Contract Disputes Arising From The Ukraine Conflict: Issues, Defenses And Lessons For The Future (Podcast) – Civil Law

The ongoing conflict in Ukraine has had a significant impact on
commercial activity for many organizations on a local and
international scale. Organizations with commercial operations in
the region (both Ukraine and Russia) may face challenges in
sustaining their contractual obligations. Mayer Brown partner Jim
Ferguson and associate Valerie Vanryckeghem, along with host Julian
Dibbell, will discuss common issues that certain organizations may
face as a result of the crisis and practical considerations for
drafting contractual protections with a view to avoiding the
specific business risks of the Ukraine conflict.

Transcript

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Julian:

Hello and welcome to Tech Talks. I’m your host, Julian Dibbell.
I am a senior associate in Mayer Brown’s Technology & IP
Transactions practice. I’m joined today by Jim Ferguson and
Valerie Vanryckeghem. Jim is a partner in Mayer Brown’s
Litigation and Intellectual Property practices in our Chicago
office. Valerie is a senior associate in Mayer Brown’s London
office in the firm’s Intellectual Property & IT Group.

Our topic today, the conflict in Ukraine and its impact on
commercial operations and what contracts have to do with that.
Particularly, we’re talking about what contractual or other
protections may be available to business contract parties that find
themselves in a situation where a party is no longer able or
willing to perform its contractual obligations.

Today we are going to hear from two practitioners in
international outsourcing transactions about the common issues
organizations are facing as a result of this conflict, and what
legal remedies are available to those types of organizations and
how proper drafting of contractual protections may help businesses
that are seeking to exit or be excused from performing an existing
relation.

Setting the scene – Factual scenarios

Julian:

Jim, why don’t you start by explaining briefly what kinds of
issues businesses may be facing as a result of the Ukraine
conflict?

Jim:

Thanks Julian, and hello everyone. You’re absolutely right,
Julian, that the Ukraine conflict has led to a growing number of
contractual disputes, and I think a good place to begin our
discussion today is by grouping these disputes into three major
categories based on their causes. The first category consists of
disputes resulting from the decision that many Western companies
made to withdraw from doing business in Russia. The second category
consists of disputes resulting from
non-performance—contractual non-performance—because of
the sanctions imposed on Russia by Western governments. And a third
category of disputes result from contractual non-performance
because of the actual hostilities (in other words, the “acts
of war”) between Ukraine and Russia.

Failure to Perform Following Voluntary Withdrawal from
Russia

If we look at this first category, the voluntary withdrawal from
Russia, in some cases, companies have ceased performance on
contracts after deciding to withdraw from Russia because of
reputational concerns or because the invasion was simply
incompatible with their core values. In these cases, the
companies’ decision to withdraw from Russia has led them to
suspend or withdraw from certain contracts. In fact, Valerie, I
believe you encountered this issue in a recent project you worked
on?

Valerie:

That’s right, Jim. Actually, a client of the firm with
facilities in Russia had contracted with a service provider to
provide certain services on-site at the premises of our client in
Russia. And this service provider decided—as a consequence of
the conflict in Ukraine—that it no longer wished to be
associated with Russia in any way. And so, this service provider
decided to withdraw completely from Russian territory, which meant
that it would no longer provide the contracted services at our
client’s facilities in Russia.

And as you can see right here, this issue is problematic for both
the service provider and the customer, because they are both trying
to limit reputational damage: (1) the service provider by
retreating from the region and no longer providing services in
Russia (2) but also our client, who is very aware that it may face
public backlash if it attempts to hold the service provider to its
contractual engagements in Russia.

Jim:

Yes, that’s a great illustration of how complex these
situations can be.

Failure to Perform Due to Sanctions Imposed by Western
governments

Let’s turn now to the second category of cases, which consists
of companies who have failed to perform contractual obligations
because of sanctions imposed by Western governments. We had a
recent example involving a supplier who failed to deliver
contractually required goods because of EU sanctions barring access
to European ports by any ship that last docked at a Russian port.
In these cases involving sanctions, a key issue is going to be
whether the sanction directly prevented the party from performing
its contractual obligations or simply made performance more onerous
or costly.

