Our German Desk
The current COVID-19 lockdown has brought many businesses to a standstill and, at the very least, interrupted all businesses. In light of supply chain and workforce difficulties, together with the increased cost of performance in many cases, you may be struggling to meet your contractual obligations. On the flip side, your partners or suppliers may be struggling to meet their contractual obligations to you. With continued uncertainty, the effects may be ongoing. Read on for an understanding of the key issues to get in front of and how to manage your contracts going forward.
Force majeure
Certain types of contracts – such as supply and distribution agreements – will often contain a force majeure clause. Force majeure clauses are intended to provide relief and allocate risk when a specified event occurs, due to the potentially significant disruption to a party’s ability to perform its contractual obligations. Typically, force majeure events include war, strikes, acts of God and epidemics, or similar acts that are not foreseeable and are beyond the reasonable control of the parties.
While the specific terms of each contract and the surrounding circumstances will differ, some key aspects to assess include the following:
- Are there force majeure or excusable delay provisions in the contract?
- Do the present circumstances qualify as a force majeure event as specified in those provisions?
- If so, what is the effect of the force majeure event?
- What process or notice requirements are necessary to trigger the force majeure provisions?
- What is the effect of the force majeure provisions? Will the party claiming force majeure be relieved from all obligations or only certain obligations that are affected by the force majeure event? Will the entire contract be suspended, varied or subject to termination rights by either party?
- Is there a right to terminate if the force majeure event continues? Is there a limit to how long the force majeure event can go on for before termination rights arise?
- Will payment obligations be suspended where force majeure applies?
- Are there express obligations on the party relying on the force majeure provisions to reasonably mitigate the effects of the force majeure event?
- Are there ongoing obligations to observe during the force majeure period (i.e. the party claiming force majeure must provide regular updates to the other party)?
- Can alternative arrangements be entered into with third parties (to the extent that third parties supplying a similar product or service are themselves operating)?
- Are any other provisions relevant, offer relief or are triggered by the situation (i.e. an ability to terminate the contract on providing a certain period of notice)?
Where the contract does contain force majeure provisions, it is critical to ensure that it covers the event (i.e. COVID-19 and its consequences) and that the event is materially relevant to a party’s ability to perform its contractual obligations.
A party seeking to rely on a force majeure provision will bear the burden of proving that a failure to perform or a delay in performance was due to the force majeure event and that there were no reasonable steps that it could have taken to avoid or mitigate the event or its consequences.
In light of this, where you are providing goods or services, it will be important to be able to show that you have identified and analysed the potential impact of COVID-19 on your business and are ready and willing to implement workaround measures to mitigate its effect on your ability to perform the contract. Where you are obtaining goods and services, you may wish to get in touch with your supplier to get a handle on whether they can continue to supply in order to get in front of any knock-on effects this may have on your business and contractual obligations to other parties.
Where the contract does not contain applicable force majeure provisions, the doctrine of frustration may also be relevant.
Frustration
In the absence of an applicable force majeure or similar provision, a party may look to the doctrine of frustration (with reference to the provisions of Subpart 4 of the Contract and Commercial Law Act 2017 which apply where a contract has been frustrated). Upon the occurrence of an event or factor outside of a party’s control and through no fault of their own which renders performance of a contract impossible or radically different from what the parties had agreed, the contract may be considered “frustrated”.
Where frustration can be established, the contract comes to an end and the parties are discharged from further performance. However, it will not discharge them from obligations accrued before the event in question.
The threshold for establishing frustration is very high and contracts will typically not be frustrated where the contract simply becomes more onerous for a party or an intervening event causes some delay in performance (unless that delay radically alters the performance of the contract). The courts will take a wide variety of factors into account in assessing whether a contract has been frustrated, including the destruction of essential property required to perform the contract or, in the present case, a government directive which makes ongoing performance illegal. While each case will depend on its own circumstances, in general, the courts will typically require that the contract be impossible to perform such that, in practice, frustration is rarely established.
Termination risk
Relying on force majeure provisions or claiming a contract is frustrated is not without risk. Wrongly refusing to perform contractual obligations or incorrectly terminating a contract carries the risk that the counterparty may terminate the contract and claim for damages.
It is therefore critical to obtain legal advice before suspending, terminating or refusing to perform your contractual obligations.
What to do
Whatever the specific terms of your contracts, we recommend that you take an inventory of your existing contracts, assess the likely areas of concern or failure and gain an understanding of your contractual position. Given the potential consequences and the fact that each case will depend on the exact wording of the force majeure provision and surrounding circumstances, it is important to obtain legal advice before entering discussions with the counterparty, suspending or refusing to perform your contractual obligations or seeking to bring the contract to an end. Equally, if the counterparty seeks to terminate, it is also important to obtain legal advice in respect of your rights and position.
If you have any questions about COVID-19 and your contractual rights, please get in touch with our Business Advice Team or your usual contact at Hesketh Henry.
For a discussion on related issues specific to constructions contracts, please refer here.
Disclaimer: The information contained in this article is current at the date of publishing and is of a general nature. It should be used as a guide only and not as a substitute for obtaining legal advice. Specific legal advice should be sought where required.
