Advice from our Litigation team… How will the Coronavirus affect your commercial contract?

Introduction

In the face of the current health crisis the primary issue is the health and welfare of citizens but both the health crisis itself and governmental actions implemented to halt it are already having an impact on businesses’ ability to carry out their obligations under commercial contracts.

This blog examines how that impact may affect obligations under contracts and in particular how ‘force majeure’ clauses and the principle of ‘frustration’ might affect contractual obligations.

Force majeure and frustration

Force majeure and frustration address the circumstances in which contractual performance may be modified or ‘discharged’ (i.e., no longer required) as a result of supervening events which detrimentally impact the parties’ ability to perform. Force majeure is a generic term for a common type of contractual clause – while frustration is a general doctrine which applies where the parties have not made provision to cover the event in question.

As a first step when confronted with a detrimental impact on the ability to perform the contract, consider whether the contract contains a force majeure clause and what it says; if it covers the case, frustration will have no role to play.

Force majeure

Force majeure clauses generally set out the following: (a) the types of events constituting force majeure, (b) the degree of impact on contractual performance for the clause to be activated, and (c) how contractual performance will be modified or discharged as a result. The specific terms of the clause will need to be interpreted in context.

Where there is such a clause, the first question is whether coronavirus constitutes a force majeure event within the terms of the clause. Generally such clauses include both specific examples (e.g., ‘trade dispute’) and broader terms (e.g., ‘act of God’). Perhaps because of the relative infrequency of such events, it will be rare to find a force majeure clause which specifically includes cover for the current issue but, if it does, the declaration of pandemic by the WHO and various public pronouncements by national governments may assist in arguing that coronavirus qualifies.

In the absence of such wording, it would be necessary to rely on more general language. ‘Natural disaster’ and ‘act of God’ are terms often found in such provisions but there may be an argument as to whether the coronavirus qualifies or whether they were intended to cover more sudden and immediately devastating events (e.g., earthquake, volcano, flood, etc.).

If you conclude coronavirus is covered, it will be necessary to consider if it has had the requisite impact on contractual performance (and, generally, that this impact cannot be reasonably mitigated or addressed). For example, a clause may say that a party must be ‘hindered or delayed’ in its performance for the clause to be triggered; a slight increase in the cost of performance therefore likely would not be sufficient.

If coronavirus is within the scope of the clause and it has had the requisite impact, you will need to consider the operation of the clause on performance. A major issue here, for example, will be whether performance is excused or postponed and what conditions will apply to that.

If the provision applies, it will be necessary to consider how it is to be given effect and what impact that will have. On the former, for example, the clause’s notice provisions should be considered. With respect to the second, any effect on (among other things) insurance should be considered.

Frustration

In contrast to tailored force majeure clauses, frustration is a general doctrine of law. It differs from force majeure in that it requires that contractual performance has become impossible due to some unforeseen circumstance. Its effect is blunt in that it (among other things) discharges the parties from further performance, effectively terminating the contract going forward.

The coronavirus crisis has seen an arguably unprecedented and forceful response from government in many countries, particularly in the form of generalized ‘lock downs’ and quarantines placing significant limitations on peoples’ ability to leave their homes, congregate, or otherwise engage in ordinary activities. Despite the rather narrow application of frustration, this response indicates that one specific aspect of frustration may be significant: that of ‘supervening illegality’.

Generally commercial parties enter into agreements the performance of which is legal and without providing for what will happen if performance is subsequently made illegal. Supervening illegality is a form of frustration which occurs when a change of law frustrates these expectations.

The legal prohibition must cover the entire period during which performance is due: if it only covers part of the time, then performance will be required during the other part. In the fast-changing legal context of this crisis, this may present particular difficulties.

Conclusion

In short, if faced with coronavirus-related impacts on their ability to perform contractual obligations, you may consider:

• What the extent of that impact is: is performance more difficult or expensive? Is it impossible, including during the entire time that performance is due? Could the impact be avoided or substantially mitigated by adoption of some course of action?
• Whether the agreement in question makes provision for that impact, particularly through a force majeure clause.
• If the agreement makes provision, what must be done in order to give effect to the force majeure clause: what notice must be given to the other side? What are the insurance consequences?
• If the agreement does not make provision, has the agreement been frustrated, perhaps as a result of the ‘supervening illegality’ of performance?

The foregoing is provided for information purposes and, in any specific case, there is no substitute for specific legal advice tailored to your individual situation and agreement.

If you have any concerns about a contract or your ability to perform, please contact Fred Sheppard or any other member of the Commercial Litigation team.

If you aren’t receiving our legal updates directly to your mailbox, please sign up now