As Covid-19 continues to have an impact on the global supply chain, we consider how it may affect clients’ commercial contracts and which contractual provisions they can rely on to protect themselves if performance becomes increasingly difficult or impossible.
Clauses in your contract that may help
- Force majeure: this clause excuses one or both parties from performance of the contract in some way following the occurrence of an unexpected event outside the parties’ control. Typically the force majeure clause will list these types of unexpected events either by way of example (e.g. Act of God, war or conflict) or in an exhaustive list.
Clearly, if one of the events listed is a pandemic Covid-19 is covered. If a pandemic is not listed, other specified events caused by Covid-19, such as changes in law or regulation, acts of government authorities, or the restriction or suspension of licenses are likely to trigger this clause. Covid-19 could also be covered if there is a ‘sweep up’ clause at the end of the list explaining that a force majeure clause will cover an event ‘beyond the parties’ control’.
However, parties still need to proceed with caution before exercising a force majeure clause that is triggered by Covid-19. This is because the success of these clauses will depend on their precise wording (e.g. does the force majeure event have to ‘hinder’ performance or ‘prevent’ performance of the contract) and Covid-19’s impact on the performance of the contractual obligations (does Covid-19 just make performing the obligations more expensive?).
- Termination provisions: some contracts have termination clauses that allow parties to terminate without any grounds, but require a period of notice in writing to be given first (e.g. either party may terminate this agreement by giving the other party three months’ notice). These types of provisions are often referred to as either ‘termination for convenience’ or ‘termination without cause’ clauses. If a contract contains these provisions, it may be worth considering whether to exercise them if Covid-19 is causing serious issues. However, if you are considering exercising a termination for convenience clause, ensure that:
- there are no fees due to exercise the clause or minimum order requirements that have not been fulfilled;
- notice requirements under the contract are followed; and
beware that exercising a termination for convenience clause will not protect you from a potential claim for damages based on past breaches of the contract.
- Material adverse change clause: is a term that allows a party to a contract to refuse to proceed if certain events occur. Whether this clause is triggered by Covid-19 will depend on the particular wording of the clause and the circumstances of the case. Given the severe consequences caused by Covid-19, it is likely parties will seek to rely on these types of clauses to justify a refusal to proceed with their contractual obligations.
- Negotiation / variation: contracts are often a long-term commercial relationship between two parties who have built up trust over time. As a result, the safest option if Covid-19 is causing performance issues may be to consider renegotiating parts of the contract with the counterparty. Such negotiations should be conducted on a ‘without prejudice’ basis. Amendments to the contract that result from the renegotiation should be evidenced in writing and contractual variation provisions must be followed to ensure that the amendments are legally enforceable.
Common law rules?
- Frustration is a common law principle that enables a contract to be automatically terminated when an event occurs which renders the contract physically or commercially impossible to fulfil. Examples of the types of events that have been found to frustrate a contract include: destruction by fire or other cause of the subject matter of the contract; the cancellation of an expected event; and the outbreak of war.
- Can Covid-19 be considered an event that frustrates a contract? Ultimately, this will depend on the particular facts of the case and the type of contract between the parties. However, it is worth noting that the Courts have narrowly interpreted the doctrine of frustration (Brexit was recently found not to be a frustrating event in a lease agreement) and have made clear that it cannot be invoked just because performance of the contract has become more expensive. Therefore it is clear that parties need to tread with care before relying on frustration and that if the only result of Covid-19 is that performance is more expensive, frustration is unlikely to succeed.
- Parties should note that if a contract is terminated by frustration, they may be able to recover monies paid under the contract before it was terminated by frustration.
Can implied terms help?
- The Courts apply a strict approach when considering whether or not to imply a term into a contract. In particular, the Courts ask whether the implied term must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it. As a result, it is extremely unlikely a party will be able to successfully argue that a term has been implied into the contract that allows it to avoid performance as a result of Covid-19.
There is a lot of risk associated with relying on force-majeure clauses, termination for convenience provisions and the doctrine of frustration. Equally, it may be risky taking no action if contractual performance is becoming increasing impossible. As a result, we strongly recommend clients seek legal advice on their options. We are currently working with a number of clients on strategies to assist them in effectively resolving contractual issues caused by Covid-19.
Written by Ramsay Monime, Solicitor