Renegotiating Long-Term Contracts Renegotiating Long-Term Contracts

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A jurisdictional guide Renegotiating long-term contracts Renegotiating long-term contracts

Supply-chain strains are resulting in many companies being unable to fulfil their contractual obligations. Some businesses have been able to renegotiate contracts or reach agreement on deferring performance and/or payment. But others have been unable to resolve the situation, resulting in litigation or arbitration.

If you are seeking (or your This guide aims to help you counterparty asks you) to renegotiate understand where your rights and a contract, you may be able to reach obligations lie should you be involved an agreement quickly and informally, in renegotiating a contract made for example following a short email under the laws of one of the following exchange or telephone call. nine key jurisdictions: China, England and Wales, France, Germany, Hong If this is not possible, you will have to Kong, Italy, Japan, Spain and the US. consider the contract-renegotiation law of the jurisdiction under which If you require any further information, the contract is written. For example, please don’t hesitate to get in touch some jurisdictions have laws that with a member of our team. oblige parties to enter formal renegotiation while others are silent on the issue, leaving it to the parties (and, if necessary, a court or arbitral tribunal) to look at the contract’s wording to resolve the issue.

2 Renegotiating long-term contracts

Changing long-term contracts: from informal renegotiation to litigation

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Informal renegotiation Escalation Litigation/arbitration More junior staff in, for More senior staff, for example A last resort for when example, the procurement, department managers and the negotiations fail or a party warehousing or shipping legal team, formally renegotiate refuses to renegotiate. department ‘informally’ with the counterparty. renegotiate supply schedules, Some courts/tribunals only look volumes, etc with their Requires full examination of at the words on the page; others counterparts. the contractual wording may try to uncover how/why the to determine who owes what contract was first agreed upon. The supply issues may be to whom. resolved amicably without the need for escalation.

3 Renegotiating long-term contracts

Overview of contract-renegotiation law by jurisdiction

Jurisdiction China England and Wales France Germany Hong Kong Italy Japan Spain US

Is there a Yes – statutory No Yes – Article 1195 Yes – section 313, No No No No No statutory regime? concept of change of the French Civil para.1 of the German of circumstances and Code; only applies to Civil Code statutory concept of contracts entered into force majeure on or after 1 October 2016

Are there key legal No Yes – promissory No No Yes – doctrine Yes – pacta sunt Yes – doctrine of Yes – rebus sic Yes – adequate doctrines relevant estoppel; good faith; of frustration servanda changed circumstances, stantibus clause, assurance; for performance force majeure; material application has been implicit in Spanish- force majeure; under long-term adverse change; limited to a handful law contracts; force material breach contracts? frustration of cases; concept of majeure events the allocation of risks, doctrine has seldom been applied

Is it possible to Yes Yes Yes Yes Yes Yes Yes Yes No – typically, US adjust a contract contracts do not using contractual contain provisions terms? that allow parties to renegotiate the terms post-signing

What are the The contract should It depends on what Hardship clauses The requesting party Existing terms of Hardship clauses Negotiation clauses Contracts tend not to The contract will consequences of set out what the next the contract says tend to specify can gain the right to the contract will tend to specify do not govern govern what happens likely be silent on failed negotiations step is (eg the party If the contract is consequences of a adjust the contract on continue to apply consequences of a what happens if if negotiations fail this point (in the context of who requested the silent on the point, it failure to reach an its own terms Courts will not failure to reach an negotiations fail or or a party refuses contractual terms)? negotiations may be could be terminated agreement The requesting party intervene to rewrite agreement if a party simply to respond to a entitled to rely on unilaterally or may have the right to terms of a contract refuses to respond to renegotiation request force majeure) mutually but this ask courts to adjust if parties are unable a request Renegotiation clauses again depends on the the contract to agree on how the Under the good-faith cannot allow one contract’s wording A clause can give the terms should be obligation, each party of the parties to requesting party the altered must act so as not unilaterally modify right to immediately to betray the other the agreed terms claim under terms of party’s trust in the the amended contract circumstances

4 Contract-renegotiation law by jurisdiction

China

1. General rules on renegotiating contracts 2.2 Negotiation/price-adjustment clauses be excused from performance of the contract or to Contracts can be modified or terminated if relevant While Chinese law does not generally require a terminate the contract, and any right under Chinese circumstances change significantly. However, party to attempt to renegotiate a contract before statute (see section 3) to seek the modification or whether or not a contract can be changed largely that party can invoke a force majeure clause, the termination of the contract from the Chinese courts depends on the individual case. contract itself may impose such a requirement. or in arbitration (see section 4). Whether there is an obligation to renegotiate and If a party seeks to renegotiate a contract due to whether that obligation has arisen will depend 3. Statutory provisions providing the a change in circumstances, and the other party on the specific terms of the relevant clause and possibility to adjust contracts refuses, the former party cannot rewrite the the facts. Chinese law allows parties to rely on changes contract unilaterally. However, that party may be of circumstances and force majeure to modify or entitled to apply to the Chinese courts to modify or It is not uncommon for contracts to provide that terminate a contract, even if the contract itself does terminate the contract on the basis of the change of certain terms (eg pricing or delivery time frames) not expressly provide for such a possibility. circumstances or to terminate the contract on the will be adjusted in accordance with a specific basis of force majeure (see section 3). Such entitlement formula if certain events occur, such as a change in 3.1 Change of circumstances the cost of the underlying raw materials (eg oil). can arise from the terms of the contract itself (see Under the statutory concept of ‘change of section 2) and/or statute (see section 3). 2.3 Consequences of failed negotiations circumstances’ (情势变更), a party that can show a change of circumstances may be entitled to If the contract imposes an obligation to negotiate 2. Contractual terms that can permit renegotiate its contract with its counterparties. in good faith, it is best practice for contracts to adjustment If the parties cannot agree on how the contract specifically set out: 2.1 Change of circumstances/force majeure should be revised, the affected party can seek the clauses • when the negotiations will be deemed to have modification or termination of the contract from the failed (eg upon the expiry of a certain length of Contracts may include change-of-circumstances and Chinese courts or via arbitration (as applicable). time); and force majeure provisions that mirror or broaden the The change of circumstances must: scope of the statutory counterparts of these concepts • what the next step is (eg the party who requested • be a significant change to the fundamental (see section 3), for example by providing that certain the negotiations may be entitled to rely on premise of the contract; events will constitute a change of circumstances or a the force majeure or material adverse change to force majeure event. terminate the contract, or the matter may be • have taken place after the contract was made and referred to expert determination, etc). been unforeseeable at the time of the contract; However, there are differing views on whether, • not constitute a commercial risk, ie a normal under Chinese law, parties can, by agreement, Generally speaking, if the parties cannot agree market risk that can be reasonably anticipated narrow or waive their right to invoke the on how their contract should be amended, the and assumed by the parties; and statutory concepts of change of circumstances existing terms of the contract will continue to apply, and force majeure. subject to any right under a force majeure clause to

