Introduction

The Trump Administration’s implementation of significant and widespread tariffs – and the potential for additional and farther-reaching tariffs – represents more than just a trade challenge.  For companies engaged in international commerce, the uncertainty created by these measures increases the risk of commercial disputes.  Among other things, tariffs can increase costs, reduce margins, and reveal contractual assumptions and ambiguities that lead to disputes throughout the supply chain:  between buyers and sellers, manufacturers and distributors, and in a variety of other business dealings.

Below we highlight four key questions for assessing and mitigating commercial dispute risks. Whether reviewing existing contracts or negotiating new ones, companies should take strategic steps to protect their interests and minimize potential disputes and supply chain disruptions.  

Background:  Tariffs Under the Trump Administration

Since the America First Trade Policy memorandum that President Trump signed on the first day of his second term, the current administration has imposed a variety of country- and product-specific tariffs, threatened additional tariffs, and promised other future actions.  Importers, foreign producers, and U.S. purchasers of imported products all face a heightened risk that products that they have contracted to purchase or supply may be impacted by tariffs, at times potentially altering the fundamental bargain between the parties.  The threat of retaliatory tariffs leads to even further uncertainty.

At the time of publication, the Trump Administration has imposed or threatened to impose a variety of tariffs under an array of different statutory authorities.  For instance: 

• Canada, Mexico, and China Tariffs:  President Trump ordered 20% tariffs on products from China and 25% tariffs on products from Canada and Mexico not covered by the U.S.-Mexico-Canada Agreement (“USMCA”) under the International Economic Emergency Powers Act (“IEEPA”). 
• Steel and Aluminum Tariffs:  Separately, for the Section 232 tariffs on steel and aluminum, President Trump removed country-specific exemptions, is phasing out the product-specific exclusions and removing General Approved Exclusions, and is creating a petition process for the expansion of the tariffs to derivative steel and aluminum products not already covered. 
• Reciprocal Tariffs:  Meanwhile, the Office of the U.S. Trade Representative and the Department of Commerce are leading a broad review of foreign trade partners to determine whether they are imposing nonreciprocal tariffs and other trade restrictive measures, for the United States to respond in kind (possibly with higher tariffs of its own). 
• Other Potential Tariffs:  All the while, myriad agencies are reporting to the President in April on a variety of trade and tariff issues, which could serve as the foundation for additional, future tariff actions by the Trump Administration.

Key Considerations to Assess and Manage Commercial Dispute Risk

Question 1:  Are the Goods Supplied Under the Contract Subject to Tariffs?

The threshold question is whether the tariffs affect the goods to be delivered under the contract.  This inquiry is not always straightforward and often goes beyond simply determining the country from which the product was imported.  Complicated analyses regarding a product’s country of origin for U.S. customs purposes will ultimately determine which tariff rates apply. 

In addition, tariff rates can at times shift on a daily basis, with tariff announcements later being rescinded because the United States and the foreign trade partner reached a deal to avert or suspend the application of the tariffs.  Tariffs may also be supplemental to preexisting duties that apply to the products, meaning that some goods may be subject to a complicated web of most-favored-nation tariffs, Section 301 tariffs, Section 232 tariffs, and IEEPA tariffs, among others.

Question 2:  Does the Contract Assign or Allocate Tariff Risk to a Particular Party?

If tariffs do affect the goods to be delivered under the contract, the next step is assessing whether the contract at issue assigns or allocates tariff risks, how it does so, and whether there were any assumptions underlying this provision. 

The first place to look is the contract itself.  For instance, some contracts include provisions that expressly address the possibility of tariffs, pricing provisions that specify which party bears tariff-related costs, or price adjustment clauses that allow the party to adjust prices under certain circumstances.  Some contracts may contemplate a significant surge in tariffs as a ground for renegotiating or adjusting prices.  In other cases, the parties may have implicitly addressed tariff-risks in their contract by referencing Incoterms, such as “Delivered Duty Paid” or “Ex Works,” which define the party responsible for paying tariffs, duties, and transportation costs.

