- 25 March 2020
- Posted by: Elaine McGrath
- Category: Commercial Law
Covid-19 – The impact on commercial contracts
This note is part of a series that the lawyers of Reddy Charlton will issue on the major legal, personal and business issues that will confront us all during the Covid-19 crisis.
This article focuses on the impact that Covid-19 may have on commercial contracts and in particular focuses on ‘force majeure’.
The commercial impact of Covid-19 is growing daily with many businesses and sectors of the economy, previously thought robust being significantly disrupted. A prominent question is whether a force majeure clause excuses parties from performing their obligations under contract or from performing those obligations in a certain timeframe. In short, the answer depends on the particular circumstances and the drafting of the commercial contract. In this article, Reddy Charlton seeks to clarify this matter for our clients and friends.
What is a force majeure clause?
Force majeure clauses are contractual clauses which alter parties’ obligations and/or liabilities under a contract when an extraordinary event or circumstance beyond their control prevents one or all of them from fulfilling those obligations. Depending on their drafting, such clauses may have a variety of consequences, including excusing the affected party from performing the contract, in whole or in part; excusing that party from a delay in performance, enabling that party to suspend or claim an extension of time for performance or giving that party a right to terminate.
Force majeure is a creature of contract and not of common law. As a result, whether a particular clause relieves a party of contractual liability will depend on the precise wording used in the clause, the allocation of risk between the parties provided for by the contract as a whole, the circumstances in which the parties entered into the contract and the situation that has now arisen.
It is for the party seeking to rely on a force majeure clause in order to justify its non-performance or late performance to satisfy a court that this is the effect of the clause.
Is Covid-19 a force majeure event?
In short, this depends on the contract. Force majeure clauses will generally adopt one of the following approaches to defining the type of event which may, depending on its impact, relieve a party from contractual liability:-
- Identified specific events – These may include events such as war, terrorism, earthquakes, hurricanes, strike, plagues or epidemics. Where the term epidemic, or pandemic, has been used, that will clearly cover Covid-19. Certain clauses also include an ‘act of government’, where a government has imposed travel restrictions, quarantines or has closed buildings, services or borders. However, the position is less clear where the government makes recommendations, rather than makes orders through legislation.
- Setting out a broad criteria – Commercial contracts might refer to events or circumstances “beyond the parties’ reasonable control”. Determining whether this covers issues arising from Covid-19 is a question of interpretation and is fact-specific.
- A hybrid of the above – Clauses may give a list of specific criteria, such as fire, flood, war and so on, alongside wider, general wording, such as “or any other causes beyond our control”. Although, this will depend on the interpretation of the contract and the particular words used. The general wording in this type of clause will usually be interpreted broadly, rather than being limited to events that are similar to those specifically mentioned. As a result, such a clause may still be triggered even if a health event or other relevant event is not specifically listed.
In unprecedented circumstances like the present, the courts are likely to be generous in their interpretation of this sort of wording when faced with parties who have encountered genuine difficulties in performing their obligations under a contract. However, such parties will still need to show that their non-performance was truly outside their reasonable control and that it could not have been prevented or mitigated.
- The impact of language – It is common for force majeure clauses to specify the impact that the event must have in order for the clause to be triggered. Terms such as “prevented”, “hindered” or “delayed” require different levels of impact on performance before a party will be relieved from liability.
- Notice Clause – If you are seeking to rely on a force majeure clause you must comply with all procedural requirements under the contract. It is likely that there will be a requirement to give notice of your intention to rely on the clause to the other party within particular timescales, including any formalities required for the service of notices. Failure to abide by the notice provisions may negate reliance on the force majeure clause.
- What an affected party must show – An affected party seeking to rely on a force majeure clause must also show that:-
- the force majeure event was the cause of the inability to perform or delay performance;
- their non-performance was due to circumstances beyond their control; and
- there were no reasonable steps that could have been taken to avoid or mitigate the event or its consequences.
What is the practical effect of the force majeure clause?
The usual remedy if a force majeure clause is invoked, is for one or more of the parties to be excused from their obligations and/or liability under the contract, without any damages arising. Force majeure clauses may also provide for an extension of time, suspension of time, or termination in the event of continued delay or non-performance.
If there is no force majeure clause do I have any alternative remedies?
If there is no force majeure clause, an affected party will have to look to other provisions of the contract for potential routes out of its difficulties. One such provision is that of material adverse change. Many contracts contain a clause allowing termination or adjustment of obligations in the event of a Material Adverse Change (“MAC”) or a Material Adverse Effect (“MAE”). MAC is often used interchangeably in contracts with MAE, although a MAE clause is normally construed quite broadly. Generally, such clauses are used to create parameters whereby a buyer may terminate a transaction because of an event that negatively impacts the nature or value of the target product, company or business.
Contracts often do not specify events that may give rise to a MAC or MAE, but may utilise general descriptions of the types of impacts required for such relief. MAC and MAE provisions commonly exclude specifically the effects of financial market conditions, acts of god and similar events. The threshold required in order to be material is rarely specified, but Courts have consistently considered that any factor that would have induced a reasonable party not to enter the contract is material. Invoking a MAC clause is difficult and materiality will need to be demonstrated clearly and objectively.
As a further alternative, it may in certain circumstances be possible to rely on the doctrine of frustration of contract. This arises where, without fault of either party, a contractual obligation has become incapable of being performed. The event relied upon must be unexpected and beyond that which the party relying upon it should have anticipated. The courts are reluctant to apply the doctrine and have made it clear that all of the circumstances should be strictly scrutinised.
What are the practical steps your business can take if you are relying on a force majeure clause?
- Very importantly, consider engaging constructively with the other party and seeking to agree variations to contracts. This is the most practical step a business can take.
- Consider alternative means of performing, reducing delay or minimising any loss to the other party. This may require considering alternative suppliers, or alternative methods of delivery, or alternative methods of service provision, even if at higher cost.
- Consider the precise wording of the force majeure clause in the contract as a whole and the circumstances that have arisen. This can be a difficult exercise, so legal advice should be sought.
- Consider carefully what event you allege constitutes the force majeure event, taking into account the wording of the clause and the timescales required for service of notice;
- Give any notices required under the contract and strictly in accordance with the notice provisions.
- Do not consider relying on increased cost as a reason for non‑performance or delay as this will most probably not be acceptable.
- Keep a detailed record of why performance was impossible, hindered or delayed as the case may be, the steps taken by your business to find alternatives and mitigate loss and the service of any notices. Maintain documents supporting your position.
- If there is no force majeure clause within the contract, consider alternatives including a material adverse change or the doctrine of frustration, but be aware of the high bar for applying these remedies.
How can Reddy Charlton help?
Reddy Charlton Solicitors provide the full suite of legal services to an extensive range of clients. We have a deep expertise of the sectors impacted by this crisis and of the legal challenges that businesses may face. Our clients will inevitably need advice in relation to uncertainties and disputes in the areas of employment, commercial, insurance, property and intellectual property. Unfortunately, many will require assistance on how to respond to the insolvency of their own business or the insolvency of a business which they trade with. Both our corporate team and our personal insolvency team have decades of experience in this area.
During this Covid 19 crisis, Reddy Charlton Solicitors are eager to support, encourage and guide your business. If you have any queries or are seeking further information on what impact Covid-19 may have on your commercial contracts and their performance, please contact please contact Paul Keane at firstname.lastname@example.org or Elaine McGrath at email@example.com or any of the Reddy Charlton team. We are ready to assist you.