Navigating New U.S. Tariffs: Questions to Consider

The current worldwide focus on tariffs, paired with reciprocal tariffs from various affected states, is likely to have significant impact on the costs of cross-border trade. Businesses focused on importing and exporting goods will likely feel the pinch prompting them to reassess their commercial positions. Setting aside the business impact of the tariffs, here are some key questions to ask yourself when reviewing your contractual relationships:

1. What if I or another contract party want to terminate the contract?

If, following a review of a contractual relationship, you or a counterparty decide that the contract is no longer commercially viable, the issue of whether the contract can be terminated may come to the fore. This could be under specific termination clauses or, potentially, under a force majeure or other similar clause.

a. Do the tariffs constitute a force majeure event?

The effect of a force majeure clause, depending on its wording, is to discharge or suspend performance of the obligations a party has under a contract when unforeseeable events occur that are beyond the reasonable control of the parties. These events may include natural disasters, wars, government actions, changes in law, or other events outside the control of the parties which prevent, or potentially (depending on the wording of a clause) seriously impede, performance. 

The exact wording of a force majeure clause will determine whether a change in tariff regime constitutes a force majeure event. You should carefully review the wording of each contract to identify possible force majeure events arising from new tariffs. If the force majeure clause refers specifically to government action or changes in law, depending on how exactly performance of the contract has been affected, there may be a basis for arguing that a force majeure event has occurred. For example, a government-imposed prohibition on trade could potentially be regarded as a force majeure event if it prevents performance of the contract. Other events which render performance of the contract physically or legally impossible may also qualify as force majeure. Naturally, whether performance is impossible is a question of fact. However, the following should be kept in mind:

1. New York law treats force majeure clauses very narrowly. Under New York law, “only if the force majeure clause specifically includes the event that actually prevents a party’s performance will be excused.” Urban Archaeology Ltd. v. 207 E. 57th St. LLC, 34 Misc. 3d 1222(A) (Sup. Ct., N.Y. County 2009). At the same time, New York law only recognizes force majeure where the event that prevents performance is unforeseeable. These two principles are clearly in some tension. But a force majeure clause that expressly includes in its scope a category of events where the specific occurrence is unforeseeable—for instance, a clause that includes natural disasters that is invoked for a particular tornado—can be successfully invoked.

2. It is a well-established principle under both English and New York law that a change in economic or market circumstances, affecting the profitability of a contract or the ease with which the parties’ obligations can be performed, is not, in itself, regarded as being a force majeure. In New York, at least, even where the force majeure clause does expressly include government actions, courts generally deem financial hardship—including that caused by regulation—a foreseeable event. Therefore, basing any force majeure argument solely on increased costs arising from tariffs and government action is likely to be difficult. This is to be distinguished, at least in some respects, from successful force majeure arguments that parties made in response to the COVID-19 pandemic, where government actions completely prevented businesses from operating. 

3. If the contract already allocates the risk of increased costs, it is also unlikely that a force majeure clause will be triggered. For example, the specific International Chamber of Commerce Incoterms adopted by the parties may require the seller to deliver goods with any and all duties paid (i.e., Delivered Duty Paid), in which case the risk of higher duties may be deemed to have been allocated or assumed.

4. In any case, parties are under a duty to take reasonable steps to mitigate the effects of a force majeure event, although recent English law suggests that mitigation does not require a party to change or alter its contractual rights or obligations.

5. Some force majeure provisions do not automatically terminate obligations when a force majeure event arises, but merely provide for suspension of performance. In circumstances where there is likely to be ongoing volatility in the application of tariffs, current circumstances may only suspend certain obligations temporarily, although the longer such suspension goes on, the stronger a potential case for termination may become.

b. Can the contract otherwise be terminated?

If a party decides to terminate unviable (or otherwise affected) contracts, it may be able to rely on other contractual termination provisions, such as an express right to terminate the contract with notice. However, there may be a cost associated with relying on these provisions (e.g., early termination fees), so parties should carefully consider the consequences, particularly in circumstances where the tariff position is expected to remain volatile.

It is important to note that purporting to terminate the contract in the absence of a clear right to do so may also give rise to claims for repudiatory breach. Special care should, in particular, be taken if a debt has accrued under the contract and/or the contract provides for liquidated damages in the event of breach or termination. While a party suing for breach of contract is generally under a duty to mitigate its loss (which may reduce the quantum of the claim), there is no duty to mitigate a debt or liquidated damages.