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China (continued)

• be obviously unfair to a party if the parties To rely on this concept, a party must notify the other 4. How to deal with a claim for adjustment continue to perform the contract. In other party in a timely manner, and provide evidence of in litigation or arbitration words, this concept applies even where continued the unforeseeable, unavoidable and insurmountable A party seeking to terminate or modify a contract performance of the contract is possible, but event within a reasonable time. Such evidence may on the basis of a change of circumstances can do so obviously unfair. For example, a party may take the form of ‘force majeure certificates’ issued by via litigation or arbitration (as set out in the terms of argue that its manufacturing costs have Chinese authorities such as the China Council for the contract). A party can find itself trying to either significantly increased as a result of shortages the Promotion of International Trade (CCPIT). The enforce or defend itself against such a claim. caused by the coronavirus outbreak, and that CCPIT has, for example, issued such certificates to it would be obviously unfair for the party to have companies facing claims in relation to their failure If parties do not agree on whether the contract has to supply its products to its counterparty at the to fulfil overseas orders due to COVID-19. been terminated by force majeure, the party claiming previously agreed price. force majeure may attempt to rely on it as a defence if Note that such certificates may not be determinative it is sued by other parties for non-performance of its This concept was introduced relatively recently. – a Chinese court, foreign court or international obligations under the contract. Its contours and how it differs from the concept arbitral tribunal may not accept a party’s claim that of force majeure under Chinese law have yet to be a force majeure event has occurred even if that party fully explored. For example, it is not clear what has obtained such a certificate. This is because these amounts to ‘obviously unfair’ under Chinese law. certificates will generally only certify the existence of certain facts, for example that a lockdown was 3.2 Force majeure imposed in a certain city over a certain period of Under the statutory concept of force majeure time. It will be for the court or tribunal to decide (不可抗力), a party is excused from civil liability if that fact constituted a force majeure event in It is not uncommon for contracts if it fails to perform a contract or causes loss each case. to provide that certain terms or damage to other parties due to objective In practice, the Chinese courts have adopted a very circumstances that are unforeseeable, unavoidable will be adjusted in accordance cautious approach to claims of force majeure and and insurmountable. In such circumstances, a party change of circumstances, and it has historically may be entitled to terminate the contract or be with a specific formula if certain been very difficult for a party to successfully exempted partly or wholly from non-performance. invoke those concepts in proceedings before the events occur, such as a change Chinese courts. For example, even during the 2003 in the cost of the underlying SARS outbreak, the Chinese courts found that the outbreak constituted a force majeure event in some raw materials (eg oil). cases but not in others.

6 Contract-renegotiation law by jurisdiction

England and Wales

1. General rules on the interpretation and Further, evidence from pre-contractual negotiations Given the limitations on good-faith obligations in performance of contracts is generally inadmissible. There is a body of English law, if a party wishes to rely on good faith When interpreting the meaning of an English authority in which the courts set out the in the exercise of obligations, best practice is to law-governed contract, the words of the agreement importance of contracts having a commercially include it in the contract, which the courts may will be given their ‘natural and ordinary meaning’. sensible interpretation. But the court will not then consider when interpreting the agreement. rewrite unambiguous terms on behalf of the The essential test is the construction of the parties, even where the result is a commercially 2. General rules on long-term contracts agreement at the time the parties entered into the detrimental position. There are no specific statutory provisions on the contract based on the reasonable person having renegotiation or termination of long-term contracts. all the background knowledge that would have Under English law, the general principle is that been available to the parties in their situation. parties to a contract must comply with its terms. The ability to renegotiate a long-term contract will Recent court judgments continue to emphasise this Subject to certain limited exceptions (examples depend on whether this has been expressly agreed to approach to construction, which is primarily based of which are contained in the following section), by the parties (either up front in the contract or as a on the literal words. a party cannot simply be excused performance of matter of commercial agreement once the contract a contract or seek to step away from it entirely is entered into). The specific circumstances should Although the interpretation of agreements can on the basis that it is no longer commercially be considered in each case. be overlaid by a consideration of the relevant advantageous to continue. circumstances surrounding the transaction, such Nonetheless, in the context of long-term contracts as the overall purpose of the clause and contract There is also no overarching doctrine of good with public bodies and utilities that are subject to as a whole, there are several limits on the range faith in English law and therefore, subject to the public-procurement rules, the parties do not of admissible factual background that can be certain limited exceptions, there is no general have an unfettered right to renegotiate. There are considered. Most relevantly, the ‘parol evidence’ duty to act in good faith when parties are also statutory provisions that should be considered rule provides that extrinsic evidence of the parties’ (re)negotiating a contract. for certain types of construction contracts. intention to vary the agreement cannot There are limited instances where good faith can Contracts that (subject to certain exceptions) be considered. be considered in the consumer context. There are are ‘materially amended’ generally need to be also judgments that indicate an implied duty of good recompeted and comply with formal execution faith in long-term ‘relational’ contracts, requirements. such as joint ventures, but recent cases have significantly limited the instances where the The ability of parties to terminate a contract will duty of good faith can be evoked to challenge also depend on the express terms of the contract. But an agreement in these circumstances. there is also the possibility of terminating a contract on grounds of ‘frustration’ (see section 5).

