Get out of jail free?

Force majeure clauses inserted in the small print of contracts can be a very real threat to the survival of businesses impacted by disasters. David Honour explores the issue and suggests measures that organisations can take to ensure that ‘Acts of God’ do not offer suppliers a ‘Get out of jail free’ card when it comes to business continuity issues.

Monopoly's famous ‘Get out of jail free’ card provides game players with an easy way to escape the consequences of a risk event – in a shake of the dice the player ends up incarcerated in prison but with the wave of the card the consequences no longer apply. In the real world of business a similar card exists. It’s called force majeure and it allows businesses and insurers to extract themselves from the costly consequences of natural disasters, terrorism, war and other various ‘Acts of God’. This is fine for the company invoking force majeure on its behalf, but can have severe implications for the business which suffers the Act of God.

Force majeure literally means "greater force". Such clauses are included in supplier contracts to excuse a party from liability if some uncontrollable event prevents the supplier from carrying out its obligations under the contract. A genuine example reads as follows:

“If the performance of this Agreement is interfered with by reason of any circumstance beyond the reasonable control of the Party affected as a result of fire, flood, explosion, war, strike, embargo, government requirement, civil or military authority, act of nature or the public enemy, or act or omission of carriers (each a "Force Majeure"), then the Party affected shall be excused from such performance on a day-for-day basis to the extent of such interference, provided the Party so affected shall use commercially reasonable efforts to remove such causes of non-performance.”

From a business continuity planning point of view, force majeure clauses require detailed examination, since they will come into effect under many circumstances where a business continuity plan is invoked. If you fail to do this you are leaving the door wide open to unexpected withdrawal of key services at a critical juncture for your company. Unfortunately this may involve a laborious forensic dissection of supplier contracts which will probably make you extremely unpopular within your own legal and purchasing departments as well as within supplier companies.

The first step is to audit all suppliers and to determine which are critical to operational continuity. Once this has been done, the written contracts with these suppliers must be examined with a toothcomb to identify any terms and conditions which could have a force majeure element or interpretation. You will eventually get to a stage where you will have a clear idea of what areas of which contracts need addressing.

Where force majeure clauses exist you have various choices:

1) Accept the risk
You may decide that the force majeure clauses in a particular contract are well defined, are fair and no further action is required. In this case you accept the risk that during a force majeure type event you may not be able to rely on that particular supplier.

2) Seek further clarification
There are no globally accepted definitions for what are force majeure events; at what stage force majeure clauses would be invoked; how long a force majeure period would last for; and how the decision would be made that a force majeure event has finished. These are all left as grey areas in many contracts and, for the purchaser, introduce a further element of risk and uncertainty. To attempt to negotiate these areas during a force majeure crisis leaves the purchaser vulnerable to the whim of the contractor. You may decide that these areas need to be clarified within the contract. If this is the case you may be able to negotiate an update to existing contracts, or at least require the contract to be rewritten when it comes to the end of its period.

In his article ‘Allocating risks of terrorism and pandemic pestilence: force majeure for an unfriendly world’, Patrick J. O’Connor, Jr, of Faegre & Benson, LLP, highlights three areas which should always be covered when writing or reviewing force majeure clauses. These are:
* How and when force majeure is to be declared. O’Connor states that a procedure should be included in the contract to guarantee that the client cannot prevent a fair and justified declaration of force majeure by the contractor.
* How the observation period is defined and handled.
According to O’Connor, three principles must govern this phase: the contractor shall be fully compensated from the moment force majeure is declared; the duration of the observation period must be clearly defined; and the conditions under which the contract can be resumed must be specified.
* How the contract may be fairly terminated if it cannot be resumed.

3) Implement additional mitigation measures
If, in your contract review, you have discovered various critical areas where your company’s business continuity is threatened by a supplier’s force majeure clauses and it proves impossible to renegotiate the contract to soften or remove the offending elements, it may then be necessary to take measures to mitigate the risk of losing a key supplier due to a force majeure crisis. This may involve placing a third party supplier on a standby contract, which will only come into force should the main supplier invoke force majeure. This is likely to involve additional expense, as a retainer or subscription fee may have to be paid to the third party.

