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COVID -19: Possible Impact on Commercial Contracts

by Stephen on March 6th, 2020

In recent weeks, we have seen a range of responses to the news about the spread of COVID-19 (a new form of coronavirus[1]) from the media, health authorities, the Government, various businesses and business groups, public bodies such as those in the education sector, a large number of economic commentators and those providing advice to employers and employees. 

If there is a consensus amongst economic commentators, it is that there is the potential for quite significant and widespread economic impacts.  Comparisons are being made to the GFC.

The impact of emergency planning measures is already making its presence felt in some sectors of the domestic economy with education, tourism and hospitality providers and the forestry sector already taking the heat and there is much talk about the potential impact on exporters (affecting demand and access in key export markets) and importers (affecting supply chains).

The purpose of the note that follows is to highlight a handful of key points for those businesses thinking about the impact of responses to COVID-19 in the context of their key business contracts.  Specifically, whether these developments will invoke provisions excusing performance – whether under a provision of the contract itself (i.e. for ‘force majeure’) or more generally because of the contract being “frustrated”.

Force Majeure

Typically, a force majeure[2] clause operates to excuse a party from their performance obligations where they are prevented from doing so by an event that is outside their control. 

In order to be excused, there must be a specific term of the contract.  And while there are a number of reasonably well-worn drafting paths (e.g. those which do / do not provide an opportunity for the parties to bring the contract to an end if the force majeure event continues for a specified period and/or appears, objectively, to be unsurmountable) the key issue is to have regard to the specific terms of the relevant contract.  (Note:  This may exclude contracts of insurance and those in the shipping industry where certain industry practices may blur this distinction). 

A party seeking to rely on a force majeure clause is said by the courts to face a “comparatively high hurdle”.  As a result, and depending on which commentary you subscribe to, there are said to be a number of key questions to be asked when deciding if a force majeure clause applies.

  • Specified event:  As noted above, a force majeure clause will often list a number of specific events that must occur for the clause to apply.  As well as direct application to COVID-19 (if the clause refers to the impact of disease) there may be good grounds “Act of God” wording is sufficiently wide.  Also, a Government or regulatory response (e.g. a travel ban or supply chain restrictions) may be captured by wording such as that referring to unavailability as a result of Government acts or orders or those of other regulatory bodies.  More helpful are those clauses which list a range of events and then go on to include general wording that extends to events or matters beyond the reasonable control of the parties.
  • Impact on performance:  If there is a force majeure event, then the next question is whether the impact meets the threshold test specified by the wording of the clause.  Often, this is a high hurdle – for obvious reasons (contractual obligations should not be an option and are intended to be binding and enforceable).  Typical wording often uses such words as “prevented” or “impossible”.  There is authority for the conclusion that “impossibility” is something much more than being more difficult or more expensive to perform.  Nonetheless, some force majeure clauses define lower thresholds.  As a result, the specific wording and its application to the specific circumstances need to be considered.

Another approach, driven by some commonly used wording, is that a force majeure event, requires the event / circumstances to be such that it is:

  • unforeseeable
  • outside of a party’s control
  • unable to have been avoided, and
  • the cause of a party being unable to perform its contractual obligations.

The issue of “foreseeability: is likely to be a bone of contention – and has already made its presence felt in relation to travel insurance with the result that a number of insurers have specified cut-off dates (around the end of January) after which they say that COVID-19 was a foreseeable risk for which cover cannot be obtained.  Arguably, it is the future progression (impact) of regulatory responses which is still unknown / not foreseeable.

Typically, the wording of a force majeure clause will specify that the event of circumstance (leading to the “impossibility” or failure of performance) was beyond the reasonable control of the party.  Even in the absence of such wording, there is a possibility that a court may regard this as implicit.  This could make a big distinction between (for example) regulated travel bans and self-imposed ones.

Also, even in the absence of a specific (contractual) requirement to take steps to mitigate (abate) the impact of the force majeure event, a court will expect an affected party to have taken reasonable steps in mitigation.  Increasingly, in the construction and some other industries, parties are seeking to list what they consider those mitigation steps should be. 

The knock-on impacts of a claim of reliance on a force majeure clause also need to be considered.  Does it relieve performance altogether or just provide an extension of time?  What about the impact on the purchaser whose supply chain is interrupted – does their business interruption insurance cover that impact?

(Contractual) frustration

In the absence of a specific term of the contract excusing performance for a force majeure event, some help may still be available in the form of the so-called ‘doctrine of frustration’.  This is a body of judge-made law developed since the late 19th century which has the effect of excusing both parties from their contractual obligations – where performance has been rendered impossible (or requires performance in a different manner to that originally contemplated) because of some event that was outside either parties’ control.

