Tariffs 101

Global tariffs have never been higher profile. In recent weeks, they have been applied, removed, paused and changed at dizzying speed. In this article, we aim to help clients understand how they may be affected by tariffs and what they can do to manage their impact.

What are tariffs?

Tariffs are taxes imposed on goods and collected by customs authorities at the time of import into, or export out of, a country. In practice, however, reference to a “tariff” is typically to an import rather than an export tariff.

Who must pay the tariff?

An import tariff is generally levied on the importer, who pays the tariff to the customs authority of the country into which the relevant goods are imported. 

However, it is possible to allocate responsibility for the cost of tariffs by way of contractual agreement. International commodities contracts usually stipulate that the obligation to pay import taxes is on the buyer and the obligation to pay export taxes falls on the seller. This is the case in standard form GAFTA and FOSFA contracts and also in FOB, CIF and CFR contracts. Whilst buyers are therefore most likely to be affected by import tariffs, where traders are in a contractual chain, they will of course be acting as both seller and buyer.

What can I do to manage the effect of tariffs?

For existing contracts, start with a contract review: which of your contacts or counterparties are most vulnerable to tariffs and to becoming economically unviable? Which are most at risk of counterparty default or insolvency? For these higher risk contracts, consider:

• Does the contract provide for who must pay the cost of import/export duties?
• Is there a relevant price review or force majeure clause?
• Is there scope to renegotiate the contract in order to maintain it?
• If there is a risk of insolvency, does the contract include related termination provisions?
• What is your preferred outcome if a contract becomes at risk? Would renegotiation be preferable to termination? If additional time and concessions are granted to a counterparty, these should be carefully recorded in writing.
• If in a contractual chain, are you back to back?
• Could your hedging strategy be affected? (The effectiveness of hedging contracts could be disrupted if tariffs cause volatility in commodity prices, exchange rates, interest rates, or other market conditions, so that physical positions diverge significantly from financial positions intended to hedge risk.)

For future contracts, there is greater scope to mitigate against potential risks:

• Aim for a clear allocation of risk and eliminating uncertainties wherever possible when negotiating and drafting new contracts.
• Include a clause allocating responsibility for paying tariffs and a price review clause with clear terms as to when it will be triggered and what will happen if agreement cannot be reached following a price review.
• Consider whether you should include specific provisions for termination in the event of a counterparty insolvency. Will this be an advantage, especially if you are in a contractual chain – will it impact your ability to fulfil other contracts?
• Where possible, make sure you are back to back up and down any contractual chain, particularly in relation to force majeure, termination and price review.
• Consider whether short term contracts would be preferable while the full extent of any potential trade war is uncertain.
• Consider how your hedging strategy might be affected (see above).

Can I claim force majeure (FM)?

This is unlikely, for a number of reasons:

• If tariffs are imposed, it does not automatically follow that affected parties will be able to rely on FM to excuse a failure to perform. FM will only be available to the extent that the contract expressly provides for it and the event prevents performance.

• The imposition of tariffs is unlikely to appear as a specified FM event. Although a buyer may seek to rely on more general language such as: “an act of a government or other governmental agency…not in existence at the time of signing the agreement and which directly affects the Affected Party’s ability to perform its obligations…”, such a clause would not be sufficient to excuse performance unless the tariff prevented performance altogether.

• Performance at a higher cost will not entitle a party to rely on an event even if it falls within the FM clause. That is true even where performance has become economically unviable, to the point where a party is at risk of insolvency.

• Any ambiguity will be resolved against the affected party and if the circumstances preventing performance change, they may no longer be covered by FM provisions, even if the initial circumstances were.

• Finally, in the past when parties have tried to rely on FM clauses to avoid contractual obligations in times of market upheaval, the English courts have been unsympathetic. It seems unlikely that they would change that approach now. 

Conclusion

Whilst the target, extent and longevity of any tariffs imposed in current times may be unpredictable, nevertheless commodity traders can protect themselves to some extent by adopting the measures identified in this article. Being prepared and pro-active will always help. We have published a Tariff pack which covers the issues in this article in more detail. Please contact us here if you would like a copy.