The recent floods in Queensland have led to production being halted in more than 40 coal mines across the state. Mining companies have dealt with their inability to meet supply obligations by declaring the floods an event of force majeure under their offtake agreements. As coal mines slowly start the process of returning to full production, the question of how to allocate the limited available coal amongst competing customers arises.
- The law of allocation in force majeure events is not settled in Australia.
- A mine producing enough coal to fully satisfy supply obligations under an offtake agreement may, however, be unable to rely on force majeure to excuse a shortfall in supply, even where production is insufficient to meet supply obligations to all customers.
- There is some Australian and overseas judicial support for the approach of producers allocating available coal resources reasonably amongst customers in a force majeure situation.
Force majeure—what does it mean?
Although force majeure clauses differ among agreements, they essentially relieve an affected party from all or part of its obligations to the extent that a defined event, such as flooding of the type recently experienced in Queensland, prevents those obligations from being satisfied.
While coal mines are out of action, a miner’s failure to supply agreed quantities of coal to its customers will be covered by a force majeure provision which expressly includes flooding as a force majeure event. Where a mine is restored to partial capacity, however, production may reach the point where a miner is capable of satisfying supply obligations to each customer individually, however not to all customers simultaneously. Here, a customer may argue that supplying less than the contracted quantity is no longer excused by force majeure, given that the miner is technically able to satisfy its contractual obligations to that particular customer.
For example, a miner may have contracted to supply equal quantities of coal under three separate offtake agreements, with each customer agreeing to purchase one-third of the mine’s output at full production. Where a mine is operating at half capacity, the output will be sufficient to supply just one customer with its full entitlement of one-third capacity. Technically, however, the miner is able to fully satisfy its obligations under each offtake agreement, it merely cannot to do so and simultaneous meet supply obligations to its other customers. A failure to fully supply each customer while operating at half production may therefore no longer be excused by force majeure.
So who gets the coal?
With Queensland supplying almost half of the world’s metallurgical coal, the reduction in output due to the floods has caused demand and spot prices for available coal to spike. Consumers with long term offtake agreements for Queensland coal are understandably eager to enforce their rights under these arrangements.
Australian courts are not clear on this issue. We may, however, take some guidance from the various approaches followed by English courts, where an agreement is silent on the allocation of coal amongst competing customers in a force majeure situation. The two main approaches are as follows:
- to apportion the available product pro rata amongst customers, or
- to consider a supplier’s obligations in each contract without regard to a supplier’s other commercial obligations (meaning that a failure to supply contractually agreed quantities cannot be avoided by reliance on a force majeure event if sufficient coal is being produced).
A pro-rated allocation would appear to be the fairer approach, given the competing obligations of producers to their customers. It is, however, worth noting that, should litigation occur, it is the court’s function to construe the terms of the contract in question, which may not necessarily involve consideration of a producer’s other commercial arrangements with third parties.
A middle ground approach?
A middle ground approach to apportionment has also been applied in England, with courts finding that supply could be apportioned between parties in a reasonable manner, taking into account commercial considerations, including the length of time that various contracts had been on foot.
There is also some Australian support for a middle ground approach, with the court in Colbert (UK) Limited v Austen and Butta (Sales) Pty Ltd noting that a clear English authority had not emerged. Here, the court preferred a test of reasonableness.
A similar doctrine of commercial reasonableness has also been incorporated into the US Uniform Commercial Code and is likewise followed in Canada.
Future considerations for offtake arrangements
Given the lack of decisive judicial authority on this point in Australia, it will be interesting to observe how Queensland coal mines operating below full production address this issue. There may be some merit in expanding force majeure clauses in future offtake agreements to address the apportionment of limited product between customers.
One approach may be for customers to acknowledge a producer’s supply obligations to other parties and agree to the producer acting reasonably to fulfil its obligations to all of its customers in situations of force majeure. A clause such as this in offtake agreements would allow a producer to act reasonably to satisfy all of its customers to the extent possible, whilst still relying on force majeure to excuse any shortfall in its supply.