on a single day like, for instance, an earthquake; rather its impact is cumulative over a protracted period. In this case, the arbitrators held that the impact of drought on crops became evident only at the end of August 2020 and regarded this period as the last opportunity to serve a force majeure notice. Since the seller did not send the notice at all, he could not in principle be excused from the liability based on the force majeure clause.
As a result, the arbitrators supported the buyer’s position and held that the seller was fully liable for the non-delivery of the goods.
It is high time to change your contract!
As it can be seen from the analyzed case, the disputes arising from the drought can be very controversial. Quite often, it is challenging to draw a clear red line between what can be considered a force majeure under the GAFTA contract and what is not.
In these circumstances, it is advisable to create a tailor-made solution in your contracts by adapting the force majeure clause to the possible effects of drought in Europe. In particular, the importers of the goods of EU origin can indemnify potential risks through the following amendments.
1. Limit the force majeure events only to those truly exceptional. Consider excluding drought expressly from the scope of the force majeure clause.
2. Specify that time limits for invoking force majeure must be complied with strictly.
3. Indicate that force majeure must be proven by the certificate of the chamber of commerce.
4. Designate clear consequences of force majeure (suspension of the shipping period/cancellation of contract).
In addition, it is also important to avoid concluding contracts requiring goods to be grown in specific fields or originate from a specific region of the country. If drought affects this particular region, the seller will have better grounds to invoke force majeure. Instead, importers should consider stipulating the origin of the goods widely – for example, EU corn instead of Romanian corn (if possible from a commercial point of view). This amendment will create a leeway for you to demand the supply of the commodity of alternative origin in case the planned goods become non-available for supply.
These simple steps might indemnify the risks caused by the dry weather in Europe and contribute to the smooth performance of your contracts!
Ivan Kasynyuk, partner at AGA Partners
Pavlo Lebediev, senior associate at AGA Partners
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The Greek Coast Guard has suddenly received a distress call: in the Sea of Crete, a huge vessel has collided with another ship and is steadily going under the water. The Chief of the Coast Guard immediately instructs two patrol boats and a military helicopter to rescue 16 crew members who have already sent numerous calls for help. Due to the prompt and desperate reaction of the coast guard, they have been rescued from the vessel and taken to the nearest city in Greece. But the vessel together with 7,000 tons of Ukrainian wheat was not that lucky – it has eventually gone to the bottom of the Cretan Sea.
Do you think this is a teaser for a new Hollywood movie? Not at all! Recently this event has actually shaken up the mass media becoming a subject matter of lively discussion. It has also raised several questions interesting from a legal point of view for those involved in international trade.
Will the seller receive the payment for the shipped and subsequently lost goods? Who is responsible for the loss of the cargo: the buyer or the seller of the goods? Or can the insurance company compensate for the incurred losses?
These questions are frequently posed to all those trading commodities – so, let's figure out who ultimately bears losses in this rather difficult situation!
At a first glance, a shipwreck may seem like an extraordinary event that rarely appears on the front pages of the newspapers. However, in fact, cargoes are lost during the sea voyages almost every day. According to Bloomberg, only in 2020, more than 3,000 containers of sea lines went under the water! As a result, lawyers specializing in international trade quite often encounter cases about the loss of the cargo during their carriage by sea.
Since the vast majority of international trade transactions is carried out under English law, its precedents set global trends in these matters. Ironically, the trends continue to be largely based on those rules devised by English courts over a hundred years ago.
Inglis v Stock is a landmark dispute on the loss of cargo due to a shipwreck, which was examined by the House of Lords in far 1885.
In this case, parties concluded a contract for the sale of 200 tons of sugar, which were to be shipped at the port of Hamburg on FOB terms (a buyer charters a vessel ship and a seller loads the cargo into it). Upon loading of the goods in Hamburg, the vessel set off in the direction of Bristol. But during the voyage on the Elbe, she unexpectedly went underwater. Despite that, the seller tendered shipping documents for the goods and the buyer made payment against them.
