The COVID-19 pandemic continues to devastate lives around the world and most commentators are predicting a sharp economic correction. Some contractual issues which have been raised by concerned parties are discussed below.
1. FORCE MAJEURE
Force Majeure clauses are often included in commercial contracts. The clause typically seeks to excuse a non-performing party, whereby certain circumstances render it impossible to perform the obligations under the contract. Below is a typical example of a Force Majeure clause:
“Neither party shall be liable for failure to fulfil its obligations under this Agreement, if the failure is caused by flood, extreme weather, fire, or other natural calamity, acts of a governmental agency, acts of war or terrorism or similar causes beyond the control of such party, and the term for performance shall be increased to a reasonable period of time.”
You will note that there is no mention of disease or a pandemic in this clause. However, the term “other similar causes beyond the control of such party” is arguably broad enough to capture a scenario akin to COVID-19, provided that the Force Majeure event does actually prevent the party seeking to rely on the clause from carrying out its obligations under the contract. In practice this means that the application of Force Majeure clauses will have a different impact depending on the services/goods being provided. For example – the provision of most professional services can be performed remotely, whereas services that require physical contact with another person could be viewed as being impossible to perform now. The point to bear in mind when looking at invoking a Force Majeure clause is to remember that the performance of the obligation under the contract must be impossible because of the Force Majeure event rather than simply more difficult.
It is also common for a Force Majeure event to be linked to a right to terminate the contract, should the Force Majeure event continue for a specified time period.
In the context of the COVID-19 crisis some parties may decide that certain commercial contracts no longer represent a good bargain for them in light of the various COVID-19 restrictions imposed. In such circumstances a party might seek to rely on the termination provisions within the contract.
Termination for convenience
Termination for convenience is generally viewed as the most straightforward method of terminating a contract. Termination for convenience is a right to terminate on giving notice without having to have a reason to justify termination such as a default on the part of the other party. What is attractive about this option for terminating is that no justification is required. However, in commercial contracts, it is typical that such termination rights cannot be invoked for a set time period.
Termination for breach
A commercial contract will generally allow a party to terminate the contract in the event of a “material breach”. What is considered a material breach will be a matter for the particular contract concerned. It is unusual to define a material breach in a commercial context and therefore there can be a certain level of uncertainty when a party is seeking to rely on a material breach as the basis of termination. Case law indicates that to be considered a material breach, it cannot be trivial, must be substantial and must be one that is more than minimal. This uncertainty surrounding exactly what constitutes a material breach means that where it makes sense for the party seeking to terminate the contract, termination for convenience is a less risky option than termination for breach.
Termination for Insolvency
Commercial contracts often provide that where one party is deemed to be insolvent (generally speaking, evidenced by such events as bankruptcy, the appointment of a receiver, examiner, or liquidator), the other party has a right to terminate the contract.
3. COMMON LAW RIGHTS OF TERMINATION
The Doctrine of Frustration
Where an express Force Majeure provision or event has not been provided for in a contract, a party may be able to rely on the common law doctrine of frustration to discharge its obligations under the contract. However, the test for frustration is an onerous one and unlike an expressly provided Force Majeure event in a contract it can be difficult to determine what constitutes a frustrating event. Some examples of events where the doctrine has been successfully invoked include, destruction by fire (with no fault of parties) of the subject matter of the contract or what is known as ‘supervening illegality’ where it becomes illegal as a matter of law for the contract to be performed.
In general terms, the threshold required for a court to apply the doctrine of frustration is very high. It’s likely that some parties will seek to rely on the doctrine in the context of the COVID-19 crisis but again given the narrowness of its application over the years by various common law courts it remains to be seen how successful such cases will be.
Termination for Repudiatory breach
Where one party commits what is known as a repudiatory breach the innocent party will have a right to terminate the contract at common law even in the absence of such an express provision in the contract. A repudiatory breach is a breach that is said to go the “root of the contract”, frustrates the commercial purpose of the contract and deprives the innocent party of substantially the whole benefit which it was intended it would obtain.
Identifying a repudiatory breach of contract is often very difficult and a very complex area of law. Moreover, if a party terminates a contract alleging repudiatory breach and it turns out that the guilty party’s breach was not in fact a repudiatory breach, the terminating party could in fact be treated as being the one in repudiatory breach. For this reason, it is best to rely on the contractual terms to terminate where possible.
4. SURVIVAL OF PROVISIONS / RIGHTS
It should be borne in mind that the termination of contracts resulting from the COVID-19 crisis or otherwise, does not mean that the entirety of the contract is terminated. There are many contractual provisions that will survive termination. For example, commercial contracts often contain language to the effect that all “provisions either expressly or by implication are to continue”. This would typically mean that clauses such as limitation of liability, non-compete and non-solicitation, intellectual property ownership and confidentiality shall survive termination. Alternatively, the survival of specific contractual terms will be expressly provided for within the contract. There are often time limits placed on such surviving provisions also. A party seeking to terminate must be aware of their continuing contractual obligations post termination otherwise they run the risk of contractual breach.
At common law, rights which have accrued prior to the termination will also survive termination. For example, where a party is owed for payment for goods or services that were provided prior to contractual termination.
5. MAINTAINING RELATIONSHIPS
Termination should be a last resort. As such, the above points should be viewed pragmatically, commercially and with an eye to the future. However, there is no doubt that some parties will have no choice but to extract themselves from certain contracts and may need to rely on the above points to limit their exposure. However, taking such a step can have a detrimental impact on the relationship with the other contracting party for the future.
Wherever possible parties should seek to preserve their business and contractual relationships and work together in this vein to find a solution. Where both parties are open to renegotiation, it should be borne in mind that parties are free to renegotiate the terms of their commercial contracts as they see fit. For example, by entering some form of amendment/suspension agreement, agreeing to different costs, timeframes or suspension of contractual obligations pending the resolution of the COVID-19 crisis. Indeed, some contracts may also have mechanisms, that although may not completely alleviate all responsibilities, they may provide some relief. Such mechanisms would include, change control provision and the ability to amend or cancel certain orders.
The advantage of this type of pragmatic approach means that each party knows where they stand with the other and may avoid disputes concerning questions of whether COVID-19 constitutes a Force Majeure event or, if COVID-19 means the contract is legally frustrated. Most importantly, it continues and preserves the contractual and business relationship and once it makes sense for the parties to revert to the old contractual regime such a contract will not require lengthy renegotiating.
During these challenging and unprecedented times our thoughts go out to all of those affected by COVID-19.
Please stay safe.
The content of this article is provided for information purposes only and does not constitute legal or other advice.