COVID-19 and the future for your contracts

As you are defending yourself against your fellow shoppers with that last packet of spaghetti, and using your 24 pack of toilet paper as a battering ram down the aisle of Woolies, spare a thought for the risk that your business contracts may have the rug pulled out from under them by the current coronavirus (COVID-19).

COVID-19 is severely disrupting businesses, markets and economies around the world.

But, how will COVID-19 impact your contracts with your suppliers, customers, employees (and anyone else you do business with)? I have already started receiving inquiries from clients who are contemplating the future of their business in the face of COVID-19.

This article will look at some contract issues that many may be facing shortly.

A major force

A “force majeure” (major force) clause is probably parked way up the back of your business contracts – or at least one should be.

Under Australian law (and other countries with a “common law” foundation, eg the UK), there is neither a definition nor a recognised legal doctrine of force majeure. Instead, it is a contractual method by which parties expressly determine what happens when events which fall within the contract’s definition of force majeure arise.

The usual intent of a force majeure clause is to excuse contracting parties from their contractual obligations and liabilities while they are prevented from performance (either completely or sometimes partially) by defined events or circumstances.

In some instances, a force majeure clause may also provide a right to terminate the contract, most often if the force majeure event subsists for a defined period. COVID-19 does not look like going away any time soon. In these instances, the clauses may specify which party is to retain the benefit of monies paid or work done under the contract upon termination.

When trying to enforce a force majeure clause, the burden is on the party seeking to rely on the force majeure clause to prove:

• the occurrence of the event – that won’t be too high a burden in the case of COVID-19;
• that the event prevented or delayed performance of the contract; and
• non-performance was due to circumstances beyond either party’s control and there were no reasonable steps the party could take to avoid the event or consequences.

It has started already

Many companies in China have been unable to fulfill their contractual obligations. To shield those companies from legal risk, the Chinese government has already issued more than 1,600 force majeure certificates (as at the end of February 2020). The certificates are meant to exonerate companies for their non-performance by “proving” that they experienced circumstances beyond their control and therefore cannot be subject to legal action or contractual penalties. To date¹, the force majeure certificates apply to contracts with a combined value of roughly $16 billion.

Of course, this only applies to those contracts that are governed by Chinese law, and who require such a certificate under the terms of the force majeure clause in their contract.  If you have contracted with a China-based company, and the contract is governed by the laws of China, expect to see a force majeure certificate if the contract has been affected by COVID-19. In reality, the contract may not have been affected at all because of COVID-19. Good luck fighting that case.

Check the scope of the force majeure clause

Under Australian law, force majeure is a pure creature of contract, so the event in question must fall within the scope of the force majeure clause in the contract. It is not uncommon to see a non-exhaustive list of events that could constitute force majeure so long as other conditions are satisfied, such as it being an “exceptional” event that is beyond the party’s control, which it could not have avoided, and is not attributed to the other party. Many contracts contain clauses that make the issue simple to resolve, for example, because they contain clauses that stipulate specific events such as epidemics, quarantine, biological contamination or entry and exit restrictions. However, other clauses include generic phrases such as ‘natural disaster’. It is certainly arguable, but not certain, that COVID-19 could fall under this definition.

According to the World Health Organisation, a pandemic is the worldwide spread of a new disease  However, the WHO has not (yet) declared COVID-19 a pandemic. Therefore, if the clause covers ‘pandemics’ then, as COVID-19 is currently only defined by the WHO as a ‘public health emergency of international concern’, the relief would not yet apply. You’d need a pandemic to be declared!

In other examples, if the force majeure clause:

• Expressly specifies epidemics, diseases or public health emergencies, then COVID-19 likely qualifies as a force majeure event. Such specifics became common following the outbreak of the SARS virus in 2003.
• Covers “acts of government,” then travel bans and factory closures may be covered.

