In a previous article we looked at the potential availability of force majeure relief from the impacts of COVID-19 under some standard oil and gas industry agreements. This article considers the case where your business has multiple relationships and points of connection with a single industry counterparty, potentially across a number of business divisions or group companies – for example, in the case of two oil and gas groups with activities across the value chain.
To recap: the most immediate impacts of the pandemic on business result from actions taken by governments, or by individuals and organisations of their own initiative, to manage and contain the spread of the disease. These include lockdowns, social distancing, travel restrictions and the consequential reduction or closure of many business activities. The impact on your business from such actions will include:
- direct impacts on your own operations;
- impacts on your contractors and suppliers (and further up the value/supply chain), if their ability to perform is impaired or cost of performance is increased; and
- impact on your customers/demand (and further down the value/supply chain), in terms of reduced demand for your products and services, at least at the price contracted for.
The implications for your contracts include both the potential application of specific contract terms, and wider changes in the contract parties' circumstances and attitudes to the contract. Specific contract terms that may be engaged include:
- most obviously, possible claims for force majeure relief, by you or by your counterparty. It will be important to distinguish genuine claims, based on inability to perform, from cases where the benefit to a party of performance of the contract is lost or reduced, or the costs substantially increased (which do not typically qualify as force majeure);
- terms which allocate the risk of cost increases/revenue losses resulting from a change in law, typically by allowing for price adjustments;
- other price review provisions which may be triggered by a change in market conditions, such as a price review in a long-term gas or LNG sales contract, or which allow the pass-through of exceptional changes in a party's input costs; and
- possibly, other provisions which provide relief to a party in the case of economic hardship, whether in the shape of an adjustment of the economic terms of the contract, or the opportunity to terminate or suspend the contract.
The wider impacts include the following:
- Counterparty credit risk will increase, where your counterparty has suffered impairment to its business (potentially in turn engaging consideration of "MAC" clauses in trading or other contracts, or creating problems with coverage ratios in finance documents). Of course, your counterparty may have the same concerns with the financial position of your organisation.
- Similarly, in joint ventures, risk of a counterparty failing to meet a cash call will increase, triggering processes and remedies which may ultimately lead to forfeiture or buy-out. More widely, there may be incentives for joint venture parties to seek to exercise put or call options where the balance of their respective interests change. A joint venture party looking to delay or otherwise mitigate adverse impacts might raise, as an excuse, the difficulties of holding (for example) operating committee meetings in current circumstances (although most contracts will allow for virtual meetings).
- Where the bargain or benefit of a contract has become materially unbalanced (or one party can no longer afford it), one or other party may be looking for opportunities to escape its commitments, or build a case that the other is in breach, or a defence to claims that it has breached or reneged on the contract. That may lead to an increased focus on poor performance or possible defaults, with monitoring of the minutiae of the performance specification. In a contract still subject to conditions precedent, it may become tempting for one party to look for ways in which satisfaction of the conditions can be delayed or frustrated. In addition, there may be wider pressures to renegotiate contract terms, with the recognition that accepting renegotiated terms may be a better result than forcing a counterparty into bankruptcy.
- Similar considerations will arise if you are negotiating new contracts (or contract extensions or renewals).
In all of the above, you will also have in mind the need eventually to get back to "business as usual" (or at least the next phase of the "new normal"), and so to limit special measures to the appropriate time period, and in the meantime not to do unnecessary harm to long-term business relationships.
These issues have an added significance where your counterparty has multiple points of connection with your business divisions. For example, in the world of oil and gas, your counterparty and/or its affiliates (across its or their different divisions) may be any or all of the following, potentially in multiple regions and projects:
- a joint venture partner, in upstream and/or midstream operations, and operator or non-operator;
- an off-taker for hydrocarbon production or a customer for oil products or chemicals;
- an operator of infrastructure (a pipeline, terminal, refinery, storage facility) of which you are a user, or conversely a user of infrastructure which you operate;
- a supplier (of feedstock or other raw materials) or contractor or service provider;
- a products trading counterparty across the whole range of traded energy and related products.
With these multiple points of connection, there are very real risks of inconsistency in approach, in contract interpretation, in invoking the application of specific contract provisions, as well as in the wider messaging of your approach, and in external perceptions of the impact of COVID-19 on your business and finances. At best, inconsistency will arm your counterparty with negotiating ammunition; at worst, it may prejudice your ability to argue particular positions in any contentious proceedings which may arise.
You will need to adopt a strategic approach, with both defensive and offensive goals, and which will include:
- at the outset, ensuring you have identified all group companies/divisions of each counterparty group, including majority- and even potentially minority-owned stakes; and the contracts you have in place, or are negotiating or renewing, with each of them;
- identifying classes of provisions in these contracts where inconsistency of approach could present significant risk, and potentially deciding on approaches of least regret;
- taking steps to maintain consistency in your actions and communications related to such provisions across all such contracts – for example, in claiming or resisting claims of force majeure (or applying other contract provisions as above);
- conversely, identifying inconsistencies in your counterparty's equivalent actions and communications, and using those to your advantage in negotiations or claims handling;
- in a slightly different vein, monitoring counterparty communications where these may signal a financially deteriorating counterparty – for example, through its force majeure claims (as well as other more usual signs such as a raised level of invoice disputes or late payments); and
- linked to this, reviewing cross-default and cross-termination provisions in all contracts with a given counterparty or group, and indeed considering any interaction with hedging arrangements or other inter-dependencies.
Where to start?
To help you develop a strategy for mitigating the risks of multi-contract counterparty relationships, and to deal with large numbers of simultaneously occurring force majeure claims more generally, we have developed a force majeure triage tool, which can be accessed here.
To get ahead of potential risks in a cost-efficient way, you may also wish to consider the use of legal technology products. Due diligence software incorporating elements of artificial intelligence has made it possible to audit large numbers of contracts for comparison of force majeure and other provisions much more quickly and efficiently than would previously have been the case. If you would like to explore this option, please get in touch.