With supply chain disruptions on a local, national and global scale, entire countries on lockdown and a declining economy, many businesses will be wondering whether the wording of their contracts may provide a ‘get out of jail free’ card or, if not, whether the law can help in these unprecedented times.
For an overview of what key practical steps your business can take, see our recent article on understanding how the Coronavirus can impact commercial contracts.
Force majeure clauses: is COVID-19 caught?
Force majeure clauses cover specified events which the parties agree that, if such events were to transpire, they would accept that the affected party is unable to fulfil their contractual obligations. Specialist legal advice will be required if you are seeking to rely on a force majeure clause and the contract should be considered in its entirety.
For COVID-19 to be caught by a force majeure clause and for your business to rely on this clause, several factors must be considered:
1. Is COVID-19 specifically included in the clause?
Many contracts, including contracts entered into after the outbreak was first reported in December 2019, will not expressly refer to COVID-19 in the clause or as a defined event. Instead, a force majeure clause may refer to one or some of, “epidemics, pandemics, disease, staff shortages, changes in the law or circumstances beyond the reasonable control of the parties” and any or all of these descriptions may offer scope for the clause to be relied on.
2. What does the rest of the clause say?
If the clause specifies that the event should ‘prevent’ your business from performing its obligations then this means performance has to become impossible, not just unprofitable or difficult.
On the contrary, if the event should ‘hinder’ performance then this sets a lower threshold. However, the party seeking to rely on the clause should consider the contract as a whole and carefully consider whether clauses imposing duties to perform the obligation require ‘reasonable’ or ‘best’ efforts be made in performing the obligation.
3. What does the rest of the contract say?
Is the affected obligation a small part of the contract or does it go to the root of the contract?
If the former, an extension of time or suspending the performance of the obligation may be a more proportionate remedy.
If the latter, termination or a duty to renegotiate the contract in good faith may be more appropriate.
4. Even if you can rely on the clause… should you?
There may be commercial considerations why seeking to rely on a force majeure clause may not be the best course of action for your business.
After this crisis is over businesses will need to recover and they are likely to rely on other businesses to do so. If the parties cannot agree on the interpretation of the force majeure clause, it is possible the matter becomes litigious, which will inevitably create ill-feeling (and considerable costs, time and energy) between the parties.
Litigation is the last resort in normal times and, now more than ever, businesses may want to find an amicable commercial solution wherever possible.
5. You decide you should rely on the clause… but how?
The contract should set out the procedure necessary in order to rely on the force majeure clause. Take note of the notice clause, in relation to how to communicate your intentions. Steps should only be taken after careful consideration and having sought legal advice.
If there is no force majeure clause, or the clause does not account for COVID-19, your business may be able to rely on the doctrine of frustration.
A contract may be frustrated if, after a contract is formed, an unforeseen event (not caused by either party’s conduct) causes performance of the contract to become impossible or the obligations under the contract are radically transformed and the contract does not deal with the unforeseen event.
There are a number of hurdles to overcome in order to rely upon the doctrine of frustration and the threshold for a successful claim of frustration is high. We can breakdown the above points as follows:
1. An unforeseen event after a contract is formed.
Clearly, contracts entered into before COVID-19 came into existence will meet this requirement. This becomes less clear the further into the spread of the disease the contract was entered into. Contracts entered into after the World Health Organisation declared the disease to be a pandemic may find it harder to meet this step than if they had entered into the contract before the declaration.
2. Unforeseen event not caused by either party’s conduct.
Assuming neither party foresaw COVID-19 having an impact on their ability to perform their contractual obligations and given that neither party actively or purposely contributed to the spread of COVID-19, this hurdle will be met in the vast majority of cases.
3. Performance is impossible or the obligations are radically transformed
The terms ‘impossible’ and ‘radical’ impose high standards and the specific circumstances and terms of each contractual relationship must be considered on a case by case basis. This is the key part of the threshold as, if the other hurdles are met but your obligations are not impossible or fundamentally different, the doctrine of frustration cannot be relied on.
Under common law, frustration will automatically bring a contract to an end and release both parties from further performance. This means other obligations, not necessarily those affected by COVID-19, will no longer have to be performed.
The Law Reform (Frustrated Contracts) Act 1943 sets out the legal consequences under statute of a contract being frustrated and covers situations regarding recovery of advanced payments and receipt of non-monetary benefits. There is an opportunity for suppliers to recover sunk costs (but not profit) on partially performed contracts.
You may be able to successfully argue your contract is frustrated but you will also need to consider the wider commercial context of pursuing this course of action.
Force majeure will only help release you from your obligations that are specially affected by COVID-19. As such, it is important to bear in mind that you may have other obligations that are unaffected by the outbreak that are left to fulfil. Frustration will terminate the contract, but this will include obligations the other party owes to you.
Seeking to rely on either a force majeure clause or the doctrine of frustration indicates to your counterparty that you are unable to perform your obligations and, if you are unsuccessful in your argument that the obligation is released, the counterparty could bring a claim against you for damages or seek specific performance.
Both force majeure and the doctrine of frustration offer a ‘way out’ for businesses bound by contractual obligations but careful consideration must be given to the repercussions of playing these ‘get out of jail (but not necessarily) free’ cards.
For specific advice on how to determine your contractual obligations in light of COVID-19 or how to handle an approach from an*other party seeking to rely on force majeure or frustration, please contact our commercial department on 01892 510000.