Clay: Now that the World Health Organisation has declared the outbreak of the coronavirus (COVID-19) a global health emergency, we consider the impact on businesses that may be affected, and what companies should be looking at to protect their operations.
Pete: while some areas of the world have been harder hit than others in terms of the number of confirmed cases, companies importing and exporting goods and services globally are increasingly being impacted by the disruption. China was initially the worst affected, but Europe is facing a significant number. Given the size of the population, there is no doubt that the USA is also going to have to deal with large numbers. We thought it would be helpful to set out some of the key areas businesses should consider and review within their existing contracts when considering the impact of COVID-19 and potentially ways to mitigate their exposure, including in particular the impact of force majeure.
Clay: OK, what do we mean by a “Force Majeure” clause within a commercial contract?
Pete: If a contract contains a “force majeure” clause (and it is an “if”, as not all do) the clause is supposed to allow one or more parties to a contract to exclude liability or suspend or terminate the performance of that affected party’s obligations when certain circumstances arise which are beyond the affected party’s reasonable control. It’s usually set out towards the end of a commercial contract and sometimes wrongly classified as one of the “boilerplate” terms that all commercial contracts should contain, that are drafted as standard quite often without any real careful consideration or “bespoking” to the particular contract. Often, these clauses are invoked by one party to a contract say, for example, where there has been a fire at a warehouse.
However, COVID-19 has the potential to impact businesses at all stages of the supply chain, whether it’s where a business is considering the need to rely on it to excuse non-performance without it being liable, or on the other hand, a business which may be on the receiving end of a claim for force majeure.
Clay: OK but presumably everyone knows what Force Majeure is and it’s recognised under English Law, isn’t it?
Pete: you would think so wouldn’t you? But that’s actually a common misconception. There is no common law right under English law to absolve a party’s liability where there is an event outside their (reasonable) control (in contrast, if one party to a contract is unable to perform because the other party hasn’t done something it should have done, then it has a common law right to relief). Similarly, there is no recognised definition of the concept of force majeure under English law. If parties to a commercial agreement do want to benefit from this type of protection, then an express contractual provision is required, setting out what it is intended to cover, and the process which needs to be followed to do so.
Simply removing or delaying a party’s obligations under a contract by reference to “force majeure” would be difficult to stand up in court. While parties may understand what it means in theory, it very much depends on the contractual drafting of the clause to determine how it operates, and the way upon which it might be relied on.
Clay: So, the way this is drafted can be quite bespoke then?
Pete: These clauses can be as specific or as general as the parties agree. We are often involved in drafting a range of options where the clause could be relied upon, such as, where there has been a fire, flood, epidemic etc. They are often very sector-specific (for example, in a logistics agreement you might find that a carrier of goods can’t claim for force majeure simply because of a road closure, but may be able to do so if there are no alternative routes). However, these clauses can simply often be drafted by reference to “any events beyond the reasonable control of the affected party”. Where the negotiating parties are companies, the courts will usually deem them to be able to negotiate effectively and therefore, unless there has been a clear error, the courts will tend to follow the exact wording of these clauses. They won’t look at whether the parties negotiated them in great detail.
Clay: What happens if a party does try to rely on a force majeure clause?
Pete: Again, in typical lawyer-speak “it depends” – and in this case, it depends very much on the specific contractual language. For example:
- it could excuse non-performance of all obligations under a contract;
- it may be drafted in favour of one party only, i.e. only that party can seek the benefit of it;
- it could adjust the terms to the extent necessary so that the contract can be performed (it might, for example, postpone performance for a period, so if a party can’t perform for (say) 28 days it can then claim force majeure and can continue to claim this for say 90 days after making that first claim); or
- it could (automatically or otherwise) terminate the contract between the parties.
It all hinges on the wording of the contract in the context of the circumstances.
Clay: Is there another option – “frustration” of the contract?
Pete: potentially, yes. Under English law, a contract may be discharged on the ground of “frustration” if the contract has started and something then happens which makes any further performance impossible, illegal, or radically different from what was contemplated when the contract started. This means that even where a contract does not include a force majeure clause, it might (and I do stress might) be possible to argue that the outbreak of COVID-19 has frustrated the contract. The principle has developed in the English courts over the years, although it is generally accepted that for the courts to rule that a contract has been frustrated, something must have happened:
- firstly after a contract has been formed;
- secondly, that is not due to the fault of either party;
- thirdly that is so fundamental that it gets to the root of the contract and is beyond what the parties contemplated at the time of commencement of the contract; and
- fourthly and critically that renders further performance of the contract impossible, illegal or makes it radically different from that contemplated originally by the parties.
