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Frustrating Times: Coronavirus and Commercial Contracts

With the World Health Organisation classifying COVID-19 as a pandemic, and governments encouraging ‘social distancing,’ businesses are understandably concerned about the economic impact it will have. Interruptions in supply chains, delays, travel disruptions and threats to the labour force are commonplace right now. 

These circumstances pose questions about contractual rights and obligations of businesses and their clients, customers, suppliers and other third parties. Arcane legal terms such as “force majeure”, “frustration of purpose” and “time is of the essence” are becoming more commonplace. What do these terms mean and what are their implications? Read on…

What are the contract terms?

  • Review contract terms
    • What is the impact on the parties’ obligations of the pandemic (g. delivery time frames)?
    • Is the purpose of the contract still valid?
    • Are there any timing issues or challenges in performance of the contract?
    • If so, are there any notification requirements under the contract?
    • Are there any force majeure provisions; is ‘pandemic’ specifically listed?
    • What is the contract’s governing law?
  • Consider if any contract amendment is required
    • Don’t assume that there is an automatic breach of contract.
    • But, if any of the contact terms are impacted, consider if an amendment to the contract (g. extension of delivery time frames) is appropriate.
  • Check inventory and supply chains
    • Check existing inventory (and its location).
    • Stockpile where necessary.
    • Manage the supply they have on hand to better distribute.
    • Communicate with various checkpoints in their supply chain to anticipate any shortages or backlogs.
  • Take advantage of alternative dispute resolutions
    • If matters cannot be resolved by contract amendment or otherwise amicably, check the contract dispute resolution clause.
    • Where applicable, take advantage of mediation and consultations with each other to stay on top of this evolving situation.
    • This is often the easiest and least expensive way of dealing with disputes in a commercial context.
  • Check Insurance Policies
    • Insurers may cover losses that stem from this pandemic, although it depends on the particular policy.
    • Review insurance policies to check the scope of insurance and avoid taking steps that may waive coverage.
  • Get Advice
    • To better understand your legal position.

What do the legal terms mean?

Force Majeure

Jurisdictions in the U.S. and the U.K. recognise the principle of force majeure, but the specific wording of the relevant provisions may have different implications depending on the wider contract terms and applicable law.

  • What is force majeure?
    • an express provision in most commercial contracts where
    • a party may be excused from performing its future obligations if something significant happens which is
    • outside a party’s control and
    • prevents the party from performing its duties under the agreement.
  • The intervening event has to make it impossible for a party to perform. Being more difficult or expensive is not enough to invoke force majeure. You can’t rely on breach of contract by the other party to use force majeure.
  • Common examples of force majeure events are acts of God, pandemic, civil war, terror attacks, government actions.
  • Attempting to list out all events that are unforeseeable or outside a party’s control can be cumbersome and an exercise in divination. So, most contracts will have general language such as ‘or any other cause outside either party’s reasonable control’ as sweep-up language, but this differs between jurisdictions.
  • In most cases, a force majeure provision will allow the parties to suspend their obligations until the intervening event has passed. Some contracts may allow termination of the contract if the event continues for more than a certain time period.

Examples

  • UK: A party argued that the collapse of the financial markets triggered the force majeure provisions, but the judge felt that collapse was insufficient to excuse performance because there was nothing in the list of examples in the clause that dealt with an economic slow-down.
  • US: Some states hold that including catch-all language means that only events like those mentioned are included. A New York court held that the force majeure clause which included language ‘for any reason’ did not include the circumstances of a third party cancelling certain events because the clause listed only ‘strike, boycotts, riots, and restraints on public authority’ and did not mention any similar events to the one on which the party was relying.

Frustration

If there is no force majeure provision, you may be able to rely on the general principle of frustration (sometimes known as impossibility).

  • Frustration happens:
    • When an event happens after the parties entered into an agreement
    • Which makes it objectively impossible to perform; or
    • Changes the duties of each party beyond what they considered at the time of the agreement; and
    • No party is at fault.

Examples:

  • UK: The doctrine of frustration was established when a tenant booked a music hall for a series of events which subsequently burned down. Later, the court applied this doctrine when by-laws were created in a fishing area which meant that no animal, vehicle or thing could be in the area used by the Royal Air Force while the pilots were conducting practice flights. As a result, a local fishery was left unable to fish given the limited time they had to operate. The courts held that the by-laws resulted in the fishery being unusable, excusing its performance.
  • US: A party argued that it could not obtain sufficient liability insurance under the contract after its insurer refused to renew the policy because of an insurance crisis in the U.S. in the mid-1980’s. The court found that the doctrine did not excuse the party’s non-performance, and it applies only when the destruction of the subject matter of the contract or means of performance makes performance objectively impossible.
  • It is possible that the impact of COVID-19 would rise to the level of frustration of purpose, particularly with the cancellation of major events like the Premier League football matches, or South by Southwest.
  • These concepts do not mean that the contract is of no effect; rather, the party’s future performance is frustrated, and so it is excused from future performance (even if temporarily) until the moment that it can begin to perform again, unless otherwise agreed between the parties.

Time is of the Essence

In addition to the ordinary meaning that time is very important or essential, in a contract “time is of the essence” has a further meaning. If time is of the essence for a contractual deadline, even a slight deviation may have drastic effects:

  • Contractual Rights
    • If time is of the essence for exercising a contractual right, then the right is generally lost if not exercised within the time set.
  • Contractual Obligations
    • If time is of the essence for performing a contractual duty, then the time limit is a condition of the contract. Any delay in performing the duty may be grounds for terminating the contract, in addition to any other available remedy.

Impracticability – a U.S. Remedy

For contracts on the sale of goods which are based in U.S. law, the Uniform Commercial Code (UCC) may be relevant as it has codified the doctrine of impracticability.

  • UCC Section 2-615(a) provides that delays in delivery or non-delivery are not breaches if it’s been made impracticable by an event:
    • the event was not contemplated at the time the contract was made and
    • this does not include increases in costs alone.
  • The doctrine has been invoked in the U.S. where new environmental laws have created significant burdens on parties in an effort to reduce air pollution. Given the increasing rates of government intervention to contain the pandemic across the globe, including border closures, parties under a U.S. contract may be able to successfully rely on the doctrine of impracticability if government orders prevent them from delivering goods on time.

Mitigation

In any circumstance, parties would be expected to attempt to mitigate any impact from events outside their control. Businesses should identify their biggest risks and take steps to reduce the risk where possible. Given the global impact of this virus, businesses should use force majeure or frustration only as a last resort, and maintain good relationships with suppliers and customers for as long as possible.

 


 

The Intellectual Property, Data and Contracts (IPDC) team at MBM are familiar with the many legal implications of COVID-19 on business contracts and understand how it may impact our clients, based both in the UK and the US. If you have questions or concerns about your contracts, contact the IPDC team at ipdc@mbmcommercial.co.uk.

This is general advice only. Specific advice should be taken on an individual basis with someone qualified in your jurisdiction.


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