Failure to Perform Due to “Acts of War” Between
Ukraine and Russia

The third category of cases focuses on the actual “acts of
war” between Ukraine and Russia. In this category, companies
fail to perform their contractual obligations as a direct result of
the hostilities—the “acts of war”—between the
two combatants. As an example, some suppliers might not be able to
deliver certain contractually required hardware because of the
Russian blockade in the Black Sea. Or, another example, an IT
service provider based in Ukraine might not be able to perform its
contractual obligations because its major facility has been
destroyed during the war. As with sanctions, in these cases
involving “acts of war,” the key issue is going to be
whether the hostilities directly prevented contractual performance
or simply made performance more onerous or costly.

Defenses Based on Contract Provisions

Julian:

Ok, interesting. So Valerie, are there contractual defenses or
protections available to the parties involved in these types of
disputes, and what are they?

Valerie:

Yes, of course, Julian, there are. Regardless of the governing law,
we see that parties usually choose to include provisions in their
contract, at least in relation to force majeure, which we all know
about.



Force Majeure

Scope

These clauses are really creatures of contract, and so, their scope
depends largely on the specific wording that is used in the
agreement. But, at its core, it’s important to know that a
force majeure provision seeks to limit a party’s liability in
case there are certain unforeseeable events that are beyond the
control of this non-performing party and that prevent or impede the
performance by this party. And so, in order to invoke a force
majeure defense, the non-performing party should really be able to
demonstrate that there is a triggering event that qualifies as a
force majeure event as defined in that clause; that this event
directly prevented the performance of certain contractual
obligations; and that the non-performing party took all reasonable
steps to mitigate damages.

The Ukraine Conflict

Now, looking at force majeure clauses in the light of the conflict
in Ukraine, a party that is unable to perform as a result of the
conflict may very well be able to show that either the war itself
or government sanctions qualify as a force majeure event, because
most force majeure clauses specify or explicitly include “acts
of war” or “acts of government” as examples of force
majeure events. Now, that being said—and this is where there
might be an issue—if the parties negotiated the contract
after the invasion began, then the non-performing party may face
challenges in showing that the event was “unforeseeable.”
Another major issue in the case of many Ukraine-related contract
disputes is likely to be causation—meaning, did the alleged
“force majeure” event directly cause the failure to
perform? For example, even when “acts of war” are
explicitly listed as a force majeure event, it may be hard for a
service provider to rely on it if the “acts of war”
occurring in Ukraine have not caused a service provider to be
unable to perform certain contracted services on-site in
Russia.

And now, in most jurisdictions, the courts also do not regard
“economic hardship” (or reputational injury) as
sufficient grounds for a force majeure defense. And so, if an IT
service provider claims that it has become impossible to perform
its contracted services in Russia because the risk of reputational
damage is too high, it’s likely that this service provider will
face difficulties in showing that the alleged “force
majeure” event (i.e., the Russian invasion of Ukraine) has
directly prevented it from performing its contractual obligations
because it is merely the fear of reputational damage that is
causing this service provider to attempt to stop providing
services. Now, similarly, if an IT service provider or even a
hardware vendor has ceased performance because sanctions or
“acts of war” have made performance of its obligations
simply more costly or more onerous, again, their force majeure
defense may not succeed.

So, really the question is, if a non-performing party could have
provided the contracted services from one of its other
establishments—not directly within the conflict zone in
Ukraine—or eventually have repurposed another establishment
for such services (albeit at a higher price), then it may not have
a strong force majeure case based on the war. By contrast, though,
if either sanctions or the war in Ukraine have directly prevented a
party from contractual performance, this party would have a much
stronger force majeure defense. For example, if a data center used
by a service provider to provide certain services has been
destroyed by a missile, it would likely have a strong force majeure
defense, of course.

Julian:

That’s a great overview of how a force majeure might intersect
with these issues and a great masterclass in the basics of force
majeure. Thank you, Valerie. So that’s the obvious one, force
majeure. Are there any other contractual defenses that might be
available or come into play in these types of situations,
Jim?