7 Contract-renegotiation law by jurisdiction

England and Wales (continued)

3. Renegotiation and amendment For a ‘no oral variation’ clause to be effective: Nonetheless, generally in commercial contracts, informal variations are not binding and written 3.1 Renegotiation • there must be words or conduct unequivocally representing that the variation was valid variations supported by adequate consideration are Provisions of a contract that permit the parties notwithstanding any informality; and the best practice for achieving amendments. It is to renegotiate its terms are generally valid and also the case that, if the contract itself were required • something more would be required for that enforceable under English law, including where one by law to be made in writing, it must also be varied purpose than just the informal promise that party has the right to unilaterally change the terms in writing. of the agreement. the variation is valid, which recognises that English law generally requires consideration For long-term contracts, where it is understood that Conversely, the position of provisions that oblige the for an agreement to bind. the circumstances/requirements may change over parties to renegotiate terms of the contract is more time, it is good practice for parties to agree when For an amendment to bind the parties, it is generally complicated and these provisions may, or may not, subsequent events allow revision of the agreement, necessary to show adequate consideration is given. be enforceable. Such terms may not be regarded as setting out clear and precise review clauses that Consideration addresses the exchange of ‘value’ binding but as mere agreements to agree, which are allocate the risk between the parties. generally unenforceable. between the parties for amending the agreement. Promissory estoppel can act as a defence to a claim The position under English law is more difficult As noted above, the courts will assess the terms that can prevent a party relying on one construction in the case of an agreement whereby one party used with limited reference to the factual of a contract, which can have a similar effect to an undertakes an additional obligation, but the other circumstances to assess the extent to which such amendment. It arises in situations where a party party is merely bound to perform its existing clauses are enforceable. relies on a representation that the counterparty will obligations, or an agreement whereby one party not enforce its strict legal rights. However, the scope 3.2 Variation/amendment undertakes an additional obligation, but for the of the doctrine is very narrow and only applies in benefit of that party alone. English law-governed contracts typically include a limited circumstances. provision stating that they can only be varied with There is a line of established authority that supports the consent in writing of all the parties (or, in some the view that, in such a case, the agreement will cases, an agreed majority of the parties). not be effective to vary the contract because no consideration is present. However, recent authorities have adopted a more liberal approach and the courts have been prepared to find consideration and enforce the agreement where it has conferred a ‘practical benefit’ upon the promisor. Whether a practical benefit arises will depend on the particular circumstances of the case.

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England and Wales (continued)

3.3 Severance of invalid terms 4. Contractual protections/risk allocation The typical approach to construction is that a force Where part of a contract is, or becomes, illegal, a in an economic slowdown majeure clause is to be treated as an exemption court may be able to ‘sever’ (ie delete) the relevant As set out above, as with the provisions of the clause and as such is generally strictly construed wording from the contract. contract itself there is no general statutory/ against the party relying on it. The burden of proof automatic rebalancing or obligation to renegotiate lies on the party asserting force majeure. However, the court will only do this where it is long-term contracts. possible to easily delete the offending clause/part of Importantly, additional expense is generally an a clause, where the severance accords with public However, parties in commercial transactions insufficient event to rely on such a clause and the policy, where the remaining terms are supported by frequently agree upfront risk allocation of party seeking to rely on the clause must show adequate consideration and where severing the certain events. that there were no reasonable steps that it clause would not fundamentally change the could have taken to avoid or mitigate the event A contractual term by which one (or both) character of the contract. or its consequences. of the parties is entitled to cancel the contract The court will also not redraft the contract by or is excused from performance of the contract, 4.1 Hardship clauses adding or rearranging words, or by substituting one in whole or in part, or is entitled to suspend A hardship clause allows a remedy where word for another, and it will not sever provisions if performance or to claim an extension of time performance has become ‘excessively onerous’ this would alter the entire nature of the agreement. for performance, upon the happening of a as opposed to impossible (as required for Where the illegal clause is not ‘severable’, the specified event or events beyond his control force majeure). contract becomes entirely void. [emphasis added]. However, generally hardship clauses apply where English law-governed contracts typically include Chitty on Contracts (21st edition) circumstances fundamentally alter the equilibrium a standard clause to evidence that the parties intend Under English law, force majeure is a contractual of the contract because either the cost of a for any illegal provisions to be severed from the construct, in that an express term must be included party’s performance has increased or the value of agreement and for the rest of the contract to survive. in the contract. Although there are general performance received by a party has diminished. This clause may also include an obligation on the principles of interpretation of force majeure clauses in This is often based on movements in the market parties to negotiate in good faith to amend or the case law, whether a particular circumstance is relative to the contract price. The effect is replace any invalid or unenforceable provision with covered in each case turns on the precise language generally that the disadvantaged party can request a valid and enforceable substitute provision. This is of the clause. renegotiations, but this does not entitle the party to so that, after the amendment or replacement, the Often a number of events are specified then withhold performance. commercial effect of the agreement is as close as followed by the words ‘or any other cause beyond If the parties do not reach an agreement, they possible to the effect it would have had if the relevant our control’, which is to be construed as having its provision had not been invalid or unenforceable. can resort to the court or consider breaching or natural meaning. terminating the contract (see section 5). But either action will likely result in the payment of damages to the counterparty.

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England and Wales (continued)

