Unfortunately, problems with supply chains, staff absences and restrictions on travel and movement, mean that most businesses are likely to feel the impact of COVID-19 over the coming months.
This means that it will be more important than ever for businesses to be up to speed with their legal rights and obligations under business-critical contracts. Equally, businesses need to ensure that they fully understand the circumstances in which such rights and obligations may not apply or are subject to provisions granting relief.
Important points to be aware of include the following:
Force majeure clauses
Many contracts will contain a force majeure clause dealing with how the parties’ obligations are affected by an out of the ordinary event that impacts on a party’s ability to perform.
However, ‘force majeure’ does not have a defined legal meaning under UK law and the drafting of force majeure provisions varies from contract to contract. This means that businesses will need to carefully read over the detail of any force majeure provision to work out whether it will apply and if so, what the consequences are.
The issues that will need to be considered include:
- Is COVID-19 covered as a force majeure event? This may well be the case if the definition specifically refers to epidemics or pandemics. Equally, it may be covered if ‘force majeure’ is defined using general, broad wording (such as referring to ‘acts of God’ or ‘events beyond the parties’ reasonable control’). A definition of force majeure may also provide relief if it covers performance issues resulting from governmental orders, decisions or administrative actions;
- How does the clause operate? Must the force majeure event prevent performance (in which case a party seeking to rely on the clause would need to be able to demonstrate that performance is physically or legally impossible, rather than simply more difficult)? Alternatively, can the clause be triggered if performance is simply hindered or delayed? Again, it will depend on the precise drafting. Increases in the cost of performance will rarely be a sufficient trigger for a force majeure clause (unless, unusually, the clause includes specific drafting to that effect);
- Does the clause expressly exclude events that are reasonably foreseeable? If so, it is conceivable that disputes could arise as a result of claims that, in the light of the recent SARs outbreak and other similar epidemics, COVID-19 was foreseeable;
- Is reliance on the clause conditional upon the affected party having taken certain steps? Often there will be a requirement to take action to mitigate the impact of the event, which will require a party to show that it identified all appropriate steps that could be taken and then took such steps. In addition, compliance with specific notice provisions is often a pre-requisite to a claim of force majeure;
- What does the clause say about the consequences of establishing force majeure? Usually, the affected party will be temporarily relieved from performance/given an extension of time to perform. This may be coupled with a right for one or both of the parties to terminate without further liability if the force majeure event persists for a certain period of time. Less frequently, compensation or costs may be payable after a certain period.
Businesses should also check whether their contracts are governed by UK law. This is important since some countries have specific legislative definitions of force majeure which will (if a contract is subject to the governing law of such a country) override the terms of any contractual force majeure provision. In some situations, this could mean that relief provided under the terms of a contract is not available (or vice versa).
Over recent weeks, many Chinese exporters have already had to break contracts due to COVID-19. In response to this, the China Council for the Promotion of International Trade has issued a record number of force majeure certificates to Chinese companies, in the hope of protecting them from legal action. However, if your business receives such a certificate, do not simply take it at face value. In particular, where the relevant contract is subject to UK law, it will be important to look at the precise wording of the force majeure clause to establish whether the provision has actually been triggered.
You can find out more about the issues your business needs to consider in relation to force majeure clauses from our recent article (see LINK).
Doctrine of frustration
If a contract doesn’t include a force majeure clause (or there isn’t a written contract), relief from obligations under a contract which has become impossible to perform may sometimes be available under, what is known as, the ‘doctrine of frustration’.
For this legal concept to apply:
- Performance of a contract must have become a legal or physical impossibility or radically different to what was contemplated at the time the contract was made; and
- The cause must be a significant change in circumstances which was beyond the control of the parties.
If a contract is deemed to have been ‘frustrated’ the parties will be excused from further performance (the contract will be deemed to have automatically terminated) and may also be able to recover monies already paid under the contract.
Unsurprisingly, the courts are very reluctant to rule that the doctrine of frustration applies to a contract. In particular, relief will not be granted just because a contract becomes more difficult or expensive to perform.
The circumstances of the case will also be key. For example, in a 2003 case related to the SARs epidemic, a tenant was unsuccessful in their claim that their tenancy had been frustrated because they were unable to occupy the relevant premises for 10 days due to an isolation order. The court’s decision was largely made on the basis that a 10-day period of non-occupation was not significant in the context of a 2 year-long lease.
A careful analysis of the situation will, therefore, be essential before a claim of frustration is made, sincegetting it wrong could mean that your business is then sued for wrongful termination. Conversely, if one of your contracting parties claims that a contract has been frustrated, it is important that your business recognises that it may well have grounds to challenge that claim.
These days, a number of businesses will have business interruption insurance. However, again, the devil will be in the detail when it comes to working out whether your business has cover for loss or disruption resulting from COVID-19. Many such policies are ‘add-ons’ to a business property insurance and will only cover loss of income resulting from physical damage to insured property. In addition, there are often strict requirements relating to mitigation, consultation with insurers and notification within a particular time frame.
It is therefore essential that businesses read over the terms of any business interruption policy carefully so that they fully understand the scope of and any conditions relating to, their cover.
Variation of terms
The ability to vary the price or alter delivery times may make all the difference between being able to perform or falling into breach of a contract. Rights to vary the terms of a contract may come in a variety of guises, including provisions dealing with increases in costs, ‘Change Control’ clauses and provisions tackling changes in applicable law (the latter may extend to government decrees or orders). Again, therefore, businesses should carefully read over the terms of any key contracts in order to establish whether they include rights to vary and if so, how those rights work (e.g. does one party have a unilateral right to amend the contract or must any changes be agreed?).
In order to be prepared for a worst-case scenario, it goes without saying that your business needs to understand what termination rights there are under any key contracts (whether in favour of your business or the other contracting party). Termination rights can vary considerably from contract to contract, so, again, it will be crucial to review the terms of each agreement carefully. In particular, pay careful attention clauses which specify which insolvency events trigger termination.
In the event that you do seek to terminate a contract, make sure that you follow the notice provisions in the contract to the letter.
Limitations/exclusions of liability
As part of any risk analysis, understanding your exposure if you cannot perform a contract will be crucial (for example, if resources or supplies are limited, such knowledge will enable your business to prioritise its contracts). In particular, check whether liability under a contract is subject to an overall financial cap and/or whether certain types of loss are excluded completely.
Material adverse change clauses
Material adverse change (‘MAC’) clauses aren’t that common in run-of-the-mill contracts for the supply of goods or services. However, it is well worth checking whether any of your business-critical contracts include a MAC clause. The exact rights such a clause will give you and when it can be invoked, will depend on the precise drafting of the clause, so you will need to review the drafting carefully.
Governing law and jurisdiction
As mentioned above, it is also important to take into account the governing law applicable to any key contracts. In the event that the laws of a country other than the UK apply, you may find that provisions which would provide relief under UK law are unenforceable or superseded by local legislation. In addition, check which courts have jurisdiction over disputes, since enforcing a contractual provision overseas may be far from straightforward.
FINANCIAL SERVICES SECTOR
Additional considerations apply to businesses in the financial services sector. The FCA has already issued a statement on COVID-19 setting out its expectations of businesses in that sector. Key messages include:
- That financial services firms should already have contingency plans in place to deal with major events;
- The FCA will be reviewing the contingency plans of such businesses; and
- That it expects financial services firms to take all reasonable steps to continue to meet their regulatory obligations.
We will be publishing more detailed advice for firms in the financial services sector over the coming days.
For more information about any of the issues covered above, please contact a member of our Commercial Team