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Force Majeure clauses in contracts should be optimized to reduce costs and litigation potential.

Force Majeure clauses in contracts should be optimized to reduce costs and litigation potential.

Mar 17th, 2010

We will discuss today why Force Majeure clauses in contracts should be optimized to reduce costs and litigation potential.

Force Majeure clauses in contracts should be optimized to reduce costs and litigation potential.

Indeed, any time spent in the aftermath of a mishap “discussing” if the event was Force Majeure, negligence or had other causes severely impacts operations. In addition it can significantly increase the costs of consequences.Force Majeure clauses in contracts should be optimized to reduce costs

Thus the need to optimize the Force Majeure formulation. If it was possible to renegotiate contracts in the future, or for any new contract, a proper formulation would constitute an important proactive mitigative measure. Indeed one with a very large ROI (Return On Investment).

There are numerous areas where optimization could take place. For example under the form of:

  • a more detailed explanation of terms,
  • definition of threshold values,
  • enhanced definition of mitigative levels that industry considers as  “common practices” or “best practices”. Finally, also as
  • a definition of negligence, as well as the setting of
  • limiting value of Force Majeure.

You can check out Riskope’s presentation on this subject here.

Riskope work in this area constitutes a specialized technical support to the lawyers drafting the contract. The basis are Risk Based Decision Making (RBDM) concepts. They allow for transparent definition of terms like:

  • “reasonable” precautions/alternatives,
  • due diligence in running an operation, maintaining it, being proactive to ensure the contractual performance criteria, etc.

Riskope’s recommendation

Riskope recommends the use of a balanced list of potential hazards which possibly lead to a Force Majeure event. Indeed, the list has to be either generic or detailed, but should indeed be homogeneous and balanced. Furthermore, an optimized Force Majeure clause formulation should encompass likelihood/probability/frequency vs. magnitude limits to “ordinary” vs. “Acts of God” events.

We need a very clear definition of what constitutes an Act of God in order to optimize the Force Majeure clause. We can show this with an example. If we consider a commercial contract for a facility in Salt Lake city, one could have said that a tornado in Salt Lake city was an Act of God before 1999.  Indeed scientific consensus was that a tornado was not a credible, “impossible” event in Salt Lake city. That consensus broke up when one tornado happened on August 11, 1999. From that point on, a tornado in Salt Lake City became a rare, but credible event.

Of course at this point terms such as “credible” have to be clarified. Indeed there is a definite link between their definition and the limiting value of Force Majeure. We can also say that lack of preparation (contingency plans, maintenance, mitigation) for a credible event is a default, even a negligence.

Standardized levels of risk reduction

In the chapter devoted to general concepts of risk mitigation in our book (Improving Sustainability through Reasonable Risk and Crisis Management, by Franco & Cesar Oboni, ISBN 978-0-9784462-0-8, 2007) we wrote about “standardized levels of risk reduction”. Indeed, in recent times various industries have formulated them. At least three of these definitions are now in common use among analysts.

These three levels of risk mitigation also represent a convenient way to elude explicit tackling of risk tolerance. That is especially when we need to deal with the delicate theme of human life. However we can interpret these standardized levels of risk reduction as a way to define “state of the art” practice”.

We consider as “negligent” anything below a pre-defined ALARA, ALARP, BACT level. In fact, in recent years we note that public opinion tends to consider negligent even mitigative levels that are above these limits. That leads to image risks even when corporations follow “reasonable mitigative behavior”.

Risk, mitigative costs, vs public outcry.

Risk, mitigative costs, vs public outcry.

 

ALARA, ALARP, BACT

Here are the definitions of the three “standard” levels of mitigation:

ALARA.  ALARA is an acronym for the phrase As Low as Reasonably Achievable (Wilson, Crouch, 1982). It generally applies in reference to chemical or radiation exposure levels.

ALARP.  ALARP stands for As Low as Reasonably Practicable. It generally suits safety-critical and high-integrity systems. The ALARP principle is that the residual risk shall be as low as reasonably practicable. For a risk to be ALARP it must be possible to demonstrate that the cost involved in reducing the risk further would be grossly disproportionate to the benefit gained.

The ALARP principle arises from the fact that it would be possible to spend infinite time, effort and money attempting to reduce a risk to zero. It is not simply a quantitative measure of benefit against detriment. It is more a best common practice of judgment of the balance of risk and societal benefit.

BACT. BACT means Best Available Control Technology. For example: an emission limitation based on the maximum degree of emission reduction (considering energy, environmental, and economic impacts) achievable through application of production processes and available methods, systems, and techniques.

BACT does not permit emissions in excess of those allowed under any applicable Clean Air Act provisions. Use of the BACT concept is allowable on a case by case basis for major new or modified emissions sources in attainment areas and applies to each regulated pollutant

No matter which mitigative level one selects as “standard, non negligent, practice”, a fundamental step is to define against which event it is necessary to mitigate  and against which event, we humans, have to humble, as it can be considered an Act of God.

Definition of credibility

Like for risk, the technical definition of credibility differs quite substantially from the “colloquial” definition. The next paragraph defines “credibility” in technical terms.

The definition of a credible accident by the Process Industry literature, and other industries where major accidents/events are a concern,  is ‘the accident which is within the realm of possibility (i.e., probability higher than 10-6/yr) and has a propensity to cause significant damage (at least one fatality)’.

This concept comprises both probable damage caused by an accident and probability of its occurrence.
Seismic, geological and other geo-sciences use the threshold value of 10-5  to define “maximum credible events”.
So we can assume, for the optimization of the Force Majeure clause, that events with a probability of occurrence of less than 1 in a million (10-6), or less, belong to Acts of God , whereas events with a probability of at least 1 in hundred thousand (10-5), or more are credible.

Riskope has gathered within its research numerous examples of definition of Maximum Credible Events (MCE), which can be very different per industry, type of events, basic understanding or consensus of what is credible/non credible, thus stressing the fact that proactive formulation/optimization would greatly enhance contracts.

Furthermore, if we put these findings in perspective with our rapidly changing world (cyberspace, blogosphere, climatic changes, demography etc.) it becomes apparent that limiting uncertainties in the definition of MCE in a Force Majeure Clause is of paramount importance.

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Category: Consequences, Crisis management, Hazard, Probabilities, Risk analysis, Risk management

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