4.2 Price escalation A term should not be implied into a detailed – force majeure clauses, which may allow for A price-escalation clause is, in principle, valid and commercial contract merely because it appears fair termination of the contract without liability. enforceable under English law. or that the parties would have agreed it if it had This will largely depend on the drafting of been suggested to them. the clause and the impact of the event on the For example, it is not unusual for complex, long-term Further, where there is a clearly articulated contract. Unlike the position with frustration construction/infrastructure contracts to contain express term, the courts will be slow to allow the (described below), a force majeure clause can price-escalation clauses that allocate the risk of implication of terms. cover existing or foreseeable events; and who will pay any increased costs depending on how – material adverse change (MAC) clauses, which they arise. The parties can also limit the implication of terms by express terms and entire agreement clauses. permit a party to terminate an agreement Such terms will be interpreted in a relatively (or, in the context of a loan agreement, to literal way (as described in section 1). It is therefore 5. Termination of contracts call an event of default) where there has important for the drafting and scope of any such A further consideration will be whether either party been a material adverse change or a material clauses to be carefully considered at the outset. has a right to terminate the long-term contract. adverse effect. They normally require a high threshold before they can be invoked. (They An additional important factor, including in the English law-governed contracts can terminate for a may be specifically drafted this way or, for context of COVID-19, is that the inclusion of a wide range of reasons, which include: more general provisions, tend to be interpreted price-escalation clause will make it difficult to argue • express termination provisions may provide for this way.) The English courts have held that that an increase in price is an event of force majeure automatic termination either after a specified a party cannot trigger a MAC clause on the (even if it is severe). The clause will be viewed as duration or upon the (non-)occurrence of a basis of circumstances it was aware of when evidence of how the parties allocated this risk. specified event; it signed the contract, unless it could not have 4.3 Implied terms • termination by mutual agreement of the parties; anticipated the extent of the adverse impact. It is also often a requirement that the event that Terms can also be implied into an agreement by the • termination by fundamental or repudiatory triggers the MAC clause is not temporary. courts on several grounds, including: breach of one party. A fundamental breach is a • by statute (eg the Sale of Goods Act); breach that has a far-reaching effect such that Parties could seek to vary an existing long-term it goes to the core or root of the contract and the contract by agreement to include/exclude COVID-19 • to give effect to business efficacy, which is based counterparty to the breach may elect to terminate in force majeure and MAC clauses. This is likely to on the interpretation of notional reasonable (and claim damages) or affirm performance become increasingly relevant in light of disruption people in the parties’ position; and/or (and in turn lose the right to terminate); and triggered by the pandemic. • to recognise custom or usage. • unilateral termination (and in doing so be excused from complying with its obligations) under the terms of the agreements. This might be, for example, where the following clauses are triggered:

10 Contract-renegotiation law by jurisdiction

England and Wales (continued)

It is also possible that agreements can be declared void or rescinded by the courts, such as where Parties could seek to vary an existing long-term the doctrine of frustration applies to set aside contract by agreement to include/exclude COVID-19 an agreement. in force majeure and MAC clauses. This is The doctrine is limited in scope and generally only arises where an event occurs after contract likely to become increasingly relevant in light of formation, which is not either party’s fault, that makes the contract physically or commercially disruption triggered by the pandemic. impossible to fulfil, or renders a party’s obligation radically different from that undertaken when the contract was entered into. The doctrine is narrow and will not be available: • if the contract provides, expressly or impliedly, for the risk of the supervening events that have occurred (eg through a force majeure clause); • simply because a contract has become less economically lucrative; or • if the circumstances were foreseeable.

11 Contract-renegotiation law by jurisdiction

France

1. General rules on renegotiating contracts For contracts entered into on or after 1 October 3. Statutory provisions providing the A contract can sometimes be amended if an event 2016, the parties must verify whether their contract possibility to adjust contracts contains a renegotiation clause, given that the terms fundamentally changes the contract’s equilibrium. 3.1 Possibility to request a renegotiation of a renegotiation clause will take precedence over This can be done on the basis of a contractual clause of the contract tailored to the parties’ contractual relationship (see the statutory regime. As stated in section 2, the statutory regime that section 2) or on the basis of the statutory regime (see In particular, so-called hardship clauses can governs the adjustment of contracts following an section 3). provide that parties must renegotiate if an unforeseeable change in circumstances is applicable The negotiation phase, which exists in both event causes a fundamental alteration of the to contracts entered into on or after 1 October 2016. instances, can be followed by the contract being equilibrium of the contract. In some instances, it is necessary to determine revised by a court or an arbitral tribunal. The obligation to renegotiate the contract entails an whether the statutory regime applies, such as when: obligation to make good-faith efforts, for example by • a contract was entered into before 1 October 2016 2. Contractual terms that can refraining from proposing unreasonable measures and was renewed or extended by the parties on or permit adjustment or by not blocking negotiations. after that date; or A statutory regime that allows contracts to be Hardship clauses tend to be tailored to the parties’ • a framework agreement was signed before adjusted following an unforeseeable change in contractual relationship and specify: 1 October 2016 and contracts implementing it circumstances was instituted in 2016 (Article 1195 were signed on or after that date of the French Civil Code) and applies to contracts • the types of events that can trigger the entered into on or after 1 October 2016 if it is not hardship clause; As the statutory regime is recent, there is little contractually excluded (see section 3). • the circumstances to consider when analysing the feedback on its application. The statutory regime equilibrium of the contract (such as increase in applies unless the parties specifically excluded Except in specific areas of law or where the parties price, delay and lower product/service quality); it, which is often the case in practice, or if they set a specific procedure in advance to revise the included a hardship clause in their contract to • the deadline by which the parties must attempt contract, for contracts entered into before tailor the terms to their contractual relationship to negotiate; and 1 October 2016, a renegotiation clause is therefore (see section 2). the main way for one party to legally demand the • the consequences of a failure to reach an adjustment of the contract in the event of a change agreement. of circumstances.

12 Contract-renegotiation law by jurisdiction

France (continued)

Article 1195 of the Civil Code enables a party to 3.2 Consequences of failed negotiations The obligation to renegotiate request a renegotiation of the contract from its If the conditions for the applicability of Article 1195 counterparty by showing that: of the Civil Code are fulfilled, the contract revision the contract entails an • there has been a change in circumstances that follows a three-step mechanism: obligation to make good-faith (regardless of its nature) was not attributable to 1. The parties attempt to renegotiate the contract the requesting party and was unforeseeable at the – unlike a contractual clause, the law does not efforts, for example by time the contract was concluded; and specify the conditions of renegotiation. refraining from proposing • rendering performance under the contract would 2. In case of refusal or failure, the parties may agree be excessively onerous for a party that has not to either terminate the contract or jointly ask a unreasonable measures or by agreed to bear the risks. court or an arbitral tribunal to adjust the contract. Importantly, the party requesting renegotiation 3. If the parties fail to reach an agreement within not blocking negotiations. must continue performing its obligations. a reasonable time, which is determined on a case-by-case basis, a party can ask a court or an Regarding the excessively onerous nature of arbitral tribunal to revise or terminate the performance, an increase in the cost of a product or contract, according to terms and conditions service is not, in itself, a ground for adjusting the that it decides. contract, as each party must bear the risks of normal variations resulting from the evolution of circumstances that preceded the contract. Whether the ‘excess’ threshold is reached is determined on a case-by-case basis.

