On 11 March 2020 the World Health Organization declared COVID-19 to be a pandemic and travel bans, self-isolation and quarantine measures continue to be imposed. Whilst the most concerning aspect continues to be the threat to human health, the unexpected nature of the outbreak has impacted commercial contracts and economic considerations.
This note will address the provisions of force majeure clauses in commercial contracts and the related common law doctrine of frustration, and how they may be relied upon in the context of a pandemic.
Force majeure provisions
A force majeure clause typically excuses one or both parties from performance of the contract in some way following the occurrence of certain events. There is no general concept of force majeure in the common law. Therefore parties generally have to depend upon specific express force majeure terms in their contracts. If successful, the party affected will typically be excused from performing their obligations for the duration of the event and may be entitled to compensation.
Whilst there are some common features to force majeure provisions, each clause will depend on its own precise terms and will vary according to the context. Therefore each contract must be looked at and considered individually.
What constitutes force majeure?
Generally speaking, there are three criteria for a force majeure clause:
1. The event must be beyond the reasonable control of the affected party
A force majeure clause commonly deals with political and/or natural events. Many contracts will contain a list of specific force majeure events. If a contract reference a ‘pandemic,’ it will be easier to bring a force majeure claim for COVID-19 but it will still need to satisfy the other criteria.
If the contract does not include a specific reference to ‘pandemic’, it may have wider ‘sweep-up’ terms such as ‘Act of God,’ ‘action by government’ or some over catch all provision. Most force majeure provisions contain language in respect of events which are “outside the reasonable control of the party affected”. It seems fairly clear that a pandemic such as COVID-19 would qualify as force majeure under such a provision, or indeed, a consequence of the outbreak which affects parties’ abilities to fulfil contractual obligations.
2. The affected party’s ability to perform its obligations under the contract must have been prevented, impeded or hindered by the event;
There must be a causal link between the force majeure event and the affected party’s inability to perform. This means the event must have directly or indirectly caused the non-performance.
Again, the wording of the individual contract is important – a clause which only requires the party to be ‘impeded’ or hindered’ in their performance will be more easily relied upon than one which requires a party to be ‘prevented’ from performing its obligations.
As a specific example for COVID-19, if a work place or team is required to self-isolate and therefore is unable to perform obligations, under many contracts this would qualify as a force majeure event. However, a disruption which merely leads to increased costs to perform those obligations will most likely not be sufficient, even if the economic downturn is inextricably linked to the outbreak. English case law clearly demonstrates that just because a contract has become more expensive – or even uneconomic – to perform, that will not constitute force majeure.
3. The affected party must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences.
The final criteria is that the party seeking to rely on a force majeure clause will have to show that they have taken all reasonable steps to avoid or mitigate the event. There must also be no alternative solution to performing the obligations. Again, it will be important to analyse each contract individually to decide what may be reasonable, but any additional costs and impact of delays may be taken into account.
In the context of COVID-19, it may be difficult to mitigate its effects, due to the global impact. In this case, it will still be important to consider all reasonable steps that may be taken whilst still following guidelines on limiting the spread of the virus.
An affected party must promptly notify the other party of their inability to perform, and provide appropriate evidence to support this. The parties must comply with any further requirements of the contract, such as giving notice of any anticipated consequences. Some contracts have a ‘time-bar’ clause which specifies that notice is to be given within a set period after the affected party first became aware of the force majeure circumstances. A failure to provide adequate notice can result in a loss of entitlement to claim.
Unlike a natural disaster, which is usually time limited and geographically confined, COVID-19 has spread so extensively and rapidly that parties have adopted the approach of issuing ‘rolling’ or ‘protective’ force majeure notices. These take into account the developing nature and impact the outbreak has on contract obligations.
If a force majeure claim is successful, the consequences for the parties will largely depend on the nature of the obligations affected, as well as giving rise to the right to any remedies that are specified in the contract. Contractual remedies can include an extension of time or suspension of performance for the duration of the event. If the event is extended, the provisions may allow for termination of the contract.
Cross border contracts
Another point is the governing law of the contract, as this could affect the force majeure clause. Parties need to be alert to the fact that many countries law defines events as being force majeure events, regardless of whether a contract contains a force majeure clause. This could be found in once piece of legislation, such as in the Netherlands, or in several, as in Germany where the context of the contract has to be examined to establish whether the force majeure legislation applies. The consequence is that a particular Government could rule that an event constitutes force majeure. This is how the Chinese government has responded to COVID19, leading them to issue thousands of exemption certificates to companies.
In practice, national differences will also affect the consequences for and the remedies available to the parties. For example, in France, the law carries the right to renegotiate adjustments if the performance of the contract proves uneconomic. In some instances, if the contract contains express wording identifying force majeure events, then this could override the general position in jurisdictions where the term is codified.
Therefore, it is important to still consider the individual circumstances of the contract as well as its governing law to establish whether the force majeure clause is treated differently to English law.
Doctrine of frustration
In the absence of an express force majeure clause, the common law doctrine of frustration may apply. However, frustration can be extremely difficult to establish.
The doctrine of frustration will apply if:
- the frustrating event is not the fault of either party;
- the frustrating event occurs after the formation of the contract and was not foreseen or could not have been foreseen by the parties; and
- it is now impossible for the parties to physically or commercially fulfil the contract, or the contracts obligations are rendered entirely different as a result of the frustrating event.
These criteria show that to be successful in establishing frustration, the event has to strike at the obligations that sit at the very heart of the contract.
The consequences of frustration are that the contract automatically comes to an end and the parties are no longer bound to perform their obligations. It is because of this extreme consequence that the threshold for establishing frustration is much higher than for force majeure clauses, and why this is usually difficult to prove.
Due to the global spread of the pandemic, it is possible that Governments will start to pass laws with the intention of containing the virus but with the knock on effect of preventing parties from performing contractual obligations, such as travel restrictions. A party’s ability to argue frustration will depend upon the individual circumstances.
In order to be fully prepared, below are some recommended, proactive steps clients may consider taking:
- Consider your insurance and whether it may cover any losses.
- Check the existing terms of any contracts, specifically any force majeure provisions and their scope.
- If a contract does include a force majeure clause, review its definition to confirm whether there is any express event which would cover COVID-19 or if not, whether the language is more general and may ‘sweep up’ events to include the outbreak or its consequences.
- If there are any obligations which may now be impossible to perform, determine whether this is due directly or indirectly to COVID-19 or a different reason.
- Consider what steps have been taken so far as a business to minimise the spread of COVID-19 and to reduce its impact on your ability to perform contracts. How far have these been in line with official guidance?
- Review any notice requirements and if they require supporting documents. Note whether there are any time limits imposed.
- Note the impact of any contracts that were to be terminated.
The unaffected party
For the party receiving the notice of force majeure, they should carefully examine the claim. They should determine that the event is consistent with the scope of the clause and whether any notice provision has been complied with.
If the party is involved with back to back contracts or has several interrelated deals, they will need to consider the overall impact of a claim for force majeure and the effect of unperformed obligations.
Parties relying on force majeure
If a party has been affected by the outbreak, they should record any steps they have already undertaken to mitigate the impact on their contractual obligations.
If a party wants to make a force majeure claim, they should approach it with care and they should take advice. A wrongful claim could have serious consequences, such as breach of contract, repudiation of contract or the other party claiming damages. If a party wants to proceed with the claim, then the consequences that have flowed from the outbreak of COVID-19 need to be properly considered and also fully documented.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at April 2020.