COVID-19 and Commercial Contracts: The 10 most important questions answered
Phil Osborne, 14th April, 2020
As COVID-19 tightens its grip, businesses across the world are faced with unprecedented challenges in seeking to safely navigate through the economic storm caused by the pandemic. Disruption to their supply chain, and a reduced demand for their goods or services create problems managing cash flow and increase the risk of litigation.
Gosschalks is assisting a range of clients with these issues on a daily basis and is producing positive outcomes, securing businesses and safeguarding jobs. We remain open and fully functioning during the current COVID-19 pandemic, working remotely with full capability.
As the economic costs mount, businesses must carefully consider their contractual obligations and ensure that they, their suppliers, their customers and their commercial partners can continue to meet their contractual obligations in a world that looks very different to the one in which those contracts were entered into. For example, a party to a contract may seek to: -
Renegotiate the price or other key terms of the contract; and /or
Delay and / or avoid performance (or liability for non-performance); or
Terminate the contract.
If performance of a contract is likely to be impacted by COVID-19, including any measures introduced by the Government to halt the spread of the virus, it is essential for businesses to review the terms of their contracts.
Gosschalks is supporting many businesses across our client base in understanding their rights, obligations and potential liabilities under their contracts, varying widely in type, complexity and commercial value.
In this article, Gosschalks’ Partners Phil Osborne and James Phinn provide answers to important questions clients are asking about the impact of COVID-19 on their commercial contracts. This is particularly relevant to ‘trading’ contracts (including T&Cs) relating to supply of goods/products or the provision of a service of some kind.
1. If I cannot perform the contract, can I renegotiate the terms?
Where there is a risk that the contract cannot be performed, the first step is to ascertain whether the parties can vary the terms of the contract, such as the timing of performance of the contract and/or the applicable payment terms. Any variations will generally have to be with the consent of all the contracting parties, and should be carefully documented where these are agreed. If you have agreed to vary any of your commercial contracts, you should contact James Phinn to ensure that this is properly recorded to prevent risk of future litigation.
However, if one or more of the other parties to your contract are already in breach of the contract and request that you do not enforce or terminate, you should seek legal advice because care must be taken to ensure that your rights are reserved, and that you do not waive (i.e. lose your rights to enforce) the breach of contract by your words or conduct when faced with this situation.
2. What if the other party will not renegotiate and I cannot perform the contract?
As a general rule, the principle of ‘absolute contracts’ means that if performance of a contract becomes more difficult, or even impossible, the party who fails to perform their obligation is in breach and liable in damages to the non-breaching party. The damages should, so far as a monetary award can do, put the innocent party in the position it would have expected to have been in had the contract been performed – so this should cover all losses which are sustained, including lost profits and financial benefits that the innocent party would have made as a result. However, the amount of damages that may be recovered are subject to the certain rules and limits under the common law principles of ‘remoteness’, ‘causation’ and ‘mitigation’.
Just because an event such as COVID-19 makes a contract more difficult or expensive to perform does not automatically release the affected party from their contractual obligations, or their liability for failing to meet these obligations.
3. Will the contract contain any clauses that can help deal with the impact of COVID-19 on my business?
The starting point is always to check whether the contract in question contains a force majeure clause. Most commercial contracts will contain a force majeure clause (usually at the end of the contract amongst other “boiler plate” clauses), although they do not need to be labelled as such; what is important is the substance of the clause, regardless of how it may be headed or titled.
4. What is a force majeure clause and how does it work?
The purpose of a force majeure clause is to protect the parties from a breach of contract claim if they are unable to perform their obligations because of an event outside of their reasonable control.
As there is no settled statutory or common law definition of force majeure (or a force majeure event) in English Law, the contracting parties are free to agree what will amount to a force majeure event, and the consequences of such an event on their contract. Therefore, it is not possible to say whether, generally, an event such as COVID-19 would constitute a “force majeure” event, and the implications if it does, without considering the terms of each individual contract.