In domestic contracting context, the ‘doctrine of frustration’ has some legislative support that has been folded into the Contract and Commercial Law Act 2017.  These provisions are designed to deal with the effect of the discharge of obligations on those parts of the contract already fulfilled, supplementing the doctrine by:

  • giving a right to recover money paid – even if the payment was made before the frustrating event;
  • allowing a claim compensation for work done and/or expenses incurred up to the frustrating event, and
  • permitting the benefits received up to the frustrating event to be taken into account when determining the recovery of moneys paid or expenses incurred.

Importantly, the parties can contract out of the impact of the doctrine of frustration – where they specifically address the risk (and consequences) of the frustrating event.  As a result, there is said to be a high bar for invoking the doctrine (and its legislative support).

The typical examples of frustration include:

  • The subject matter has ceased to exist – the classic example being contracts for hire where the object has been destroyed.
  • The purpose of the contract has become impossible – which may be relevant where personal performance is key.
  • The specific method of performance has become impossible – such as transport by refrigerated shipping container, where those containers case to be readily available.

And it is quite conceivable that Government interventions, such as law changes or directives (e.g. preventing movements of people or goods – or imposing new compliance obligations) making performance impossible (illegal) or radically altering the contemplated method of performance, could be valid sources of “frustration”.

Other contractual provisions

A range of other contractual provisions may also be relevant.  An increasing number of standard terms and conditions of trade contain quite widely-drafted ‘boilerplate’ provisions that may have widespread application – including when considering the knock-on impacts of COVID-19.  One common example is that of the severance (or change of law) clause.  Typically, such a clause provides that, if a provision of the contract becomes invalid, illegal or unenforceable, that provision must (to the extent of the invalidity, illegality or unenforceability) be ignored or severed from the application of the contract – and the balance of the terms of the contract continue in full force and effect.  For more carefully-considered change of law clauses – the contractual safety valve applicable to the change of law (particularly one that makes performance unlawful) may extend to suspension of the relevant obligation or a requirement that the parties negotiate / use their best endeavours to find an alternative means of performance – or even a right of termination.

Other contractual provisions to be considered include:

  • Termination clauses:  In some cases, the knock-on impact of COVID-19 may enable a termination right to be triggered (e.g. where force majeure has continued for a certain time).
  • MAC clauses:  Whilst they are sometimes thought of as a bit of an Americanism,  material adverse change clauses are creeping into a variety of contexts – including those for supply chain matters.  Depending on the wording – a MAC clause may lead to a re-negotiation or even termination. 

(Note:  Excluded from this discussion is any consideration of performance and financial covenants such as those contained in banking and other financing arrangements.)

A checklist approach

A checklist approach to risk management is suggested.  Checklist items might include:

  • Does the relevant contract include a force majeure clause?
  • Is COVID-19 (and its consequences) covered by the specific wording?
  • What are the notice and other practical requirements – for dealing with the other party?
  • What form of engagement (with the other party) is required? – can we workshop alternative means of delivery / performance to avoid or minimise the impact?
  • Consider other steps required by the duty to mitigate.
  • Is it an escape clause – enabling termination of the contract in if there is a prolonged force majeure?
  • Consider the knock-on impacts – on other contracts and/or a project.
  • Consider insurance cover (and discuss with broker and/or insurer) – including the specific steps to meet the requirements of the policy.

Take care when asserting a force majeure event or frustration

Whilst it should be apparent that the impact of COVID-19 (e.g. the impact of Government measures to contain its impact) on a party’s contractual obligations must be significant in order to claim force majeure or even frustration – because performance of the contract has been made impossible or radically different.  However, any business that is considering whether to assert force majeure or frustration must also be aware of the serious consequences of a mistaken assertion of either of these legal rights.  Specifically, a party refusing to perform their obligations (incorrectly) on the basis of force majeure or frustration may amount to a breach (or anticipatory breach) or even a repudiation of the contract.  Depending upon the severity of that breach, the other party could be entitled to claim damages or even to terminate the contract.

For these reasons, prior to claiming a force majeure event, or that a contract has been frustrated, it is very important to take legal advice.

Further information

Please contact me should you have any queries concerning the information to be provided.

[1] Coronaviruses are a group of viruses that cause diseases in animals.  In humans, they are described as causing respiratory tract infections that are described as typically mild, but some forms (such as SARS and MERS) can be severe.

[2] From the French = superior force.

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