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            COVID-19 & Contractual Obligations: A Strategic Approach

            This note considers the effect of COVID-19 on contractual relationships with a focus on force majeure and the doctrine of frustration under English law. 

            Date: 23/03/2020

            Introduction

            From its initial outbreak in China in 2019, COVID-19 (the coronavirus), has rapidly spread around the world and was declared a pandemic by the World Health Organisation on 11 March 2020.  At the time of writing, much of Europe is seriously affected by the virus and many governments, including the United Kingdom, have responded by imposing travel bans, cancelling mass gatherings and introducing social distancing.  

            The resultant disruption to business and the financial markets has been colossal, and that appears highly likely to continue for the foreseeable future.  Many parties involved in contractual relationships are finding that they have to operate in a very different world to the one in which those contracts were agreed.

            This note considers the effect of COVID-19 on contractual relationships, particularly in the context of force majeure provisions and the related doctrine of frustration under English law.
            As a preliminary point, it is worth noting that many businesses, including banks, appear more willing than at any point in recent history to consider re-negotiating contractual arrangements.  Whilst any subsequent agreement should be clearly recorded in writing, early consideration ought to be given to negotiation (potentially on a without prejudice basis) in parallel with the principles considered below.  

            Force Majeure

            Force Majeure refers to a situation where unforeseen circumstances prevent a party from fulfilling its contractual obligations.  Whilst this "doctrine" creates rights for parties in many jurisdictions, including continental Europe, under English law there is no general principle of "force majeure".  Consequently, a party's ability to rely on force majeure under an English law agreement is determined by the terms of the particular contract itself and the interpretation of the effect of the specific force majeure clause (which may or may not be entitled "force majeure").  Where a contract contains no specific force majeure clause, then English law is unlikely to imply a right to rely on force majeure and parties should instead consider alternative rights that might exist, such as under the contract more generally or the doctrine of frustration. 

            Whilst each force majeure situation must be considered in light of the specific contract to which it relates, such clauses typically share a common features, which are addressed below.  

            In general terms, a successful claim for force majeure will enable a party to suspend performance for the duration of the force majeure event.  In some situations, or if the force majeure event is sufficiently detailed, it may also grant rights of termination.  

            Reliance on force majeure clauses

            To rely on a force majeure clause, a party will typically be required to show three things:

            • the occurrence of one or more "events" identified in the contract as giving rise to a force majeure;
            • their non – performance was due to circumstances beyond their control; and
            • no reasonable steps could have been taken to avoid or mitigate the consequences of that circumstance.

            Is the event capable of triggering a force majeure?

            Force majeure clauses will ordinarily stipulate a list of events beyond the control of the parties to which it applies.  A standard list will include specific items such as war, natural disasters, civil unrest which will then be followed by a catch all statement such as "other event or events outside the reasonable control of the parties ".  Specific references to "epidemic" or "pandemic" will substantially assist a claim that COVID-19 is capable of constituting a force majeure.  If not, then it may be necessary to ask whether the situation can fit into another category or a catch all provision.  

            Note that the event in respect of which the force majeure is claimed need not be COVID-19 itself where other relevant grounds exist, which may or may not have been themselves caused by COVID-19.  It is also worth considering that parallel rights may exist within the contract (but outside of the force majeure provisions) arising from, for example, material change of law, which may afford equivalent or greater rights than the force majeure provision itself.

            Effect on performance 

            Frequently, parties seek to rely on force majeure in circumstances when otherwise they would be at risk of incurring financial penalties for late performance or termination for non-performance.  The critical issue here is the causal link between the event relied upon and performance.  Again, the strength of that relationship will depend on the precise contractual wording of the relevant clause.  Some provisions impose a high standard in that performance must have been "prevented" whereas others may refer to a lower standard such as "hindered" or other language like "substantially prevented" or "materially impeded".  

            In terms of COVID-19, one effect on performance will inevitably be driven by governmental and medical advice regarding the ability of workers to perform roles in particular locations or having to self-isolate.  However, where this simply makes performance more difficult or unprofitable, that is unlikely to be enough.  Similarly, whilst fact specific, the fact that the outbreak may have made it less safe for a business to carry out a particular task is unlikely of itself to comprise a force majeure event.