Typical examples of force majeure events that are listed in standard force majeure clauses are Acts of God, natural disasters, acts of terrorism or wars. Many force majeure clauses do not specify pandemics (although they should in future). ‘Acts of God’ have been shown to cover ‘biblical’ events such as floods, and potentially may be wide enough to cover plagues and global pandemics with mass fatalities, although the legal position is not clear cut and expert legal guidance is needed. Many ‘boiler plate’ force majeure events, have already been the subject of litigation and therefore, there are judicial authorities as to their meaning and scope. At Gosschalks we can advise you quickly on the authorities to ensure that your business is protected.
Where the contract does not specify a pandemic (or similar term) as a force majeure event, a party may still be able to rely on the clause where the impact of COVID-19 engages other defined force majeure events such as changes in the law or regulation by government or public authorities (for example, restrictions on imports or exports or licensing). Alternatively, the clause may contain a general “sweeping up” provision covering all events beyond the parties’ reasonable control.
The force majeure clause should also be checked to see if it specifies the level of disruption that the force majeure event must have on a party or the parties to engage the clause. For example, some clauses will state that the force majeure event must “prevent” a party from performing its obligations (i.e. making it legally or physically impossible), whereas others may include the lower threshold of “delay”.
It is important to remember that the party seeking to rely on the force majeure clause will bear the burden of proof in demonstrating the scope of the clause and that the facts fall within its scope. The non-performance must be due to circumstance that are beyond the control of the party, that the party has not assumed responsibility for those circumstances and that there were no reasonable steps which could have been taken to avoid or mitigate the event of its consequences. Parties should be mindful that where their obligation under the contract is limited to making payment, as opposed to supplying goods or a services, a force majeure event is unlikely to make it legally or physically impossible for that party to perform that obligation. Sometimes the clause will actually state that force majeure will not affect payment obligations, particularly in supplier-biased contracts and T&Cs.
5. What are the consequences of engaging a force majeure clause?
The consequences of a force majeure clause will usually be specified in the clause itself. Usually, the performance of the affected party’s contractual obligations is suspended, or its liability for non-performance excused whilst the force majeure event continues, rather than the contract been automatically discharged. The clause may include a time limit (or ‘long stop’) on the relief that the force majeure event can provide an affected party before their obligations must be performed. Where there is no long stop date and the suspension is potentially indefinite, the parties may consider whether there are grounds to terminate the contract under the common law doctrine of frustration (discussed below).
Where the force majeure clause is engaged, and unless the clause makes any other provision, the default position is that any payments already made, or costs already incurred, under the contract by either party in performing the contract will not be recoverable.
6. What should the business do if it wants to rely on a force majeure clause in the contract?
It is imperative that you seek specialist advice, because many contracts require the party seeking to rely on the force majeure clause to adhere closely to strict procedural requirements in order to obtain the benefit of the clause. The ability to rely on a force majeure clause can be lost if the procedural requirements in the contract (including any stipulations about when and how a notice to the other party of the relevant event, and the effects it is going to have on performance, should be served) are not followed in good time. This is particularly important where the parties are in discussions to try to agree a way forward without invoking the force majeure clause. To protect your position, you should contact Gosschalks Litigation Department.
7. What if my contract does not contain a force majeure clause?
If the contract does not contain a force majeure clause, you will need specialist advice on whether the contract can be brought to end by relying on the doctrine of frustration.
The common law doctrine of frustration has developed to automatically terminate a contract when something occurs after the contract was formed that is:
beyond the control of the parties; and
makes performance of the contract impossible, or renders the performance radically different from that contemplated by the parties when the contract was formed.
The issue is whether the frustrating event was in the contemplation of the parties at the time the contract was formed. If it was, then the parties are likely to have expressly or impliedly allocated the risk of the event, which would mean that frustration is not available to them. If the event was not in their contemplation, then it is more likely to give rise to arguments that the contract has been frustrated, with the consequence that both parties are no longer bound to perform their obligations.
8. Do you have any examples of when the courts have held that a contract is (or is not) frustrated?
Like force majeure clauses, frustration requires more than an event that makes performance more difficult or economically less viable. It must be impossible or render performance radically different than that which was contracted to be provided.
Examples of cases where the court has held that a contract is frustrated are: -
Destruction (by fire or other cause) of the subject matter of the contract (i.e. a venue for hire).
Cancellation of an expected event.
Unavailability of the subject matter of the contract. In the COVID-19 context, this may be the unavailability of raw materials or transport providers.