13 Contract-renegotiation law by jurisdiction

Germany

1. General rules on renegotiating contracts These clauses share the principle that, if the 2.2 Negotiation clauses Contracts can be amended if relevant circumstances legal requirements are met, the parties must Negotiation clauses, which may be inserted into change significantly. However, whether or not a enter into negotiations with the aim of amending a contract in addition to or instead of adjustment contract can be changed largely depends on the the agreement. clauses, tend to be either: individual case. Ignoring adjustment requests is not recommended • more narrowly framed than adjustment clauses If a party requests that a contract be renegotiated, (see subsection 2.3). and already provide the exact adjustment formula it is recommended that the request is agreed to as (eg for how prices should be adjusted); or 2.1 Adjustment clauses a refusal can give the requesting party the right to • phrased more broadly (eg so that the parties must determine the revised terms without the need for Adjustment clauses, which can be found in many negotiate whenever unforeseen circumstances legal enforcement. long-term supply agreements in the industrial arise during the contract’s term). sector, set out the conditions for requesting changes In addition, a claim for adjustment can be legally to a contract. If such a negotiation clause requires the parties to go enforced via litigation or arbitration (see section 4). beyond just discussing the possibility of changes and The wording of adjustment clauses varies but instead enter straight into meaningful negotiations, The grounds on which a contract can be adjusted generally they: the parties must co-operate. can be found in the contract itself (see section 2) • are broadly phrased in order to cover a range and/or statute (see section 3). However, in many cases, such clauses do not govern of situations; and what happens if negotiations fail or a party simply 2. Contractual terms that can • cover all the economic, technical and legal refuses to respond to a request. permit adjustment changes that are fundamental to – and could trigger the option to adjust – the contract. 2.3 Consequences of failed negotiations When seeking to amend a contract, the contract generally has priority over statute. These changes in circumstances must pass a If negotiations fail, the requesting party can gain threshold of materiality, which is determined the right to simply adjust the contract on its For long-term contracts, it is useful to distinguish on a case-by-case basis. An adjustment is only own terms. between the framework agreement and the (usually possible if the ‘trigger event’ results in the limit one-off) exchange contract. In the framework In other instances, the requesting party may have of what a party can reasonably be expected to agreement, the parties typically allow for the right to ask state courts or arbitral tribunals (as bear being exceeded. adjustments via either proper adjustment clauses the case may be) to adjust the contract. Furthermore, (see subsection 2.1) or negotiation clauses The same test applies to the consequences of the German Federal Court of Justice has ruled that a (see subsection 2.2). an adjustment: the nature of the changes and negotiation clause can also give the requesting party the extent to which they affect the other party the right to immediately claim under the terms of are limited by a standard of reasonableness. the amended contract.

14 Contract-renegotiation law by jurisdiction

Germany (continued)

Therefore, it can be very risky for a party to adopt 4. How to deal with a claim for If negotiations fail, the a ‘wait-and-see’ approach when asked by the other adjustment in litigation or arbitration party to adjust the contract. Claims for adjustment can be legally enforced requesting party can gain via litigation or arbitration (as set out in the terms 3. Statutory provisions providing the of the contract). A party can find itself trying the right to simply adjust possibility to adjust contracts to either enforce or defend itself against such the contract on its If a contract does not contain an adjustment or a an adjustment claim. negotiation clause, the agreement could be amended own terms. A party trying to enforce an adjustment claim under section 313, para.1 of the German Civil Code. may seek to either: For the contract to be amended, there must • have the other party agree to a particular have been – after the conclusion of the contract – adjustment; or a serious change of circumstances: • request that the other party meet its obligations • for which the requesting party does not under a particular adjustment (which can be contractually bear the risk; and more efficient). • that makes it unacceptable for the requesting If a party is defending itself against a claim party to continue meeting its obligations for (non-)performance under the unadjusted under the contract. contract (despite the circumstances having On this second ‘acceptability’ point, while the changed significantly), it can use its claim for pandemic continues, whether or not the requesting adjustment as a defence. party has received state aid may be a relevant consideration.

15 Contract-renegotiation law by jurisdiction

Hong Kong

1. General rules on renegotiating contracts A typical force majeure clause may provide that 2.3 Consequences of failed negotiations As in most common-law jurisdictions a party is excused where it is prevented (or hindered If the contract imposes an obligation to negotiate, (ie jurisdictions where the courts create unwritten or delayed) from performing its obligations due it is best practice for contracts to specifically law via legal precedent), contracts governed by to ‘acts of God, flood, drought, natural disaster, set out: war or any other cause beyond the control Hong Kong law can generally be amended only • when the negotiations will be deemed to have of [that party]’. with the consent of all parties. failed (eg upon the expiry of a certain length There is no generally available right in law to Material adverse change (MAC) clauses allow, of time); and renegotiate or adjust a contract if there is a for example: • what the next step is (eg the party who requested change of circumstances. • buyers in M&A transactions to walk away from the the negotiations may be entitled to rely on the acquisition before closing if events occur that are force majeure or MAC to terminate the contract, However, under common law, the doctrine of materially detrimental to the target company; or or the matter may be referred to expert frustration may allow the parties to treat the determination, etc). contract as discharged if something occurs after • a lender to call a default if there is a ‘material the formation of the contract that makes it adverse change in the borrower’s ability to perform Generally speaking, if the parties cannot agree on physically or commercially impossible to fulfil its obligations under the finance documents’ and/ how their contract should be amended, the existing the contract or transforms its performance into or in the ‘business, operations, property, financial terms of the contract will continue to apply, subject something radically different. condition or prospects’ of the borrower. to any right under a force majeure or MAC to be excused from performance of the contract or to Contracts can also provide that parties will 2.2 Negotiation/price-adjustment clauses terminate the contract. The Hong Kong courts will be excused from performance if there is a While Hong Kong law does not generally require not intervene to rewrite the terms of the contract force majeure event or a material adverse a party to attempt to renegotiate a contract before if the parties are unable to agree on how the terms change in circumstances (see section 2). that party can invoke a force majeure or MAC clause, should be amended. the contract itself may impose such a requirement. 2. Contractual terms that can permit Whether there is an obligation to renegotiate will adjustment depend on the specific terms of the relevant clause 2.1 Force majeure/material adverse change and the facts. Commercial contracts often contain force majeure It is not uncommon for contracts to provide that clauses, which excuse a party from performing certain terms (eg pricing or delivery time frames) in certain circumstances or may even allow for will be adjusted in accordance with a specific termination of the contract without liability. formula if certain events occur, such as a change in the cost of the underlying raw materials (eg oil).

