Discuss the role of hardship clauses in controlling liability by contract.

It must, however, be noted that performance of the contract will not constitute "hardship" just because the contract has become unprofitable for one party due to changes in the economic or technical setting. Rather, only a breach of the commercial "limit of sacrifice" because of a fundamental change in the commercial balance of the contract will suffice. Further, neither party must have expected the changed circumstances to arise and those circumstances must be beyond the control of the parties so that no one can take unfair advantage of self-made changes. 

The object of a hardship clause is, by way of negotiation, to convert the contractual relationship from one that is frozen at the point of formation into an evolutionary one. The new circumstances that have unexpectedly created a fundamentally different situation may not necessarily torpedo the business relationship between the parties. The hardship clause brings the parties to the negotiation table with the objective of adjusting the contractual equilibrium. Though the legal and practical efficacy of such clauses is questioned by some people, these clauses, by their very presence in a contract, encourage the parties to renegotiate agreements positively where their relationship has not broken down irretrievably. 

In the absence of a hardship clause, it will be rare for a party to overcome hardship arising from change of circumstances by invoking the doctrine of frustration. In any event, frustration results in termination of the contract and releases the parties from their obligations under the contract. Such a solution may not be appropriate when a party is really hoping for an adjustment of the offending contract terms. In addition, under frustration, the economic losses are not allocated under the contract (one clear advantage of relying on hardship clause) but lie where they fall, subject to any statutory or other legal adjustments that might be made to ameliorate those effects. It is therefore frequently the case that each contracting party will be prepared to accept the need to incorporate in the contract some mechanism for the adjustment of the contract, and thus apportion liability in the changed circumstances.  

3.        Reliance on Hardship Clauses in Controlling Liability by Contract

For a party to rely on hardship clauses so as to modify his liability under the contract, three steps must be considered. The first step involves consideration of the events that constitute hardship. The second step is whether the event is beyond the control of the party invoking the hardship clause. The third step involves the effect of the event on the performance of the contractual obligation.

Step 1: Is there an event of hardship?

The hardship clause should set out the circumstances in which the clause is applicable. It is possible to provide, as with force majeure, a catalogue of circumstances which constitute hardship but in such case it will be necessary to have a concluding general clause because it is the characteristic of hardship that not all its contingencies are foreseeable. Some examples are significant rise in raw materials or sharp devaluation of currency making the initial contractual arrangement “financially disastrous” to a contractual party.

In addition to setting out the circumstances, one has to ask if the hardship event was reasonably foreseeable by the parties to the contract, and if yes, there is no excuse for invoking hardship clause. The rationale behind the test is that the failure of a party to contractually insulate itself from the occurrence of a foreseeable contingency is ipso facto an assumption of that risk.  In answering the issue of foreseeability, the arbitrator should neither refer to an excessively concerned "pessimist who foresees all sorts of disasters" nor to a "resolute optimist who never anticipates the least misfortune." The issue rather is whether any of the parties ought to have reasonably foreseen a realistic possibility that an impediment to performance would occur.

Step 2: Was the event reasonably beyond the control of the party invoking the hardship clause?

The second step deals with the causality that connects the event and its effects to the nonperformance of the contract. The magic phrase that is often included in a hardship clause is that an excuse under the clause cannot be invoked when the events were " reasonably within the control of either party. " There are two related notions in the term "reasonable control." The first notion is that a party may not affirmatively have caused the hardship event. The second notion is that a party is not allowed to rely on the event if the party could have taken reasonable steps to prevent it. Prevention should take place in an effective manner from economic perspective. 

Step 3: When and to what extent does the event render the contract extremely difficult to be performed?

The third step in the analysis is factual, but has important legal overtones. Here the focus is on the increased burden placed on the party who is to perform. This seems to suggest that the difficulty can be judged as a matter of degree by way of a quantitative analysis. How much do costs have to increase before they become extremely difficult? What can still be called a business risk? In addition to the quantitative approach ("how much"), there is also a qualitative approach ("how different"). It must be shown that the increased cost is due to some unforeseen contingency which alters the essential nature of the performance. 