            Requirement to mitigate the effect

            A party relying on force majeure must be able to show that it has taken reasonable steps to mitigate the consequences of the event before relying on force majeure. Again, in terms of COVID-19, this might include changing operations, processes or equipment in order to continue performance – albeit in a reduced fashion.  Precisely what comprises "reasonable steps" will be fact specific depending on the individual contract in question, although it will be judged on the basis of the availability of alternatives, the costs of mitigation (both financially and more generally) and the burden of taking mitigating steps.  Examples of mitigation might include sourcing products from an alternative supplier, utilising alternative sub-contractors, or enabling staff to work from home.  Whatever mitigating steps are taken, or even considered, records should be kept in order to demonstrate that in the event of dispute.

            Notice provisions

            Force majeure clauses typically require the party relying on force majeure to serve a notice that clearly sets out the event of force majeure being relied upon.  If such a process is required but not followed, then the right to claim force majeure may well be lost.  Depending on the contract, the notice may also be required to contain additional information such as the impact of the force majeure event and anticipated duration, and periodic updates may be required.  

            Where the event of force majeure is ongoing (and not a one off event, such as a volcanic eruption or flood) parties may be well advised to submit repeated notices periodically as the situation develops and to guard against changing circumstances rendering an old notice ineffective. 

            It is also worth noting that many contracts require the provision of a notice when the event of force majeure has ceased to affect performance. Should the event of force majeure cease for a period, then a new notice will be required if it recommences.

            Any party receiving a force majeure notice would be well advised to investigate each of the three substantive requirements set out above for strict compliance with the contract, and also to check whether the notice is in conformity with the process set out in the agreement.  Where these requirements are not met, then the notice may be ineffective and can be rejected.  

            Similarly, where a party is involved in a chain of contractual obligations and it receives a force majeure notice it should consider whether it has grounds to claim force majeure both up and down the supply chain.

            Consequences of a valid claim for force majeure

            Again, this will depend on the contract and the event of force majeure.  As a minimum, most contracts will grant additional time for performance whilst the event of force majeure is in effect.  Depending upon the duration of the force majeure period, the contract may permit termination at one or the other parties' election. 

            Whilst there are great benefits in making a successful claim for force majeure, the consequences of getting it wrong can be significant and could amount to a breach of contract granting termination rights to the counterparty.  

            Frustration: what if the contract does not contain a force majeure clause?

            Since the right to claim force majeure is based on the contractual agreement between the parties, it cannot be asserted lawfully under English Law where the agreement contains no force majeure provision. 

            In that situation, the common law doctrine of frustration may provide a remedy. 

            Frustration, as restated by Lord Simon in National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675 requires the following:

            • a supervening event which is not caused by the default of either party;
            • which was not and could not have been reasonably foreseen at the time the contract was entered into and for which the contract makes no provision; and
            • which fundamentally transforms the nature (and not merely the expense or onerousness) of the outstanding contractual rights or obligations.

            The effect of a valid claim for frustration is that the contract will be brought to an end. 

            A further distinction between frustration and a typical force majeure clause is the threshold is higher in respect of frustration.  It is therefore substantially more difficult to successfully rely on frustration, since it must be shown that the obligations that have been affected by the event were fundamental to the contract. This is particularly the case where the contract imposes several obligations on a supplier that can be carried out independent of each other. 

            Changes in legislation or the cancellation of scheduled events can frustrate a contract.  Parties currently in the process of negotiating agreements, however, might be precluded from raising COVID-19 (or even widespread infection) related frustration in the future as the outbreak and its business impact should now be in the reasonable contemplation of the parties.  Of course, in that situation one might consider making express provision for COVID-19 related issues in the final agreement.

            Alternative remedies

            In situations of non-performance, in addition to force majeure and frustration, the entire contract should be considered as a whole.  Many contracts contain provisions that permit termination as a result of "change of law" if it becomes unlawful to perform.  As government's COVID-19 responses become increasingly strict and require isolation, this may create options.  In addition, there may be termination rights, such as termination for convenience or termination on short notice that can be triggered.  And of course, in the present environment, it may be possible to renegotiate agreements and reschedule payment terms. 

            About the authors

            DWF have experienced litigators and contract lawyers who regularly advise its clients on legal issues arising from COVID-19. If you would like to find out more please contact Richard Twomey (richard.twomey@dwf.law), Sahar Farooqi (Sahar.farooqi@dwf.law), Camarley McIntosh (camarley.mcintosh@dwf.law) or Vinesh Mistry (vinesh.mistry@dwf.law).

            Related people

            Sahar Farooqi

            • Barrister // Director of Advocacy

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