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"When markets are disrupted - such by during geopolitical conflicts, pandemics, sanctions, shipping disruptions or extreme price swings - the fault lines in long‑term arrangements that once appeared robust are exposed."
Contracts are performed quietly in the background, liftings are made, invoices paid and legal and regulatory risk is largely theoretical. Long‑term commodity contracts are designed to provide certainty in an uncertain world. They secure supply, stabilise pricing structures and underpin strategic trading relationships across volatile markets and complex geographies.
But when markets are disrupted – such by during geopolitical conflicts, pandemics, sanctions, shipping disruptions or extreme price swings – the fault lines in long‑term arrangements that once appeared robust are exposed. Contracts negotiated in one economic cycle may become deeply uneconomic – or operationally fragile – in the next. Contracts that appeared fully performable only weeks ago may suddenly become commercially unattractive, or even operationally impossible, to perform. These contracts are then stress‑tested in real time and often in full public view through disputes and arbitrations.
A practical playbook to management defaults in long-term commodity contracts
Every period of market stress feels unique to those experiencing it, leading to the claim of the ‘unprecedented’ crisis. However, to a trained pair of legal eyes, many of the challenges facing commodity traders today are familiar. Courts and tribunals have long grappled with arguments rooted in frustration, force majeure, repudiation and mitigation arising out of wars, canal closures, trade embargoes and financial crises. The legal positions on long‑term commodity contracts have adapted to the new circumstances of these ‘black swan’ events but are fundamentally rooted in long tried-and-tested principles. This continuity offers both comfort and warning: crises do not rewrite legal doctrine but they do punish the imprudent.
Pre-empting defaults: drafting for stability
Careful drafting remains the first and most effective line of defence against later disputes. Clarity around commencement and termination dates, levels of contractual commitment and the sequencing of obligations is essential, particularly for agreements spanning many years.
Volume mechanisms, such as annual or quarterly delivery obligations, take or pay provisions and make up rights, continue to play a central role in balancing risk between buyer and seller. Equally important is operational and optimisation flexibility, whether through alternative sourcing rights, destination flexibility or substitution clauses that allow parties to adapt to changing market conditions without defaulting.
Security packages, including guarantees and indemnities, performance bonds, standby letters of credit, assignments of shares and receivables etc. should be backed by reputable entities and/or institutions. Careful drafting is also required to ensure that such security can be enforced in situations of default. Drafting, however, has its limits. No contract can anticipate every shock. The true test begins when performance falters.
Wilful defaults in long-term commodity contracts
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"When markets turn sharply, non-performance is often driven less by impossibility than by economics."
When markets turn sharply, non-performance is often driven less by impossibility than by economics. Long-term contracts that move out of the money place considerable strain on parties, particularly where one party begins to explore creative legal defences to justify what is, at its core, a pricing or commercial decision.
For the innocent party, the early strategic objective should be clarity, not escalation. Establishing liability at the outset – by dismantling unsustainable defences and fixing responsibility – can fundamentally reshape the trajectory of a dispute. Once liability is clear, the conversation moves away from excusing performance and towards valuation, mitigation and resolution. For a defaulting party, reflexive resistance made solely on instinct and without sufficient basis can be costly. Putting forth legally or factually deficient defences and/or disputing liability without a credible legal foundation rarely succeeds when the merits of a dispute are scrutinised by trained judges and arbitrators, and often only increases costs for the parties involved.
What should the strategy be in practice? The following sets out guidance for parties to protect their positions if issues arise in the performance of long-term contracts.
Start (and end) with the contract
When confronted with changed circumstances the first and most important step is deceptively simple: read the contract.
Specifically:
- what are the parties’ obligations?;
- when and how must those obligations be performed?; and
- are those obligations absolute or qualified by external events?
Too often, commercial teams form strong views on how such changed circumstances inevitably mean obligations cannot be performed. Whilst there is sympathy and understanding that emotions run high from the urgency and pressure in these situations, it must be emphasised that legal relief does not arise from how dire the situation feels but from what the contract and the law allows. This in turn requires examining how the terms of the contract are drafted and whether the facts fall within the scope of such terms.
For in-house legal teams, this means immediately assembling and reviewing the full wording of the contract along with entire suite of underlying documents. Given that these situations are often time sensitive and involve multiple trades contracts in rapidly evolving (and often fast deteriorating) circumstances, an in-house legal team may struggle to accord each of these matters with the attention they demand. Accordingly, in-house legal teams should engage trusted external counsel, as early as possible, for the management of such matters.
For traders and commercial teams, the takeaway here is to resist the instinct to assume that changed circumstances automatically excuse performance and to seek advice from their in-house legal advisors early on, if not at the inception of the changed circumstances.
Force majeure and Material Adverse Change (“MAC”) clauses: need for precision
Clauses that are often turned to in long-term commodity contracts in situations of changed circumstance affecting the performance of obligations would be the force majeure provisions. However, force majeure remains one of the most misunderstood concepts in commodity trading.
In brief, force majeure is not a doctrine of fairness: it is a strictly contractual mechanism where relief exists only to the extent expressly provided for in the contract and only if the factual circumstances fall squarely within the specified wording. To rely on force majeure, a party must usually demonstrate:
- the existence of a qualifying event expressly covered by the wording of the clause;
- a causal link between that event and the inability or hindrance to perform; and
- compliance with any notice, mitigation and evidence requirements.
"In brief, force majeure is not a doctrine of fairness: it is a strictly contractual mechanism where relief exists only to the extent expressly provided for in the contract and only if the factual circumstances fall squarely within the specified wording."
