CONTACT US 0845 345 5004

Nobody Expects the Spanish Inquisition: The Unexpected Impact of Covid 19 on Contractual Arrangements

As a result of coronavirus and Covid 19, a vast range of contractual arrangements have been affected by the almost worldwide lockdown and the ensuing economic impact.

Against this background, Cat MacLean looks at some of the issues arising for businesses and individuals:

Force Majeure

Force majeure (FM) is a term which is getting increasing airplay in contractual and insurance discussions. FM provisions are contractual clauses which alter parties' obligations and/or liabilities under a contract. They usually apply when an extraordinary event or circumstance beyond the control of the parties prevents the parties from fulfilling their obligations.What FM actually means is a matter of highly fact-specific and contract-specific contractual interpretation.

Depending on their drafting, FM clauses may do a number of different things, including:

  • excusing the affected party from performing the contract in whole or in part;
  • excusing a delay in performance,
  • entitling suspension or extension of contract, or
  • entitling termination.

In both English and Scots law, FM arises only via a contract, so can only be relied on if there is a specific contractual provision that refers to it. If a contract is silent on FM, the law will not imply it into the contract, and so if the contract doesn’t have a FM provision, you can’t rely on it.It therefore differs from some other (usually civil law) legal systems where FM is a general legal concept and where courts may declare a particular event, such as a pandemic like Covid-19, as a FM event.

It is for the party seeking to rely on a FM clause in order to excuse its non-performance, or late performance, to satisfy a court that FM applies to this situation and that this is the effect of the clause.

Generally speaking, you can rely on a FM event where it prevents or delays (to the standard required by the provision) your ability to perform your obligations under the contract.It is highly unlikely, howeverthat a FM provision can be relied on simply because performance is more expensive, difficult or commercially undesirable.

Is coronavirus a FM event? This will depend on the wording of your particular contractual provision. Often, the FM clause will listthe events or circumstances in which the provision will apply. These are usually set out in a list of “force majeure events.” The events in this list can be either specific or more general, but typically they are all things beyond the reasonable control of the party or parties.

The FM clause may list specific events such as war, terrorism, earthquakes, hurricanes, acts of government, acts of god, plagues or epidemics. Where the term epidemic, or pandemic, has been used, that should clearly cover Covid-19.

An act of government will have occurred where a government body has imposed travel restrictions, quarantines, or trade embargoes, or has closed buildings or borders. A lockdown backed by legislation will clearly qualify. The position is less clear where the government merely makes recommendations rather than legislating.

An “Act of God”is an act which, (i) involves no human agency; (ii) is not realistically possible to guard against; (iii) is due exclusively and directly to natural causes; and, (iv) could not have been prevented against with any amount of foresight, plans, and care.

Clauses may give a list of specific criteria, such as fire, flood, war and so on, alongside wider, general wording, such as "or any other causes beyond our control".

  • lists that include “epidemic” and/or “pandemic” will likely cover COVID-19;
  • other events or circumstances such as “acts of government,” “acts of god,” “acts of nature” and “civil emergency” (among others) are also likely to cover coronavirus (although not without doubt); and
  • events stated to be “beyond a party’s reasonable control” are also likely to cover COVID-19.

The general wording in this type of clause will usually be interpreted broadly, rather than being limited to events that are similar to those specifically mentioned.However, none of the points in the three bullets above have been tested yet in the courts.

Where no relevant event is specifically mentioned, it becomes a question of interpretation. Given the almost unprecedented nature of the Covid-19 outbreak and/or the actions of governments around the world in response, it is likely that Covid-19 would constitute FM, and it is also likely that the courts will be generous in their interpretation of this sort of wording when faced with parties who have encountered genuine difficulties in performing.

However, by contrast the courts are equally likely to have sympathy for parties who are faced with a breach from the other contracting party, where it may appear that the party in breach has taken advantage of the current crisis to justify non-performance. Even if a FM event has occurred, a party cannot rely on the clause if it would not have been ready, willing and able to perform its contractual duties if the FM event had not occurred. Just because a FM event has occurred does not necessarily mean that the parties will protected from liability for failing to perform or delay in performance.Any party in breach will still need to show that their non-performance, or late performance, was truly outside their control, was genuinely related to the FM, and could not have been prevented or mitigated.

Is the fact that performance is now more difficult or expensive in the current climate enough? Generally, no. Usually, FM clauses in contracts will specify the impact that the event or circumstances in question must have in order for the clause to be triggered. Commonly the clause may refer to the event having "prevented", "hindered" or "delayed" performance. These terms require different levels of impact on performance before a party will be relieved from liability.

"Prevented" means that it must be physically or legally impossible to perform. This is a high bar. "Hindered" ( or "impeded", "impaired" or "interfered with") is a lesser standard and may in appropriate circumstances be triggered by performance being made substantially more difficult. However, the fact that performing would simply be less profitable is generally unlikely to be sufficient to qualify as FM.Proving that performance has been "delayed" should be less onerous than proving it is legally or physically impossible: it is not necessary to show that obligations have been "impossible" to perform or "prevented" for a period of time, just that complying as quickly as required under the contract is substantially more difficult.

