COVID-19 and commercial contracts – practical tips for business
Businesses are facing increasingly significant concerns about what remedies are available to deal with the disruption of commercial contracts given the drastic economic impact of the COVID-19 pandemic.
Here, special counsel Selina Nutley explains—
- force majeure (FM) and 'frustration' and how these remedies operate, and
- what you should do next if you are concerned about how your business will continue to fulfil contractual obligations in the midst of the current COVID-19 disruption.
WHAT IS FORCE MAJEURE?
FM is a way for a party to a contract to exclude liability where they fail to perform a contractual obligation due to an event beyond their control – a FM event.
WHAT DOES FORCE MAJEURE INCLUDE?
FM must be expressly included in a contract, and the clause will be strictly interpreted. It covers events which—
- are beyond the reasonable control of the affected party
- cause or result in default or delay of the affected party performing its contractual obligations
- occur without fault or negligence of the affected party
- the affected party could not reasonably have been expected to prevent, avoid, or overcome by exercising a standard of skill, care and diligence.
While each clause is different and must be interpreted on a case by case basis, FM events usually include extreme weather events, riot, war, invasion, government or regulatory action, including strikes, terrorism or the imposition of an embargo. A FM clause does not often expressly cover a global health emergency, pandemic or epidemic, although these types of events may be covered by a catch all phrase such as 'any other event outside the reasonable control of the party'.
Contracting parties must be careful in declaring the COVID-19 pandemic a FM event and cease performance of their obligations. A party who incorrectly declares a FM event may risk repudiating the contract, entitling the other party to a right to terminate the contract and/or claim damages.
It is important to bear in mind that a party is unlikely to be relieved from performance of obligations as a result of a FM event just because compliance is more expensive, difficult, or less commercially desirable.
WHAT IS REQUIRED FOR A FORCE MAJEURE CLAIM?
If you believe you have a FM claim you must promptly notify the other party of the FM event, state your claim for relief from performance, and provide evidence of the FM event and its impact on your performance. If you fail to give prompt notice you may be liable for losses suffered by the other party, or be taken to have waived your right to rely on the clause. You must also use your best efforts to mitigate the effect of the FM event or risk the FM clause not coming into effect.
It is important to note that a FM clause will not usually apply—
- where the contract is entered into after the FM event
- to non-performance of monetary payment obligations, or
- if the FM event occurs after the affected party delays performance.
WHAT REMEDIES RESULT FROM FM?
If you can successfully rely on a FM clause, then, depending on the individual clause—
- you are excused from civil liability, including damages, in relation to your non-performance or delay, and
- you or the other party may terminate the contract where the essential purpose of the contract cannot be realised as a result of the FM event.
However, it is important to note that the occurrence of a FM event will not automatically result in the contract being terminated. Rather, depending on the precise terms of the clause, it may only result in the suspension of the parties' obligations during the FM event.
HOW DOES 'FRUSTRATION' OPERATE?
If a FM clause is not included in the contract, or the FM clause does not adequately cover pandemics such as COVID-19, then you may be able to discharge the contract through 'frustration'.
Frustration operates where an intervening post-contractual event occurs through no fault of the parties, which—
- makes a contractual obligation impossible to perform, or
- transforms a contractual obligation into a fundamentally different obligation.
It is important to note this remedy has limited application and can be difficult to establish. Frustration will not apply—
- where the parties have contractually agreed the consequences of the supervening event (eg by using a FM clause)
- when an alternative method of performance is possible
- because performance has become more expensive, or
- because a party has been 'let down' by one of its suppliers.
Practical tips for business
If you are concerned about your business and how it will continue to fulfil contractual obligations in the current COVID-19 disruption, we recommend you consider—
- the terms of existing contracts for protection, such as a FM clause
- whether a FM clause covers the disruption (whether by reference to a pandemic or to government action in response to the pandemic)
- whether there are any timing or procedural requirements which will invoke the benefit of a FM clause
- what steps can be taken to mitigate the effect of non-performance
- the flow-on effect from invoking a FM claim and the implications of wrongfully terminating the contract, and
- if a FM clause cannot be invoked, whether frustration will apply to discharge the parties from their contractual obligations.
Our lawyers can answer your queries about force majeure and frustration and help step you through what you need to do next.
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