COVID-19 consequences for contracts – now and in the future

With the disruption to business caused by COVID-19, it is timely to consider your contractual position both for contracts that are “on foot” as well as your future contracting position.

“On foot” contracts

For customers and suppliers alike, delays or non-performance of obligations are an inevitable result of COVID-19. Both suppliers and customers should consider how their agreements contemplate such an event – and as always, the devil will be in the detail.

Parties may look to delay, or to avoid altogether, performance of their obligations. In some cases, they may look to terminate the contract. This may be because COVID-19 has prevented them from performing their contractual obligations, or because a party seeks to use it as an excuse to get out of a bad deal.

So, what might people look to use for relief?

Force majeure clauses:

Most contracts contain force majeure clauses. They usually only refer to the party most likely to be impacted but can include rights and remedies for both parties. Such clauses are designed to provide relief for, or to excuse altogether, a party from performing its obligations on the happening of certain express events or matters beyond their reasonable control. Typically, force majeure clauses call out specific events such as fires, floods, acts of terrorism or war as events in which relief is granted. Some contracts will have included “epidemic or pandemic” as a specific force majeure event which will make the parties’ positions clearer with COVID-19. Often, they also include a “catch all” such as an event “which is beyond a party’s reasonable control”. But the clauses differ wildly and will need to be carefully considered – as they can lead to rights to terminate.

Whether a party would be successful before the courts ultimately depends on the impact of COVID-19 on the performance of the contractual obligations, and the precise wording of the contract and specific force majeure clause. Given the fact-specific nature, this is likely to result in disputes.

Doctrine of frustration:

You may be subject to the doctrine of frustration even if there is no force majeure clause in the contract. The doctrine of frustration means that a party does not need to comply with a contract where, through no fault of their own, an event makes performance impossible or completely different from what the parties originally intended. Some examples are where:

  1. the thing that is the subject is no longer available (e.g. when a hall to be hired burns to the ground);
  2. the purpose of the contract cannot be achieved (e.g. an event, which is the subject of the contract, is cancelled);
  3. there is government intervention (e.g. some actions required under a contract may be prohibited by law); or
  4. long delays frustrate a contract, but only where the long delay means that the parties are dealing with completely different conditions to those previously agreed on contemplated.

However, the threshold for frustration is high. It is not enough that performance is now more expensive, onerous or difficult. The effect of COVID-19 must be so significant that the parties are required to perform something quite different to that originally contemplated by the parties. The courts tend to consider several factors in deciding whether a contract has been frustrated including:

  1. the terms of the contract;
  2. its factual background or context;
  3. objectively, the parties’ knowledge, expectations and assumptions regarding risk;
  4. the nature of the event which is causing the non-performance; and
  5. whether the contract may be able to be performed in the future.

Finally, take care and get legal advice before asserting frustration. The doctrine of frustration may be excluded if the contract already deals with a particular risk expressly; and if you have no basis for asserting frustration of contract, you may be found to have breached the contract resulting in a potential claim against you.

When might a “force majeure event” fail to trigger relief?

If an agreement contains business continuity and disaster recovery (BC/DR) obligations, these may require a party to have taken certain preparatory steps in anticipation of certain disruptions (like an epidemic or pandemic) occurring. In this situation, the BC/DR plan would need to be implemented in the case of a force majeure event occurring (as opposed to the existence of the force majeure event giving the party a blanket excuse for non-performance).

The success of the BC/DR clause in insulating an arrangement from disruptive events, or supporting claims for breach, will depend on the scope of the obligations and may come down to the level of detail required from suppliers around the lengths to which they must go to in their contingency plans.

 What of the future?

While it is most pressing to look at the impacts on your organisation under existing contracts, thought should also be given to contracts currently under negotiation and to templates for future deals.

Under negotiation

Parties need to consider how COVID-19 (a known event) will be viewed if the contract under negotiation was executed, and the impacts of COVID-19 continue or worsen.  A force majeure clause is designed to deal with the unknown and unexpected (for example, a flood in an area not known for floods, or civil unrest in an otherwise stable country). COVID-19 has been declared as a global pandemic and its impact could be felt for some time to come, with flare ups occurring in new locations or even reappearing in locations thought to be past the worst.

As with all contracts, being explicit and express in your intent is critical. So, if you are a supplier and COVID-19 could cause you to fail to meet an obligation, and you need relief, be express in your contracts. Likewise, if you are a customer and if COVID-19’s long-term impact may cause you to exit an agreement, obtain the express right up front.

Templates

If you haven’t reviewed your contract templates recently (particularly, your force majeure and BC/DR clauses) consider now an excellent time to do so.

Consider other clauses that may need reviewing such as material adverse change, price review and limitation/exclusion clauses. Think through how you would want the contracts to respond if COVID-19’s impact is long term, or if a similar event was to occur in the future – and act now.

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