If there is no FM clause, an affected party will have to look to other provisions of the contract for potential routes out of its difficulties.

Frustration

Absent a FM clause, it may in certain circumstances be possible to rely on the doctrine of frustration of contract.

Frustration is different to FM as it is a legal doctrine applied by the Courts, rather than being a freely negotiated contract clause. Its purpose is to relieve the parties of their obligations under a contract where a supervening event (which is not the fault of either party) has made performance of the contract radically different from what was originally agreed between the parties.

Frustration can only apply to an event that occurs after a contract has been concluded. It will therefore not apply to any contracts agreed after the outbreak of COVID-19.

The doctrine is very narrowly applied by the Courts and a contract will not be deemed to be frustrated on the basis that it is more expensive or difficult to perform or because another supplier has failed to perform its own obligations. One of the reasons for this is because, on one level, the operation of the doctrine of frustration is at odds with the fundamental principle of contractual certainty and being able to rely on the terms of the agreement you have entered into. The Court always seeks to hold parties to their bargain, if possible. Therefore, if there is a different way for the parties to perform their contract, even if it is more expensive or more difficult than the original expected method of performance, the Court will seek to enforce that form of performance.

Where a contract is deemed to have been frustrated, the parties are freed from further performance of the contract and are not liable for damages or non-performance of the contract without having to take any further action. Helpful for the party who can’t perform their part of the contract, but less so for the party at the other end of the transaction.

Traditionally it has been seen as very difficult to show that a contract has been frustrated. There was/is a need to show that an unforeseen subsequent event has made the contract impossible to perform, or has transformed performance of the obligations so radically that it would be unfair to hold the parties to their obligations. One extreme situation where the courts historically held that a contract was frustrated occurred when war broke out and the government banned the works and seized and sold the necessary equipment. It is not difficult to see the analogy with Covid 19.

As with the test for "prevention" of performance under FM clauses, however, the fact that performance has been made more difficult or costly is not enough. Temporary frustration is not possible so, if a contract has been frustrated, this will be permanent.Because the effect of the doctrine of frustration is blunt (in that it discharges all future performance obligations), for larger and more complex contracts – particularly those that are longer term and “relational” in nature – it may have the effect of cutting across potentially very important rights and obligations dealing with the parties’ mutual disengagement.

Business Interruption: Guidance for Policy Holders

Most businesses will have comprehensive insurance programs in place, but will insurers pay out for anticipated losses associated with the spread of the Coronavirus?

Business Interruption cover for loss of profits is found in a variety of commercial policies. This will be a primary focus for businesses facing a reduction in income and increase in costs as they try to cope.

The first challenge to establishing a BI claim is the trigger for coverage.  In some cases, express Infectious Disease cover may be provided. If not, the availability of cover will be entirely dependent on the context of the specific wording.

Those policyholders with an express Infectious Disease cover or extension might appear to be well-protected, but the scope of cover tends to be very tightly drafted and it is possible that this might not extend to novel pathogens such as the coronavirus.

Some policies provide cover for losses caused by any ‘notifiable’ disease. This is likely to mean losses suffered before the date on which the disease became notifiable are not covered. To the extent that the business’s profitability has already suffered before the disease becomes notifiable, this will therefore affect the amount the business is able to claim as loss of profit going forward.COVID-19 became notifiable in Scotland on 22 February 2020, and in Northern Ireland on 29 February 2020, whilst in England the authorities only took the decision to make it notifiable on 5 March 2020. The wording of any policy will therefore need to be checked carefully to establish which date acts as an effective trigger for BI cover. If multiple triggers apply, calculating the amount of covered loss will be complex.

Even where broad coverage for notifiable diseases is provided, policies frequently include an express list of excluded diseases. Whilst this is unlikely to include any reference to Coronavirus or COVID-19 specifically it may include catch-all language such as ‘or any mutant variant thereof.’ Some insurers are arguing that losses from COVID-19 are excluded as a mutant variant of ‘SARS’ (which was itself a form of coronavirus) and this is likely to be a significant area of dispute. It is not yet clear which way the courts will go on this.

Even where cover for BI losses is established, there will inevitably then be disputes over causation and measurement of loss. Where a business elects to implement or follow certain measures for the protection of its employees or customers, the position will be different from that where it is following mandatory orders from a public authority. Even where a business is forced to close or scale down its operations, there will be arguments over to what extent the losses are caused by the immediate effects on the business, rather than the effects on the wider marketplace and the absence of customers.

The US Orient Express case which followed on from Hurricane Katrina is likely to be relied on by insurers in this context. A hotel in New Orleans was prevented from recovering its lost profits following Hurricane Katrina, on the basis that damage to the wider area meant that even if the hotel had been able to continue operating, it would have had no custom anyway. It seems likely that a large number of ‘wide area damage’ type arguments will be run by insurers seeking to avoid indemnifying businesses.

