US-Iran Conflict: Contractual Risks for Global Supply Chains

At a Glance

• Identify and assess contracts most at risk from supply chain disruption and price volatility.
• Maintain thorough records of disruptions and steps taken to mitigate their impact. Comply strictly with contractual provisions if seeking relief.
• Consult with legal counsel at all stages — particularly before invoking force majeure or termination rights — to reduce the risk of unintended liability and to maximize productive and positive outcomes.

The ongoing conflict in Iran and the wider Middle East is causing instability across global supply chains. Disruption to shipping in the Strait of Hormuz and the resulting shocks to energy markets are having global consequences, including for businesses dependent on timely deliveries, stable prices, and reliable logistics.

Other recent geopolitical crises (including the COVID-19 pandemic and the Russia-Ukraine conflict) suggest these current events will lead to an increase in commercial contract disputes, with parties seeking variously to avoid or enforce their contractual obligations.

The merits of a contracting party’s position will always turn on the construction of the contract in question, in accordance with its governing law. However, there are several aspects of English and US commercial contracts that commonly come into play in such situations.

Common Contractual Protections

Force Majeure Clauses

Force Majeure (FM) clauses excuse performance if it becomes impossible or impracticable due to events like war, armed conflict, or government actions. They may also provide a right to terminate.

• The party seeking performance will argue for a narrow construction of the FM provision, limiting the counterparty’s ability to claim relief. It will challenge any suggestion that the event in question caused an inability to perform, and seize upon any failure by the party invoking FM to comply with contractual notification provisions or to mitigate the effect of the event in question.
• The party seeking to terminate or suspend will seek to rely on a broad construction, including of specified events such as “war”, “armed conflict”, “acts of government”, “fire or explosion”, etc. It will argue the event in question fits within the specified events, caused its failure to perform, that it has taken appropriate mitigation steps, and potentially that the prolonged duration of the event gives rise to a right to terminate the contract.

Material Adverse Change Clauses

Material adverse change (MAC) and material adverse event (MAE) clauses generally provide for renegotiation, variation, or termination if circumstances change significantly, in a way that was unforeseen at the time of contracting, affecting the contract’s value or feasibility. Triggers can be subjective or objective.

• The party seeking performance will argue the threshold for a MAC or MAE is not met.
• The party seeking termination will again press for a broad construction, potentially citing financial, operational, or supply chain disruptions; price jumps; or loss of market access as amounting to a material adverse change.

Frustration

Frustration may apply where an unforeseen event occurs after formation of the contract that is beyond the parties’ control and renders performance of the contract fruitless due to radical transformation of the obligations originally entered into. In addition, under English law, frustration also applies where the contract has become impossible to fulfil (which is not the fault of either party).

Under English common law, a frustrated contract is automatically discharged with the parties being excused their future obligations. The potentially extreme consequences of the common law rule are moderated by the Law Reform (Frustrated Contracts) Act 1943, which applies to most commercial contracts governed by English law.

While rare, examples of situations in which an English court has discharged a contract for frustration include the destruction of the subject matter of a contract, supervening illegality of performance, abnormal delay in performance due to an unexpected event, and the outbreak of war between states in which either party is domiciled.

In many US jurisdictions, as in English common law, frustration of contract relieves both contracting parties from performance. In some cases, one or more contracting parties may still be obligated to perform if the language of the contract so provides. US courts have found frustration following changes in government regulation, fundamental shifts in a party’s position, and unforeseeable changes in market prices.

Impossibility

Under US law, impossibility applies where the performance of a contract becomes objectively impossible or unreasonably burdensome to perform due to a circumstance unforeseen at the time of contracting. Examples often cited for unforeseen events are destruction of subject matter, change in government regulation, natural disasters, and war. An increase in difficulty or expense to perform under a contract often will not meet the level necessary to establish impossibility.

In an English context, impossibility can repudiate a contract in circumstances where one party has acted or defaulted (deliberately or otherwise) in such a way that performance is rendered impossible. This is distinct from frustration, where the fact that the contract has become impossible to fulfil is not the fault of either party.

Performance Obligations

Clauses specifying performance and delivery obligation are critical during shortages and delays. “Reasonable” or “best” endeavours wording within contracts will be relevant to the interpretation of performance obligations. War-related disruption may affect what is deemed “reasonable”, and disputes may arise as to what is specifically required to meet that threshold.

In the Delaware Court of Chancery, for example, where reasonable efforts clauses are often analyzed in the context of corporate acquisitions and mergers, courts have stated that a best-efforts obligation is implicitly qualified by a reasonableness standard, which does not require a contracting party to do “everything possible under the sun.”¹ This same standard is also often interpreted within the bounds of commercial reasonability.

• The party seeking performance will likely hold its counterparty to strict performance and resist attempts to excuse delays not expressly permitted by the contract.
• The party seeking to terminate or renegotiate may argue that war-related disruptions justify late or non-performance.

Price Adjustment & Volatility Clauses

Contracts may allow for price adjustments — e.g., due to changes in raw material, commodity, or transportation prices — allowing for renegotiation or automatic adjustment.

• The seller may seek to pass on increased costs or renegotiate.
• The buyer will likely resist price adjustments, except where clearly stated. The buyer may argue that the clause in question is an unenforceable — or in the US jurisdictions only, partially enforceable — agreement to agree.

Termination

Contracts may allow for termination in certain conditions. Disputes may arise over whether termination thresholds have been met, the calculation of termination payments, and the consequences for goods and services already delivered.

• The party seeking performance will seek to limit termination rights and ensure any termination triggers are tightly construed. It will also seek to capitalize on any failure to comply with notification and other contractual requirements regarding termination.
• The party seeking to terminate will insist on a broad interpretation of termination rights, perhaps arguing that war-related disruption provides a trigger event.

Practical Steps for Parties to Commercial Contracts

1. Identify and assess contracts most at risk from supply chain disruption and price volatility.
2. Consider early engagement with counterparties to clarify positions and potentially avoid escalation.
3. Maintain thorough records of disruptions and steps taken to mitigate their impact.
4. Comply strictly with contractual provisions if seeking relief.
5. Understand and follow the contractual process for amending or varying your contract if that is the chosen course.
6. Consult with legal counsel at all stages — particularly before invoking force majeure or termination rights — to reduce the risk of unintended liability and to maximize productive and positive outcomes.