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COVID-19 and the ongoing impact on your commercial contracts – Part 1

22 April

Introduction

There has been much discussion in the past month regarding the operation of force majeure and frustration in relation to commercial contracts impacted by the Covid-19 outbreak. This article looks at these technical points in more detail, how they apply to your contracts.  Part 2 can be found here and goes through some common questions we receive.

 

What is a force majeure clause?

A “force majeure” clause in a contract deals specifically with how the parties’ obligations may be affected by an event (usually unforeseen events outside the control or influence of either party) that affects a party’s ability to perform the contract.

Force majeure clauses are all different but are common place in commercial contracts.  They usually list certain defined circumstances which might prevent performance of contractual obligations such as “acts of god” (e.g. earthquakes) and certain acts of man of a disruptive and unforeseeable nature (e.g. industrial action).  The clause will usually also prescribe what the parties must do next, e.g. notify the other party and possibly take certain reasonable steps to mitigate the effect of the event impacting performance.  In England and Wales, force majeure is not implied as a matter of law, and express clauses are interpreted strictly. If there isn’t a clause in the contract, you won’t be able to rely on it.

 

What is frustration?

The common law principle of frustration allows a party to be discharged from its contractual obligations where a change in circumstances makes it physically or commercially impossible to perform the contract. The circumstances where frustration can be applied are narrow.

 

How are my commercial contracts affected by force majeure events and frustration?

It is important to note that under English law, contracts that require ongoing performance are, in principle, absolute. Therefore, there is no automatic right of release if a party is experiencing Covid-19 related business disruption – that party is required to perform its obligations and will be potentially liable to its counterparty for a failure to do so.

The two key exceptions to this rule are:

  • the operation of any force majeure clause in a contract; and
  • the common law concept of frustration,

however, each individual commercial contract will need to be examined to see what is, and is not possible under the agreement, in order to establish whether either of these exceptions apply, and what practical steps must be taken to benefit from their reliefs.

 

Force Majeure – key factors to consider

Below are some key factors which operators need to consider:

  • Is Covid-19 specifically covered as a force majeure event? Some force majeure clauses contain references to epidemics or pandemics which would be likely to include Covid-19.
  • If no specific epidemic/pandemic reference, is there any wording relating to governmental decisions or administrative action that would cover the action taken in relation to Covid-19?
  • Has causation been established? The party seeking to rely on force majeure must establish that the force majeure event has prevented or hindered it from performance of the contract.
  • Has the party seeking to rely on force majeure taken reasonable steps to mitigate or avoid the effects of the force majeure event?
  • Have parties fulfilled any notice requirements set out in the force majeure clause?
  • Examine the consequences of establishing force majeure – some clauses allow one or both parties to terminate the contract so ensure early discussions are instigated with the counterparty to establish ongoing aims/objectives for the contractual relationship, and consider all possible outcomes.

 

Frustration – relief available

If there is no force majeure clause in a contract, a party may still be able to claim frustration to enable it to be discharged from its contractual obligations if the change in circumstances makes it physically or commercially impossible to perform the contract, or would render performance radically different.

The courts have confirmed that the circumstances where it can be invoked are narrow but it is likely that frustration may be accepted where, for example, performance of a contract is rendered impossible due to a state-imposed lockdown.

If frustration applies, the contract is automatically terminated, and the Law Reform (Frustrated Contracts) Act 1943 allows recovery of monies paid under the contract before it was discharged, subject to an allowance, at the court’s discretion, for expenses incurred by the other party.

 

Conclusion

Check the specific terms of your force majeure clause, or terms of business as a whole before serving any notice in respect of Covid-19 business disruption.

Always consider the long-term effects of invoking force majeure.

Consider reviewing your commercial contracts to see what amendments may be required, either now or in the future, to cover contract performance difficulties due to Covid-19.

Please contact a member of our corporate team for advice on commercial@backhouses.co.uk.

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