The California Oil Industry’s Use of Force Majeure Claims in the Wake of COVID-19

COVID-19 Update

The precipitous drop in the demand for oil is not going away anytime soon. Some models suggest that it will be eight or nine years before the price per barrel of crude oil returns to February 2020 pricing. In the past, oil and gas companies have used mergers and acquisitions as an escape hatch during economic downturns. But as we all have repeatedly heard, COVID-19 is “unprecedented.” Aside from the dearth of financing for deals and operators’ misgivings about selling at the bottom of the market, extreme price volatility has effectively taken that option off the table. Meanwhile, buyers are not buying and, therefore, producers are not producing. And analysts project that oil storage in the United States may fill up by May and globally by June. Local petroleum product storage is already exhausted in most of California.

In response to these troubling realities, parties at all points of the supply chain for the production and sale of oil and gas will claim force majeure—perhaps all at once. A claim for force majeure excuses a party from a contractual performance obligation where it is prevented from performing due to an event (or force) outside of its reasonable control. Courts will enforce force majeure provisions of contracts as written.

Below are some basic tips in managing force majeure claims:

Responding to a Force Majeure Claim

  • Scrutinize the Contract Language: Carefully read the force majeure clause in the contract, and then read it again. Is the claimed “force majeure event” actually covered by the contract? In tackling a force majeure claim, a court’s paramount concern will be to determine whether the parties’ written contract evidences an intent for a specific contingency to be covered or not. Courts never want to rewrite a contract and, with the likely deluge of force majeure claims in the wake of COVID-19, they will likely be more discerning than ever when determining whether litigants actually contemplated for a particular event to be covered by their force majeure provision.

    For example, your contract may state that force majeure is limited to very specific events expressly spelled out in the provision. As a result, a court may conclude that no other events—other than those listed—are covered.

    Alternatively, the definition of a “force majeure event” may expressly exclude changes in the financial markets or carve out certain obligations of the parties under the contract.
  • The Notice Provision: Compare the force majeure clause in the contract to the counterparty’s notice. What is stated in the notice may be different from what the force majeure provision actually covers. Also, confirm that the counterparty has otherwise complied with notice provisions (e.g., timeliness of the notice and whether any required supporting documentation has been served). Though atypical, if a force majeure notice requests your acceptance via a signature, do not countersign. Doing so may constitute a waiver of future claims.
  • Alternate Method of Performance: Evaluate whether the contract terms provide for an alternate method of performance, including deferred performance. Such terms may give rise to an argument that the force majeure provision is inapplicable because the contract terms provide the counterparty with a pathway to performance.

Making a Force Majeure Claim

  • Again, Scrutinize the Contract Language: Carefully review the force majeure provision in the contract in order to determine whether the force majeure event is expressly covered or whether the general language of the provision is sufficient to capture the event.
  • Comply With Notice Provision: Make sure you comply precisely with any notice requirements, including timely serving the notice, which may be a condition precedent to any relief.
  • Substantiate Your Efforts to Mitigate: Document and record your efforts to mitigate against your inability to comply.
  • Receipt of a Force Majeure Claim May Trigger Your Own Claim: If you have received a force majeure notice from an upstream party, it may trigger the need for you to issue your own force majeure notices to downstream parties in the supply chain. Even if the notice you received is invalid, depending on the terms of your downstream contracts and the particular circumstance you face, you may nevertheless have a bona fide force majeure claim as to your downstream obligations.

What If Your Contract Does Not Contain a Force Majeure Clause?

  • Frustration of Purpose: In California, you may be able to invoke the doctrine of frustration of purpose. The doctrine of frustration applies when performance remains possible but the fundamental reason of both parties for entering into the contract has been frustrated by an unanticipated supervening circumstance, destroying substantially the value of performance by the party standing on the contract.
  • Impossibility: California law also recognizes the doctrine of impossibility. “Impossibility” has been defined as not only strict impossibility but as impracticability because of extreme and unreasonable difficulty, expense, injury or loss involved. Courts have recognized temporary impossibility where a duty under a contract is suspended while the impossibility exists.
  • Both defenses to contractual performance are highly factual and courts have interpreted them narrowly. But in the absence of a clear force majeure provision, companies should evaluate with the assistance of counsel whether these doctrines provide relief from present or upcoming contractual obligations.

Please contact Craig Moyer or Viral Mehta if you need assistance navigating these issues with your upstream or downstream contracts.

manatt-black

ATTORNEY ADVERTISING

pursuant to New York DR 2-101(f)

© 2020 Manatt, Phelps & Phillips, LLP.

All rights reserved