Coronavirus puts contractual risk on the agenda

Given the extreme lockdown measures taken by the UK government, organisations are beginning to ask whether businesses, suppliers, customers and commercial partners can continue to perform their contractual obligations. And if they cannot, what risks does this pose?

Two of the main legal terms that have come under the spotlight are force majeure and whether a contract has been frustrated. While all contracts are different, these principles are often the bedrock upon which they are built.

Force majeure

Most commercial contracts contain a force majeure clause. It is intended to protect the parties from a breach of contract claim if they are unable to perform their obligations because of an event that is outside their control. But the terms of the force majeure is decided by the people involved in the contract as there is no statutory or common law definition of the term in English Law.

“The parties to a contract therefore have the freedom to agree what will amount to a force majeure for the purpose of their contract and what the consequences will be if such an event happens,” according to an article by law firm partners Ben Longworth and Paul Jones at Farrer & Co. “That means there are no generic answers to questions about how force majeure applies – each party must look at the wording of their own contracts to establish how it works in the relevant circumstances.”

If the small print says the pandemic is a force majeure event, the consequences will still be governed by the specific wording of the contract itself. Generally speaking, such an event essentially suspends the contract, but not always.

“A party whose performance is not made impossible, such as those whose only obligation under the contract is to make payment, will often not be relieved of the obligation to perform, even if the other party’s obligations are suspended,” says the article. “That can feel unjust. However, a force majeure clause is essentially just a means of allocating risk and in some cases that risk will fall on the party not directly affected by the force majeure event.”

Frustration

The principle of frustration also applies where an event was unforeseen by the contact and makes performance of the contract impossible. While it seems similar to force majeure, the consequences can be different.

“If the contract is “frustrated” then the parties are completely released from their contractual obligations,” says the article. “The contract is not merely suspended (which is the usual position as a result of a force majeure) it effectively comes to an end. The courts will therefore not invoke the principle lightly and parties should carefully consider the implications before claiming that a contract has been frustrated.”

Focus on contractual issues

The law firm Kemp Little has produced a checklist for businesses to work through to assess contractual risk:

  1. Coronavirus related changes: Companies should assess the effect of Coronavirus on key contracts. For example, will additional costs arise? Who is responsible for these? Are there any contractual protections for any delays or non-performance? How can any failures in performance be dealt with? Are there any restrictions in the contract which need to be considered in a distributed working model, such as with employees working from home?
  2. Supply chain impacts: Companies should assess whether their key suppliers are affected by Coronavirus, and whether there will be any follow-on impacts companies need to consider and cater for, including delays and non-performance, and risks of insolvency. Plans may need to be put in place to mitigate and manage any risks.
  3. Charges: Suppliers and customers may try to pass on charges for specific Coronavirus- related issues such as supply chain delays, cost increases, reductions in demand, or try to use them to exit contracts (force majeure/material adverse change). Parties might look to “re-set” fixed prices, attempt to move work into or out of scope, or remove agreed discounts.
  4. Unlawful contract terminations: There may be attempts to exit contracts which have become unprofitable due to Coronavirus by unlawful means, including spurious breach notices, wrongful exercise of contractual provisions regarding termination, inappropriate use of force majeure clauses and claims of “frustration”.

 

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