Price Adjustment Clauses

Jim:

The answer Julian, of course, is yes. And the further answer is it
depends on the contract, because some contracts also have a
so-called price adjustment clause which contains some mechanism to
adjust the price to prevent a contract from becoming too
financially onerous for one of the parties. They are intended to
reflect changing market conditions—particularly over the
course of a long-term contract. For example, the Ukraine conflict
has led to an increase in the cost of raw materials, energy,
transportation, and many other vital items, all of which may cause
the contract to become more financially onerous for the service
provider. And, as we noted earlier, government-imposed sanctions
and acts of war may also increase the cost of performance. If a
contract does include a price adjustment clause, then the ability
of a service provider to invoke it will depend on the language of
the clause, including whether the specified factors necessary to
trigger a price adjustment have occurred; whether the service
provider has complied with the contractually required process for
invoking the provision; and whether the customer, under the
contract, has any right to veto the adjustment.

Material Adverse Event Clauses

In addition to force majeure clauses and price adjustment clauses,
some contracts may have what is known as a Material Adverse Event
(MAE) clause, which is designed to protect against the risk that an
unforeseen event may have a materially adverse effect on one of
parties. If the contract includes such a clause, then the
party’s ability to invoke it will once again depend on the
language in the clause, including, most importantly, whether the
unforeseen event satisfies the contractual definition of
“material”; and also whether the party has complied with
the contractually required process for invoking the MAE clause,
including any required notice or mitigation efforts.

One other thing we would look at in connection with MAE clauses is
whether the clause specifies the specific consequences of a
Material Adverse Event. For example, the clause may require the
non-performing party to take immediate steps to mitigate the impact
of an MAE event, or it may give one or both parties a right to
suspend or even terminate the contract altogether. These
provisions, Material Adverse Event in particular, generally work to
reduce the risk allocated to the service provider. But Valerie, I
know you have been involved in projects where the MAE provision
actually provided comfort to the customer. Do I have that
right?

Valerie:

Yes, that’s right, Jim. I guess you might even say that there
has been some sort of a learning curve on the customer side as
well. And so, in large-scale outsourcing and SaaS (Software as a
Service) projects where the services are crucial to ensure business
continuity on the side of the customer, we see that customers do
want to be informed immediately of certain pre-defined events that
the customer has qualified as “Material Adverse Events.”
Often designed to even include events that could have a material
adverse impact on the customer. And also, these customers then want
to be able to take action. For example, to veto the use of a
certain subcontractor, or the use of a datacenter at an
unacceptable location, or to force the parties around the table to
find a solution. And, if all else fails, to terminate the contract
or part thereof.

Another field in which our team has seen some sort of a learning
curve is, of course, the financial sector. Many jurisdictions now
have regulations or guidelines in place for outsourcing in the
financial sector and Europe specifically has the outsourcing
guidelines of the European Banking Authority. Under those
guidelines, financial institutions are required to include MAE
provisions in their outsourcing arrangements to ensure that they
stay informed on Material Adverse Events such as, for example, the
financial situation of their supplier, any mergers, divestments
that the supplier might have, and the use of subcontractors by
their supplier, just to name a few. And so these guidelines require
financial institutions to be able to take action and to include an
explicit right of termination for certain of these Material Adverse
Events.

Now looking at this scenario in light of the conflict in Ukraine,
if a financial institution has, for example, engaged an IT service
provider who uses a subcontractor in Ukraine, and as a result of
the war, this service provider proposes to change its subcontractor
to a new subcontractor in a country that does not have an adequate
level of protection for personal data, then the financial
institution would need to be informed of this, and would have a
right to veto the use of this new subcontractor and
ultimately—if no solution is found—would have a right
to terminate the contract or the relevant part of it.

Defenses Based on General Principles of Civil and Common
Law

Julian:

Ok, well, so, there’s a fairly robust—if somewhat
complicated—set of contractual defenses that may be available
in these situations. What if no actual contractual defenses are
available? Are there defenses or protections possible based on
common law principles or civil law, as the case may be?