Subsequent change in the law or circumstances can make performance illegal. Again, in the COVID-19 context this may result from restrictions on imports, exports or licenses.
An unexpected delay in performance due to an unexpected event or change in circumstances, where the delay must be so abnormal as to fall outside what the parties could contemplate at the time of contracting. In those circumstances, the length of the delay in the context of the duration of the contract will be a relevant factor.
Contractual performance imposing a burden on one party that is radically different from that contemplated at the time of contracting, without performance actually becoming impossible.
Some examples of cases where the courts have held that frustration is not available include: -
Where the contract is merely more expensive to perform.
Where the parties have made express provision in the contract for the consequences of the particular event that has occurred – for instance, where the risk is within scope of a force majeure clause.
Where the alleged frustrating event should have been foreseen by the parties. In the COVID-19 context, this will be important because it could be argued that the event could have been foreseen after the virus was reported in the international media, (and it will certainly be foreseeable for contracts now being negotiated).
Where the event is already apparent when the contract is made and gets no worse during the contract term.
Where the alleged frustrating event is due to the conduct of one of the parties.
Where an alternative method of performance is possible.
However, each case will turn on its own facts so you should seek specialist advice.
9. What are the consequences if a contract is frustrated?
The effect of frustration is that all rights and obligations under the contract are cancelled with immediate effect, not simply suspended. It is not rescinded, so where a party has already provided goods or services under the contract, that performance is not undone.
Where a contract is frustrated, the ability to recover money depends on the application of the Law Reform (Frustrated Contracts) Act 1943 (‘the Act’). The Act applies to many commercial contracts governed by English law that have become impossible to perform or frustrated, with the exception of contracts that are excluded from its effects (these include certain shipping contracts, insurance contracts and contracts for specific goods which have perished).
The Act provides that:
all money payable under the contract ceases to be payable, and any money already paid may be recovered (section 1(2));
a party who has incurred expenses is permitted, if the court thinks fit, to retain an amount up to the value of the expenses out of any money it has been paid by the other party before frustration; or where money was due and payable at the time of frustration, recover a sum not exceeding that amount for expenses (section 1(2)); and
the court may order a party who has gained a valuable benefit under the contract before the frustrating event occurred to pay a "just" sum for it, regardless of whether or not anything was paid or payable before the frustrating event occurred (section 1(3)).
10. What about contracts that are currently being negotiated and future contracts?
If you are currently negotiating a contract, we would recommend that you have the terms reviewed by our specialist lawyers before entering into the contract, to ensure that the force majeure clause is drafted in such a way as to protect your business against the impact of COVID-19 or any other epidemics, pandemics or similar events outside of the parties’ control. Similarly, where the business trades on its standard T&Cs, you should have these reviewed and updated to ensure they are up-to-date and well drafted. James Phinn, Partner in Gosschalks’ Commercial department has over 20 years’ experience in advising clients on drafting and negotiating all types of commercial contracts and will be able to offer advice on the necessary changes.
The economic shock waves of the COVID-19 pandemic will be felt by businesses in all sectors and of all shapes and sizes for some time. Therefore, it is crucial for all businesses to consider, as part of their response to the pandemic and their continuity planning, whether they or their contracting partners are able or will be able to perform their contractual obligations. If performance is likely to be significantly affected, you should seek specialist advice from Gosschalks to understand your rights and obligations because each contract and case is unique and will turn on its own facts. We are providing clients with the advice they need today to ensure that their businesses are in the best position possible to weather the storm.
You can read our related article here: Minimum Purchase/Volume Commitments & Lockdown – a trap for the unprepared?
Get in touch with one of our specialists today...
We are advising many clients on the issues raised in this article - if you think we can help you and your business then please don't hesitate to get in touch with one of our specialists today:
Phil Osborne (Partner, Commercial Litigation) Tel: 01482 590256 or 07530 648582 - e:firstname.lastname@example.org
James Phinn (Partner, Commercial) Tel: 01482 590262 or 07792 385067 - e:email@example.com
Nigel Beckwith (Partner, Company / Commercial) Tel: 01482 590272 or 07949 132934 - e:firstname.lastname@example.org