If the above three steps are satisfied, a party may invoke the hardship clause which will then impose on both parties an obligation to renegotiate in the changed circumstances.

4.        Obligation to Renegotiate and its Relationship to Controlling Liabilities

Primarily a hardship clause will impose on the parties a duty to renegotiate the contract. As to the standard to be applied to reaching an agreement, reference is made to "good faith," "fairness and equity" or the goal of reconstructing the "contractual equilibrium as intended by and in the initial spirit of the contract." The arbitral tribunal in the AMINOIL arbitration interpreted the obligation as follows:

[T]he general principles that ought to be observed in carrying out an obligation to negotiate, - that is to say, good faith as properly to be understood; sustained upkeep of the negotiations over a period appropriate to the circumstances; awareness of the interests of the other party; and a preserving quest for an acceptable compromise.

The function of the clause is limited to adapting the contract to the changed circumstances. It does not justify a restructuring of the entire contract unless this is clearly expressed in the clause. In addition, in this sort of consensus procedure, the prohibition to cause damages to the other side and to exploit the other party's weakness to the detriment of that party is exceedingly important.

If the negotiations fail to make progress or threaten to collapse, the question arises whether the parties are obliged to reach an agreement. The unanimous opinion is that renegotiation clauses are complied with even if the parties do not reach an agreement, e.g. because one party rejects the other side's proposals for reasons that are based on normal commercial judgment. However, where the non-agreement is proven to be caused by bad faith or, when negotiations are intentionally obstructed or where proposals by one side are rejected for reasons other than normal business judgment, the defaulting party will be in breach of his obligation under the hardship clause, and be liable for damages. 

It should be noted that the failure of renegotiation where one party is at fault will not change the original contractual distribution of risk. The contract remains in force, unless the parties have determined otherwise in the clause or have clearly expressed via the adjustment clauses that the validity of the contract is restricted to the circumstances as they existed at the time of concluding the contract. Finally, it is also conceivable that a party which does not accept an offer from the other side “within the framework of the consensus structure” is in breach of its general duty to minimize loss, and that would be to its detriment when calculating its claim for damages. In this way liability could also be assessed proportionately. 

Sanctions for Failure to Reach Agreement

One practical way to ensure that the parties make a bona fide attempt to resolve the difficulties by way of negotiation is to include sanctions, whether they be arbitration, litigation or termination of the contract, into the contract. The most common sanction is an arbitration clause. This will usually provide that if, as a result of renegotiation, the parties do not reach agreement or do not do so within a stated time, either party shall be entitled to invoke arbitration. To ensure that the decision of the arbitrator is in conformity with the initial intention of the parties, care should be taken to include guidelines for arbitrators in adapting contract in changed circumstances.  Apart from arbitration, the parties may also provide that, if the renegotiation results in failure, the contract shall be suspended or terminated or that either party may claim suspension or termination. They may also provide for third party intervention or for recourse to the courts, a clause which would seem to be superfluous unless combined with prorogatio fori, because otherwise it is self-evident that recourse to the courts is open to the party who feels aggrieved.

Conclusion:

The absolute application of the pacta sunt servanda rule in long-term contracts may be quite harsh since during the existence of the contractual relationship unpredictable and unavoidable factors could render the performance of the contractual obligations excessively onerous or unfair. The purpose of hardship clauses is to ensure that the parties renegotiate the terms of the agreement in such changed circumstances so as to adjust their contractual obligations in a mutually acceptable manner. Care should be taken in drafting such clauses so that no party can take unfair advantage of such clauses; only fundamental change in circumstances beyond the control of the parties should allow reliance on hardship clause. Further, to maximise the effectiveness of hardship clauses, it is suggested that an arbitrator or a third party intervenor should be appointed under the clause to adapt the terms of the contract should the parties fail to come to a mutually acceptable solution.

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