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What does the knock-on effect of the coronavirus mean for commercial contracts?

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Posted by Pete Maguire on 06 March 2020

Pete Maguire - Commercial Contracts Lawyer
Pete Maguire Partner

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 in order to protect their operations.

Whilst China has to date been the worst hit in terms of number of confirmed cases, companies importing and exporting goods and services globally are increasingly being impacted by the disruption.  We have set out below some of the key areas businesses should review within their existing contracts when considering the impact of COVID-19 and potentially ways to mitigate exposure, including in particular the impact of force majeure.

What is a “Force Majeure” clause within a commercial contract?

Often 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 and that are drafted as standard without careful consideration, the “force majeure” provision sets out the situation whereby one or more parties to a contract may exclude liability or suspend or terminate the performance of the affected party’s obligations when certain circumstances arise beyond the affected party’s reasonable control. 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, regardless of whether there is an import or export of goods or services between countries, either in respect of those parties now considering the need to rely on it or those who may be on the receiving end of force majeure being raised as a defence.

Background under English law

There is no common law right under English law to absolve a party’s liability where there is an event outside their (reasonable) control. If parties to a commercial agreement wish to benefit from this type of protection, then an express contractual provision is required.

How is “force majeure” defined?

There is no recognised definition of the concept under English law. Simply removing or delaying a party’s obligations under a contract by reference to “force majeure” would be difficult to stand up in court. Whilst parties may understand the premise of it, 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.

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.. However, these clauses can simply often be drafted by reference to any events beyond the reasonable control of the affected party. Where negotiating parties are companies, the courts will deem them to be able to negotiate effectively and therefore, absent manifest error, will tend to follow the exact wording of these clauses without consideration as to whether the parties did in fact turn their minds to the precise drafting of the relevant clauses.

What would be the result of reliance on force majeure?

Again, this very much depends on the specific contractual language. For example:

  1. it could excuse non-performance of all obligations under a contract;
  2. it may be drafted in favour of one party only, i.e. only that party can seek the benefit of it;
  3. it could adjust the terms to the extent necessary such that the contract can be performed; or
  4. it could (automatically or otherwise) terminate the contract between the parties.

Another option – “frustration” of the contract?

Under English law, a contract may be discharged on the ground of “frustration” where, after a contract has been formed, an event occurs which renders any further performance impossible, illegal, or radically different from what was contemplated at the commencement of the contract. This means that even where a contract does not include a force majeure clause, it 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 a frustration event:

  1. occurs after a contract has been formed;
  2. is not due to the fault of either party;
  3. is so fundamental as to be regarded as striking at the root of the contract and is beyond what was contemplated by the parties at the commencement of the contract; and
  4. renders further performance of the contract impossible, illegal or makes it radically different from that contemplated originally by the parties.

Whilst some jurisdictions do not distinguish between frustration and force majeure, English law does. The main differences are:

  1. the test the courts employ is generally stricter in relation to frustration, such that something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract; and
  2. discharging the contract (i.e. the contract falls away altogether) may not be the only outcome where a party seeks to rely on a force majeure provision (this will depend on the scope of the provision – it could for example allow for suspension until the force majeure event passes); whereas if a contract has been frustrated, it is automatically discharged and the parties are excused from their future obligations.  

If there is no force majeure clause within an agreement (or, indeed, even where there is) and performance is becoming increasingly difficult, the parties should have an open discussion in relation to this at the earliest opportunity, certainly before asserting that the contract has been frustrated, notwithstanding any WHO or government announcement/measures in place. Where an assertion of frustration or force majeure is found to be incorrect, this may amount to a breach (or anticipatory) breach of contract, which can entitle the other party to damages and potentially even being entitled to terminate the contract.

Will insurance cover this?

Clearly, 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, it is often the case that for a policy to respond to 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

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 there is an order from a government authority that interferes with normal business operations.

As can be seen from the above, the devil is often in the detail in respect of insurance policies, and different insurance companies will use different wording across their policies. As such, businesses should consider the policies they currently have in place to determine whether there is likely to be any applicable cover that could assist should the need arise, and then identify and follow specific policy procedures if seeking to claim, to reduce the risk so far as possible of invalidating any claim.

What should companies do now to prepare and protect themselves best?

In light of the daily developments in respect of COVID-19 and the increasing impact and awareness across the country and beyond, companies should consider if and the extent to which any of their contracts might be affected by COVID-19, including their own terms and conditions, and whether and to what extent force majeure clauses are included within their agreements. With the current uncertainty shown in the markets, and some companies already starting to declare force majeure in response to the difficulties they face, payment provisions should also be reviewed, to determine whether earlier payment might be an option where typically longer costs exposure is not in normal circumstances considered an issue.   

Often, “force majeure” discussions arise where there is an incident that affects one party to the contract. In this current situation, both parties may be affected to a certain extent, particularly if the Government or the WHO makes certain statements and/or recommendations that could affect trade and dealings between businesses, in order to seek to stem the progression of the virus.

Whilst some businesses might seek to exploit the outbreak of COVID-19 to extract themselves from unfavourable contracts, the majority of companies who have entered into agreements are likely to want to seek to “complete” the agreements for their anticipated mutual benefit. Early contract consideration and discussions between parties is recommended, as often, there might be alternative solutions that could be put in place contractually and logistically, even if in just the short term and/or particular to any direct impact of COVID-19, to enable the same or substantially the same obligations to be performed with as little deviation to the original agreement as possible.   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.

About the author

Pete specialises in the drafting and negotiation of outsourcing and commercial contracts.

Pete Maguire

Pete specialises in the drafting and negotiation of outsourcing and commercial contracts.

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