The Challenge of Contracting and the World Pandemic Crisis

Commercial enterprise all over the world has been facing the kind of challenge rarely seen outside wartime, with transport, oil and gas, supply chains, logistics, property, retail and hospitality suffering the wholesale suspension of trading activities. The number of liquidations and personal insolvency, mass unemployment and the scale of governmental intervention will not in combination have been seen before by anyone now living.

The enormity of the potential problems now facing most of us pose questions in every sector concerning whether the conduct of business will ever return to normal, or will profoundly change occur in the way we engage with each other?

In the short term, lawyers will be considering the parameters of existing contracts: can ongoing liability for contractual performance be enforced, or will such liability be suspended by operation of force majeure? Has the contract been frustrated? Will the parties take a commercially realistic view and re-negotiate the contract? Can they be forced to do so? Are losses covered by business interruption insurance? What happens if the insurer avoids the policy? What flows from a party’s insolvency?

In the longer term, how should contracts take in the possibility of further waves of a pandemic, or new pandemics occurring? How can contracts be designed to accommodate crises with a flexible but realistic response? 

These are matters of concern to the whole of commerce, and not confined to the academic theory of the law. Businesses may require a long-term strategy based on an innovative approach.

In the short term many businesses are asking simple questions, either can I enforce a particular contractual obligation, or else do I have to perform/pay?

First, see if there is either a force majeure clause in your contract or something like it. A force majeure clause typically excuses a party seeking to rely on it from the performance of a contractual obligation, usually temporarily, following the occurrence of certain events, usually defined as acts, events or circumstances beyond the reasonable control of the party concerned.

If there is a force majeure clause in your contract it is possible that COVID-19 may be covered, depending on the wording of the clause, which will list examples of the events that fall within its scope. For example, the clause might specifically list “pandemics” or refer to contagions. It may also be covered under an “Act of God” which was defined under English law by Lord Hobhouse in Transco PLC v Stockport Metropolitan Borough Council [2003] UKHL 61, as an act which, (i) involves no human agency; (ii) is not realistically possible to guard against; (iii) is due exclusively and directly to natural causes; and, (iv) could not have been prevented against with any amount of foresight, plans, and care. Finally, it is also possible that the clause will refer to government actions, which would include the wholesale closure of cities and countries within Europe and any restrictions placed on travel or imports by governments. The party seeking to rely on the clause to avoid its obligations will likely have also to show that: (i) its non-performance or default was caused by the force majeure event (and not by, for example, an act or omission within the party’s own control); (ii) that the force majeure event has made it legally or physically impossible to perform its obligations; (iii) there were no reasonable steps that one could have taken to avoid or mitigate the event or its consequences. 

This is, of course, is all subject to the express wording of the clause. In addition, it should be remembered under English law a party cannot rely on the clause unless it is ready, willing and able to perform its contractual duties if the force majeure event had not occurred (Classic Maritime Inc v Limbungan Makmur SDN BHD & Anor [2019] EWCA Civ 1102). The burden of proof is on the party seeking to rely on the force majeure clause, who must prove that the event (in this case COVID-19) falls within the force majeure clause and that non-performance of contractual obligations was due to the event.

On the other hand, if your counterparty is seeking to rely on a force majeure clause to avoid its contractual obligations to you, and it is unclear whether COVID-19 is covered by the clause, in order to prevent implicit or express waiving of your contractual rights, correspondence should be handled carefully.  In certain circumstances, it may be appropriate to include in correspondence an express statement that nothing you have said should be taken as a waiver of your contractual rights.  If COVID-19 is clearly covered by a force majeure clause, it might be prudent to consider negotiating with the other party to see if a workable solution can be achieved.

If you are seeking to avoid your contractual obligations and there is no force majeure clause in your contract, there may still be a remedy available to you under the legal  doctrine of frustration where performance has become commercially or physically impossible. A parallel American law doctrine of impossibility or frustration of purpose exists although the bar for resisting the original obligation is high since the Court always seeks to hold parties to their bargain, if possible, and that remains the starting point for an obligation under Sharia: if there is a different way for the parties to perform their contract, even if it is more expensive or more difficult than the original expected method of performance, the Court will seek to enforce that form of performance.