One may also want to consider the common law doctrine of frustration which allows a contractual obligation to be deemed discharged due to the occurrence of an unforeseen event that renders performance of the contract impossible, illegal, or something radically different than what was contemplated by the parties at the time they entered into the contract. However, the test for frustration under both English and New York law, is a high bar, and it can be challenging to demonstrate. For example, frustration is a narrow doctrine that does not excuse performance solely on the basis of increased costs (such as the imposition of tariffs).

2. What should I do going forward?

Whether you are assessing your current contractual relationships or ones you are currently putting into place, some considerations to bear in mind include:

a. Draft to allocate the risk

You may wish to specifically allocate tariff-related risks in future contracts. Contracts may allocate the risk entirely to one party (either the importer or exporter) depending on their bargaining power and market conditions. Examples of such contractual mechanisms include incorporating tariff adjustment clauses, which allow renegotiation or price adjustments if tariffs materially affect the cost of goods, and specifically identifying escalating tariffs as a termination event.

It may also be beneficial to include notification obligations in case of further tariff changes, as well as dispute resolution mechanisms tailored to handle such eventualities (e.g., including an obligation to negotiate cost-sharing arrangements in good faith). By anticipating the potential impact of tariffs at the drafting stage, you can reduce the likelihood of costly litigation and maintain commercial relationships.

One should consider possible dispute scenarios, including those arising from the imposition of tariffs, and how forum choice may affect the prompt availability of appropriate remedies. On the one hand, arbitration may offer a suitably neutral forum, yet local courts often provide quicker access to the kinds of injunctive relief that may be essential when events develop quickly. Careful consideration will be required to select the appropriate forum and governing law for international trade contracts.

b. Keep in mind the broader counterparty risks

Your review of contracts should also consider the impact tariffs will have on your counterparties. From your perspective, important contracts may remain viable under the tariff regimes, but your counterparties may face other related disruptions which are difficult for you to foresee. Counterparty risk should therefore regularly be revisited to consider the changing tariff landscape. 

c. Assess knock-on effects on the supply chain

Beyond individual contracts, the imposition of tariffs may disrupt entire supply chains by increasing the cost of imported materials, causing delays, and prompting businesses to re-evaluate their sourcing strategies. You should evaluate the likely ripple effect throughout your supply chain, as changes in one area (e.g., raw material sourcing) can impact downstream processes (such as production or distribution).

With careful legal review, strategic contract drafting, and proactive supply chain adjustments (e.g., diversifying suppliers, exploring alternative sourcing regions, and optimizing inventory management), you can work to ensure flexibility, reduce dependency on vulnerable supply chain links, and improve resilience against tariff-induced disruptions, all of which are essential to mitigating risk and maintaining business continuity.

d.  Consider availability of treaty-based investment protections

The imposition of tariffs may impact an investment which qualifies for protection under a bi- or multi-lateral treaty, implicating investor-state claims typically resolved by way of specialist arbitration. Investment treaties have precise definitions for the terms “investor” and “investment” to determine for whom, and in relation to what investments, protection is available. Investment treaty protections typically prevent unfair or discriminatory treatment, and there may be an argument that certain tariff measures constitute such treatment.

Any such possible claim will however remain challenging because: (i) there are strict qualifying requirements for treaty protection; (ii) there is often a discrimination requirement; and (iii) certain states have a more limited bilateral investment treaty network. Further, the costs and complexity of such proceedings will typically only make them suitable for the most severe instances where tariffs threaten the viability of a business. It is important to receive specialist advice on the availability of investment treaty claims.

Conclusion

As trade costs increase, companies must adapt to a shifting commercial landscape and reassess their contracts and relationships to ensure long-term viability. Whether through renegotiation, strategic contract drafting, or relying on legal clauses like force majeure, businesses must be proactive in managing the financial risks associated with tariffs. This requires a careful balance of immediate action and long-term strategy.

Ultimately, the key to navigating the uncertainty lies in anticipating the broader implications of the tariff changes for business operations. By considering counterparty risks, supply chain disruptions, and the need for tariff-related adjustments, and establishing their deals and transactions accordingly, businesses can build resilience. This proactive approach will not only safeguard against financial strain but also position companies to adapt quickly to evolving trade environments, ensuring sustained growth and operational efficiency despite external challenges.

Any questions? Need some advice or want to run a contract review question by us? Please reach out to your MoFo contact who can connect you to the individuals who are best suited to assist you.