21 October 2020

Commercial Contracts and the effect of Covid-19

What is the position if parties are unable to perform a contract due to COVID-19?

The outbreak of the Covid-19 has caused locked down and closure for many businesses which triggered many contracts, physically and commercially impossible to fulfil. Here we consider the options available to parties who are unable to perform a contract due to the lockdown or restrictions.   

Currently there is no guidance as to the position the courts in England and Wales are likely to take on COVID-19 issues.

The general rule is that if a party fails to complete its obligation under a contract then this will give rise to liability towards the other party. To avoid any potential liability arising, parties should consider whether there is an option of relying on a material adverse change or force majeure clause (which translates from French as “superior force”) or the doctrine of frustration. 

Whether Covid-19 is a force majeure event or not will depend on the drafting of the force majeure clause. Where the clause expressly refers to ‘pandemic’ or ‘epidemic’ then COVID-19 is most likely to constitute a force majeure event otherwise, parties may need to look into the interpretation of any broadly drafted clause to see if COVID-19 could fall within its scope.

To rely on a force majeure clause, a party must demonstrate the following:

• that the event in question has occurred (the Force Majeure Event);
• that the Force Majeure Event is the cause of its being unable to perform its obligations;
• that it has taken all reasonable steps to avoid or mitigate the Force Majeure Event or its consequences.

Parties should check the provisions of the relevant clause as there may be a number of conditions (such as a requirement of notice with a particular timeframe and consideration of options to mitigate the effects of the force majeure event) that the party must fulfil in order to alleviate itself of certain obligations and/or liability.

To rely on a force majeure clause, a business will need to show it is the event that is the primary cause of its non-performance.

In effect the force majeure clause is an exclusion clause, therefore, it will need to comply with the Unfair Contract Terms Act 1977 (“UCTA”). Any such clause that is drafted heavily in favour of one party or is particularly onerous towards a party could potentially be struck out for being unfair under UCTA.

Further the Consumer Rights Act 2015 (“CRA”) covers all aspects of unfair terms in business-to-consumer contracts and it deals with implied terms in relation to quality of goods and services, and regulates attempts on the part of a trader to exclude its liability for breach. The CRA also introduced a “fairness” test.

The five guidelines to interpreting “reasonableness” laid down in Schedule 2 to UCTA are in summary:

• the relative strengths of each party’s bargaining position;
• whether the customer received any inducement to accept the term;
• whether the customer knew or should have known that the term was included;
• in the case of a term excluding liability if a condition is not complied with, the likelihood of compliance with that condition at the time the contract was made; and
• whether the goods were made or adapted to the special order of the customer.

However, these guidelines are not exhaustive.

If a contract does not include a force majeure clause then the contract may still be able to be terminated on grounds of legal frustration. Frustration is when an event occurs after the formation of the contract, which renders it physically or legally impossible to fulfil the contract. If a contract is frustrated, it is automatically discharged and the parties are excused from their future obligations. In order to claim that a contract is frustrated a detailed analysis of the circumstances is necessary. 

If performance of a contract becomes impossible or illegal (e.g. in contravention of a government order), then a party may be able to rely on the doctrine of frustration in order to get a refund for advance payments made before the COVID-19 outbreak. However, this will depend on the circumstances and parties should review the contract to see whether there is a clause covering refund for advance payment.

The following practical steps should be considered in relation to terminating a contract:

• Consider what sums have been paid under the contract and to what extent the contract has been performed;
• Review relevant clauses, such as force majeure or material adverse change clauses (if any) to check whether is COVID-19 is covered and consider any conditions that need to be fulfilled in order to alleviate any potential liability.

The following points should be considered for any new agreement:

• When is the contract due to be entered into and when is performance due? 
• Consider if you want to list COVID-19 as an force majeure event.
• What is the realistic effect of COVID-19 on you and the counterparty and the ability to perform or benefit from the contract?  
• Have you communicated with the counterparty and has it been discussed or agreed how risk or liability should be allocated should the contract be delayed or not performed? 
• Can the obligations be performed using contingency measures?
• Review the terms of the agreement, in particular give thought to whether the impact is fundamental and relevant force majeure /material adverse change provisions in the contract, and review whether they apply or whether termination or another form of relief is available. 
• Possibility of obtaining insurance in the event that performance is delayed or prevented.