Trade tariffs are very much in the news.
The Brexit negotiations between the UK and the EU are moving into the key discussion phase which will shape the post-Brexit trading landscape for British business.
If the UK leaves the customs union (as the Prime Minister has said it will) and there is no trade deal reflecting the current arrangements the UK will accordingly have the right to set its own customs tariffs on goods imported into the UK from all external countries.
The tariffs imposed would be required to be within the parameters stipulated by the World Trade Organisation rules. Businesses exporting into Europe would be subject to import duty at rates stipulated by the EU and vice versa. If there is a deal reached the tariffs will depend on the detailed terms of the agreement. The position for UK business is accordingly currently unclear (although mitigated somewhat in the short term by the transitional agreements which aim, in essence, to preserve the status quo for a limited period).
Adding to this uncertainty President Trump appears to have fired the starting gun for a trade war with China by imposing tariffs on aluminum and steel, a dispute which has the capacity to significantly impact business activity globally should it escalate. China has responded by outlining plans to impose $3bn in additional tariffs on US goods including pork, recycled aluminum, steel pipes and fresh fruit. Further tariffs on soybeans and Boeing aircraft, key US export items are now also being implemented. World stock markets fell significantly in light of these recent developments. It is clear that protectionist action by the US would have widespread repercussions for world trade and the global economy.
Increasing tariffs invariably lead to an escalation in defaulting counterparties. This is caused by unexpected direct increases in prices as a result of the imposition of specific tariffs or as a result of the wider indirect economic slowdown which escalating trade wars predicate. The price of commodities in particular become volatile in these circumstances which significantly contribute to wider economic uncertainty. See previous article on: Falling Commodity Prices.
Against this uncertain wider macro background what practical steps can British business take to mitigate against the adverse effects of the imposition of tariffs? Whilst each sector will have varying and specific requirements there are a number of steps which can be taken by businesses now regardless of sector.
As ever, the first step is to review contractual documentation.
Most contracts for the sale of goods will contain express provisions which specify which party is required to meet the costs of the tariff increase.
These may be bespoke provisions or the parties may incorporate standard terms, such as Incoterms. For instance, in the absence of any specific agreed variation, contracts applying FOB terms specify that the seller must pay all costs relating to the goods until such time as they have passed the ship’s rail at the named port of shipment; pay the costs of customs formalities necessary for exportation as well as all duties, taxes and other official charges payable upon exportation. The buyer is obliged to meet the costs relating to the goods from the time they have passed the ship’s rail at the named port of shipment. This includes meeting all duties, taxes and other official charges as well as the costs of carrying out customs formalities payable upon importation of the goods and where necessary for their transit through another country.
In the current climate careful attention, particularly it is suggested by buyers, should be paid to such terms to ensure that the contract reflects the parties’ intentions and accordingly who bears the risk of having to meet the imposition of sudden and perhaps dramatic protectionist trade tariffs.
As indicated, the sudden impact of tariffs can make a once profitable contract uncommercial. Many parties seek in such circumstances (and usually after the event) to invoke force majeure clauses or argue that the contract has been frustrated.
A contract may be discharged on the ground of frustration when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract or transforms the obligation to perform into a radically different obligation from that undertaken at the moment of entry into the contract.
Arguments seeking to persuade an English Court to frustrate a contract following the imposition of trade tariffs very rarely succeed before an English Court. Rarely will a contract be impossible to perform as a result (as opposed to be significantly more difficult or expensive to complete).
Equally, under English law simply because a contract becomes more expensive (perhaps considerably so) or problematic to perform does not necessarily give rise to force majeure. The English Court will review the relevant contract and if the parties have specifically provided for force majeure within the contract the wording will be carefully considered to see if the event giving rise to the claim of force majeure has in fact prevented performance of the contract and is one which is provided for under the relevant provision.
It is up to the parties at the drafting stage to make specific provision for events they would consider would give rise to force majeure. Clarity in drafting is essential as ambiguity in the wording adopted will be construed against the party seeking reliance on the clause.
Many businesses bound into longer term contracts will commonly be able to rely upon price review clauses which can help to mitigate the effects of market turbulence caused, which ordinarily follow the imposition of widespread trade tariffs. Such clauses provide mechanisms for the price for goods supplied under the contract to be adjusted or renegotiated so that they accurately reflect changes in the market. Again it is critical that the drafting of such clauses is undertaken with care. There needs to be clarity, for instance, as to what events will trigger a review clause, what procedures will be implemented in calculating the revised price, what consequences follow if the parties cannot agree and so on. The imposition of trade tariffs will impact on different markets in different ways so careful attention should be given as to whether such a clause will provide sufficient protection.
Where contracts become uncommercial to perform if renegotiation proves impossible this may well lead to non-payment, failure to provide goods and so on leading to significant commercial liabilities. Contracts should again be carefully considered before these events arise to ensure that any potential losses are mitigated. Where parties seek to extract themselves from uncommercial contracts care must be taken so as not to open the door to significant liability for prematurely terminating a contract.
In contracts with businesses operating in high risk sectors or countries where the imposition of significant trade tariffs might have a damaging impact on the profitability of a contract careful attention should be given to whether your counter party will be able to absorb significant increases at short notice or whether there is risk of default and /or insolvency. Considering the implications now and adjusting contracts in advance will, if not eliminate entirely, will certainly assist in mitigating future possible risks.