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Covid-19 And Escaping Contractual Liability

How may the COVID-19 pandemic affect force majeure clauses in contracts?  ACID Legal Affiliate Gavin Llewellyn takes us through the clauses in contracts that may or may not support businesses through crises.

Background

Force majeure clauses are a mechanism by which parties to a contract, who are not at fault, are prevented from fulfilling their contractual obligations as a result of supervening events which are beyond the parties’ control.  Inclusion of such a clause in a commercial contract aims to protect parties from becoming liable for failure to perform in accordance with the contract. An example of a typical force majeure clause which may be present in a commercial contract is detailed below:

“Neither party shall be in breach of this agreement nor liable for delay in performing, or failure to perform, any of its obligations under this agreement if such delay or failure result from events, circumstances or causes beyond its reasonable control. In such circumstances the time for performance shall be extended by a period equivalent to the period during which performance of the obligation has been delayed or failed to be performed. If the period of delay or non-performance continues for six months, the party not affected may terminate this agreement by giving 30 days’ written notice to the affected party.”

The scope and effect of a force majeure clause is dependent on how it is drafted.

The above clause, for instance, does not provide a prescriptive list of events that may constitute a force majeure event and the determination of the same is determined based on the view of the parties (or the court in the case of a dispute) as to what events, circumstances or causes may be beyond the parties’ reasonable control.  It also applies to both parties, but a force majeure clause can be drafted in favour of one party only.

In the alternative, some contracts provide further detail as to what may constitute a force majeure event, listing circumstances that may include:

  • acts of God, flood, drought, earthquake or other natural disaster;
  • epidemic or pandemic*; and
  • terrorist attack, civil war, civil commotion or riots, war, threat of or preparation for war, armed conflict, imposition of sanctions, embargo, or breaking off of diplomatic relations.

*A pandemic is defined by the World Health Organisation (“WHO”) as the worldwide spread of an infectious disease affecting an exceptionally high proportion of the population within a short period.

The effect of a force majeure clause also depends on the drafting. Generally speaking, however, operation of such a clause will usually either lead to:

  • A suspension of the parties’ contractual obligations (for example, the obligation to pay or to carry out works are paused until the force majeure event has come to an end, at which time the obligations will be re-activated). This will include a situation where the parties agree to delay an event, for example, and allow money paid or preparations undertaken to be “carried over” to the re-scheduled event.
  • Liability under the contract for failure to fulfil contractual obligations is removed as long as the event is ongoing (for example, the requirement to pay interest on late payment does not apply as a result of the force majeure event).
  • The parties have a right to terminate the contract and “walk away”, usually after a set period of time. In such cases, where the contract required pre-payment for the provision of goods or services, the paying party will usually be entitled to their money back.

COVID-19

Many businesses are experiencing large-scale disruption as a result of the COVID-19 pandemic, which is now expected to be exacerbated by the closure of all non-essential shops and the cancellation of events.  It is important to consider whether COVID-19 could trigger operation of a force majeure clause (where such a clause is included in a written contract).

Where a force majeure clause specifically lists “pandemic” as a force majeure event, COVID-19 will fall within this on the basis that the WHO has classified it as a pandemic.  On this basis, the parties will need to look to the specific drafting of the clause to determine how their obligations have changed (i.e. whether they are granted an extension for completion of their obligations, a right to postpone an event by a certain period of time or a right to cancel the contract).

Where (as with the example clause listed above) there is no specific definition of what may constitute a force majeure event, it is necessary for the parties to consider whether COVID-19 has resulted in an inability to perform contractual obligations. Of course, this determination very much depends on the drafting of the clause and so the parties’ obligations could vary.  Below, we have set out some key drafting points to note those that may affect the enforcement of a force majeure clause in the current situation:

  • Where a force majeure clause requires an event to prevent performance, the party aiming to rely on the clause will need to show that performance is physically or legally impossible (and not just difficult). For example, if a venue has a booking for a wedding next week, the contractual obligation on the venue to hold the wedding will now be impossible in view of the Government’s ban on all weddings (at least).
  • Where a a force majeure clause provides that events that are reasonably foreseeable will not be considered force majeure events, it may be arguable that the COVID-19 pandemic would not constitute a force majeure event on the basis that it is similar to outbreaks of similar viruses, such as SARS or MERS, in the past.  However, the current lock-down situation in the UK could arguably be a point of difference on the basis that the present situation is unprecedented and so arguably not reasonably foreseeable.
  • In some cases, a force majeure clause may contain an obligation to mitigate the consequences of a force majeure This means that in order to trigger a force majeure clause the party seeking to delay or cancel its contractual obligations must take reasonable steps to reduce their potential loss. Where such an obligation is imposed, it is necessary to ensure mitigation however possible, for example through additional expenditure to comply with obligations or to amend the scale or scope of a project, such as reducing an order from a supplier, for example.

Absence of Force Majeure Clauses

In some cases, for example where an oral contract is entered into, there may be no force majeure clause to rely on. In such circumstances, the parties may be able to rely on the doctrine of frustration in order to exit the contract. This applies where an unforeseen event occurs after a contract is entered into, which is not the fault of either party and makes performance impossible or radically different.  If this is the case, the parties’ obligations under the contract will be “discharged” and neither party will be held to be in breach.  This means that parties are freed from their future obligations (including an obligation to provide goods or a service and an obligation to pay).

In respect of past obligations, the law states that money paid in advance may be recovered and money due before the frustrating event need not be paid.  However, where one party has already benefitted, for example in the case of a construction contract where part of the work has been completed, the party that has undertaken the work is entitled to payment that is fair and just in the circumstances (even if this is not payment in full).

Stone King LLP

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