Clay: so aren’t force majeure and frustration the same thing then?
Pete: You might think so - some jurisdictions don’t differentiate between frustration and force majeure, but English law does.
Clay: so what’s the difference then?
Pete: The main differences are:
- the test the courts employ is generally stricter in relation to frustration – the key element is that to claim frustration something must have occurred after the commencement of the contract which renders it physically or commercially impossible to fulfil; and
- secondly unlike frustration, where a party seeks to rely on a force majeure provision, discharging the contract (by that we mean that the contract falls away altogether) may not be the only outcome. This will depend on the scope of the force majeure clause, which could, for example, allow for suspension until the force majeure event passes. In contrast, if a contract has been frustrated, it is automatically discharged, and the parties are excused from their future obligations.
Clay: so what should companies think about doing in those circumstances?
Pete: If there is no force majeure clause in the agreement (or, indeed, even where there is) and performance is becoming increasingly difficult, we would suggest that the parties should have an open discussion as soon as they can, and certainly before asserting that the contract has been frustrated, notwithstanding any future WHO or government announcement or measures. If an assertion of frustration or force majeure is found to be incorrect, this may amount to a breach of contract (or what we call an anticipatory breach of contract), which can entitle the other party to damages and potentially even being entitled to terminate the contract as well.
Clay: Will insurance cover this?
Pete: we’ve circulated some articles about this. It’s a subject which can get pretty complicated. As COVID-19 is a new virus, there will be no express existing insurance that specifically names the virus to cover companies and the performance of their existing contractual obligations. Similar considerations have arisen in recent years, not least in relation to the impact of the eruption of the Icelandic volcano in 2010.
The most common source of available coverage for many businesses may be business interruption insurance (which is often an extension of a property damage policy). However, you quite often find that for a policy to cover a business interruption claim, some form of insured event giving rise to damage (or fear of damage) is required – as an example, policies for hospitality providers at a sporting event which is cancelled for high winds are more likely to respond if (say) the event is cancelled after a marquee is blown down – this was the case on a matter I dealt with a few years ago when the Cheltenham Festival was cancelled due to storms.
Some businesses may also have specific cancellation insurance in place which may or may not be dependent upon damage, and some policies will have civil authority cover, which would cover a situation where a government authority makes an order that interferes with normal business operations.
The devil is often in the detail in respect of insurance policies, and different insurance companies will use different wording across their policies. We would advise clients to:
- firstly consider the policies they currently have in place to determine whether there is likely to be any applicable cover that could assist;
- secondly, if a client does decide to claim, they should identify and follow any specific policy procedures (you don’t want to find that you run the risk of invalidating a claim because you’ve not followed the correct procedure).
Clay: So to sum up, what should businesses do now to prepare and protect themselves best?
Pete: There are daily developments relating to COVID-19, and our steer is that businesses should consider if any of their contracts (including their own standard terms) might be affected by COVID-19 and if so to what extent. They should look at whether and to what extent their contracts include force majeure clauses, and how specific those clauses are. With the current uncertainty shown in the markets, and some companies already starting to declare force majeure in response to the difficulties they face, we’d suggest businesses should also be looking at their payment terms and provisions, to determine whether earlier payment might be an option where under normal circumstances they might be happy to accept longer payment terms – at the end of the day cash is king at the moment.
Often, “force majeure” discussions arise where there is an incident that affects one party to the contract. The difference at the moment is that both parties will no doubt be affected to a certain extent.
While some businesses might seek to exploit the outbreak of COVID-19 to extract themselves from unfavourable contracts, we think the vast majority of companies who have entered into agreements are likely to want to do what they can to “complete” the agreements as this would benefit both parties. We’d recommend early discussions between parties and looking at contractual terms as soon as possible as often, there might be alternative solutions that could be put in place contractually and logistically, even if these are short term arrangements to enable things to keep ticking over. If nothing else, taking a commercial view and working with the other party to mitigate the effect of COVID-19 could actually improve a relationship and embed it for the long term. At the end of the day, it’s always good to talk!