HARDSHIP UNDER THE UNIDROIT PRINCIPLES – Part 1

In this first part, we delve into the specific articles of the UNIDROIT Principles, exploring how they define and manage hardship scenarios, thereby providing a structured approach to renegotiation and potential judicial intervention.

A. Text

Article 6.2.1

Where the performance of a contract becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations subject to the following provisions on hardship.

Article 6.2.2

There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and

(a) the events occur or become known to the disadvantaged party after the conclusion of the contract;
(b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;
(c) the events are beyond the control of the disadvantaged party; and
(d) the risk of the events was not assumed by the disadvantaged party.

Article 6.2.3

1) In case of hardship the disadvantaged party is entitled to request renegotiations. The request shall be made without undue delay and shall indicate the grounds on which it is based.
(2) The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
(3) Upon failure to reach agreement within a reasonable time either party may resort to the court.
(4) If the court finds hardship it may, if reasonable,
(a) terminate the contract at a date and on terms to be fixed; or
(b) adapt the contract with a view to restoring its equilibrium.

B. HARDSHIP PROVISIONS & HARDSHIP CLAUSES IN INTERNATIONAL BUSINESS CONTRACTS

As an introduction, it seems interesting to remind the reader of the definition of force majeure and of the difference between force majeure and hardship.

Whereas force majeure is an unforeseeable event which prevents a party from fulfilling its contractual obligations or fulfill them on time and excuses such non-performance or delay, hardship refers to a change in economic circumstances which prevents no party from fulfilling its contractual obligations, but makes performance of the whole contract much less profitable for this party – or even costly for this party, with the latter actually losing money because of the contract¹.

The phenomenon of hardship has been acknowledged by various legal systems under the guise of other concepts such as frustration of purpose, Wegfall der Geschäftsgrundlage, imprévision, eccessiva onerosità sopravvenuta, etc. The term hardship is used because it is widely known in international trade practice as confirmed by the inclusion in many international contracts of so-called hardship clauses.

Several domestic laws thus deal with hardship situations, through rules intended to protect the disadvantaged party in case events have rendered performance more onerous than could reasonably have been anticipated at the time of the conclusion of the contract. However, the solutions adopted by national laws may be substantially different from country to country. When the national laws request the parties to renegotiate the contract, and the renegotiation fails, the consequences of such failure may vary: under some laws the disadvantaged party will only be entitled to terminate the contract, while under others the disadvantaged party will have the right to request adaptation of the contract to the changed circumstances by the judge or arbitrator.

I. UNIDROIT PRINCIPLES²

1. Article 6.2.1

Where the performance of a contract becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations subject to the following provisions on hardship.

Binding character of the contract the general rule

The purpose of this Article is to make it clear that as a consequence of the general principle of the binding character of the contract (see Article 1.3) performance must be rendered as long as it is possible and regardless of the burden it may impose on the performing party. In other words, even if a party experiences heavy losses instead of the expected profits or the performance has become meaningless for that party the terms of the contract must nevertheless be respected.

Illustration

A, a forwarding agent, enters into a two-year shipping contract with B, a carrier. Under the contract B is bound to ship certain goods from country X to country Y at a fixed rate, on a monthly basis throughout the two-year period. Two years later, alleging a substantial increase in the price of fuel in the aftermath of a political crisis in the region, B requests a five per cent increase in the rate. B is not entitled to such an increase because B bears the risk of its performance becoming more onerous.

2. Change in circumstances relevant only in exceptional cases

The principle of the binding character of the contract is not however an absolute one. When supervening circumstances are such that they lead to a fundamental alteration of the equilibrium of the contract, they create an exceptional situation referred to in the Principles as “hardship” and dealt with in Article 6.2.2:

Article 6.2.2

There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and
(a) the events occur or become known to the disadvantaged party after the conclusion of the contract;
(b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;
(c) the events are beyond the control of the disadvantaged party; and
(d) the risk of the events was not assumed by the disadvantaged party.

Hardship defined

This Article defines hardship as a situation where the occurrence of events fundamentally alters the equilibrium of the contract, provided that those events meet the requirements which are laid down in sub-paragraphs (a) to (d).

Fundamental alteration of equilibrium of the contract

Since the general principle is that a change in circumstances does not affect the obligation to perform (see Article 6.2.1), it follows that hardship may not be invoked unless the alteration of the equilibrium of the contract is fundamental. Whether an alteration is “fundamental” in a given case will of course depend upon the circumstances.