16 Contract-renegotiation law by jurisdiction

Italy

1. General rules on long-term contracts Hardship clauses tend to be tailored to the parties’ The defendant may offer to change the terms of the Under Italian law, the general principle is that contractual relationship and specify: contract to avoid the termination. parties must comply with the contract’s agreed • the types of events that can trigger the However, the Italian Supreme Court has published terms (pacta sunt servanda). The renegotiation of hardship clause; a report stating that, according to the paramount long-term contracts is only allowed in specific • the circumstances to consider when analysing the principle of good faith that underlies the Italian circumstances (eg the terms of a lease contract equilibrium of the contract (such as increase in legal system, the party affected by the imbalance may be renegotiated if the leased asset is affected price, delay and lower product/service quality); may ask the other party to renegotiate the terms by defects). • the deadline by which the parties must attempt of the contract and the latter is under the The parties are allowed to include clauses in the to negotiate; and obligation to renegotiate. contract that allow its terms to be renegotiated • the consequences of a failure to reach an The Supreme Court also added that, if the upon the (non-)occurrence of a specific event. agreement. renegotiation fails, the party disadvantaged by the imbalance can start proceedings to obtain 2. Contractual terms that allow a 3. Legal remedies providing the possibility a judgment by which the terms of the contract renegotiation by the parties to adjust contracts and/or terminate them are adjusted. If the agreement contains provisions that allow Under Italian law, save for specific circumstances, However, the report is not binding on either the parties to renegotiate the terms originally the party to a long-term contract is not entitled to the Supreme Court itself or the lower courts. agreed upon, these provisions prevail over any claim that the terms of the contract have changed In addition, the position taken by the Supreme Court legal remedies. due to unforeseeable circumstances arising that in the report has not yet been tested in any court. Any provision that leaves the validity or the alter the balance of the contract. performance of the contract to the discretion of one Alternatively, the party affected by the imbalance 4. Unilateral termination of commercial of the parties will be considered null and void. may start proceedings for terminating the contract contracts with unlimited duration In particular, so-called hardship clauses can under the following circumstances: Under Italian law, the parties to a contract with provide that parties must renegotiate if an • the event causing the imbalance is exceptional unlimited duration can withdraw from the contract event fundamentally alters the equilibrium and unforeseeable by the party; without cause at any time (a so-called ad nutum termination) even if the contract does not contain of the contract. • the event causing the imbalance is not due to the a withdrawal clause. The obligation to renegotiate the contract entails an conduct of any of the parties; obligation to make good-faith efforts, for example by • the imbalance makes it excessively onerous to A party must notify the other party of its intention refraining from proposing unreasonable measures perform the contract; and to withdraw. If the contract does not specify, the notice period must comply with good faith, or by not blocking negotiations. • the party requesting the termination is not in according to the circumstances of the case. breach of its obligations under the contract.

17 Contract-renegotiation law by jurisdiction

Japan

1. General rules on renegotiating contracts Any question arising out of, or in connection 3. The statutory basis for adjusting Contracts can be amended if relevant circumstances with, this agreement or any matter not stipulated contracts change significantly. However, whether or not a herein shall be settled upon consultation in good If a contract does not contain a negotiation clause contract can be changed largely depends on the faith between the parties hereto. (or it does contain one, but negotiations fail), the individual case. Negotiation clauses usually require the parties to agreement could be amended under the doctrine of ‘changed circumstances’ (jijo henko no gensoku) The grounds on which a contract can be adjusted discuss the possibility of amending the contract but permitted under Japanese law. can be found in the contract itself (see section 2) do not govern what happens if negotiations fail or and/or statute (see section 3). if a party simply refuses to respond to a request. Under this doctrine, the court might allow a contract to be adjusted if the circumstances have In addition, a claim for adjustment can be legally Under the good-faith obligation set out in the changed significantly and the court deems it enforced via litigation or arbitration (see section 4). Japanese Civil Code, each party must act so as not to betray the other party’s trust in the circumstances. unfair for the parties to continue to be bound by the original terms. However, this doctrine is only 2. Contractual terms that can permit For example, if one party refuses to negotiate with allowed in exceptional circumstances, and its actual adjustment the other party and aggressively exercises its rights under the contract, a Japanese court could bar the application has been limited to a handful of cases. When seeking to amend a contract, the contract exercise of those rights, based on a violation of the generally has priority over statute. For example, the court applied the doctrine in a good-faith obligation. However, this would be an case where, in a sale and purchase agreement for For long-term contracts, it is useful to distinguish exceptional outcome, and generally there would not a plot of land, the price of the land significantly between the framework agreement and the (usually be any recourse in the good-faith obligation even if a increased after the agreement was executed. one-off) exchange contract. In the framework party refuses to negotiate. The court concluded that the increase was beyond agreement, the parties may typically seek to make Accordingly, negotiation clauses do not tend to force the parties’ expectations and so it was unreasonable adjustments via negotiation clauses. the parties to adjust the terms of a contract, and and unfair to maintain the purchase price the Such clauses, which are commonly found in thus the parties cannot usually rely on these clauses parties had originally agreed. contracts, tend to include language similar if they seek to enforce a claim for adjustment. The above doctrine is the only statutory provision to the following: under Japanese law that might allow the amendment of a contract. For example, Japanese law does not have a force majeure provision that would allow a party to amend a contract.