Depending on the precise formulation of the relevant clauses, whether and how the contract allocates tariff-related risks may depend on a number of other factors, including whether the tariffs at issue are of the types of tariffs that the parties contemplated when forming the contract.  The Trump Administration is relying on a mix of authorities to impose tariffs, some of which have clear precedent while others are more novel and untested.  

For example, the President’s ability to impose national security tariffs under Section 232 and tariffs under Section 301 in response to discriminatory or unfair foreign trade practices has already been litigated, with courts largely upholding presidential action.  Contrast these authorities with the tariffs that President Trump imposed on China, Mexico, and Canada under IEEPA, a statute that has never served as the basis for the imposition of tariffs.  How courts will treat a challenge to the IEEPA tariffs remains to be seen.  The questionable legal foundation or lack of prior precedent for certain tariffs may raise questions about the assumptions underlying the contract and the parties’ contractual allocation of tariff-related risks.

Question 3:  Can the Tariffs Be a Possible Basis for a Party’s Non-Performance?

A party that bears tariff risk may have avenues for relief.  The flip side, of course, is that a party who has clearly negotiated to shift the tariff risk onto a commercial partner should be able to enforce the terms of that agreement.  Many contracts fall in a gray area, however, and a case-specific inquiry will depend on multiple factors, including the express language of the contract and the governing law. 

On occasion, the terms of the contract may excuse performance due to the implementation of tariffs.  For example, a party facing increased costs may seek to invoke a force majeure clause – a contractual provision that can relieve a party from liability for non-performance or delayed performance caused by certain specified events.  This may especially be the case where the force majeure clause explicitly contemplates certain economic shocks or changes in economic conditions as events of force majeure.  However, courts have generally been reluctant to excuse performance on the basis of changes in cost, price, or market conditions, even if such changes were caused by government action, and “acts of government” were included as a listed event in the relevant force majeure clause. 

Other potential excuses for non-performance can include the legal doctrines of impossibility or commercial impracticability.  Generally, such doctrines may apply when the non-occurrence of an event was a “basic assumption on which the contract was made.”  An increase in costs alone is usually insufficient to establish commercial impracticability, and market stability is not usually a “basic assumption” on which a contract is made.  Courts may be inclined to find that tariff-rate increases are a routine aspect of international commerce that parties should account for when entering into contracts for the sale of goods.  Nevertheless, courts have recognized that where costs have become excessive and unreasonable due to an unforeseeable event, performance may be excused.  

The application of contractual provisions and legal doctrines to excuse performance will depend on the facts and nature of the contract.  A loan agreement, for example, may contain a material adverse effect (“MAE”) clause, and tariff-rate changes that substantially impact a borrower’s profitability could trigger an MAE clause if a relevant exception or carveout does not apply.  Careful legal and factual analysis is required to identify the rights of the parties under such agreements.

Question 4:  How Can I Assert My Rights or Negotiate a Resolution?

Any party entering into new contracts with tariff exposure should be aware of the potential risks and develop a strategy to mitigate tariff-related contract disputes.  Key considerations include the governing law, express or implicit allocation of tariff risk, the language of certain key contractual provisions, and the dispute resolution clause under the contract.

Parties that have already entered into contracts impacted by tariffs can undertake a few key steps to assess their risks and exposure, including analyzing the contract terms to determine whether those terms address or assign tariff risks and what legal remedies exist.  The next step is to review carefully the dispute resolution mechanisms provided under the contract to identify options for pursuing litigation, arbitration, or other formal and informal means of recourse.  Finally, impacted parties should develop strategies for negotiating with counterparties over tariff risks, and identifying win-win solutions, wherever possible.

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Covington is advising a range of clients on tariff risk strategies and potential disputes, having pulled together an inter-disciplinary team of international trade and commercial disputes experts.  We encourage you to contact members of the International Arbitration and International Trade Practice Groups if you have any questions.