International Contracts and Geopolitical Instability: How to Protect Your Business with a Hardship Clause

In today’s environment, marked by growing geopolitical instability, conflicts, trade tensions and sudden shifts in economic and tariff policies, the economic balance originally agreed by the parties to an international commercial contract may be significantly disrupted. Unforeseen events arising after the contract has been entered into may make the performance of contractual obligations considerably more onerous for one of the parties, or more generally affect the economic balance of the transaction, without making performance impossible. How, then, can the parties protect themselves against this risk in advance?

It is in this context that hardship clauses play a particularly important role in international commercial contracts, as a means of addressing the consequences of unforeseen events capable of significantly altering the original balance of the contractual relationship. International contracts, precisely because they involve parties from different countries, are more exposed than domestic contracts to the risk that, during their performance, an unforeseen event may occur that makes one party’s performance excessively more onerous.

Among the events capable of affecting the economic balance of international commercial contracts is the introduction or increase of customs tariffs after the contract has been entered into. Recent developments in international trade policy, and in particular the United States’ use of tariffs across various sectors, show how sudden increases in import costs can significantly alter the economic framework of transactions that have already been agreed. In such circumstances, including a hardship clause may prove particularly useful, as it enables the parties to regulate in advance the consequences of such events and establish a renegotiation mechanism aimed, where possible, at preserving the economic balance and continuity of the contractual relationship.

Before examining hardship in greater detail, an important distinction should be made. Hardship must be distinguished from force majeure. Force majeure concerns an impediment to performance and may release a party from liability for non-performance; hardship, by contrast, presupposes that performance remains possible, but that the contractual equilibrium has been fundamentally altered.

Hardship under the UNIDROIT Principles and the ICC Hardship Clause 2020

The principal instruments developed for international commercial contracting are the 2016 UNIDROIT Principles and the ICC Hardship Clause 2020. The former set out a general framework governing hardship, while the latter constitutes a model clause prepared by the International Chamber of Commerce for incorporation into international contracts.
Section 2 of Chapter 6 of the UNIDROIT Principles of International Commercial Contracts addresses hardship on the basis of the principle of the binding force of contracts. The party therefore remains bound to perform even where performance has become more onerous than anticipated at the time the contract was concluded.

Hardship exists where events fundamentally alter the equilibrium of the contract, either because the cost of a party’s performance has increased or because the value of the performance received by a party has diminished. In addition to this requirement, four conditions must be satisfied:

• the events occur, or become known to the disadvantaged party, after the conclusion of the contract;
• they could not reasonably have been taken into account at the time of the conclusion of the contract;
• they are beyond the control of the disadvantaged party;
• the risk of such events was not assumed by that party.

A central element is the gravity of the alteration of the contractual equilibrium. Moreover, a supervening event cannot give rise to hardship where it could reasonably have been taken into account by the disadvantaged party at the time the contract was concluded. The allocation of risk is similarly relevant: hardship cannot be invoked where the risk of the supervening event was assumed by the party seeking to rely on it.

The disadvantaged party has the right to request renegotiation without undue delay, stating the grounds on which the request is based. However, a request for renegotiation does not automatically confer a right to suspend performance. The disadvantaged party therefore remains, in principle, under an obligation to perform during the renegotiation process. Renegotiation must also take place within a reasonable period of time.

If the parties fail to reach an agreement within a reasonable period of time, either party may refer the matter to the court. Where the existence of hardship is established, the court may, where it considers this reasonable, terminate the contract on such date and subject to such conditions as it may determine, or adapt the contract with a view to restoring its equilibrium. Judicial adaptation may, for example, also entail a modification of the price, without necessarily implying full compensation for the loss suffered by the disadvantaged party.

The ICC Hardship Clause 2020 adopts a similar approach. As a general rule, a party remains bound to perform its obligations even where circumstances have rendered performance more onerous than could reasonably have been anticipated at the time the contract was concluded. The party invoking the clause must establish that performance of its obligations has become excessively onerous as a result of an event beyond its reasonable control, which could not reasonably have been taken into account at the time of the conclusion of the contract and which could not reasonably have been avoided or overcome, including its consequences.

The ICC Hardship Clause 2020 likewise places particular emphasis on the consequences of the failure of renegotiation. The fundamental choice concerns the role to be assigned to the court or arbitral tribunal and, in particular, the possibility of conferring upon it the power to adapt the contract where the parties have been unable to reach a negotiated solution on their own. Accordingly, in the event of failure to reach an agreement, the ICC model provides for three different options: Option A grants the party invoking hardship the right to terminate the contract; Option B allows either party to request the court or arbitral tribunal to adapt the contract with a view to restoring its equilibrium or to terminate it; Option C, by contrast, allows the court or arbitral tribunal to be requested exclusively to terminate the contract.

What Happens if the Contract Does Not Include a Hardship Clause?

The ICC Hardship Clause 2020, discussed above, is a model clause intended to be incorporated into the contract. Its provisions therefore presuppose that the parties have chosen to incorporate or reproduce it in their agreement.
In the absence of a specific contractual provision, the remedies available depend on the law applicable to the contractual relationship, bearing in mind that national legal systems may adopt different approaches both with regard to renegotiation and to the consequences of a failure to reach an agreement.

Where Italian law applies, Article 1467 of the Italian Civil Code provides that, in contracts for continuous or periodic performance or deferred performance, the party whose performance has become excessively onerous as a result of extraordinary and unforeseeable events may seek termination of the contract. Termination may not be sought where the subsequent increase in onerousness falls within the normal risk inherent in the contract. The party against whom termination is sought may also avoid termination by offering to modify the contractual terms fairly.

Italian law therefore adopts a structure that differs from the international hardship models that directly grant the disadvantaged party the right to request renegotiation and, in certain circumstances, also contemplate judicial or arbitral adaptation of the contract.

Hardship Clauses in International Contracts: Conclusions

In light of the foregoing analysis, the hardship clause proves particularly useful where the parties are exposed to the risk of circumstances arising that are neither reasonably foreseeable nor attributable to their sphere of control, and that are capable of significantly altering the original contractual equilibrium.

Its function is to promote the renegotiation of the terms originally agreed upon, so as to allow, where possible, the continuation of the contractual relationship on terms compatible with the new economic framework resulting from the supervening event. The ability to reconcile the stability of the contractual obligation with the need to adapt to changed circumstances is one of the principal reasons for the usefulness of the hardship clause in international commercial contracts.

Dott. Greta Bosio - de Capoa Law Firm