Force Majeure

From Open Risk Manual

Definition

Force Majeure denotes a clause that may be used in a variety of legal contracts to excuse (free, unbind) a counterparty from the liabilities or obligations stipulated in the contract under material adverse events.

Conditions

The possibility of absolving a party from some or all their responsibilities under the contract is linked to a number of conditions:

  • Externality of the Risk Event: the occurence is outside the control of the contracting party
  • Unpredictability: the occurence could not have been foreseen
  • Unavoidability (or Irresistibility): the party could not overcome the impact of the event

Force Majeure Events

The contract might stipulate specific types of Force Majeure Risk, for example

  • Physical Damage
    • From Natural factors (Floods, earthquakes etc, sometime termed "Act of God" events)
    • From catastrophic failure due to human causes (mechanical failure, human error etc)
  • Civil disturbances and other forms of Political Risk

Mitigation

Risk Mitigation of Force Majure events is (similar to other risks) a context dependent combination of aiming to alter the Risk Profile or obtaining some form of insurance:

  • Business Interruption Insurance
  • Property Casualty Insurance

Example

In the context of evenrgy futures trading contracts,[1] Force Majeure is defined as any circumstance (including but not limited to a strike, lockout, national emergency, government action, or act of God) which is beyond the control of the buyer or seller, and which prevents the buyer or seller from making or taking delivery of electric energy or effecting payment and which, by exercise of due diligence, the affected party could not have been reasonably expected to avoid and which, by exercise of due diligence, said party is unable to overcome.

Issues and Challenges

  • Force Majeure is variably defined in different legal systems (See Wikipedia for some examples) most notably the differences between Common Law and Civil Law systems.

See Also

References

  1. CBOT: Electricity Futures and Options: The Reference and Applications Guide

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