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APR 16 2020
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Is COVID-19 Preventing your Business from Performing its Contractual Obligations?

EXTRAORDINARY CIRCUMSTANCES

The economic effect of the COVID-19 pandemic is developing rapidly, leaving many businesses uncertain about their future.  Many of our clients we’ve spoken with expect the COVID-19 level 4 or 3 lockdown to have a significant impact on their revenues.  Some are concerned with their business’s inability to perform contractual obligations and the anticipated exposure to damages. 

Normally, liability for non-performance of contract does not depend on fault, and performance is not excused by changes in circumstances.  However, we live in extraordinary times.  The law’s response to extraordinary circumstances has been the development of force majeure provisions in commercial contracts and the related common law doctrine of frustration. 

This note briefly addresses these legal principles. We hope it will help you to better understand and respond to the challenging economic circumstances we are all facing and ultimately increase your business resilience.

FORCE MAJEURE CLAUSES

A force majeure clause provides relief to a contractual party in an event which occurs outside the reasonable control of that party and which prevent that party from performing its obligations under the contract.

A party affected by a force majeure event will generally be relieved from performing their contractual obligations for the duration of the event and may be entitled to compensation.  This will depend on the proper construction of the terms of the contract and will be considered in its specific context.

Accordingly, each contract will need to be individually assessed on a case by case basis.  However, there are some common features.  Many force majeure clauses set out a specific list of events which are agreed to be force majeure events, such as “pandemics” or “diseases”.  The COVID-19 pandemic would plainly come within the scope of such clauses.

Even if the clauses do not specifically provide for “pandemics” or “diseases”, COVID-19 or the level 4 or 3 alert may nevertheless be captured by such provisions if the clause contains:

  • wording such as “act of God” or “act of government”; and/or
  • ‘catch-all’ wording, such as “an event beyond the reasonable control of a party, including but not limited to…”.

In either of these cases it would be necessary to consider whether COVID-19 or the level 4 or 3 alert may be nonetheless be deemed a force majeure event under the terms of the particular contract. 

FORCE MAJEURE EVENT

To qualify as a force majeure event and successfully obtain relief from contractual obligations, the following three criteria must usually be satisfied:

1.     the event must be beyond the reasonable control of the affected party;

2.     the affected party’s ability to perform its obligations under the contract must have impeded by the event; and

3.     the affected party must have taken all reasonable steps to mitigate the event or its consequences.

Subject to the COVID-19 pandemic or the level 4 or 3 alert lockdown being within the scope of a force majeure clause, it seems fairly clear that the first criteria should easily be satisfied. It’s the second and third criteria that need to be looked at more closely.

DOCTRINE OF FRUSTRATION

In the absence of an express force majeure clause the parties to a contract may be able to rely on the common law doctrine of frustration.  The doctrine of frustration will not be available if the contract contains a force majeure provision, as that will be regarded as the agreed allocation of risk between the parties.

The doctrine of frustration will apply if:

  • the underlying event is not the fault of any party to the contract;
  • the event or circumstance occurs after the formation of the contract and was not foreseen by the parties; and
  • it becomes physically or commercially impossible to fulfil the contract; or
  • the obligation to perform is transformed into a radically different obligation from that undertaken initially.

A contract automatically comes to an end if it is frustrated.  The parties to the contract will no longer be bound to perform their future obligations.  However, the threshold for proving frustration is much higher than that for force majeure provisions; it must be established that the obligations impacted by the event are fundamental to the contract. 

A change in law, such as the announcement of the level 4 or 3 ockdown, that makes it impossible for the affected party to perform its contractual obligations could trigger the application of the doctrine of frustration.

PRACTICAL STEPS

We would recommend that businesses which are unable to discharge their contractual obligations because of the current COVID-19 lockdown should consider the following:

  • review the relevant contracts, such as standard terms of trade, to identify whether they include force majeure provisions;
  • if they do not, consider whether the doctrine of frustration may apply;
  • if they do, determine whether the COVID-19 pandemic or the level 4 or 3 lockdown are express events and, if not, whether the general language of the force majeure clause is sufficient to include COVID-19 and its consequences;
  • if COVID-19 is a force majeure event under the relevant contracts, consider whether the inability to perform the obligations is due to the consequences (direct or indirect) of COVID-19;
  • consider any steps that could be taken to avoid or reduce so far as possible the effects of COVID-19 on the business.  For example, will remote working help mitigate the effect on the business?;
  • determine whether there are any requirements of notice to the contract counterparty to trigger entitlement to relief;
  • review financing agreements, insurance policies and related documents to determine whether there are any notice provisions that must be complied with in relation to any force majeure claims.

The above considerations similarly apply if a business is concerned that any of its clients or customers are unable to meet their obligations under a contract with that business.

If in doubt in relation to any of the above points, seek legal advice at an earlier stage.  Some force majeure clauses have strict notice requirements.  Failure to satisfy these requirements may affect a party’s entitlement to remedies.

Anderson Creagh Lai would be pleased to assist you with any queries you may have about your business’ contractual obligations and help you through this challenging time.

ANDERSON CREAGH LAI LIMITED
Article written by Jeffrey Lai and Mihai Pascariu
For further information please email us at contact@acllaw.co.nz