CONTRACTS IN A CRISIS
27 March 2020COVID-19 and its Potential Effects on Contract Terms
In addition to inordinate public health impacts, the Covid-19 pandemic has devastated global trade and commerce. In particular, manufacturing supply chains have slowed, if not frozen, due to widespread restrictions on movement, business lock-downs and quarantine measures. The virus’ continuing spread has also increased uncertainty on the viability and status of commercial contracts as businesses look to limit financial outgoings. This is true on both domestic and global scales. In light of the crisis, it is vitally important for businesses to review their operative contracts. Options involving force majeure clauses and the concept of frustration can be particularly pertinent. This applies equally to parties wishing to enforce or avoid their contractual obligations.
What Is a Force Majeure Clause?
Force majeure clauses excuse the enforcement of a party’s contractual obligations in agreed circumstances where factors outside the control of that party affect performance. Phrases such as “acts of God” and “natural disaster” are commonplace in force majeure clauses. These clauses commonly arise in all levels of commercial, construction, property and insurance contracts and will have almost certainly been included in agreements made by individuals, small businesses and large corporates alike.
Given these clauses are formed in commercial agreements, they are largely governed by the intended scope of the clause itself. An assessment of the words used in drafting the clause, the considerations to be taken into account when assessing force majeure, and the relevant facts of each case are essential in analyzing the extent of coverage.
Will COVID-19 be a Force Majeure Event Under my Contract?
The first step for parties seeking relief under force majeure is to confirm the commercial contract in question contains such a clause. Secondly, one must assess whether the Covid-19 crisis is covered by the language used. For example, some contracts will identify events as epidemics, pandemics, biological disasters, or even trade restrictions as satisfying force majeure and thus be relatively straightforward to assess. Conversely, other force majeure clauses can be extremely broad and simply cover natural disasters or acts of God, leaving the interpretation of coverage open to argument.
Following the occurrence of an agreed force majeure event, these clauses generally prescribe a process that parties must adhere to. For example, the clause may specify that a party claiming force majeure must notify the other party in writing, and take reasonable steps towards mitigating the event’s impact upon the contract.
Parties relying upon force majeure clauses to absolve obligations may contend that the unprecedented, far-reaching nature of the Covid-19 pandemic is analogous to a catastrophic event, such as an earthquake. Parties demanding to enforce existing contracts will argue these phrases were intended to cover only sudden and immediate natural events, rather than the current progressive public health crisis.
These are difficult interpretive questions, and the outcome will likely differ depending upon the nature of the obligations contemplated by the contract, and the extent to which Covid-19 has actually impeded possible performance. Depending upon the specific process nominated within the clause, the contract may be postponed or terminated altogether.
Frustration
Without a force majeure clause, parties seeking to avoid contractual obligations may potentially be relieved under the common law doctrine of frustration. Frustration will bring a contract to a close where an event occurs which makes a contractual obligation or obligations impossible to perform, or results in an obligation being entirely different to its intended operation. This creates an extremely high threshold whereby a factor or factors essential to the performance of the contract no longer exist. A change in the commercial profitability or the ideal target market of a supply, for example, would not allow a finding of frustration.
Examples of frustration include:
Changes in the law which effectively make performance of the contract illegal;
Events which create a fundamentally different situation to the subject matter of the contract, rendering performance impossible;
The application of an injunction preventing performance of the contract.
Clearly, the rapidly evolving nature of the Covid-19 crisis raises a number of potential scenarios in which frustration may arise, especially where contracts pertaining to the supply of goods/services are concerned. For example, a musician’s ability to perform at a mandatorily closed venue would be likely to lead to a finding of frustration, subject to the wording of the contract.
Frustration, COVID-19 and Leases
Given the high threshold required to establish frustration, it will be very difficult for tenants to do so in the present context of Covid-19. Indeed, recent changes to a landlord’s ability to evict tenants may even reduce the need to do so from a tenant’s perspective. Regardless, when assessing whether frustration is available for a lease agreement, the specific determination of how the property is to be used will be relevant. If the property is able to be used for a permitted use then the lease will not be frustrated. In this respect, we note the following examples:
Employee absenteeism whilst working from home would be unlikely to satisfy frustration of a commercial lease;
Although a retail café may claim frustration due to limits on the number of people able to work or attend the relevant premises, if they are still able to provide a service/product to consumers, frustration is unlikely to be found;
Conversely, frustration of a short-term lease of a large music venue whereby the sole purpose is to accommodate 100+ people would be more likely to be established (subject to the lease wording).
Of course, this will change on a case by case basis and, given the rapidly evolving nature of the crisis, as the law changes. Already we have seen substantial changes in operational requirements of businesses and, for example, the consideration of what constitutes an essential service.
KKP Comment
The effect Covid-19 will have upon business contracts is highly context and language dependent. Before asserting that a force majeure clause does or does not apply, it is strongly advised that commercial parties seek professional legal advice. If you require advice of this nature, please do not hesitate to contact us at Kerr & Kerr Partners on 03 9600 2234, or via email to enquires@kerrpartners.com.au.