COVID-19: impact on commercial contracts

In light of the escalating status of the COVID-19 as a pandemic and the UK moving into the delay phase of disease control, a number of businesses are looking for more guidance around what they should be doing to manage their contracts.

As a follow on from our previous update, more and more businesses are looking for relief from their contractual obligations. This article provides a recap on force majeure as well as considering what alternative options may be available.

Force majeure - when does it apply?

The starting position is that force majeure does not apply unless it can be justified to fit within the scope of the clause. In assessing this, the parties should consider the following key issues:

The timing of the contract

 Unless the contract specifies otherwise, force majeure is not usually considered to apply when the event was ongoing or in the contemplation of the parties at the time of entering into the contract. The point at which the impact of COVID-19 can be said to have been in contemplation of the parties is open for interpretation, and is likely to be determined on a case-by-case basis. Whilst COVID-19 has only recently been classed as a pandemic, some countries had already started taking drastic measures to try to control the spread of the disease and this is likely to affect that determination.

The description of force majeure

Each clause is unique and depends on the specific drafting. Wording that includes health crisis or pandemic is likely to be supportive of COVID-19 being considered a force majeure event. If the governmental restrictions become mandatory, then this allows the parties to consider other force majeure events listed, such as regulatory measures and acts of government. There may be other impacts of COVID-19 that may be considered force majeure even if COVID-19 itself is not.

How has the force majeure event affected the business

The fact that the force majeure event itself exists is not sufficient to be relied upon. Consider whether the clause requires the event to “prevent“ or “hinder”/”delay” performance of the obligations. Clearly being prevented from performance is a higher standard to demonstrate than being hindered or delayed from performance.

Mitigation of the effects of force majeure

 Force majeure clauses are not get out of jail free cards. They are a measure of last resort to seek relief where a party cannot perform its obligations under a contract.

Therefore, it is important that the affected party can show that it has done what it can to mitigate the effects of the force majeure event, whether or not the clause requires it. For example, it may be able to employ temporary workforce to cover for employees being off sick, source goods/services from an alternative supply chain where the existing one is affected or implement remote working where this is an alternative etc. 

The purpose of the force majeure clause is to provide relief for non-performance of obligations under a contract; its purpose is not to terminate or suspend the contract when performing those obligations become more costly.

The mechanism under the clause

 A force majeure clause is a contractual clause agreed between the parties; therefore, the mechanism in which the clause can be invoked is important. If it is not followed, then the clause cannot be relied upon. The contractual mechanism may include: how quickly the other party needs to be notified; how to notify; and how long the parties can wait before taking further action. Where no timelines are specified, the parties should act reasonably towards each other depending on the circumstances.

The option to terminate

The normal effect of a force majeure clause is to suspend the services. Some clauses may allow the parties to terminate if the event continues for a prescribed period of time. If the force majeure clause is silent on the consequences of termination, then the parties should look to the normal consequences of termination under the agreement on how to deal with termination. If termination is not addressed at all, the effect of the clause is to suspend the affected obligations until they can be resumed.

In the event that a force majeure option is not included in the contract, or would not allow the parties to invoke it, the parties should consider alternatives.

Doctrine of Frustration

Frustration is a right at law and applies without the need to include a contractual right. It allows a contract to be set aside where a completely unforeseeable event strikes to the root of the subject matter of the contract and therefore makes the contract absolutely impossible to perform, rather than commercially undesirable.

Frustration has an extremely high burden of proof. An event that causes a significant cost increase or delays to delivery times due to supply chain issues could fall within force majeure (depending on the clause wording) but would not be an event of frustration. Frustration may arise where circumstances make the performance of the contract illegal, such as where regulatory measures are introduced. An example is the shutdown of a venue imposed by the UK government as part of its COVID-19 measures and this prevents a time-critical event being held.

If a business wishes to rely on frustration, it should seek specialist legal advice on the likelihood of it applying.

Non-contractual relief

It is worth noting that contracts are just one way of managing a business agreement. In practice, the relationship is much more than words on a piece of paper and the best way to handle the impact that COVID-19 may have on the performance of a contract, is to speak to the other party. Having open dialogue about the impact of COVID-19 allows both parties to work collaboratively to find a solution in the best interests of maintaining the relationship.

Further, the practicalities of the issues being experienced are often not adequately addressed by the contract, as they are unforeseen and usually not adequately addressed.

Therefore, businesses should have open conversations about the impacts of COVID-19 on their relationship. As part of those discussions, the parties should bear in mind the following:

• How COVID-19 could affect either party (even the party least affected by COVID-19) if governmental measures are escalated;
• The financial strain that could be put on a party by having to comply with its obligations;
• Continuity of supply or service once the worst of the pandemic is over and businesses start to resume activities as usual (a small business affected by COVID-19 is likely going to have cash flow issues and may even have difficulties staying solvent);
• Reputational concerns where there is a disparity of power between the parties and the stronger party seeks specific performance or otherwise acts without empathy;
• The effect on the relationship and goodwill between the parties and whether they wish to carry on working together. For example if a party refuses to work with an affected party to allow some form of relief from obligations, then the affected party is unlikely to want to work with the other party again and it may share its experience in the industry. This may result in other similar businesses refusing to work with the other party too; and
• Regulatory concerns and/or obligations that may influence the decision.

If the parties to a contract do agree a course of action that deviates from the wording of the contract then it is important to document it.

For example, where it is essentially a waiver of a breach, this should be set out in writing expressing the circumstances of the waiver to avoid assumed waiver of those obligations generally. If there is a variation or change order, it is important that this is linked to the impacts of COVID-19 so that when those impacts cease to exist the contract continues as it had done originally. Whilst agreements can be varied by conduct, it is always better to document what was agreed and have it signed by both parties.

The clients we have advised in the wake of COVID-19 have commented that initial conversations with their contracting parties have frequently resolved issues without looking at the ink of the contract. However, it is advisable for businesses to know what their rights are both in law and under their contract, as this will help them decide how to approach the other party.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at March 2020. Specific advice should be sought for specific cases. For more information see our terms & conditions