Also:

• Force majeure clauses typically list a number of force majeure events. As the coronavirus outbreak is new, your list will probably not include this. Your list may refer events such as ‘disease’ or ‘epidemic’ which would likely capture this outbreak.
• Force majeure clauses generally contain some catch-all words such as ‘or any other causes beyond our control’ which may be a good way to rely on the clause in the absence of a defined force majeure event covering COVID-19.

Beware though: Courts (in the USA) have also rejected the application of force majeure provisions to unexpected business interruption caused by the September 11 terrorist attacks, sudden changes in market conditions, union strikes and unseasonable weather.

Check the notification provisions in your contract.

In some contracts (such as major construction contracts) force majeure provision only allows for time and cost relief in the event that notice has been given within 14 days after the party became aware, or should have been aware, of the event constituting force majeure. If your contract has such a provision, you have probably missed your chance to trigger such a claim.

So you should urgently check all your relevant contracts!

Check the jurisdiction of your contract

Force majeure also operates differently throughout the world. For example, common law jurisdictions (such as Australia) have different rules and considerations compared to civil law jurisdictions (such as Italy). Whether you can rely on, or dispute the other party’s reliance on, a force majeure clause will depend very much on where in the world the parties do business, and the terms of the contract (if any) between them. You’ll likely find the “jurisdiction” clause also conveniently nearby your force majeure clause in the back end of your contract.

Frustration? You bet!

What if parties do not have a formal written contract, or if the contract lacks a force majeure clause? As noted above, our common law does not recognise a doctrine of force majeure. If your contracts do not contain a force majeure clause, then you cannot try and rely upon the doctrine – and neither can the counter-party.

A party still may be excused from its contractual duties, however under the narrower doctrine of “frustration” of the contract purpose.

Generally, to invoke this doctrine, the event must:

• be not reasonably foreseeable by the parties or reasonable people in their position (ie you can’t just turn a blind eye to an event, and then cry “frustration!”); and
• make a contractual obligation impossible to perform or transform a contractual obligation into a fundamentally different obligation.

Merely escaping a bad bargain is not enough to claim the contract has been frustrated.

A contract will generally not be frustrated if:

• it has an operative force majeure clause that can deal with the relevant issue;
• the impossibility of performance is the fault of either of the parties;
• performance of the contract has only become more onerous or expensive. The intervening event should lead to serious consequences, and not a mere change in circumstances for performance; or
• the change is only temporary. One Hong Kong case arising from the SARS epidemic illustrates this issue. In Li Ching Wing v. Xuan Yi Xiong², a tenant the subject of a 10-day isolation order due to SARS, who was 13 months into a 24-month lease, sought to invoke frustration to discharge a lease to which he was a party. The court rejected the tenant’s argument on the basis that the isolation order was only of a short duration in the context of the entire lease.

In some states of Australia (NSW, SA and Vic), there is specific legislation governing the application of the concept of frustration to a contract, although not all the legislation is the same.

Effect of frustration

Frustration operates to bring a contract to an end in circumstances where an intervening, post-contract event has occurred through no fault of the parties.

Frustration is typically not easy to establish and has a much narrower scope that a force majeure clause.

Other than in those States of Australia that have governing legislation, the effect of a finding that a contract has been frustrated is to simply bring the contract to an end.  No party is entitled to damages for non-performance.

Insurance coverage

If your business suffers a loss from your inability to fulfill your contractual obligations because of the outbreak of COVID-19, that could provide a basis to make an insurance claim. Coverage will depend on the policy’s specific terms and conditions. Attention should be given to the policy’s specific notice provisions. However you will not be able to obtain a new policy now.

Conclusions

There is nothing preventing the parties to a contract from re-negotiating the terms. That at least may keep the business alive and kicking. But if the fundamental objective of the contract simply cannot be completed at all because of the impact of COVID-19, then it is time to exercise the force majeure clause, if you have one, or notify the counter-party that the contract is entirely frustrated.

Your business interruption insurance may come to your rescue, but you won’t be able to take out new insurance to cover business interruption from COVID-19. You’ve missed that swift-sailing boat, even assuming it could leave the dock!

1 At least at 10 March 2020

2 [2004] 1 HKLRD 754