When it comes to commodity supplies, drinks producers have to balance legal and commercial pressures

When it comes to commodity supplies, drinks producers have to balance legal and commercial pressures

Times have been 'interesting', to say the least, for the sugar industry recently, with well-publicised outbreaks of extreme weather affecting crops and prices. But, what about the drinks manufacturers who depend upon sugar - and other crops vulnerable to unforeseen exceptional price increases - as an ingredient in many of their products? Although manufacturers will usually have contracted well in advance for delivery of their requirements, suppliers caught out by crop failures and rising market prices may attempt to invoke force majeure clauses to escape these bargains. Trevor Withane of Allen & Overy LLP considers such attempts and how drinks manufacturers might respond.

The weather has not been kind to sugar producers in past months, most notably in Australia, a major exporter. Heavy rains late last year forced farmers in the country to leave much of their sugar cane crop unharvested in the fields. Then, in February, Cyclone Yasi struck Queensland and caused serious damage to sugar crops in the state. Later that month, heavy rains blighted sugar production in the far north of Queensland, with more than 500mm of rain falling in four days, adding to the already dire state of affairs for the country's sugar producers. Rains have also affected sugar harvests in Brazil and last summer's floods devastated the crop in Pakistan.

Such failures can mean the sugar refiners who rely on affected farmers for their raw materials find themselves in a difficult economic position. Refiners often contract to supply sugar at agreed prices to their customers in advance of an agreed delivery date. Faced with producers whose crops have failed, they may have no option but to go onto the market and source raw sugar at considerably higher prices than they envisaged at the time of contracting with their customers. This may leave the refiner facing a rather unpalatable loss from what once seemed a sweet deal.

In such circumstances, it is not surprising that refiners would seek to renegotiate their contracts with their customers. One route that the refiners may look to in these negotiations is the force majeure clauses, commonly found in commercial contracts. Such clauses typically provide for the parties' obligations under the contract to be suspended or terminated altogether on the occurrence of one or more events specified in the contract (in varying degrees of detail). A refiner stuck with a contract rendered unprofitable by unexpected events that disrupt its supply of raw materials may look to argue that they constitute events of force majeure, releasing it from its contractual obligations. Indeed, a refiner may use the mere threat of invoking the force majeure provision with a view to seeking renegotiation of the contract price in its favour, even if the refiner does not wish to stop delivering altogether.

So, should drinks manufacturers be worried (and refiners comforted) by such provisions? Not necessarily. As a general rule, the courts rarely allow a party to escape its contractual obligations simply because the contract has turned out to be less favourable to that party than initially expected. After all, part of the rationale for contracting for delivery in the future at a fixed price is to transfer the risk of unforeseen price increases to the supplier. In reaching any decision, the courts will consider carefully the precise language agreed by the parties. A clause simply stating that a supplier's obligations will be suspended or terminated in the event of  force majeure, without further explanation, is unlikely to be engaged especially where that refiner can obtain the raw materials needed to uphold its end of the deal – even if it is at a price which renders the deal unprofitable. On the other hand, a provision which expressly defines such circumstances as events of force majeure would be likely to receive very different consideration. Refiners and customers concerned about the impact of unexpected events on their businesses may therefore wish to closely scrutinise the force majeure provisions of their contracts.

What should a drinks manufacturer do if one of its suppliers threatens to suspend supplies on the basis of force majeure? The first issue, of course, is whether the contract entitles the supplier to do this. If this appears not to be the case, the most obvious instinct may be to apply for an interim injunction requiring the supplier to continue to deliver the goods. However, before going down the route of injunctive relief, it is worth considering whether an injunction is really the best solution in the circumstances. If nothing else, in deciding whether to grant the injunction, the court will, among other things, consider whether damages would be an adequate remedy. If they are, and if supplies are readily available on the market, the court may well expect the customer to obtain replacements and then claim any increased expense from the supplier. However, the more commercially important point for drinks manufacturers to bear in mind is the long-term cost of damaging a valuable supplier relationship. If an injunction is sought against an established and otherwise valued supplier, the damage done to the relationship may outweigh the one-off benefit to the manufacturer of enforcing the contract strictly according to its terms. Balancing the competing legal and commercial pressures can be far from straightforward.

Of course, these points are not confined to sugar contracts. Any agreement for the supply of a commodity in short supply and prone to disruption by uncontrollable events is likely to face similar risks. With the prices of many commodities at record highs, careful consideration of force majeure clauses, both in contracts already signed and those negotiated in the future, is likely to be an important means for ingredient suppliers and drinks manufacturers alike to manage the risks to which they are exposed.

Trevor Withane is an associate at Allen & Overy.

For more just-drinks comment on the effects of sugar price rises, click here.