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The Russian invasion of Ukraine has caused the fastest-growing humanitarian crisis in Europe since the Second World War, as well as unleashing turmoil in commodity markets. While an ever-increasing list of sanctions being imposed upon Russia and mounting public pressure for companies to cease dealing with the country mean few new deals will be agreed, existing commodities contracts – often signed months in advance – are causing a headache for financiers and traders. GTR speaks to Tom Webley, a partner in Reed Smith’s global commercial disputes group, to explore the options available to them.

GTR: What are the main queries you’re hearing from corporates and banks with exposures to Russia and Ukraine?

Webley: At the moment, people are trying to work out exactly where their position leaves them contractually. There are certain black and white issues such as sanctions, which are, in many cases, more straightforward. There are entities and individuals who are sanctioned entities, and parties can’t do business with them. From an English law perspective, a party cannot require another party to perform an agreement or an obligation under a contract if it is illegal to do so, so this can be quite clear. It’s the greyer areas which can be more challenging, for example where there are obligations under the agreement which are now more difficult or more expensive to perform but not impossible or illegal. Alternatively, it could be where there’s a huge amount of pressure from the public or from government not to deal with certain entities who are not actually sanctioned. This is when it becomes very tricky.

GTR: What options are there for getting out of a contract?

Webley: It is not easy. There is a view that’s been long adopted in English law that contracts are absolute. Once you have agreed to do something, you have to do it. There are exceptions which might apply in this case. One is whether there is what’s known as a force majeure event. Force majeure is not a general concept in English law; it is a contractual clause. Therefore, it will only apply and the party can only rely on it if there is a clause within the relevant contract which covers the events you want to rely on to excuse yourself from having to perform certain obligations.

This is very much a contract-by-contract analysis, and the wording of these clauses is important. You need to ascertain what events are covered, and whether the clause says that a party has to be prevented from performing the contract to be able to rely on the clause or whether performance has to be hindered or delayed, which is a lesser burden.

Another legal pathway is that of frustration. What that means is that obligations under a contract are completely discharged and fall away if something happens after the parties have agreed to contract, that is entirely beyond what the parties contemplated at the time, and renders performance of the contract impossible, illegal – for example due to sanctions – or unrecognisable from what the parties thought they were agreeing to.

Frustration is a bit more nuanced because it is not just about it being impossible. It is also if the situation makes performance under the contract so radically different from what was contemplated by the parties at the time they entered into the agreement, that it’s just unrecognisable. That is quite an interesting nuance that people need to be thinking about: it is not just whether you are prevented from performing the contract.

In the case of a bank that is looking at its borrowers in a commodity finance facility, it is not just necessarily whether the borrowers are absolutely incapable of paying, but if the facility itself has changed so much, or the underlying factual background or transaction or commodities or assets have changed so much, then that might be sufficient to be considered a frustrating event, and your borrowers might be able to get out of paying you back.

That’s where you need to start thinking carefully about where any potential exposure lies. It is not just whether you can get out of your obligations, but what rights your counterparties have to get out of their obligations to you.

GTR: Where does this leave commodity financiers and traders?

Webley: Where it might leave a financier is non-payment or delayed payment. What it might mean in a commodity supply chain is that your suppliers are able to rely on force majeure or frustration to get out of their obligations to supply you. However, you, in turn, as an intermediary in a supply chain, might not be able to get out of your obligations to supply a third party. That’s where the analysis really needs to be very detailed across the whole chain of obligations, not just individual contracts.

GTR: What can lenders do to mitigate the risk of defaults?

Webley: Often, issues can be resolved by commercial discussions, amending contract terms by agreement or agreeing repayment holidays, for example.

Financiers need to be looking at carefully at who the borrowers are, and how secure the obligation to repay is and what security is in place. The economic position has changed dramatically. There are issues with currencies and there are issues with fuel and raw materials costs, which if you’ve got a long chain of logistics could massively affect people’s profitability and ability to repay debt. For large companies, that won’t matter so much, but if a financier is financing small companies doing individual trades, cumulatively, and they default, that could have quite a significant effect on the bottom line of those providing the finance.

The next step is to try to work out if there’s any way of limiting that exposure. For example, in the case of rolling finance, that might be working out whether you’re able to stop providing it until things start improving, or if there’s any way of accelerating outstanding finance so you can start to get money in sooner. In particular, in relation to trade finance, something that we’ve seen a lot of in the past is the fact that a lot of this can be guaranteed by a third party. Therefore, you’ve got to look at the guarantees. How good are they? When will the guarantee be triggered? If a borrower isn’t paying because of a force majeure clause, can you still rely on the guarantee?

There may well be little you can do about it other than realise what the exposure is, what the risks are, and check what security you’ve got. But that in itself is important.

GTR: What takeaways are there from this situation?

Webley: Risks such as these may have been foreseeable to some extent, but it’s impossible to predict when an adverse event is going to happen, where it’s going to happen, and how badly it’s going to hit you.

What people will be increasingly aware of is the need to ensure wording does exactly what you need it to do if and when that risk materialises. Put it in the contract, make it as clear as you possibly can. If you want rely on an economic consequence, be that currency risk or commodity price volatility, to justify non-performance, make sure the contract provides for this.