Since the buyer did not receive the purchased goods, it applied to the insurance company with a demand to reimburse its losses caused by the loss of the cargo. The insurance company refused to pay compensation, which led to legal proceedings between them. As a result, the English courts had to figure out who was ultimately responsible for the loss of the goods.
After several rounds of legal battles, the House of Lords established the basic principles of transfer of risks under the FOB contracts:
(1) once the seller has loaded the goods on board the vessel, all risks pass to the buyer,
(2) accordingly, upon receipt of the shipping documents, the buyer must pay for the goods, even if they were lost during the sea voyage,
(3) the buyer is entitled to recover its losses under the insurance policy if it covers the risks in question.
As a result, the English court upheld the buyer’s claim in this dispute and ordered the insurance company to pay the buyer compensation for the lost cargo.
This precedent shows that in the case of loss of goods during their carriage by the sea – either by vessel or by containers – the following questions are crucial to establishing which party is liable for the losses.
The answer to this question can be found in your contract – in most cases, the delivery will be executed on the terms of 'Cost, Insurance, Freight' (CIF) or 'Free on Board' (FOB).
For CIF deliveries (and their modifications – CFR, CIFFO), the seller charters the vessel and loads the cargo. FOB terms have a significant difference – the buyer organizes transportation by sea and the seller must load the goods into the vessel.
Despite this fundamental difference, the FOB and CIF terms are equivalent in terms of the risk transfer – the risk shifts when the goods are loaded onto the vessel . In other words, as soon as the goods have crossed the ship's rail, the seller can relax since the buyer undertakes all the risks connected with the sea voyage.
In international trade, a buyer naturally expects that it is purchasing certain goods when concluding a CIF or FOB contract. But surprisingly, from a legal point of view, it is not the goods that are purchased but the documents for them .
This rule is explained by the legal peculiarities: the buyer normally must pay for the goods after receiving the shipping documents specified in the contract. And it does not matter for the buyer’s payment obligations whether the ship eventually arrived with the cargo at the port of destination or not.
This legal feature leads to a very interesting consequence: once the goods are loaded and the documents are tendered, the buyer must pay for the cargo, although it may never receive the goods if they are lost during the sea voyage.
For CIF deliveries under the terms of the International Grain and Feed Trade Association (GAFTA), it is also important whether the seller has fulfilled his obligation to appropriate the goods.
Usually, buyers purchase not a specific product but goods of certain description (for example, Ukrainian wheat). Accordingly, after loading the cargo onboard the vessel, the seller needs to determine the specific goods that are supplied to the buyer under the contract. To this end, the seller must send the buyer a special notification (“appropriation”) with the name of the vessel, the loading port, at least the approximate amount of the loaded goods and the date of loading (which must fall within the period specified in the contract).
In any event, the appropriation notice must be submitted within the contractual period – even if the cargo is lost during the sea voyage. As a consequence, if the seller tenders shipping documents but fails to appropriate the lost goods within the specified time, the buyer will be entitled to refuse to pay.
When determining who is responsible for the loss of the goods during the sea voyage, it does not matter who is the actual owner of the goods.
This is explained by the fact that the risk of loss/damage and title to the goods can transfer at different times. Quite often, the risks are transferred to the buyer at the loading of the goods but it becomes their owner only after the full payment.
Thus, the ownership and the transfer of risks exist independently of each other. For this reason, the identity of the owner is not critical in establishing who is responsible for the loss of cargo.
Notably, it was this argument that played a key role in Inglis v Stock mentioned above and led to the liability of the insurance company for the loss of the goods.
For such a complex situation, still, there is an efficient means of protection – to obtain the insurance of the risks of loss of and damage to the cargo during the sea voyage.
If the buyer is forced to pay for the lost goods, it will get a chance to receive compensation for its losses from the insurance company. The terms of the insurance policy are of fundamental importance here as they will decide the fate of the compensation in such a dispute.
In case of any accident during the sea voyage, every hour is worth its weight in gold. It is critical to take the right and timely measures so that your company does not become the one responsible for the unfortunate loss of the cargo or its deterioration. In this situation, these are experts in international trade law who can save your company from an unexpected storm in your business.
This article is available in Ukrainian only.
This article is available in Ukrainian only.
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