The availability of insurance coverage for such losses is far from certain and it seems likely that many claims will be contested by insurers. We should expect a big push back on indemnification. Public comments made by insurers to date suggest that theyconsider most losses will be excluded. This will in turn lead to a significant level of litigation around business interruption in particular, and businesses may need to prepare themselves to go into battle against their insurer. Insurers are extremely concerned at the possibility of facing a deluge of business interruption claims and will be focussed on rejecting claims wherever possible. The moral of this particular story is not to accept what your insurer is saying at face value, take external advice and push back on any rejection of your claim.

Practical Issues to consider as we emerge from Lockdown – the potential litigation deluge

The comments made above indicate that there is likely already to be a backlog of disputes building up, and therefore a potential deluge of litigation on all of these contractual issues which will flow as we emerge from lockdown.

The British Institute of International and Comparative Law, which met, virtually, on the 7 April with attendees including Lord Neuberger, Lord Phillips and Sir David Edward addressed some of the practical difficulties and concerns posed by these contractual issues in the post-lockdown era.

In particular, the Institute considered the risk of a "plethora of defaults" leaving irreversible damage. A large number of economic measures have been deployed internationally at the fiscal and monetary level. The Institute addressed the response at the private law level, where the challenges are likely to be equally great.

Economic damage is likely to happen as parties trigger default clauses, and counterparties maintain that they are excused from performance. Most contracts have provisions dealing with unexpected events, and the law has principles to cover this – but just as no-one expects the Spanish Inquisition, no one anticipated a pandemic with the disruptive effect of Covid 19. There really is no appropriate analogy in past case law.

In at least one European jurisdiction, measures have been introduced to give a "breathing space", offering temporary relief to specified businesses and individuals unable to fulfil their contractual obligations because of COVID-19. However, in the UK there is no provision of this sort in place, and due to the Covid 19 crisis, UK courts and tribunals are likely to face a wave of commercial cases, with businesses invoking their inability to meet their obligations.Arguably, such litigation will produce unsatisfactory binary outcomes where one party is a winner and the other a loser. This risk of litigation deluge, and the risk of unsatisfactory outcomes, can be mitigated by agreement, or by mediation - both of which must be encouraged and will have a crucial role in increasing the prospect of more constructive solutions.

As the economy begins to reopen, the best policy approach is to encourage partiesto negotiate rather than focus on their contractual rights, which in any event aregoing to be uncertain. According to Lord Phillips, former President of the SupremeCourt, “parties should consider mediation, and conciliation should be encouraged atan early stage of legal proceedings”.

In many jurisdictions, procedural rules already encourage conciliation, and Lord Neuberger indicated a need for these to be developed further to give a breathing space.Speaking on the BBC's Today programme on Radio 4 recently, Lord Neuberger, former President of the UK Supreme Court, introduced the breathing space project, saying that “the legal world has a duty to the rest of the world to prepare itself”.

According to Sir David Edward, a former Judge of the European Court of Justice, "the law cannot insist that parties' contracts must continue as if nothing has happened, or simply declare that frustration has brought them to an end. If commercial life is to go on, a rational and equitable solution must be found."

In Scotland, Core – Scotland’s largest mediation provider - has already moved online and will now offer wholly virtual online mediation. The stumbling block, however, is still the fact that mediation is wholly voluntary, and is an “opt in” process. Scottish judges have always tended to the view that unlike some other jurisdictions, mediation cannot be imposed on parties. Unless we see a significant shiftin that thinking, the approach which is urged by Neuberger, Phillips and Edward will remain academic and the deluge will be an inevitability.

Conclusion

For now, there are a number of practical steps that can and should be taken by businesses in these unprecedented times:

  • Review the terms of any applicable FM (or hardship) clauses in your commercial contracts closely and consider whether they apply to the ongoing pandemic.
  • Consider whether it is impossible to perform the contract as originally anticipated: if there is no FM clause covering COVID-19, consider whether ‘Frustration’ applies.
  • It is important to be aware of your contractual rights and obligations, act quickly, and be careful in correspondence with your counterparty. It may be appropriate to include in correspondence an express statement that nothing you have said should be taken as a waiver of your contractual rights.
  • If COVID-19 is clearly covered by a FM clause in your contractual documentation, it might be prudent to consider negotiating with the other party to see if a workable solution can be achieved.
  • Push any party you’re in dispute with to negotiate and if you can, to mediate. That’s going to be a much faster way to resolve disputes than waiting for the courts to clear its backlog – bearing in mind that they may be working remotely for some time to come.
  • Check the detailed wording of any insurance product you have in place, if need be, take advice, and do not accept any refusal to indemnify at face value.
  • Going forward, include specific wording in all future contracts (including standard terms and conditions) to cover disruptions caused by the pandemic and ensure that contracts detail how these clauses will work.
Spring 2020 - Being Resilient
Funders’ Forebode

Contact us

Invalid Input
Invalid Input
Invalid Input
Invalid Input
Invalid Input

You must confirm you have read and accept our Website Privacy Policy.

Invalid Input

Contact us

Invalid Input
Invalid Input
Invalid Input
Invalid Input
Invalid Input
You must confirm you have read and accept our Website Privacy Policy.
Invalid Input