One of the immediate issues facing many businesses as we enter this new and uncharted territory concerns the performance of commercial contracts. In the past few weeks, we have already seen increasing numbers of businesses, irrespective of size, being unable or unwilling to fulfil their contractual obligations.
Many of our clients are now assessing whether they are obliged to carry on with contracts they have entered into. The starting point in answering that question is to check whether the contract includes a force majeure clause. If it does, the next step is to assess whether that clause is drafted in a way that will cover non-performance for the relevant COVID-19 related reason(s) giving rise to the non-performance.
Any force majeure clause should give some indication of the circumstances in which one or both parties might be excused from performing their contractual obligations. Such clauses are, of course, coming under particular scrutiny right now.
Whether the consequences of the coronavirus outbreak will constitute a force majeure event in any particular case will depend on the wording of the clause, the nature of the non-performance and the reasons for it. The following will be relevant:
- Does the clause define what is meant by a force majeure event and, if it does, does the definition mention pandemics, epidemics or similar events?
- Even if the clause makes no express reference to pandemics, epidemics or similar events, all is not necessarily lost as it may be possible to argue that words such as “acts of God” or “events outside the parties’ reasonable control” are sufficient to cover the reasons for the non-performance. The precise drafting, the circumstances of the non-performance and the intentions of the parties at the time of entering into the contract will all be relevant;
- If the force majeure clause requires the defaulting party to have been “prevented” from performing the contract, it will be necessary to show that performance was either physically or legally impossible. It will not be sufficient to show that performance had simply become unprofitable.
If a contract does not include a force majeure clause that covers the situation, then the parties may need to rely on what lawyers call the doctrine of frustration. It is highly unlikely that events amounting to frustration will be defined in the contract itself. The doctrine of frustration will normally only apply where a change in circumstances has made it impossible, whether commercially or physically, to perform the contract or has made the performance of the contract radically different from what the parties originally intended. The circumstances in which a party can rely on frustration are therefore narrow and the evidential threshold is high.
Whether circumstances arising from COVID-19 will meet the threshold for frustration remains to be seen, but the courts are likely to continue to take a highly fact-sensitive approach in making that assessment. At this stage, it is fair to say that the primary issue is likely to be the extent of any State-imposed restrictions in the territory where the contract is to be performed and the extent to which those restrictions render performance either impossible or radically different.
If there is no effective force majeure clause in the contract and the contract cannot be terminated for frustration, what are the penalties for a breach? Does the business have insurance that will cover damages for breach in these circumstances?
What if it is your counterparty to the contract that has failed to perform as a result of an effective force majeure clause or has been able to avoid the contract on grounds of frustration? What rights do you have in respect of your losses resulting from the non-performance? In these circumstances, you won’t have any claims against the counterparty, but you should check whether you have insurance cover for business interruption and, if so, the terms of that cover.
Typically, business interruption insurance covers the income of a business if the business, or a counterparty, fails to comply with their obligations following a disaster (usually physical damage). However, if your business interruption insurance includes an extension in scope, it is possible that the policy will cover losses caused by non-physical events, which could then include Coronavirus. As ever, the exact wording is critical.
There may also be some Government help available.