The impact of Covid-19 on contractual obligations
As you read this article you are likely to have been impacted by Covid-19 (also known as the Coronavirus) in some way, whether personally or professionally. The infection is spreading and the Government response is also evolving. It is clear that the outbreak, now officially classed as a pandemic, is having real and significant affects on businesses and the people working in them.
In this article we will highlight some of the issues that we are currently advising UK businesses on related to the outbreak and provide some practical pointers for managers to consider. We appreciate that most people are looking for ways to deal with suppliers, customers and employees fairly but also have a need to protect the business from supply problems and cash flow issues. As you read this please bear in mind that everyone's situation is different and as events unfold there may be other options and issues that are not covered here. We are not able to provide specific legal advice in this article but our contact details appear at the end of the article so please do contact us if you would like advice on any of the matters covered.
Two key concerns that we are being asked about concern the impact of Covid-19 on contractual obligations and how to manage staffing issues, particularly where a drop in customer demand is being experienced or anticipated. In this note we address the contractual issues. Please see the following link for our advice on staffing issues: https://bit.ly/3a4vkXi
The pandemic is having a variety of adverse consequences for business including interruption in supplies, rising costs and unforeseen changes in demand. If your customers or suppliers are experiencing difficulties in meeting contractual obligations they may have mentioned 'force majeure' to you. Of course this may also be relevant to you if your business is struggling to meet a contractual obligation. Force majeure does not have a particular meaning in English law and its scope and effect depends on how it is drafted in a contract (if indeed it is included at all).
Force majeure provisions usually excuse a party from delay or failure to perform any of its obligations where it is unable to do so due to an event outside of its control. Clauses differ but generally they include the following concepts:
- A description of what amounts to a 'force majeure' event, such as epidemic, natural disaster, severe adverse weather, industrial action, embargo, government action etc. The fact that economic circumstances have changed is unlikely to be considered as force majeure but the causes of that change might be. It is important to check whether the clause provides an exhaustive list of events or whether they are examples but other matters could apply;
- That the event must prevent, impede or hinder a party from performing its contractual obligations. It would not usually assist where performance is possible but simply more difficult or expensive; and
- The party seeking to rely on the clause must use some efforts (e.g. reasonable / all reasonable / best endeavours) to overcome the events.
It is for the party seeking to claim force majeure to prove that it applies. I.e. it is not for the other party to have to dis-prove it.
Force majeure clauses often refer to 'disease, epidemic or pandemic' as possible relief events in which case we would expect this to apply in the case of Covid-19. If the clause that you are looking at does not, the effects of Covid-19 may still fall within the clause if, for example, it refers to 'acts of God' (which one would consider to be a natural phenomena not caused by human action and a court may accept Covid-19 to be an example of), or due to government action (for example forcing businesses to close or preventing the export or import of goods). Many clauses also have some form of 'catch-all' wording such as 'or any other event outside the reasonable control of the affected party and which could not have been avoided with reasonable foresight'. Again, it depends on the drafting of the clause as to what is caught and whether the specified events are a conclusive list or by way of example only.
If you think the force majeure clause in your contract might apply to the consequences of this pandemic, it is important to check how it applies to the particular circumstances that have arisen. The event might be covered by the definition but has the event stopped a party from performing their contractual obligation? For example, a supplier unable to get products to its customers due to a government prohibition on movement of goods could claim force majeure to excuse it from a failure to deliver on time. However, a customer may struggle to rely on the same clause (even if pandemic is expressly included) as in many cases its obligation is to pay for the goods and take delivery (which may not be impossible as a result of the force majeure event). The fact that demand for the goods has dried-up is unlikely to trigger the protection of a force majeure clause for the customer (but see further below for other possible remedies).
If force majeure does apply the clause will usually require the affected party to give notice of the issue to the other party. It is important to ensure that any notice requirements set out in the contract are strictly followed, as failure to do so may mean that the notice is not valid. It is also important to check what obligations the affected party has. Usually these would include endeavouring to overcome the issue and to perform as soon as the force majeure event ends. Such a clause generally suspends the obligation but does not end it. However, the contract's termination clause will often allow the other party to terminate it if the force majeure event continues for a particular period of time.
Changes to pricing
If a contract is possible to perform but has become more expensive it is worth checking any pricing clause to see whether it is possible to increase the price to take account of the unforeseen costs. This will not always be the case but sometimes price increases can be passed on if there is an increase in underlying costs of materials or shipping costs.
If your contract has specified service levels, with service credits where certain levels are not achieved, then it is worth checking what the contract says. It may be that as drafted the service credits are actually a mechanism to adjust the price, rather than a form of damages, with the result that, where service credits are being applied, the poorly performing party will not be in breach of contract (and therefore at risk of termination).
If the contract lacks a force majeure clause, or if the situation falls outside of the force majeure clause, then it may be possible to say that the contract has been 'frustrated'. This applies in certain restricted circumstances where performance has become impossible. It is not often used but if it does apply it is important to understand that, unlike force majeure which keeps the contract in place but suspended, the remedy for frustration is termination of the contract and discharge of each of the parties from their obligations.
Broadly, a frustrating event is an event which:
- occurs after the contract has been formed;
- is so fundamental as to be regarded both as striking at the root of the contract and as entirely beyond what was contemplated by the parties when they entered the contract;
- is not due to the fault of either party; and
- makes further performance impossible, illegal or radically different from that contemplated by the parties at the time that they entered into the contract.
For example, an agreement for the hire of a particular event space for an event on a particular date may be discharged by frustration if the Government were to ban public gatherings.
Change in law / material adverse change
While not as common as force majeure clauses, some contracts contain a similar provision which provides for the effects of a change in law. The relief is usually to allow either a variation or renegotiation of the price or to allow one of both parties to terminate the agreement.
With regard to Covid-19 we would consider that any new legislation brought in to ameliorate the effects of the pandemic, such as the closure of transport hubs or requisition of certain supplies, could trigger a change in law clause. However, if your contract contains such a provision do check that changes having a general affect on all businesses are covered and it is not confined to matters affecting only the sector that the parties operate in.
Some contracts address the issue of a change in economic circumstances through a material adverse change or effect clause. Broadly these can give one party relief of some sort if their circumstances have changed or allow the other party to terminate the arrangement.
Now is the time to look at any contracts which your business is party to if you have any concerns that you or your counterparty might experience difficulty in performing the contract. In many cases the parties will come to a commercial arrangement rather than jump to termination or initiate a formal dispute, but those discussions are much easier to prepare for once you understand your contractual options.