Contracts and COVID-19: Force majeure and frustration02 Apr 2020 // Insights
Corporate Solicitor George de Stacpoole details the key things to know regarding force majeure, the Doctrine of Frustration, and your contracts.
Understandably, businesses currently have a myriad of concerns related to the COVID 19 pandemic. A major concern will be the effect on their commercial contracts; especially those which relate to ongoing delivery of services or which contain prepayment or deferred payment clauses.
In the current environment, a business may seek to rely on contractual force majeure provisions or the common law rules on frustration to avoid liability for what would otherwise be a breach of contract. This article looks at how these concepts might be applied.
Force majeure are clauses in a contract that excuse one or more parties from their performance as a result of specified exceptional circumstances. These are contractual provisions and the concept will not be implied into a contract by an English court. This means that any dispute will turn on the drafting of the clause and the facts of the case.
If a party is seeking to rely on a force majeure clause, it should examine the scope of the clause and the effect on the contract.
Scope and effect
Scope: Does the COVID-19 pandemic fall within the scope of the clause?
The force majeure provision may have an express reference to ‘pandemic,’ ‘epidemic,’ or ‘infectious disease’, or there may be a sweep-up language like ‘events outside of a party’s reasonable control’. If the latter is the case, the drafting in the rest of the clause will have to be examined as the language may be directed at a different situation.
To illustrate the importance of defining this clause properly, the words "any other cause beyond the Seller's reasonable control" in a contract relating to aircraft purchasing was not satisfied by the economic collapse of financial markets in 2008, as the preceding specified force majeure events had little to do with economic downturns.
Effect: Has the clause been triggered?
The clause may specify that the performance must be completely prevented. This would mean legally or physically impossible, not just difficult or unprofitable. The force majeure clause may contain a lower bar; that performance would be ‘hindered’ or ‘delayed’. This will be satisfied if performance is substantially more onerous; but may not if it is merely more expensive.
In a COVID-19 context, a business that is contracted to manufacture and supply HEPA filters that suddenly experiences employee shortages due to self-quarantine may have to incur the expense of procuring temporary workers to cover the potential loss in production.
Notification: If required in the force majeure clause, the party seeking to rely on the clause will have to serve notice on the other party in order to benefit from the clause. If not required, the protections of the force majeure clause will automatically be available to the non-performing party when that force majeure event occurs.
Mitigation: A clause will usually contain an obligation to mitigate the impact of the force majeure event on the performance of the contract; if a party is able resolve the effect of a force majeure event, then it’s not ‘outside of the party’s control’. If this duty is not present in the clause, a duty to mitigate may be implied anyway.
Sole cause: A force majeure event must be the only effective cause of default by a party under a contract that is relying on a force majeure provision.
The consequences of a force majeure event are contractual, highlighting the importance of a well-drafted clause which considers the commercial reality of the contract.
Consequences typically include an extension of time to perform the relevant obligation; the obligations do not fall away. The obligations may be suspended while the force majeure event continues, unless the parties agree otherwise.
Some force majeure clauses allow termination of the agreement to allow alternative arrangements to be made. Although, this preserves a neutral position, it may be disadvantageous where pre-payments have been made or deposits delivered. A well drafted clause may include the ability to recover payments made on account of goods or services which are not provided due to the force majeure event.
There are statutory control measures contained within the Unfair Contract Terms Act 1977 - where the force majeure clause must be ‘reasonable,’ otherwise they might be invalid - and the Consumer Rights Act 2015. These depend on the nature of the contract and the facts of the case.
The doctrine of frustration will result in the termination of a contract, but will not be available if there is a force majeure clause which ‘fully and completely’ deals with an event which would otherwise frustrate the contract.
In the absence of such a clause, or the force majeure clause does not cover COVID-19 ‘fully and completely,’ a contract may be terminated using the common law doctrine of frustration.
There is no singular test to prove frustration, as the doctrine evolves as the courts decide. In general terms, the points below serve as a guideline as to what is required for an event to frustrate a contact.
Time: The frustrating event must occur after the contract has been formed.
Nature of event: The event must ‘strike at the root of the contract’ and be beyond what was contemplated by the parties when they entered the contract.
No fault: The event cannot have been caused by either party, it must be outside their control.
Effect on performance: As a consequence of the frustrating event, further performance of the contract is made impossible, illegal, or radically different from that contemplated by the parties at the time the contract was made.
In a COVID-19 context, it is likely that the pandemic and quarantine will only have been foreseen in contracts which have been concluded very recently. A frustrating event might include a situation where the government passes legislation that would make the performance of certain contracts illegal.
Effect of frustration
The contract will automatically terminate, and the parties will be excused from their future obligations. The contract is not rescinded, meaning that obligations incurred before frustration are still deliverable and, as neither party is at fault, damages are not available for non-performance after frustration.
The Law Reform (Frustrated Contracts) Act 1943 was introduced to allow, in some events, payments made in advance of frustration to be recoverable. Furthermore, it was intended to allow for the retention of monies on the account of expenses and payment of a ‘just’ sum for any benefit of the contract which has been delivered.
Given the current crisis, it is highly likely that businesses will seek to rely on force majeure clauses to protect themselves against claims, and perhaps to a lesser extent, the doctrine of frustration.
Neither concepts are straightforward. Even if a contract contains a force majeure clause, it is uncertain if a party could rely on it as a result of COVID-19 and, subject to the facts of the case, frustration may still be available.
Action for businesses
Now is the time for businesses to undertake a review of their own contracts to identify risk and reach out to counterparties in order to reach a renegotiation or suspension of obligations, if affected or potentially affected by COVID-19. Furthermore, they should review their risk exposure of key counterparties seeking to rely on these provisions themselves.
Should you have any questions regarding the above information, or need any related legal advice on how force majeure or the doctrine of frustration applies to your contracts, please get in contact with George de Stacpoole at George.deStacpoole@seddons.co.uk.