Performing under pressure: Invoking hardship in energy and natural resources contracts

The hardship theory, a notion embodied in differently in various legal systems, such as the German "Wegfall der Geschaftgrundslage" or the French "Théorie de l'Imprévision", broadly refers to the unforeseeable external modification of a contractual relationship that renders performance excessively onerous for one side to fulfil.

This theory is particularly significant in the energy and natural resources sector, which is governed by powerful and often erratic external factors including price volatility, cross-border relationships, complex supply chains and long-term agreements – all of which are vulnerable to modification.

Even though different legal systems have reached common ground on definitions of hardship, its application in practice has proved more troublesome.

Some recent codifications, notably in France and Belgium, have provided greater legal certainty respecting hardship.

Reluctant to wait for the law to catch up, however, the natural resources industry has developed contractual solutions to hardship cases.

Risk response

Given the high level of risk in natural resources markets, energy and mining companies struggle to prevent negative consequences from changes in circumstances, which could not have been foreseen or avoided.

These consequences typically make it much more difficult and expensive for a party to fulfil their side of the contract than was factored into the original agreement – for example, if input costs rise or logistical delivery mechanisms (such as pipelines or shipping arrangements) are cut off.

The classic clause companies seek to rely on in such cases is "force majeure", which renders performance technically impossible on a temporary or definitive basis.

Contractual practice provides for remedies in force majeure situations, such as suspension or termination of the contract, without allocating any damages to the suffering party.

In contrast with force majeure, which is well-established in most jurisdictions, hardship, which merely renders performance harder or more onerous to an unreasonable and/or radical extent, has been more complicated to deal with.

As hardship is more open to interpretation and generally less accepted or even rejected by courts, contractual arrangements have been of paramount importance in establishing hardship as a functioning legal device – especially in energy contracts.

Common components of hardship

Usually, the factual elements required to trigger hardship consist of a change of circumstances, an impediment to the performance of the party, a fundamental alteration of the equilibrium of the contract, or the vanishing of the basis of the contract – i.e., creating "turmoil" within the agreement.

Importantly, it is not the change of circumstances in itself which triggers hardship, but the consequences stemming from it.

If parties fail to agree on whether or not hardship has occurred, evaluation of the threshold at which hardship is triggered – i.e., the gravity of the turmoil – is generally left to the courts to determine on a case-by-case basis.

Even though it could theoretically promote legal certainty, it is very difficult to pre-set a numerical threshold for hardship, as every case will have its own unique circumstances.

Three main criteria are unconditionally required to trigger hardship, namely:

• The origin of the hardship must be external and not be caused by the behaviour of the aggrieved party, even indirectly;

• The origin event or events must not have been foreseen or foreseeable at the moment of conclusion of the contract between the parties;

• The aggrieved party must have taken reasonable steps to prevent negative consequences on the economical equilibrium of the contract stemming from the event.

There is also a hypothetical element of the hardship theory: it concerns the probability that the party which suffers the negative consequences of the hardship would not have entered the contractual relationship under the new economical balance between the parties created by the hardship.

In practice, the hypothetical element can be very delicate to establish and usually comes down to what the contract states about risks and remedies.

Legal remedies

Once hardship has been established, the aggrieved party is then free to access remedies.

Generally, remedies involve adapting contract terms with the aim of reinstating the previous balance with the contractual agreement, or establishing a new balance agreeable to both sides.

While some legal systems vest judges with the power to modify agreements, it is more common to allow the aggrieved party to demand a renegotiation, or oblige the other party to offer this.

The ultimate commonly provided remedy is termination of the contract, which usually happens if the parties fail to renegotiate or if the adapted contract remains impossible to perform.

Contractual approaches to hardship in the natural resources sector

Energy and natural resources contracts are generally characterised by lengthy terms and often have international components.

This means agreements are highly vulnerable to changes of circumstances within political, economic, legal and even technical spheres.

In such cases, comprehensive contracts have proved to be the best shield against the intervention of harsh, sudden and unforeseen contractual distortions and imbalances.

Hence, hardship clauses have been developed and inserted in many types of contract, including power purchase agreements (PPAs), SWAP agreements, concessions, public-private partnerships (PPPs) and sale agreements.

A high degree of precision and forethought is required for the layout and shaping of the hardship clause to offer the best chances for contracting parties to preserve their interests and the longevity of their relationship.

The clause will need to cover in detail:

• The effects of the triggering event on the contract (what these are and how serious these need to be for hardship to exist);

• The arrangement of the renegotiation process and the desired consequences;

• The remedies available to the parties if renegotiation fails (these might include resorting to a judge or arbitrator, or termination of the contract);

• And, finally, the conditions that must be met to resort to termination.

If an agreement does not provide for renegotiation through a hardship clause, it may be possible to make a case for impossibility of performance, or rely on a force majeure clause. However, in most cases, it is desirable to include a hardship clause to guard against turmoil.

The future of hardship

The concept of hardship as a practical alternative to force majeure in circumstances where contracts are disrupted but not frustrated appears to have been welcomed in most European jurisdictions. 

Its contractual embodiment has been well developed through international "soft" law and contractual practices, but recent developments have shown that equity, good faith and the protection of the purpose of the contract have been harder to reconcile with the hardship theory in formal legal codes.

Adaptation of the law has been achieved in France, Belgium and Germany, as the logical consequence of long and well-established contractual practice and it is possible that other European jurisdictions will eventually follow suit.

These developments are largely positive for the energy and natural resources sector in particular, as guarantees of legal certainty and long-term continuous contractual interactions in what are by their nature are often high-risk deals.

Nevertheless, clients in these sectors are only well served if the hardship clauses are well-drafted by industry experts with the necessary experience to deliver precise, comprehensive contracts.

*David Haverbeke is partner in the energy and utilities practice in Fieldfisher's Brussels office and visiting scholar at the University of Aberdeen. Guillian Baclin is legal assistant in the energy and utilities practice in Fieldfisher's Brussels office and LLM student in energy and climate law at the University of Groningen. A full version of the article "Hardship in the Energy Sector" can be accessed via Oil, Gas & Energy Law D. Haverbeke; G. Baclin (2019) "Hardship in the Energy Sector" (OGEL, ISSN 1875-418X) August 2019, www.ogel.org.