4) Rescind the contract
If the force majeure elements in the contract are too open-ended and attempts to further define or renegotiate these clauses prove impossible then you are placed in a situation where it may be safer for your company to attempt to rescind the contract, or at least refuse to renew under the existing force majeure terms.

5) Buy insurance
There are various specialist insurance policies that cover force majeure invocations and provide financial reimbursement for the consequences of a force majeure event and for the losses incurred due to events beyond your reasonable control. Insured interests will normally include such areas as: debt repayments ; operating loss; loss of tax credits due to missed deadlines; loss of revenue ; increased costs of working ; out of pocket expenses; and costs of executing contingency plans.

FORCE MAJEURE AND TERRORISM
Acts of War has been a standard force majeure clause since time immemorial and this risk has generally been one that has simply been accepted, however the threat of global terrorism has changed the threat in this area and opened up a whole can of worms as far as definitions are concerned. Terrorism is an area that requires careful consideration in force majeure clauses. Specific areas that need examining are:

a) What is a terrorist attack? Does the definition include information warfare as well as more conventional forms? What knock-on disruption can reasonably be linked to the actual terrorist attack?
b) When will an incident be declared a terrorist attack? Will loss or life or physical damage be required before force majeure is invoked or is the disruption caused by an attempted, but failed, attack enough to invoke the clause? Is a governmental announcement that an incident was caused by terrorists necessary before the clause is invoked?
c) When is a terrorist attack over? At what stage will it no longer be applicable to invoke force majeure?

FORCE MAJEURE AND DISASTER RECOVERY SUPPLIERS
Force majeure is an especially important subject when it comes to contracts which are made with third party disaster recovery suppliers. By their nature such contracts will only be invoked under extreme circumstances, many of which will come under the normal terms of force majeure. The following is a genuine force majeure clause from a standard contract issued by one disaster recovery company:

FORCE MAJEURE. Neither party shall be liable for, nor shall either party be considered in breach of this Agreement due to, any failure to perform its obligations under this Agreement as a result of a cause beyond its control, including any natural calamity, act of God or a public enemy, act of any military, civil or regulatory authority, change in any law or regulation, disruption or outage of communications, power or other utility, failure to perform by any supplier or other third party, or other cause which could not have been prevented with reasonable care. If, due to any such cause, [the company] is unable to provide to Customer the Recovery Resources described herein and this inability continues for a period of more than 30 days (the "Outage Period"), then the term of this Agreement shall be extended by the Outage Period. If this inability continues for more than five days after Customer has declared a Disaster, then Customer may terminate this Agreement, without penalty, by giving written notice of termination to [the company] at any time before the inability ends and receive a pro rata refund of any prepaid fees for any period after the date of termination from [the company’s] Billing Agent.

Many companies may be surprised to find that their disaster recovery contract may not be as watertight as they expected. The above clause means that if the disaster recovery supplier fails to provide its services during any disaster which could be defined as a force majeure event then the disaster recovery supplier has no legal obligation to its client unless it can be proved that it did not take ‘reasonable care’ to prevent the force majeure crisis having an impact on the disaster recovery supplier’s operations. The only option given to the customer is the ability to cancel the contract if the disaster recovery supplier has been unable to provide disaster recovery services within five days of an invocation. For many businesses this is simply an unacceptable period of time. For many organisations five days would result in incredible, survival threatening, financial losses. To be offered a refund in prepaid fees will hardly provide adequate compensation.

Although it is obviously incumbent on the disaster recovery supplier to protect itself from unlimited liability the very general and undefined nature of its standard force majeure clause and the wide number of disasters it includes would seem unacceptable given the nature of the service being offered. If your organisation has a contract with a third party disaster recovery supplier, make it a priority to check the small print!

•Date: 14th May 2004 •Region: UK/World •Type: Article •Topic: BC general
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