13 November 2019 by Disoute Resolution Alert

Invoking hardship in difficult economic times to renegotiate commercial obligations

With suppressed economic activity in South Africa, suppliers, distributors and service providers are all feeling the economic pinch and seeking various means to obtain some financial reprieve to remain sustainable for the next economic upswing. While the obvious option may be business rescue proceedings, such a solution comes with its own pitfalls. Parties in long-term commercial relationships often look to rather explore options to re-negotiation the commercial terms that underpin their relationship.

Hardship clauses

Long-term agreements in the mining, energy and natural resources sectors ordinarily contain a hardship provision which allows, under certain well-defined circumstances, one of the contracting parties to submit a request to the other contracting party for the re-negotiation of particular commercial terms causing economic hardship. A hardship dispute may arise, for example, if the production cost for goods, say mined ore, becomes unsustainable for the miner/supplier relative to the purchase price for such product. Since the outcome usually introduces a material change in the commercial terms that underpin the relationship, parties often get locked into protracted negotiations and sometimes arbitration to achieve a fair landing on the new commercial terms.

By incorporating a hardship clause in their final agreement, parties essentially create a contractual regime to regulate unforeseen circumstances to deal with any severe financial impact on the long-term sustainability of the relationship. The purpose behind any hardship clause is thus to ensure the commercial relationship operates on the basis of commercial fairness.

A hardship provision typically triggers when a new situation or circumstance arises that:

  • is outside the control of the affected party;

  • could not reasonably have been anticipated by the affected party at the time of the conclusion of the agreement; and

  • results in:
    • a major material disadvantage to affected party and a corresponding major material advantage to the other party; or
    • severe hardship to the affected party without any advantage to the other party.

If these criteria are met, the affected party may then serve a notice on the other party setting out the relevant circumstances with such expert evidence to support the hardship being experienced.

Renegotiating commercial terms

With complex long-term supply arrangements in which both parties to the commercial relationship are interdependent on each other (for example, a dedicated coal mine for a particular power station), it is normally easier to renegotiate commercial terms (such as price, quantity and qualities). However, due to the potential financial impact re-negotiation may have on a counterparty’s commercial terms (such as a higher price for product), the counterparty will probably push back. Thus, before invoking any hardship provision under an agreement it is important to strategize on the end-goal and understand all the commercial pushbacks of the counterparty. The major problem with hardship provisions is that the process can take a significant time to conclude and during that period the hardship experienced by the affected party usually persists. If the counterparty is a state-owned entity or government, it adds an additional layer of complexity. In addition to the commercial considerations during the negotiation to deal with the hardship event, public entities or governments may have certain prescribed legislative requirements to meet before being able to agree to any amendments to existing commercial arrangements.

Before any negotiations under a hardship notice can commence, there is a process in place for the counterparty to react to the validity of the affected party’s hardship notice and/or the commencement date of the alleged hardship. If the counterparty disputes the validity of the hardship and/or the commencement date of the alleged hardship, the matter is referred to arbitration for an arbitrator to settle the issue. Once resolved, the parties may commence with negotiations to deal with the so-called relevant circumstances causing the hardship as set out in the hardship notice. Should the parties fail to agree on an appropriate amendment to the agreement to deal with the hardship, the particular issues which inhibit the conclusion of amendments to the agreement will go to an arbitrator for final resolution.    

Any party to an agreement that contains a hardship provision must ensure a strategy is developed that deals with all possible eventualities, especially how to avoid being dragged into disputes with the counterparty as opposed to quickly resolving real issues that affect the long-term sustainability of the relationship. A party invoking a hardship negotiation with arrogance risks the counterparty pulling-up its arms to dispute the hardship – dragging the hardship process out for an undefined period of time, costing money and potentially jeopardising the long-term relationship.

What if there is no hardship clause?

If a long-term agreement does not provide for re-negotiation through a hardship clause, it may be possible to consider whether a case can be made out for impossibility of performance. Under South African law a party may avoid obligations under a valid agreement under the doctrine of supervening impossibility. A supervening impossibility arises if, pursuant to a valid agreement having come into existence, performance of an obligation arising from it becomes objectively and permanently impossible through no fault of either of the parties. The typical examples of such impossibility are irresistible force (vis maior) or unforeseeable accident (casus fortuitus). Most commercial agreements contain a vis maior/force majeure and/or casus fortuitus clause – clauses that are usually distinguishable from hardship provisions.

Conclusion

In tough economic times, tough decisions must be made by businesses to ensure sustainability in the long run. When re-negotiating pertinent commercial terms, it is important to have a well-defined strategy that deals with all the pertinent matters to entice the counterparty to negotiate in good faith in the shortest possible time to achieve a long-term commercial benefit for both parties. Failure to do so may result in unnecessary arbitrations and negotiations that outlast the actual period of economic hardship.

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