March 21, 2018 Practice Points

How to Respond to a Trade War

Contractual implications of the imposition of trade tariffs.

By David Loh and Chris Raleigh

U.S. Treasury Secretary Steven Mnuchin recently attended the Group of 20 finance ministers meeting in Buenos Aires, Argentina. On Monday, March 19, 2018, it was widely reported that a number of his counterparts were demanding exemptions from President Trump’s March 8 tariff on the importation of certain steel and aluminum products entering the U.S. Mr. Trump has already said he would exempt Canada and Mexico from tariffs upon a successful renegotiation of the North American Free Trade Agreement. Secretary Mnuchin has indicated that other countries could also get exemptions. Since the U.S. has yet to detail what would qualify a country for an exemption, other than a vague reference to national security and the reduction of trade deficits, it is unclear what will be the overall impact of this tariff on trade, and whether it will trigger retaliatory levies from other nations.

If tariffs are imposed, prices will likely increase, which should slow the demand for raw materials and other commodities, including soybeans, grain, and other foodstuffs.

During this uncertainty, it would behoove all buyers and sellers of goods moving to or from the U.S. to review their respective sales contracts for the potential impact of tariffs.

When an unexpected external event occurs, a commonly invoked clause is force majeure. FM is found in many contracts, including those relating to the international purchase and sale of goods. There are several principles to be mindful of when FM is being considered as a grounds to suspend performance: (1) the burden of proof rests upon the party relying upon FM to suspend performance; (2) FM clauses are narrowly construed; and (3) the fact that a FM event simply makes performance more costly is generally not sufficient to sustain the defense.

The availability of FM as a defense depends on whether the contract specifically describes the external event which, if it occurs, prevents performance by one of the parties to the agreement. Most FM clauses list events such as “fire, or other casualty, strikes, lockouts or other labor disturbances, embargo, extraordinary unavailability of materials or supplies, act of terrorism, riot or war.” In our experience, FM clauses typically do not list the imposition of a tariff or duty as an example of “force majeure.” Furthermore, “tariff” generally is not included in the list of events triggering FM because the buyer is required to pay import taxes, so a seller would be reluctant to grant such a concession during contract negotiations. Another factor relating to FM is whether the imposition of the tariff simply makes performance more expensive, as opposed to preventing performance. If the former, courts are reluctant to enforce a FM clause simply because performance has become less profitable.

Contract frustration is another potential argument which comes to mind in the event of a sudden tariff increase. Frustration is theoretically available when an external event occurs which so fundamentally alters the conduct of the contract such that its continued performance would be unjust. But, as with force majeure, the imposition of a tariff would simply make the contract more expensive or difficult, and, as such, would not likely render performance by one party impossible.

Potentially, a properly worded price review clause might have more success in managing the risk of a suddenly imposed tariff. Such clauses, if well drafted, permit the parties to renegotiate the contract price under certain circumstances, typically when a sudden rise or fall in prices occurs in a particular market. Depending on its wording, a price review clause might be interpreted favorably in the event of market volatility due to a trade war.

The nature and scope of the Trump Administration’s steel and aluminum tariff remains to be seen. In the meantime, entities which are parties to long term sales contracts, or which are considering entering into such arrangements, should consider the effect of potential “trade wars” on pricing and how to best respond to those risks.

David Loh and Christopher Raleigh are with Cozen O'Connor in New York City, New York.

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