18 Contract-renegotiation law by jurisdiction

Japan (continued)

There is a concept of the allocation of risks (kiken futan) in the Japanese Civil Code, where if a Negotiation clauses usually require the party’s performance of its obligation has become parties to discuss the possibility of amending impossible due to reasons not attributable to either party, the other party may refuse to perform its the contract but do not govern what corresponding obligation. However, this doctrine has seldom been applied. happens if negotiations fail or if a party simply refuses to respond to a request. 4. How to deal with a claim for adjustment in litigation or arbitration Claims for adjustment can be legally enforced via litigation or arbitration (as set out in the terms of the contract). A party can find itself trying to either enforce or defend itself against such an adjustment claim. A party trying to enforce an adjustment claim may seek to either: • have the other party agree to a particular adjustment; or • request that the other party meet its obligations under a particular adjustment (which can be more efficient). If a party is defending itself against a claim for (non-)performance under the unadjusted contract (despite the circumstances having changed significantly), it can use its claim for adjustment as a defence.

19 Contract-renegotiation law by jurisdiction

Spain

1. General rules on long-term contracts 2. Contractual terms that allow a The rebus sic stantibus clause derives from Under Spanish law, the general principle is that renegotiation by the parties jurisprudence and is implicit in Spanish-law parties must comply with the contract’s agreed If the agreement contains provisions that allow the contracts. Although there have been contradictory terms (pacta sunt servanda). There are also no specific parties to renegotiate the terms originally agreed decisions, the most recent position of the Spanish statutory provisions that allow for the renegotiation upon, these provisions shall prevail over legal Supreme Court is that the rebus sic stantibus clause of long-term contracts. remedies, if any. only applies to long-term contracts. Terminating the contract before the due date or Any provision that leaves the validity or the For the rebus sic stantibus clause to apply, three altering its conditions is only allowed under certain performance of the contract to the discretion of requirements must be met: circumstances. one of the parties will be considered null and void. 1. The circumstances that prevailed when the • The contract contains clauses that allow its terms Therefore, renegotiation clauses cannot allow one of contract was signed have changed fundamentally to be renegotiated (see section 2). the parties to unilaterally modify the agreed terms. and unforeseeably. • The circumstances that existed when the contract Unfortunately, in many cases, such clauses also 2. The balance of obligations between the was signed have changed fundamentally and do not govern what happens if negotiations fail contracting parties has shifted to the extent that unforeseeably. This is also known as the rebus sic or a party simply refuses to respond to a the cause of the contract is annihilated due to stantibus clause (see section 3.1). renegotiation request. the imbalance of the obligations, which in effect results in the collapse of the contract. • A force majeure event arises that prevents one of the parties from fulfilling its contractual 3. Legal remedies providing the possibility 3. This imbalance of obligations was caused by obligations (see section 3.2). to adjust contracts and/or terminate them the unforeseeable and fundamental change in circumstances. • The contract, such as a distribution or supply There are specific situations that allow the parties to agreement, is of an unlimited duration breach the pacta sunt servanda principle that governs Applying the clause may result in the contract either: Spanish-law contracts. (see section 3.3). • changing for the duration of the changed 3.1 The rebus sic stantibus clause circumstances; or The rebus sic stantibus clause solves issues that arise • terminating – but only if it is impossible to restore when the circumstances that prevailed when the the balance of obligations between the parties. contract was originally agreed have unforeseeably The parties can agree on the circumstances that could and fundamentally changed. In particular, the trigger, and the effects of, the rebus sic stantibus clause. clause helps to restore the balance of obligations between the parties.

20 Contract-renegotiation law by jurisdiction

Spain (continued)

3.2 A force majeure event • If the force majeure event partially prevents the A party must give notice to unilaterally terminate A force majeure event, under certain circumstances, performance of the obligation, the relevant party the contract. If the contract does not specify, may extinguish a party’s contractual obligations does not have to perform the part of the obligation a party must give a notice period that complies under statutory law without the party being liable. that is prevented by the force majeure event but must with good faith, according to the circumstances still perform the part that can be carried out. of the case. For the force majeure event to extinguish a party’s • If the inability to perform is merely temporary, obligations, the event must: In the case of agency contracts, Spanish law the relevant party is not liable for the delay but states that the notice period must be one month • either: must perform when it becomes possible to do for each year that the contract was in force, up – be unforeseeable, ie not occur on a regular or so again. to a maximum of six months. Spanish scholars ordinary basis; or As previously stated in the case of the rebus consider that, in the case of supply or distribution – if foreseeable, be inevitable, insurmountable or sic stantibus clause, parties can agree on the agreements, a notice period of one month before irresistible; circumstances that constitute force majeure terminating the contract generally complies • make it impossible for a party to perform or and the effects of the force majeure event. with good faith. conclude a contractual obligation, against its will However, depending on the circumstances of the 3.3 Unilateral termination of commercial to perform; and case, it could be considered that a one-month contracts with unlimited duration • have caused the change in circumstances that notice period is inappropriate and does not accord affected the party’s ability to meet a contractual If the contract has provisions governing its with good faith, and therefore a different notice obligation. termination, these provisions will prevail over period (shorter or longer, as the case may be) statutory remedies. However, Spanish law would be required. However, whether the existence of a force majeure specifically rejects the idea of contracts with event extinguishes a contractual obligation depends unlimited duration and so allows a unilateral on the extent to which the obligation’s performance termination of the contract without cause is prevented or hindered by the event. (a so-called ad nutum termination). • If the force majeure event makes performance Therefore, commercial contracts typically entered impossible, the relevant party’s obligation into by parties within the industrial sector, such as is extinguished and it is not liable for supply, agency or distribution agreements, allow for non-performance. This does not apply to unilateral termination by one of the parties when payment obligations. they do not specify a duration or state that they are of an unlimited duration.

