Contractual risk allocation in times of uncertainty

Global warming, natural disasters, migration, the Covid-19 pandemic, material shortages, supply chain bottlenecks, the war in Ukraine, surging energy prices, soaring inflation and looming stagflation ­­­­– Europe and the world are facing several overlapping, interrelated crises that give rise to plenty of risks and lessen business confidence among market players. Against this backdrop, contractual provisions addressing risk allocation and reducing risk to the absolute minimum are constantly gaining in importance.

Force majeure clauses

Force majeure clauses, also called hardship or vis maior clauses, typically cover situations where the contracting party cannot fulfil its contractual obligations due to an unforeseen event beyond its control. The Anglo-American term "act of God" used to describe force majeure events is restrictive in the sense that force majeure certainly also includes events triggered by human actions such as war, strikes and terrorism. Since the Austrian Civil Code does not provide a definition of force majeure events, reference to the Austrian Supreme Court shall be made. In the Court's reading the term "force majeure" (höhere Gewalt) stands for an "extraordinary event affecting the business from outside which does not occur with a certain frequency and regularity, and is not to be expected, and which can neither be averted nor rendered harmless in its consequences by the utmost reasonable care".

In the interests of clarity and of establishing a secure legal framework, a force majeure clause may list the circumstances explicitly or even describe the events invoking such a clause. A different approach would be to include a "catch-all" phrase that comprises all possible force majeure events. The wording and thus the scope of application of force majeure clauses is subject to the discretion of the parties (Privatautonomie). The clause may set out that all objectively uninfluenceable events qualify as force majeure or merely those that are at the same time subjectively unforeseen. In addition, the impact of force majeure events may vary from making the performance impossible, illegal or inadvisable, to commercially impracticable.

Further differentiation can be made in respect of the standard of care (Sorgfaltspflicht), the obligation to take reasonable measures in order to avert force majeure events, or legal impossibility (Abwendungspflicht). However, the standards set for such criteria should not be too high and should constitute reasonable efforts, otherwise the party concerned can be made liable for the consequences of accidental legal impossibility. In other words, in the case of an obligation to avert force majeure events without limitation, a performance guarantee would be imposed on the affected party.

Similar to the reach of force majeure events, the legal consequences of invoking force majeure clauses can also be determined by the parties. Usually, notification obligations, suspension of contractual performance, rights of rescission (termination), cancellation of contractual performance obligations or exclusion of liability are considered and agreed upon as legal consequences. A viable approach could be to initially suspend the obligation to perform as long as the impediment to performance exists, backed up with the possibility of adjusting the contract to the new circumstances, or to entitle the affected party to terminate the contract after a certain period of time. The International Chamber of Commerce offers model clauses for force majeure which basically follow the method described above (can be found here). Without doubt, it is advisable to include an ICC model clause individually tailored to the parties' needs.

MAC/MAE clauses

Material Adverse Change or Material Adverse Effect clauses address significant (permanent) negative developments in circumstances of utmost relevance for the legal transaction (Rechtsgeschäft). They are primarily used in M&A transactions (as negative closing conditions), financing agreements and long-term supply contracts to grant the parties the right of rescission or, if the clause is designed as a representation, a claim for compensation or price reduction.

The terms MAC clause and MAE clause differ in meaning from each other as follows: whereas Material Adverse Change exclusively encompasses new changes in substantial circumstances occurring after the contract is concluded, Material Adverse Effect also includes circumstances already existing at the time the contract was concluded, which nevertheless profoundly deteriorated compared to the situation at the time of conclusion. The requirement in each case is unforeseeability and that the contracting party would not have concluded the contract (with the same content) if it had been aware of the worsening of the circumstances.

When incorporating an MAC/MAE clause into the contract, material adverse events must be defined prudently. They can either be described vaguely with a general phrase (and potential carve-outs) to leave room for interpretation, or they can be drafted precisely by defining a catalogue of triggering events. Catalogues must be interpreted with a pinch of salt, as an exhaustive list of MAC/MAE events will hardly be possible due to their actual purpose of protecting against unforeseeable risks. The range of events covered by MAC/MAE clauses is subject to the legal transaction concerned and bargaining power of the parties. Typically, reference is made to the operative business of the target company (key financial figures), relevant market environment, financing of the transaction or force majeure scenarios. Material adverse events affecting subsidiaries or target group companies can also be subject to MAC/MAE clauses.

It is common to define quantified thresholds (also by percentage) for materiality below which the clause cannot be invoked. If the materiality threshold is not defined, the basic motives of the parties to conclude the contract, their market behaviour with respect to the averted circumstance prior to concluding the contract, the duration of consequences and other provisions of the contract will be analysed. If these aspects indicate that the event for the affected party is material, legal consequences, primarily those mentioned above, stipulated by the contract will apply.

Price variation clauses

Price variation clauses are meant to protect the equilibrium between price and service to be paid for. They are typically incorporated in long-term contracts to counter inflation and sudden material price changes that occur in the time between signing and performing the contract and thus to rebalance the value of the services. Price variation clauses can be split into value protection clauses (Preisgleitklausel) and price adjustment clauses (Preisanpassungsklausel). The former link the consideration to a variable reference value (e.g. the consumer price index) and thus "automatically" compensate for price fluctuations without the need for any declaration to invoke the clause. Depending on the discretion of the parties, price alteration can take place with every change in the reference value or only when the change exceeds a certain threshold. In contrast, price adjustment clauses do not provide for any automatism, but merely grant the right to unilaterally adjust the consideration based on variable reference values by way of a declaration.

Different rules apply for b2c and b2b contracts. In the case of consumer contracts, Section 6 (1)(5) of the Austrian Consumer Protection Act provides strict rules for price variation clauses. It stipulates that the entrepreneur may unilaterally increase the consideration payable for the service by the consumer if (i) the clause provides for reciprocity, meaning it considers price decreases to the same extent as price increases, (ii) the circumstances determining the change in the consideration are described precisely in the contract and are objectively justified, and (iii) the occurrence of such circumstances does not depend on the entrepreneur's will (e.g. change in material and energy prices). The circumstances stated in the contract must be justified, i.e. they must be objectively related to the specific contract, in particular to the entrepreneur's business and its costs. Furthermore, the price variation mechanism (and the circumstances) must be sufficiently transparent for the consumer to anticipate the consequences of such a clause.

In the case of b2b contracts the law is less restrictive and leaves greater leeway for the parties. The reciprocity of price increases and decreases, and the prohibition of arbitrary pricing, (willkürliche Preisfestsetzung) are also applicable to price variation clauses between entrepreneurs. Section 1056 of the Austrian Civil Code does not contain any material prerequisites for price determination. However, according to case law the price determination must not be obviously unreasonable (offenbar unbillig) and exceed what the other party could have expected. If this is the case, and the price was determined without reasonable discretion (billiges Ermessen), an adjustment by the court can be requested.

Conclusion

While each of the clauses presented above is somewhat different, they have the same goal: to mitigate the risk of uncertainty. Recent unforeseen events like the Covid-19 pandemic and the Ukraine crisis have drawn attention to contractual arrangements countering legal uncertainties. It is anticipated that these arrangements will gain in importance in the coming years.

author: Gabor Kulcsar