Whether it is open to claim the effects of COVID-19 amount to a frustration event successfully to avoid contractual obligations will be specific to the contract and the facts of each case. If a government has put mandatory restrictions in place as a result of the outbreak/spread/occurrence of COVID-19 that is not due to the fault of either party. If this occurs after the contract has been formed and it makes future performance impossible, illegal or makes it so fundamentally different from that contemplated by the parties at the time of the contact, there are reasonable grounds for claiming frustration.  However, if the contractual obligation is merely to make a payment, neither force majeure nor frustration is likely to be of immediate assistance. If you are found in this position, where possible, it is worth taking steps to attempt to mitigate your loss by re-negotiating with the other party as to what is a sensible commercial solution. If there are to be future commercial relations between you, that may be the best solution for you both.

If a party can prove that a frustration event has occurred, the contract is automatically discharged and that brings an end to the parties’ obligations. There is no option for a party to elect to continue the contract. If one party has paid money to another under a contract before the occurrence of the frustrating event (for example, money paid as an advance in consideration for the future supply of goods or services), it may be possible under English law to recover monies paid (or at least a portion of monies paid) under the contract under the Law Reform (Frustrated Contracts) Act 1943 and elsewhere, possibly by more creative arguments relying on the law of unjust enrichment or restitutionary principles that have substantially developed since the 1943 Act.

Practically, it is clear that the spread of COVID-19 will have an impact on thousands of contracts worldwide.  It is important to be aware of your contractual rights, obligations, act quickly, and be careful in correspondence with the other party.

That addresses the short-term problem. But what of contracts in an age where the residual impact of a pandemic is a cause of continuing concern?

The starting point will be to review your key contracts as soon as possible. You’ll need to consider:

• What are the parties’ obligations under the contract, and when must they be performed? Are the obligations stated sufficiently clearly?
• How does COVID-19 impact on the parties’ ability to perform their respective obligations under the contract? What specific practical difficulties does it create?
• Does the contract contain provisions allowing one or both parties to terminate it, or postpone performance? If so, in what circumstances can the parties do so?
• Does the contract explain what the consequences of termination, or delayed performance, would be? In particular, what are the financial consequences for the parties, and do you risk being sued for a failure to perform your side of the bargain?
• Is performance of the contract physically or commercially impossible, such that it may have been frustrated?
• Or, can you rely on coronavirus and its effects as a force majeure event? Is there an express force majeure clause in the agreement? What, in practice, are the consequences of invoking it?
• What would you ideally like to achieve – ending, suspending or varying the contract – and how important is it to preserve your commercial relationship with the other party?

Whilst there may be short-term solutions to this problem, and each contract will need to be considered on its own specific facts, you will need to work out what your legal position is likely to be and inform your negotiations with the other party in seeking new contractual arrangements. The disruption caused by coronavirus has inevitably led organisations and individuals to review their insurance policies to see whether the risks and potential losses arising from the virus and from the government’s reaction to it are covered, particularly the indemnity offered either under an all risks policy, or one dedicated to business interruption insurance.

You are likely to need specialist advice, perhaps from a chartered loss adjuster, to understand whether and how insurance policies may help deal with the current situation. The starting point may be to consider what “risks” are covered. Even though standard commercial insurance policies usually cover a wide range of risks, they are unlikely to cover specialised or unlikely risks, such as the effects of coronavirus, and newer policies may exclude coronavirus as a “pre-existing circumstance”.

Even if your policy does include notifiable disease as a risk, check to see that it does not fall into any of the exclusions (for example, a mutant variation of atypical pneumonia or SARS) and that you are still covered. As every policy needs to be considered on its own terms and the specific facts relevant to the possible claim, understanding your rights may not be easy.

The scope and nature of business interruption cover should extend to cover for the loss of directors or key personnel and trustees, and you will need to navigate the risks you may face both as organisations and personally.

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