Most would agree that there is risk associated with pretty much everything that we do. There is a certain level of risk when we drive to work, close a sale, sign off on your subordinate’s work, etc. But knowing that there will always be some risk, we are able to better prepare for it.
Lawyers and insurance companies rely on the black and white of contracts to protect themselves. So, to protect yourself, make sure that all your contracts include an act of God and force majeure clauses. Theses clauses protect you from any event out of your control. It is like putting on your seat belt when driving… The risk associated with not doing so is too high not to wear it.
What is Force Majeure?
Force majeure is a superior force that acts against the best interest of the company. The Entrepreneur’s Guide to Business Law claims that force majeure is “used to designate problems beyond the reasonable control of a party”. In the case that there is a contract between two entities, this clause allows both parties to be freed from any obligations when extraordinary circumstances prevent one of the entities from fulfilling their end of the contract. These events must be unforeseen and/or unforeseeable.
For example, you have a restaurant with contracts and/or promises with vendors to purchase a certain amount of goods. A riot destroyed the property, forcing you to temporarily shut down the facility, this would free you from any obligations set up in the contract. This riot was out of your control. As a result, you were required to shut down for a period. In addition to events such as a riot, crime, event, war, strike, etc., there are acts of God that tie into the force majeure.
So, what’s the difference between force majeure and acts of God?
Difference Between Force Majeure & Acts of God
Simply put, force majeure is a human caused event. In comparison, acts of God are physical events that natural occurrences cause. The force majeure can be related to human, political, and/or movement issues. These events can cause severe financial dents in companies, if those clauses are not in writing.
Why have them?
Why not? These clauses protect your company when it is at its weakest and when it is unable to conduct business like normal. But it is critical when writing these clauses that you include every type of event that could impact the operation of your business. The wording “but not limited to” can be used in a court of law to dispute any claim not written in ink.
Example of Force Majeure
Over the past six months, BHP Billiton had imposed, enforced, and lifted a force majeure. They had originally exercised their force majeure clause because the workers in their coal mine in Chile went on strike for 43 days. Therefore, they could not fulfill business deals and contracts. This clause protected them from lawsuits, etc. This Chile strike cost the company $1 Billion without it being their fault or in their control, but the damage could have been much worse without the force majeure clause in their contracts.
No Party Accountable
With no party accountable during these events, you as the financial leader can put a plan together, recover, and get back to an operational state of business. But before we go into how to get back into the game, it’s good to start off with a basic no party accountable force majeure clause. The Entrepreneur’s Guide to Business Law provides a template:
“Party A will not be liable for any loss, including, without limitation, the loss of Party B’s prospective profits, resulting from events outside of Party A’s control. Examples of occurrences outside of Party A’s control include, but are not limited to, strikes, lockouts, fires, floods, mud slides, earthquakes, machine breakdowns, lack of shipping space, carrier delays, governmental actions, and inability to procure goods or raw materials.” (page 302)
Allocation of Risk
Typically, those in charge of financial functions try to avoid risk at all costs. These clauses mitigate the legal risk associated with physical or natural events. By spreading out and minimizing the risk with this clause, an actual situation becomes a lot more management… Both financially and legally.
What happens when these events occurs?
When these human-related or natural events occur, it’s critical to have a game plan (and even better to have the plan prior to it happening). Brainstorm with your team and while you’re in negotiations with the other party about what each scenario would look like. Imagine that a hurricane destroyed your warehouse holding all the supplies. What percentage of the product would still be functional and in good condition? How long would it take to rebuild the building, recover damaged goods, and start distributing again? What order of actions would you need in the case of these events? These questions indicate the potential financial implications of an event like this. By answering these questions, you and your team will hopefully identify the costs associated and calculate the length of time and the profits lost during that time period.
Time for Suspension of Force Majeure
At some point, you need to lift the force majeure. As the wingman and financial leader, calculate when would be the prime time for the company to resume conducting business again. As entrepreneurs, we are taught to create a minimum viable product and/or be a lean startup. With that know how, what is the earliest that you can start operating, even in a small way? It is not intelligent to suspend the force majeure only when everything is back to 100%. The company would risk running out of cash, the patience of Party B, and going out of business.
What happens if this event extends longer than expected?
There are some cases that an event lasts longer than originally expected. Set up KPIs to track the progress of the resolution – both externally and internally. Notify legal, executive, and the other party with a revised plan of action and/or projections.
Guide Your CEO
In times of uncertainty, your executive team can be blinded by the distractions of events and/or reactions of the company. Be the eyes and guide them using the financials. The ability to be the wingman or trusted advisor your CEO needs will get the company out of harm’s way, elevate your status, increase the amount of trust, and steer your company to success. Download our free How to be a Wingman guide today!