Whilst not typically found in commodity contracts, another form of contractual mechanism that parties are increasingly borrowing from finance transactions is MAC or hardship provisions. MAC clauses operate similarly to force majeure clauses and are highly contract specific. The relief available, the trigger threshold and the consequences of invoking the clause depend entirely on drafting.
In the absence of express wording, parties are left with common law doctrines such as frustration or impossibility of performance. Both of these common law defences have far higher thresholds to meet: (a) a party seeking to rely on the doctrines of frustration or impossibility of performance would usually be required to demonstrate that an unexpected event has occurred that fundamentally changes the situation and that performance is therefore rendered truly impossible, illegal and/or radically different from what parties originally agreed; and (b) the contract is not typically rendered frustrated or impossible to perform on the basis that performance has become more difficult to perform.
Economic change is not typically a legal escape
One of the most persistent arguments raised in distressed long‑term contracts is that dramatic shifts in economic conditions should excuse performance, whether in reliance of force majeure provisions or under the common law doctrines of frustration or impossibility of performance. English law has consistently found otherwise. In this regard, it should be noted with caution that a contract is not typically frustrated or rendered impossible to perform simply because performance has become more expensive, less profitable or commercially inconvenient.
Indeed, it was held in Davis Contractors Ltd v Fareham UDC [1956] AC 696 that frustration will only be applicable where performance becomes “radically different from that which was undertaken”. Similarly, in Tsakiroglou & Co Ltd v Noblee Thorl GmbH [1962] AC 93, the court ruled that a contract for the sale of groundnuts, to be carried from Sudan to Hamburg via the Suez Canal, was not frustrated even though the Suez Canal was shut and shipment round the Cape of Good Hope would have cost the sellers a 100% increase in freight. The court ruled that the contract was not frustrated because it was not the case that “shipment was prevented by the closure of the Suez Canal”.
We have published in-depth commentaries on force majeure and relevant considerations, including those in light of the recent Strait of Hormuz disruptions.
Party in default: termination and mitigation
Termination of long-term commodity contracts
In long-term supply relationships, a missed or delayed shipment often triggers strong reactions. An often-instinctive response to treat the contract as repudiated can be both legally and commercially dangerous.
In this regard, unless provided expressly as a ground of termination in the underlying contract, the position under English law is that a breach relating to a single shipment will not ordinarily entitle the innocent party to terminate the entire agreement. As established in Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26, termination usually requires a breach that goes to the root of the contract and deprives the innocent party of substantially the whole benefit of the bargain.
Further, it is imperative to note that wrongful termination reverses the legal position entirely, where the party wrongfully terminating the contract would be held in repudiatory breach. This then exposes the terminating party to potentially substantial liability for the remaining term of the contract.
"It is imperative to note that wrongful termination reverses the legal position entirely, where the party wrongfully terminating the contract would be held in repudiatory breach."
From a commercial perspective, terminating a long-term contract on account of a single (or a few) shipment/s can be potentially damaging to the commercial relationships between the parties. Long-term commodity contracts often underpin strategic relationships and supply chains; terminating for a single shipment breach may damage relationships, potentially causing greater harm than the breach itself. Preserving relationships through pragmatic solutions, such as renegotiating delivery terms or agreeing on compensation, can safeguard continuity and reduce litigation risk.
It is therefore crucial that decisions to terminate long-term contracts must be taken with restraint supported by strong evidence and careful legal analysis.
Mitigation: mandatory not optional
Once the liability of the defaulting party is established, the innocent party’s obligations continue. Mitigation is a key principle in English contract law and plays a critical role in managing risk in long-term commodity agreements. When a breach occurs, the innocent party cannot allow losses to accumulate. Instead, they are under a legal duty to take reasonable steps to reduce the impact of the breach. Failing to mitigate can limit the damages which can be recovered. The courts have consistently reinforced this obligation. In British Westinghouse Electric and Manufacturing Co Ltd v Underground Electric Railways Co of London Ltd [1912] AC 673, the House of Lords held that a claimant must act reasonably to minimise loss, even if that involves incurring some expense.
Likewise, if contractual wording requires a party to mitigate (e.g. in the event of force majeure or before a right to terminate can be exercised), this is a mandatory requirement.
For commodity contracts, mitigation may involve sourcing alternative supply, reselling cargoes into the market, adjusting hedging positions or renegotiating delivery schedules. These steps can shape how tribunals assess credibility, reasonableness and ultimately quantum. Parties that mitigate promptly and can evidence their decision‑making tend to place themselves in materially stronger positions, often resolving disputes before proceedings escalate.
Evidence determines outcomes
"English law sets a high bar for doctrines like frustration and repudiation, meaning parties cannot rely on these principles to escape a bad bargain or terminate for minor breaches. Instead, proactive risk management is essential."
In a dispute, the outcome will depend on evidence. In a crisis, the commercial priority is to ‘trade through’ the disruption, i.e. to secure alternative supply, manage exposure or renegotiate downstream positions. Evidence collection understandably feels secondary.
However, to a court or tribunal, evidence is paramount. The court or tribunal’s decision will inevitably depend on whether the evidence adduced in the proceedings supports or detracts from a party’s case. For example, a seller unable to load cargo due to shipping disruptions must be able to show attempts to source tonnage, including engagement with the freight market, rejection by shipowners and rejection despite the offer of risk premiums. This is where experienced external counsel can add immediate value by managing evidence preservation in parallel with commercial mitigation.
Conclusion
Long-term commodity contracts present unique challenges that go beyond the initial negotiation and drafting stages. Issues such as frustration, repudiation, mitigation and the calculation of quantum require careful legal and commercial consideration. English law sets a high bar for doctrines like frustration and repudiation, meaning parties cannot rely on these principles to escape a bad bargain or terminate for minor breaches. Instead, proactive risk management is essential.
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