Valerie:

Yes, there certainly are, Julian. In addition to the contract-based
defenses, there are a number of defenses rooted in general
principles of civil or common law. Looking at the civil law
jurisdictions first, it is useful to remember that many civil law
jurisdictions (especially those with a civil code that is based on
the code napoleon, such as France, Belgium, or Netherlands)
recognize that force majeure is a general principle of law.

Force Majeure (civil law)

And of course, the importance of this is that contracts that have
any of these jurisdictions as their governing law, these contracts
may still include the remedy of force majeure, even when the
contract does not explicitly include a force majeure provision. So
that’s one thing to be aware of.

Economic Hardship or “Imprévision” (Civil
Law)

There is also the principle of Economic Hardship, or
“Imprévision” in civil law jurisdictions. The
remedy of economic hardship is not available in all civil law
jurisdictions. Not all of them recognize this principle; I think
France does, but Belgium, for example, actually does not. And so
Economic Hardship is similar to force majeure in that it is also
based on a change of circumstances that was unforeseeable at the
time of the conclusion of the contract. So, as with force majeure,
the circumstances would need to be new or reasonably unknown to the
party seeking to rely on Economic Hardship. And reasonably unknown,
for that to be determined, the judge could take into account, of
course, the professional background, for example, of this party.
But, contrary to force majeure, for Economic Hardship, it is
sufficient that the unforeseeable circumstances render the
performance of the contract excessively onerous for this party who
had not accepted to bear such risk. In fact, you could say it is
rooted in the civil law concept of “good faith” and the
requirement in many civil law jurisdictions for parties to a
contract to at all times behave and exercise their rights “in
good faith.” And so, in the case of Economic Hardship, the
assumption is that if the situation is so excessive, then it would
no longer be “acting in good faith” if the other party
would still demand the performance of the contract without any
adjustments. If we take France as an example, as the process and
consequences may be different, of course, in other civil law
jurisdictions; but a service provider whose performance of the
contract has become excessively onerous as a result of the conflict
in Ukraine, would then be allowed to demand the renegotiation of
the contract. If the other party refuses such renegotiation or the
parties fail to reach an agreement, then the parties may either
agree to terminate the agreement on the date and subject to the
conditions they determine, or they might mutually ask a judge to
decide on the revision of the contract or its termination on a date
and subject to the conditions that the judge sets. And so this is
unique to civil law jurisdictions, because—in a way—it
allows a judge to substitute the parties and for the judge to
decide what the contractual terms will be going forward.

Jim:

You’re absolutely right on that point, Valerie. In common law
jurisdictions, courts generally do not get involved in re-drafting
the parties’ contracts. But there are two closely related
common law defenses that might apply to these kinds of contractual
disputes—one is Frustration and the other is Impossibility or
Impracticability.

The Frustration Principle

The frustration principle excuses non-performance when an
unforeseeable occurrence outside the parties’ control destroys
the very purpose of the contract. An example we might imagine is a
customer who contracts with an IT service provider to host a data
center in Kiev and a missile destroys the data center. This means
the very reason for the contract, which was to host a data center
in Kiev, has been destroyed or frustrated.

Impossibility/Impracticability

In the case of the impossibility/impracticability doctrine, it
excuses non-performance when an unforeseeable occurrence outside
the parties’ control renders the parties’ performance
either impracticable or impossible. One thing to note is that all
of these defenses, both in civil law and in common law, require
that the event be unforeseeable—reasonably
unforeseeable—at the time of contract. But in the case of the
Impossibility or Impracticability doctrine and the Frustration
doctrine, these are common law doctrines, and the governing law of
the contract may impact the application of these principles to the
specific case. Most importantly, in many jurisdictions—common
law jurisdictions—the courts will strictly apply the
principle of impossibility, holding that performance must be
absolutely impossible, while other courts are willing to consider
market conditions and economic costs in determining whether
performance is impossible.

