COVID-19, the so called ‘Coronavirus’ is having far reaching effects across the UK and indeed the world. This is only set to increase over the coming weeks.
One key area of concern for many businesses is the potential impact COVID-19 will have on a wide range of commercial contracts. This could include supply chain disruption, travel (and therefore delivery) restrictions and labour shortages. The economic repercussions for businesses of failed commercial contracts are serious when businesses tightly manage cash flow.
All parties may struggle to perform their current contractual obligations properly. Whether there is scope for either party to be excused from their contractual obligations will depend on the terms of each contract and the relevant factual circumstances. Consideration needs to be given to force majeure and material adverse change clauses, as well as remedies in law such as frustration.
Key steps to take now
While the situation is rapidly developing, there are some practical steps businesses can take now, to help plan for and minimise the impact of the virus on current and future contracts.
- Carry out a thorough assessment of your current contractual obligations and how these may be impacted going forward. Look at ways to potentially mitigate any risks you identify, and discuss any issues with your counterparties sooner rather than later if there are elements you may not be able to deliver on. The discussion could include options such as prioritising certain contractual obligations or looking at ways to stagger or postpone
- Look at your supply chain and identify where you need to find back-up suppliers, especially in terms of suppliers either not being able to deliver on their obligations in the short term or becoming insolvent further down the line
- Consider where or how you could adjust your workforce to meet the requirements of key contracts. Can some staff be re-deployed or re-trained? Are there options for temporary workers?
- Think about how you will respond to any disputes and check whether your insurance policies cover the outbreak or its knock-on effects. Ensure you know what rights you have and the technical requirements for pursuing such rights. For example there are likely to be specific notice requirements which are preconditions to exercising a force majeure clause or insurance protection
- Start a detailed log of how the coronavirus outbreak is impacting your business – this may be useful in later disputes or claims. Consider carefully the text of any communication or record that is created working on the basis that what you write may be later scrutinised by a counterparty’s lawyers and by a Court. Check effective dispute resolution provisions are in place
- In contracts which are being drafted at the moment, it will be very hard to argue that the consequences of the outbreak were unforeseen. It is important to include additional commercial terms to try to protect yourself against the effects of the outbreak. These can be conditional so that they will only bind the parties in particular circumstances
- Open a dialogue with your sources of finances to see if additional liquidity can be provided if there are temporary cash flow issues within your business. If you are going to have difficulty paying your suppliers, consider an open dialogue and asking for forbearance in the circumstances.
Terminating an English law contract due to COVID-19
It may be that as a result of the virus outbreak, one of the parties in a contract wishes to terminate it (or be excused from liability for breaching its terms). The options will depend on the terms and conditions that apply, and the individual facts. However, these could include:
- Force majeure clauses: these clauses relieve parties from the consequences of a failure to comply with an obligation, where that failure is due to the occurrence of an event outside its control and may allow for termination of the contract without liability. The clause should be analysed to see whether the outbreak falls within its scope. For example, is there specific reference to an epidemic, pandemic or contagious disease? Do the factual circumstances actually fall within the range of force majeure events? A force majeure clause can cover existing or foreseeable events. For new contracts, parties may want to specifically include coronavirus-related events.
- MAC: these clauses allow parties to terminate an agreement where there has been a Material Adverse Change (MAC) to the market conditions or factual circumstances of the contract. They normally require the party depending on the clause to show that the MAC exceeds a high threshold and so are often a last resort. The general consensus is that in isolation, the coronavirus outbreak would not be sufficient to trigger a business MAC on standard terms in commercial contracts. However, for some companies, the economic repercussions may give grounds to argue for a MAC on financial condition grounds.
- Frustration: this can be relied on if something occurs, which is not due to either party’s fault, that makes it physically or commercially impossible to fulfil a contract, or renders a party’s obligation radically different from that undertaken when the contract was entered into. The threshold for a court to hold a contract frustrated is high and it will not be available in all cases, including, for example:
- If the contract provides for the risk of the events that have occurred (such as, for example, where a force majeure clause has been included which covers the situation)
- Simply because a contract has become more expensive to perform or less profitable
- If the circumstances were foreseeable.
As such, whether a party can invoke frustration as a result of the virus will depend on the length and intensity of the disruption, and whether this can be overcome with time or not.
Other elements to be aware of
Aside from the steps laid out above, and the clauses which could allow for contract termination due to the outbreak, there are a number of other areas for businesses to consider when it comes to contracts. These include:
- Commercial terms: these may need to be renegotiated to reflect travel disruption due to border closure, supply chain impacts or restrictions on movement of people.
- Representations, warranties and undertakings: consider if these should these continue to be given. For contracts being negotiated, consider carve-outs or qualifications, limitations on liability or disclosures. For existing contracts, waivers may be required.
- Invalid terms: this standard clause could become vital if there is a change in law resulting from the virus, which renders a contract clause invalid or nonsensical. Aside from any express invalid terms/partial invalidity clause, the common law doctrine of severance may also be applied to a contract where elements can be struck-through, if the remainder of the contract makes sense.
- Remedies: think carefully about whether an obligation to negotiate in good faith or a variation procedure would be the best remedy rather than jumping straight to damages or specific performance.
The situation with COVID-19 is changing on an almost hourly basis. Planning ahead is vital, as is having access to trusted advice. If you have any questions about how the coronavirus might impact your commercial contracts, get in touch with our team of expert lawyers today.