Illustration

In September 1989 A, a dealer in electronic goods situated in the former German Democratic Republic, purchases stocks from B, situated in country X, also a former socialist country. The goods are to be delivered by B in December 1990. In November 1990, A informs B that the goods are no longer of any use to it, claiming that after the unification of the German Democratic Republic and the Federal Republic of Germany and the opening of the former German Democratic Republic to the international market there is no longer any market for such goods imported from country X. Unless the circumstances indicate otherwise, A is entitled to invoke hardship.

a. Increase in cost of performance

In practice a fundamental alteration in the equilibrium of the contract may manifest itself in two different but related ways. The first is characterised by a substantial increase in the cost for one party of performing its obligation. This party will normally be the one who is to perform the non-monetary obligation. The substantial increase in the cost may, for instance, be due to a dramatic rise in the price of the raw materials necessary for the production of the goods or the rendering of the services, or to the introduction of new safety regulations requiring far more expensive production procedures.

b. Decrease in value of the performance received by one party

The second manifestation of hardship is characterised by a substantial decrease in the value of the performance received by one party, including cases where the performance no longer has any value at all for the receiving party. The performance may relate either to a monetary or a non-monetary obligation. The substantial decrease in the value or the total loss of any value of the performance may be due either to drastic changes in market conditions (e.g. the effect of a dramatic increase in inflation on a contractually agreed price) or the frustration of the purpose for which the performance was required (e.g. the effect of a prohibition to build on a plot of land acquired for building purposes or the effect of an export embargo on goods acquired with a view to their subsequent export). The decrease in value of the performance must be capable of objective measurement: a mere change in the personal opinion of the receiving party as to the value of the performance is of no relevance. As to the frustration of the purpose of the performance, this can only be taken into account when the purpose in question was known or at least ought to have been known to both parties.

Additional requirements for hardship to arise

a. Events occur or become known after conclusion of the contract

According to sub-paragraph (a) of this Article, the events causing hardship must take place or become known to the disadvantaged party after the conclusion of the contract. If that party had known of those events when entering into the contract, it would have been able to take them into account at that time. In such a case that party may not subsequently rely on hardship.

b. Events could not reasonably have been taken into account by disadvantaged party

Even if the change in circumstances occurs after the conclusion of the contract, sub-paragraph (b) of this Article makes it clear that such circumstances cannot cause hardship if they could reasonably have been taken into account by the disadvantaged party at the time the contract was concluded.

Illustrations

• A agrees to supply B with crude oil from country X at a fixed price for the next five years, notwithstanding the acute political tensions in the region. Two years after the conclusion of the contract, a war erupts between contending factions in neighbouring countries. The war results in a world energy crisis and oil prices increase drastically. A is not entitled to invoke hardship because such a rise in the price of crude oil was not unforeseeable.Sometimes the change in circumstances is gradual, but the final result of those gradual changes may constitute a case of hardship. If the change began before the contract was concluded, hardship will not arise unless the pace of change increases dramatically during the life of the contract.
• In a sales contract between A and B the price is expressed in the currency of country X, a currency the value of which was already depreciating slowly against other major currencies before the conclusion of the contract. One month thereafter a political crisis in country X leads to a massive devaluation of its currency of the order of 80%. Unless the circumstances indicate otherwise, this constitutes a case of hardship, since such a dramatic acceleration of the loss of value of the currency of country X was not foreseeable.

c. Events beyond the control of disadvantaged party

Under sub-paragraph (c) of this Article a case of hardship can only arise if the events causing the hardship are beyond the control of the disadvantaged party.

d. Risks must not have been assumed by disadvantaged party

Under sub-paragraph (d) there can be no hardship if the disadvantaged party had assumed the risk of the change in circumstances. The word “assumption” makes it clear that the risks need not have been taken over expressly, but that this may follow from the very nature of the contract. A party who enters into a speculative transaction is deemed to accept a certain degree of risk, even though it may not have been fully aware of that risk at the time it entered into the contract.

Illustration

A, an insurance company specialised in the insurance of shipping risks, requests an additional premium from those of its customers who have contracts which include the risks of war and civil insurrection, so as to meet the substantially greater risk to which it is exposed following upon the simultaneous outbreak of war and civil insurrection in three countries in the same region. A is not entitled to such an adaptation of the contract, since by the war and civil insurrection clauses insurance companies assume these risks even if three countries are affected at the same time.

