Coronavirus and its impact on commercial contracts

Even as the government begins to ease the lockdown restrictions and businesses are allowed to open up again, there is still real uncertainty about how quickly we can return to a ‘new normal’ and the fears of a second spike are very real. Clearly, almost all sectors of the economy have been impacted by the virus. In particular, retail outlets, hotels, restaurants, bars, pubs and clubs are just some of the business which will be hit hardest.

Whilst businesses are continuing to operate as best they can, it is unavoidable that some are not going to be able to meet certain contractual obligations. The question to consider therefore is what the consequence of this will be for the parties to a contract. This involves a careful consideration of the contractual obligations and whether there are any provisions relating to non-performance of the contract.

Force Majeure

The most common contractual clause dealing with unforeseen events such as Coronavirus is a force majeure clause. Force majeure events are events which are unforeseen and unavoidable and not due to the actions of either party to the contract, which make it impossible for a party to perform a contract. Such an event is commonly known as an act of God and typically will include natural disasters such as earthquakes or typhoons but also man made ones such as riots, wars or acts of terrorism.

A force majeure clause, properly worded, will enable a party who cannot perform a contractual obligation due to a force majeure event, to escape liability for non-performance by relying on the clause.

In English law, force majeure is a creation of contract. In other words, it must be written into the contract in order to be effective and cannot be implied. It does not exist in English statute law. Whether a party who cannot perform a contract is able to rely on force majeure depends upon whether there is such a clause in the contract and the scope and wording of the clause.

There is no specific definition of force majeure. It will include what the parties have agreed when entering into the contract. Adopting the present circumstances, the force majeure clause will need to include wording to cover events of disease and pandemic, in order to be effective. It is by no means certain that Coronavirus will be a force majeure event; it will depend upon the wording of the contract and the resulting measures adopted by the government and specifically, whether they make performance of the contract impossible.

We have had enquiries from clients already as to whether the Coronavirus will relieve them of their contractual obligations. It will not always be clear. The answer will lie in the wording of the contract.   A consideration of the words used is the starting point. Did the contract set out various force majeure events, for instance? If so, is this list exhaustive? If it is, the party seeking to rely on the clause will need to demonstrate that Coronavirus falls within the list of events set out.   If it is not exhaustive, it will leave greater scope for that party to argue that Coronavirus is covered within the force majeure clause. Parties should obviously check for words such as ‘epidemic’ or ‘pandemic’ and whether the clause limits events as those occurring in a particular country. Parties should also check whether the force majeure clause is broad enough to include any government measures such as trade restrictions or quarantines, in response to such events. If they are included, the non-performing party will be more likely to escape performance based on force majeure.

In addition, it is vitally important to check the contract to ascertain whether a notice of force majeure must be served by a party wishing to rely on it. Failure to serve a notice where required will almost certainly result in a technical challenge and the non-performing party being unable to rely on force majeure. If in any doubt as to whether force majeure is available, the prudent course of action will often be to serve a force majeure notice, preserving the right to a defence of force majeure later down the line, if the position is not accepted.

Frustration

As explained above, force majeure is only available if such a clause is specifically provided for in the contact. However, not all contracts include force majeure. What is the position then if there is no force majeure clause?

The non-performing party wishing to avoid liability will have to rely on the doctrine of frustration. Frustration is a creation of English common law and it is not therefore necessary (although it is often helpful) to include a frustration clause within a contract.

In order to claim frustration, the non-performing party will have to demonstrate that it is incapable of performance due to some unforeseen event, in this case Coronavirus. This is a high threshold to meet. It will not be sufficient to show that performance has simply become more onerous or unprofitable. The non-performing party must show that performance is now either illegal, impossible, or radically different from that which was contemplated when the contract was made, such that it would unjust to now require performance. If that can be demonstrated, the contact will be frustrated.

The effect of frustration is that it brings the contract to an end and the parties are discharged from all further ongoing obligations. It does not affect those obligations prior to the event of frustration arising and sums in respect of prior performance are usually payable. In this respect frustration is crucially different from force majeure which will often merely excuse performance of a certain obligation, without bringing the contract to an end. This should obviously be a factor to consider when deciding which approach to take.

In either case, it is important to remember that in the event of non-performance, the non-performing party must first take all reasonable steps to mitigate its position and the foreseeable risk of its non-performance.   A party will not be successful in invoking force majeure or frustration where its non-performance could have been mitigated.

Summary

Whether a party’s contractual obligations will be discharged by the Coronavirus and the resultant government measures being taken, will depend upon the wording of the contract and the precise circumstances of the case. Those obligations will not be discharged simply because they become more costly or onerous; there must be something more which makes the contract incapable of performance.

A careful consideration of the position is necessary before invoking force majeure or frustration, including the legal and commercial consequences, as well as contractual notice requirements. Parties should consider whether the position can be mitigated or whether alternative means of performance are available. They should also consider whether there are any insurance or other provisions they can utilise to recover any losses arising from failure to perform.

Finally, it goes without saying that the situation is extremely fluid and the legal position may change rapidly depending on how circumstances develop and what government measures are taken in response. This article was prepared as at 23^rd March 2020.

This article is not intended and should not be relied upon for legal advice, Should you wish to discuss your matter, please contact Joe Reeves of our Litigation Department in London on 0207 481 6383 or joe.reeves@wellerslawgroup.com. For our Bromley office please call 020 8464 4242 or email enquiries@wellerslawgroup.com.