26 Mar 2020

Contracts and COVID-19: 10 Top tips

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Nobody knows what will happen over the coming months. But decisions on complying with contractual obligations need to be taken now nonetheless. We highlight key issues to be aware of from a legal perspective and suggest some practical steps that can be taken to minimise risk.

1. Force majeure contract audit

Force majeure will only excuse non-performance of a contract if the contract contains a force majeure clause. It is not a free-standing common law concept and will not be implied into a contract otherwise. Whether or not COVID-19-related events fall within a force majeure clause depends on the precise wording of the contract. Some clauses may be very specific, for example expressly citing a pandemic recognised by the World Health Organisation. Others may simply refer to an “act of God” or issues beyond a party’s control. There is no reported case law in this jurisdiction on whether a pandemic such as COVID-19 constitutes an “act of God”. While it seems reasonable to assume that courts will be receptive to treating it as such, there can be no guarantees. The starting point to minimising risk is to audit contracts now to ascertain and analyse the provisions of the relevant force majeure clauses.

2. How does force majeure work?

Generally (and subject to the precise contractual wording), you need to show a force majeure event has occurred and that: a) it was beyond your control; b) it has prevented, hindered or delayed your performance of the contract; and c) you have taken all reasonable steps to avoid or mitigate its consequences. If your contract requires you to show performance has been prevented, it must have been physically or legally impossible to perform, not just more difficult or more expensive. This is a high bar, even in these unprecedented times. Scrutinise the contract and any relevant subject matter legislation or guidance to understand what is and what is not permitted. Consider whether there are any alternative methods by which the contract can be performed. Consider what steps you can take to mitigate losses. While ensuring that internal deliberations on the topic remain privileged, make a contemporaneous note recording your conclusion once one is reached.

3. What does the force majeure clause permit you to do?

Some clauses may simply suspend performance of a contract for a period of time. Others permit termination of the contract and / or provide for what happens for past and future payments and performance already undertaken. How you choose to engage the force majeure provision in your contract will depend on whether performance has been completely prevented or whether it has merely been hindered.

4. Communications – check your notices clauses now!

Complying with legal notice clauses during a near-global lockdown is difficult. But this does not mean you can ignore the clause with impunity. Review the relevant clause and, if necessary, seek agreement to modify it to permit notice to be sent electronically. Timing is also crucial. Some clauses require notice to be sent immediately and a delay in notifying your counterparty of force majeure may invalidate your attempt to rely on it. Clauses may also require evidence of the force majeure event to be included in the notice. In a 2018 case1, failure to give sufficient notice (amongst other things) was one reason why a contractor failed to rely on force majeure.

5. How frustrating, I don’t have a force majeure clause

Where there is no force majeure clause (and the contract does not otherwise allocate risk for the situation), contractual obligations may be avoided under the Law Reform (Frustrated Contracts) Act 1943 (the “Act”). The doctrine of frustration will only apply to events occurring after the contract has been entered into. Typically, it applies where events occur which make performance of contractual obligations: a) impossible; b) illegal; or c) radically different from what the parties originally contemplated. If the relevant event was foreseeable and the contract makes no provision to address it (for example, contracts entered into since the emergence of the threat of COVID-19), frustration is unlikely to apply. As with force majeure, it is not enough for events to make performance more difficult or expensive.

6. What does the doctrine of frustration permit you to do?

Where frustration applies, the contract is automatically discharged. This means you are released from any future performance. Obligations that have already fallen due will survive, as will other relevant clauses such as dispute resolution clauses or others specified by the contract as surviving. Because the doctrine is not founded in the contract itself, there is no specific notice requirement. The Act specifies how the parties must deal with the recovery of monies already paid and future payment for obligations already performed. Claiming frustration is rarely successful. Most recently, the European Medicines Agency failed in its claim that the lease of its headquarters in Canary Wharf was frustrated by Brexit.2

7. My counterparty has claimed force majeure/frustration – how do I respond?

For force majeure, the importance of complying with the contractual notice requirements cannot be underestimated. Check that all relevant provisions have been followed and require (if not already provided) evidence of the event and its effects, the mitigation undertaken to date, and the proposals for monitoring/resumption of performance. The burden of proof lies with the party claiming force majeure.  If you accept your counterparty’s position, consider agreeing to vary the contract. If you disagree with their interpretation, review and adhere to the dispute resolution mechanism set out in the contract. From the moment litigation is in contemplation (for example because of a disputed interpretation of force majeure), remember that the parties are under a duty to preserve relevant documents.

8. Material adverse change clauses

Many contracts (including for example the Loan Market Association template documents and other finance agreements) do not contain force majeure clauses but may contain material adverse change clauses. These typically give you the right to avoid performance or to terminate the agreement where there has been a material adverse change. COVID-19-related events may potentially trigger such clauses, depending on the wording of the clause.

9. Alternative options and other issues

Claiming force majeure or frustration is a serious step, and may put an end to otherwise successful long-term partnerships. Given that COVID-19 is a global issue, it is likely that business partners, customers and competitors are facing similar issues. If parties wish to continue working together in the future, it may be that a collaborative rather than confrontational approach is preferable. Whichever route you adopt, a complete understanding of the contractual and legal position is crucial. Without it, not only does it become difficult to take the right decision now, but you risk not being able to defend that decision successfully in any future litigation. While the courts may be generous in their interpretation of force majeure in the face of COVID-19, they will also be alive to attempts to use the crisis to exit unprofitable or difficult contractual positions. A key step to take before making any decision on contract termination is to consult with insurers about the impact force majeure or frustration may have on any business interruption policies.

10. Stay safe

We hope our clients and readers remain well. For any further information on the issues raised in this article, contact your regular Stephenson Harwood contact or those listed. In these difficult times, Stephenson Harwood is pleased to donate to the National Emergencies Trust Corona Virus Appeal. The Trust is channelling those funds to local charities and grassroots organisations that can provide vital support to people as quickly as possible.

 

1 GPP Big Field LLP v Solar EPC Solutions SL [2018] EWHC 2866 (Comm)

2 Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch) although we are aware that the decision is now under appeal.

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Sue Millar

Sue Millar
Partner

T:  + 44 20 7809 2329 M:  + 44 7825 625 898 Email Sue | Vcard Office:  London

Harriet Campbell

Harriet Campbell
Professional support lawyer

T:  +44 20 7809 2517 M:  +44 7522 230 126 Email Harriet | Vcard Office:  London

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