Hardship relevant only to performance not yet rendered

By its very nature hardship can only become of relevance with respect to performances still to be rendered: once a party has performed, it is no longer entitled to invoke a substantial increase in the costs of its performance or a substantial decrease in the value of the performance it receives as a consequence of a change in circumstances which occurs after such performance. If the fundamental alteration in the equilibrium of the contract occurs at a time when performance has been only partially rendered, hardship can be of relevance only to the parts of the performance still to be rendered.

Illustration

A enters into a contract with B, a waste disposal company in country X, for the purpose of arranging the storage of its waste. The contract provides for a four-year term and a fixed price per ton of waste. Two years after the conclusion of the contract, the environmental movement in country X gains ground and the Government of country X prescribes prices for storing waste which are ten times higher than before. B may successfully invoke hardship only with respect to the two remaining years of the life of the contract.

Hardship normally relevant to long-term contracts

Although this Article does not expressly exclude the possibility of hardship being invoked in respect of other kinds of contract, hardship will normally be of relevance to long-term contracts, i.e. those where the performance of at least one party extends over a certain period of time.

Hardship and force majeure

In view of the definitions of hardship in this Article and force majeure in Article 7.1.7, under the Principles there may be factual situations which can at the same time be considered as cases of hardship and of force majeure. If this is the case, it is for the party affected by these events to decide which remedy to pursue. If it invokes force majeure, it is with a view to its non-performance being excused. If, on the other hand, a party invokes hardship, this is in the first instance for the purpose of renegotiating the terms of the contract so as to allow the contract to be kept alive although on revised terms.

Hardship and contract practice

The definition of hardship in this Article is necessarily of a rather general character. International commercial contracts often contain much more precise and elaborate provisions in this regard. The parties may therefore find it appropriate to adapt the content of this Article so as to take account of the particular features of the specific transaction.

3. Article 6.2.3

1) In case of hardship the disadvantaged party is entitled to request renegotiations. The request shall be made without undue delay and shall indicate the grounds on which it is based.
(2) The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
(3) Upon failure to reach agreement within a reasonable time either party may resort to the court.
(4) If the court finds hardship it may, if reasonable,
(a) terminate the contract at a date and on terms to be fixed; or
(b) adapt the contract with a view to restoring its equilibrium.

Disadvantaged party entitled to request renegotiations

Since hardship consists in a fundamental alteration of the equilibrium of the contract, paragraph (1) of this Article in the first instance entitles the disadvantaged party to request the other party to enter into renegotiation of the original terms of the contract with a view to adapting them to the changed circumstances.

Illustration

• A, a construction company situated in country X, enters into a lump sum contract with B, a governmental agency, for the erection of a plant in country Y. Most of the sophisticated machinery has to be imported from abroad. Due to an unexpected devaluation of the currency of country Y, which is the currency of payment, the cost of the machinery increases dramatically. A is entitled to request B to renegotiate the original contract price so as to adapt it to the changed circumstances.A request for renegotiations is not admissible where the contract itself already incorporates a clause providing for the automatic adaptation of the contract (e.g. a clause providing for automatic indexation of the price if certain events occur).
• The facts are the same as in Illustration 1, except that the contract contains a price indexation clause relating to variations in the cost of materials and labour. A is not entitled to request a renegotiation of the price.However, even in such a case renegotiation on account of hardship would not be precluded if the adaptation clause incorporated in the contract did not contemplate the events giving rise to hardship.
• The facts are the same as in Illustration 2, except that the substantial increase in A’s costs is due to the adoption of new safety regulations in country Y. A is entitled to request B to renegotiate the original contract price so as to adapt it to the changed circumstances.

Request for renegotiations without undue delay

The request for renegotiations must be made as quickly as possible after the time at which hardship is alleged to have occurred (paragraph (1)). The precise time for requesting renegotiations will depend upon the circumstances of the case: it may, for instance, be longer when the change in circumstances takes place gradually (see Comment 3(b) on Article 6.2.2).

The disadvantaged party does not lose its right to request renegotiations simply because it fails to act without undue delay. The delay in making the request may however affect the finding as to whether hardship actually existed and, if so, its consequences for the contract.

Grounds for request for renegotiations

Paragraph (1) of this Article also imposes on the disadvantaged party a duty to indicate the grounds on which the request for renegotiations is based, so as to permit the other party better to assess whether or not the request for renegotiations is justified. An incomplete request is to be considered as not being raised in time, unless the grounds of the alleged hardship are so obvious that they need not be spelt out in the request.