Drafting Risk Allocation Provisions

Julian:

We’ve been looking at various scenarios and defenses where
we’ve got a contract sitting in the drawer and something goes
wrong … a party is suddenly, as a result of the Ukraine conflict,
unwilling or unable to perform … we turn to the contract to see
if there’s a defense there. If not, we look to what possible
non-contractual defenses there might be. What about going forward?
So what lessons have we learned from this from thinking through the
Ukraine invasion and its impact that help us draft risk allocation
provisions in future contracts?

Valerie:

First, the fundamental question will be whether the drafter wants
to adopt provisions that are more favorable to the customer side or
more favorable to the side of the service provider, right? So, if
you are drafting a force majeure clause and you are seeking to
draft in favor of the customer, then the contract should include a
force majeure provision that broadly excludes risks that are known
already at the time of contract or foreseeable at the time of
contracting, specifically excludes economic hardship or burden as a
force majeure defense and also potentially specifically excludes
events relating to the Ukraine conflict as a force majeure defense.
You may also want to consider requiring the service provider that
it is able to show that it could not have avoided (or overcome) the
effects of the force majeure event. Or, you might also require the
service provider to use all commercially reasonable efforts to
continue performance while pursuing ways to mitigate the damage
done by non-performance. And finally, of course, you would want to
include some language that the customer has the right to engage an
alternative service provider to step in if that is a possibility
and provides that only a customer has the right to terminate the
contract in the event of a force majeure event.

Now, if you are drafting in favor to the service provider or a
supplier, then the contract should include a force majeure clause
that includes a broad definition of a force majeure event, ideally
including some catch-all language along the lines of “any
event beyond the reasonable control of the non-performing
party” and you may also want to ensure that the clause applies
when the force majeure event prevents performance, but also when it
impairs or delays performance or even simply results in partial
performance only.

Jim:

Thanks, Valerie. Many of those same principles would also apply if
you were drafting price adjustment or material adverse event
provisions, and your approach will certainly differ on whether
you’re drafting in favor of the customer or the service
provider. If, for example, you wanted to draft risk allocation
provisions that are more favorable to the customer, the first
question is whether you want to include any price adjustment or
material adverse event provisions at all, since these provisions
are often designed to reduce the risk allocated to the service
provider.

If you do elect to draft a price adjustment provision that’s
favorable to the customer, then it should include language that
limits the number of price adjustments that can occur within a year
and installs an initial period during which no price adjustments
can occur (for example, the first two years). It should also link
the price adjustments to an objective and reliable index, and it
should require the service provider to document increased costs and
undertake all reasonable steps to keep costs down.

On the other hand, if you wanted to draft a risk allocation
provision that is more favorable to the service provider, the
contract should include a price adjustment clause that permits the
service provider to invoke the clause at any time (for example,
each time there is an increase of more than x% in the price of
energy) and also permits the service provider to automatically bill
the customer the increased price without any prior approval needed
by the customer.

Similarly, with respect to material adverse event provisions, if
you want to draft provisions that are more favorable to the
customer, the contract should include language that explicitly
describes the material adverse events that the customer is
concerned about, as well as a catch-all phrase to capture anything
that could have an impact on the customer’s operations. The
language should also require the service provider to formulate a
mitigation plan to be approved by the customer, and it should
permit the customer to terminate the agreement if no commercially
reasonable solution can be implemented.

On the other hand, if you wanted to draft a provision that is more
favorable to the service provider, the contract should include
material adverse event language that explicitly describes the
material adverse events that the service provider is concerned
about, as well as a catch-all phrase to capture anything that could
have an impact on the provision of services by the service
provider. It should also require the parties to undertake good
faith renegotiation and agreement on the key terms, such as the
charges and deadlines if a material adverse event occurs. And,
finally, it should permit the service provider to suspend the
performance of the agreement until a commercially reasonable
solution is found.

Closing

Julian:

Thank you, Jim, and thanks, Valerie. Great overview and
insights.

Listeners, if you have any questions about today’s episode
– or if you have an idea for an episode you’d like to
hear about anything related to technology & IP transactions and
the law – please email us at [email protected].
Thanks for listening.

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