Covid 19 is causing uncertainty in society at large and the way we lead our daily lives. What might its effect be on commercial contracts? In what circumstances might parties not have to perform their contractual obligations?
Is the contract frustrated?
A contract, or the obligation to perform, may be discharged in whole or in part if something occurs after its formation which renders it physically or commercially impossible to fulfil, or transforms the obligation into something radically different from the time when the contact was entered.
This is known as the doctrine of frustration. Frustration will bring the contract to an end, for example if the physical subject matter of the contract has been destroyed. There must have been some “outside event or extraneous change of situation”[1] which takes place “without blame or fault on the side of the party seeking to rely on it”[2]. In that situation, the contract may well be discharged. The doctrine is however applied very narrowly. The fact that a contract has become commercially very unattractive is not enough; frustration is “not lightly to be invoked to relieve contracting parties of the normal consequences of imprudent commercial bargains[3]”. Further, parties to commercial contracts often make express provision for the impact which various possible catastrophic events may have on their contractual obligations. The effect of such “force majeure” type clauses is to reduce the practical significance of frustration because where express provision has been made for an event of the type contemplated, then frustration has not occurred. The wider the ambit of the contractual clause, the less relevant the doctrine.
In the Covid 19 context, the starting point is therefore likely to be the actual contract in question and any specific force majeure clause.
What is a force majeure event?
It must satisfy each of the following criteria:
- The event must be beyond the reasonable control of the affected party;
- The ability to perform must have been prevented or hindered by the event; and
- Reasonable steps must have been taken to avoid or mitigate the event or its consequences.
Looking at each in turn:
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[1] Paal Wilson & Co A/S v Partenreederei Hannah Blumenthal [1983] 1 AC 854, 909
[2] Bank Line Ltd v Arthur Capel & Co [1919] AC 435, 452
[3] Pioneer Shipping Ltd v BTP Tioxide Ltd [1982] AC 724, 752
1. The event must be beyond the reasonable control of the affected party
Force majeure clauses typically list likely categories of event, often with varying consequences and remedies. The contract may therefore specifically include a reference to a “pandemic” or similar. The inclusion of such a reference will make it easier to bring a force majeure claim, but all is not necessarily lost if it is not included. Is there language such as “Act of God”, or “government action” or similar “catch all” provisions which might apply? Covid 19 is certainly outside the party’s control so might well be caught by such a provision. Furthermore, it may be relevant to look at the effect of Covid 19 and its impact on the ability of the affected party to perform; if this has become practically impossible, it is likely to be caught.
2. The ability to perform must have been prevented or hindered
Is the inability to perform sufficient to trigger the operation of a relevant force majeure clause? There must be a causal link between the event and the inability to perform. Does the clause require a party being “prevented” from performance, or merely being “impeded” or “hindered”? If the relevant workers are for example self isolated or suffering from Covid 19, this is likely, depending on the wording of the clause, to operate as a force majeure. If the disruption however only affects the profitability of the contract then, although that might have devastating effects economically on the performer, it is not likely to trigger the clause, absent specific contractual provision.
3. Mitigation
What reasonable steps need to be taken to mitigate the effects of Covid 19? Are there any alternative means of performance? These issues are fact specific, but if alternative suppliers or manufacturers are available, force majeure might not come into effect. Factors such as additional expense and delay will all be relevant in assessing the reasonableness of any mitigation options. It will be important to be able to demonstrate that you have followed all relevant official guidance and that, for example, self isolation, required by the government is the reason behind the inability to perform. What measures could you take to ensure the continued ability of your work force to keep working e.g. hygiene/working from home policies? It will be useful to document steps taken to prevent or mitigate the impact of the outbreak on the ability to perform.
Consequences of a force majeure claim
These typically include an extension of time for performance, a suspension of performance or ultimately termination; the remedies will depend on the wording of the clause.
Please also note that there is often a notice provision; a party wanting to rely on force majeure will usually be required to serve a notice on the other party to that effect, often within a specific time frame. The Covid 19 outbreak has been very fast moving. Some companies therefore have opted to serve protective or rolling notices, taking this developing impact into account.
Any force majeure claim should be made with care; a wrongful claim could have serious consequences, including repudiatory breach of contract or a damages claim from the other party.
These thoughts are up to date as at 19 March 2020 but do not form definitive advice. Please contact us if you need more detailed advice.
Gibson & Co.
19 March 2020