21 Contract-renegotiation law by jurisdiction

United States

1. General rules on long-term contracts 2. Contractual terms that allow a Until the demanding party receives adequate In the US, the general principle is that parties must renegotiation by the parties assurances, it can usually suspend its future comply with the contract’s agreed-upon terms. Typically, US contracts do not contain provisions performance under the contract. If the counterparty There are also no specific statutory provisions that that allow parties to renegotiate the terms fails to provide adequate assurance, the demanding allow for the renegotiation of long-term contracts. post-signing. That said, parties may choose to engage party may treat this as a repudiation and terminate in negotiations to modify or amend the agreement. the contract. But if the counterparty does provide Parties to a contract governed by US law might adequate assurance of performance, the demanding be able to terminate an agreement when certain However, if the parties choose to engage in party must resume performance to avoid its own unforeseen conditions occur, but they will not negotiations, they should carefully document their breach of the contract. necessarily be able to renegotiate key terms based on correspondence with the counterparty as well as any specific provisions found within the contract. internal correspondence related to their contractual In general, the reasonableness of grounds for obligations. This is because, if negotiations fail, insecurity is a question of fact but, in some cases, The following doctrines allow a party to terminate the parties could end up in litigation, with these the issue has been resolved as a matter of law. an agreement due to unforeseen circumstances. documents becoming part of the record used by Whether an assurance of due performance is • If a party has reasonable grounds to believe a the court to adjudicate the matter. adequate is a fact-intensive inquiry. Courts consider counterparty may not be able to perform, it can several factors when assessing whether a party’s demand reasonable assurance of performance 3. Legal remedies providing the possibility assurance of performance is adequate, including regarding the sale of goods and, in some instances, to terminate an existing agreement the parties’ relationship and prior dealings, the regarding other contractual obligations. After a When circumstances arise that prevent a party from cause of the uncertainty, the non-performing party reasonably demands and fails to receive fulfilling its contractual duties or call into question party’s reputational risk and the time given to adequate assurance from its counterparty, its ability to do so, a counterparty may have the provide assurance. the party may terminate the agreement ability to terminate the contract. (see section 3.1). If the counterparty is able to provide adequate • If the agreement contains a force majeure clause 3.1 Adequate assurance assurance, the demanding party must continue to satisfy its contractual obligations. and such an event arises that prevents one of the The doctrine of adequate assurance (which parties from fulfilling its contractual obligations applies to the sales of goods in all states and (see section 3.2), a party may terminate. other contracts in some jurisdictions) allows a • A material breach by one party will contractual party with reasonable grounds to believe allow a counterparty to terminate that its counterparty will be unable to perform to (see section 3.3). demand that the counterparty provide ‘adequate assurances’ that the counterparty will perform its contractual obligations.

22 Contract-renegotiation law by jurisdiction

United States (continued)

3.2 Force majeure clauses 3.3 Material breach • the extent to which the party failing to perform While there is no statutory force majeure cause of In the US, a party’s duty to perform may be or to offer to perform will suffer forfeiture; action in the US, when agreements contain a force discharged by a counterparty’s prior uncured failure • the likelihood that the party failing to perform majeure clause, a party may use the occurrence of of performance. or to offer to perform will cure its failure, taking a force majeure event to terminate the agreement. account of all the circumstances including any However, courts have held that the counterparty’s reasonable assurances; and The language within the clause determines what breach must be ‘substantial’ or ‘material’ – a minor, types of events will constitute a force majeure. inconsequential breach will not serve to discharge a • the extent to which the behaviour of the party However, these clauses frequently cover acts of God party’s duty. failing to perform or to offer to perform accords and other unforeseeable events that were out of the with standards of good faith and fair dealing. Whether a party’s breach is material would be parties’ control. The party invoking the force majeure determined by a court. Since contract law is clause has the burden of proving that the event was governed by state law in the US, there is no single beyond its control. Typically, financial losses will not uniform standard for materiality. But generally, constitute a force majeure event. a breach is considered to be material when a Even when a contract does not contain an explicit party does not receive the substantial benefit force majeure clause, a party’s non-performance may of its bargain. be excused under the doctrine of impossibility. In determining whether a breach is material, courts Courts may, in some exceptional instances, relieve generally look to several factors, including: a party of its duty to perform when that party’s When circumstances arise that prevent performance is made impracticable because • the extent to which the injured party will be of the occurrence of an event, the non-occurrence deprived of the benefit that it reasonably expected; a party from fulfilling its contractual of which was a basic underlying assumption of • the extent to which the injured party can be duties or call into question its ability the contract. adequately compensated for the part of that benefit of which it will be deprived; As with force majeure clauses, the party asserting the to do so, a counterparty may have impossibility must prove that it is not at fault. the ability to terminate the contract.

23 Renegotiating long-term contracts

Contacts

Yong Wei Chan Kate Gough Dimitri Lecat Christophe Seraglini Moritz Becker Counsel, Hong Kong, Counsel, London, Partner, Paris, Partner, Paris, Partner, Düsseldorf, Dispute Resolution Dispute Resolution Dispute Resolution Dispute Resolution Dispute Resolution T +852 2913 2678 T +44 20 7427 3122 T +33 1 44 56 55 14 T +33 1 44 56 33 42 T +49 211 49 79 258 E yongwei.chan E kate.gough E dimitri.lecat E christophe.seraglini E moritz.becker @freshfields.com @freshfields.com @freshfields.com @freshfields.com @freshfields.com

Giuseppe Curtò Joaquin Terceño Rafael Murillo Timothy Harkness Partner, Milan, Partner, Tokyo, Partner, Madrid Partner, New York, Dispute Resolution Dispute Resolution Dispute Resolution Dispute Resolution T +39 02 625 30358 T +81 3 3584 8475 T +34 91 700 3740 T +1 212 230 4610 E giuseppe.curto E joaquin.terceno E rafael.murillo E timothy.harkness @freshfields.com @freshfields.com @freshfields.com @freshfields.com

24 freshfields.com

This material is provided by the international law firm Freshfields Bruckhaus Deringer LLP (a limited liability partnership organised under the laws of England and Wales authorised and regulated by the Solicitors Regulation Authority (SRA no. 484861)) and associated entities and undertakings carrying on business under, or including, the name Freshfields Bruckhaus Deringer in a number of jurisdictions, together referred to in the material as ‘Freshfields’. For further regulatory information please refer to www.freshfields.com/support/legal-notice. Freshfields Bruckhaus Deringer has offices in Austria, Bahrain, Belgium, China, England, France, Germany, Hong Kong, Italy, Japan, the Netherlands, Russia, Singapore, Spain, the United Arab Emirates, the United States of America and Vietnam. This material is for general information only and is not intended to provide legal advice.