Failure to set forth the grounds on which the request for renegotiations is based may have similar effects to those resulting from undue delay in making the request (see Comment 2 on this Article).

Request for renegotiations and withholding of performance

Paragraph (2) of this Article provides that the request for renegotiations does not of itself entitle the disadvantaged party to withhold performance. The reason for this lies in the exceptional character of hardship and in the risk of possible abuses of the remedy. Withholding performance may be justified only in extraordinary circumstances.

Illustration

A enters into a contract with B for the construction of a plant. The plant is to be built in country X, which adopts new safety regulations after the conclusion of the contract. The new regulations require additional apparatus and thereby fundamentally alter the equilibrium of the contract making A’s performance substantially more onerous. A is entitled to request renegotiations and may withhold performance in view of the time it needs to implement the new safety regulations, but it may also withhold the delivery of the additional apparatus, for as long as the corresponding price adaptation is not agreed.

Renegotiations in good faith

Although nothing is said in this Article to that effect, both the request for renegotiations by the disadvantaged party and the conduct of both parties during the renegotiation process are subject to the general principle of good faith and fair dealing (see Article 1.7) and to the duty of co-operation (see Article 5.1.3). Thus the disadvantaged party must honestly believe that a case of hardship actually exists and not request renegotiations as a purely tactical manoeuvre. Similarly, once the request has been made, both parties must conduct the renegotiations in a constructive manner, in particular by refraining from any form of obstruction and by providing all the necessary information.

Resort to the court upon failure to reach an agreement

If the parties fail to reach agreement on the adaptation of the contract to the changed circumstances within a reasonable time, paragraph (3) of this Article authorises either party to resort to the court. Such a situation may arise either because the non-disadvantaged party completely ignored the request for renegotiations or because the renegotiations, although conducted by both parties in good faith, did not have a positive outcome. How long a party must wait before resorting to the court will depend on the complexity of the issues to be settled and the particular circumstances of the case.

Court measures in case of hardship

According to paragraph (4) of this Article a court which finds that a hardship situation exists may react in a number of different ways.

A first possibility is for it to terminate the contract. However, since termination in this case does not depend on non-performance by one of the parties, its effects on the performances already rendered might be different from those provided for by the rules governing termination in general (see Articles 7.3.1. et seq.). Accordingly, paragraph (4)(a) provides that termination shall take place “at a date and on terms to be fixed” by the court.

Another possibility would be for a court to adapt the contract with a view to restoring its equilibrium (paragraph (4)(b)). In so doing the court will seek to make a fair distribution of the losses between the parties. This may or may not, depending on the nature of the hardship, involve a price adaptation. However, if it does, the adaptation will not necessarily reflect in full the loss entailed by the change in circumstances, since the court will, for instance, have to consider the extent to which one of the parties has taken a risk and the extent to which the party entitled to receive a performance may still benefit from that performance.

Paragraph (4) of this Article expressly states that the court may terminate or adapt the contract only when this is reasonable. The circumstances may even be such that neither termination nor adaptation is appropriate and in consequence the only reasonable solution will be for the court either to direct the parties to resume negotiations with a view to reaching agreement on the adaptation of the contract, or to confirm the terms of the contract as they stand.

Illustration

A, an exporter, undertakes to supply B, an importer in country X, with beer for three years. Two years after the conclusion of the contract new legislation is introduced in country X prohibiting the sale and consumption of alcoholic drinks. B immediately invokes hardship and requests A to renegotiate the contract. A recognises that hardship has occurred, but refuses to accept the modifications of the contract proposed by B. After one month of fruitless discussions B resorts to the court.

If B has the possibility to sell the beer in a neighbouring country, although at a substantially lower price, the court may decide to uphold the contract but to reduce the agreed price.

If on the contrary B has no such possibility, it may be reasonable for the court to terminate the contract, at the same time however requiring B to pay A for the last consignment still en route.

____

¹ According to the saying, cum grano salis: “Force majeure concerns natural earthquakes in the starting point, whereas hardship concerns “economic earthquakes” in the result.”
² Source: UNIDROIT PRINCIPLES OF INTERNATIONAL COMMERCIAL CONTRACTS 2016, Published by the International Institute for the Unification of Private Law (UNIDROIT), Rome (info@unidroit.org), art. 6.2.1 – 6.2.3 UNIDROIT Principles 2016

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