Covid-19: Your Business Continuity Contractual risk: What if you do not have a force majeure clause?
If your contract does not contain a force majeure clause, one will not be implied.
If your contract does contain a force majeure clause, but that clause does not expressly cover, Coronavirus it may be implied that it does but that is not certain. For more information on force majeure clauses see here.
In either situation, a party seeking to avoid liability for non-performance may be able to rely on a material adverse change clause, a change of law or the common law right of frustration. This note focuses on frustration only.
Frustration is an English law doctrine and so as a first step you should check that your contract is governed by English law. Since it is a common law right it arises based on the circumstances; unlike force majeure which requires an express contractual clause. If a contract is frustrated, it will automatically be terminated and the parties will not be liable to perform the contract in future. Unlike force majeure, it is a blunt instrument and will not have the effect of suspending performance during Covid-19 or of temporarily relieving the affected party of liability due to events out of their control. So when considering frustration, careful thought needs to be given as to whether you want the contract to be terminated with no right to claim damages for that termination.
If a contract is frustrated, neither party will be liable for loss caused by the frustrating event as neither party will be liable to perform the contract in future.
If, however, a party claims wrongfully that the contract has been terminated by frustration when it has not and does not perform its obligations, it will be liable for damages for wrongful termination.
So, in what circumstances, will a contract be frustrated?
A contract may be frustrated, if after the contract has been entered into, later events, which were not and could not reasonably have been foreseen by the party claiming frustration, makes performance of the contract:
1. by either party practically or physically impossible or illegal; or
2. so “radically different” from that contemplated at the date the parties entered into the contract that it would be unjust to hold the parties to the contract, even if it is still possible to perform the strict (express or implied) terms of the contract.
A contract will, therefore, not be frustrated by a later event which was, or should reasonably have been, foreseen – if it is an event which “a person of ordinary intelligence would regard [it] as likely to occur” or one “which the parties could reasonably be thought to have foreseen as a real possibility” Edwinton Commercial Corp v Tsavliris (Worldwide Salvage & Towage) Ltd  EWCA Civ 547.
For any contracts entered into before Coronavirus first appeared in Wuhan, it is highly unlikely that Coronavirus was an event which was or should reasonably have been foreseen at the date the parties entered into the contract. It is, however, arguable that a pandemic (in general terms) should have been foreseen If the contract itself caters for that eventuality and allocates risk (in a force majeure clause for instance), that shows that the parties did foresee that possibility and it will, therefore, not be possible to claim that the contract has been frustrated .
However, in most situations the pandemic itself is not likely to be the direct cause of the failure in performance. It is the subsequent consequences of the pandemic which are causing the failings (isolation rules, travel restrictions, illness etc). Therefore, the relevant question is not whether Coronavirus or a pandemic per se was an event which was or should reasonably have been foreseen. The relevant question is whether the consequences of dealing with Coronavirus were foreseeable or foreseen and catered for in the contract and, critically, whether those consequences constitute a frustrating event.
Even if a pandemic was or should reasonably have been foreseen, it by no means follows that those consequences should reasonably have been foreseen. Indeed it seems strongly arguable that such events would not have been foreseen by “a person of ordinary intelligence”, given that SARS, MERS and Ebola did not lead to such consequences and that the measures taken by governments throughout most of the world appear to be unprecedented in peace time.
It is normally very difficult to establish frustration, as a contract will not be frustrated if:
1. performance has become more expensive or less profitable;
2. performance has become more onerous or difficult; or
3. it is still possible to perform some parts of the contract.
If the disruption caused by Coronavirus is for a shorter period than the contract term, a party claiming frustration will also need to show that this will defeat the purpose of the contract for a time-specified event or that “time is of the essence”, or that the period of disruption in comparison with the contract term is so long as to defeat the main purpose of the contract. It will, therefore, be difficult to argue that a long term contract is frustrated, even if its performance is prevented for a sustained period.
However, where the delay extends to an interruption so differing in degree and magnitude from anything which could have been contemplated it may amount to frustration. Whether the delay is frustrating must be determined based on all the evidence of what has occurred and what is likely to occur
It may be necessary to wait upon events in order to see whether delay will make performance radically different and businesses do not want to wait upon events too long.
Even though it is normally very difficult to establish frustration for the reasons set out above, there does seem, in the current circumstances, to be good grounds for claiming frustration in certain situations. For example, now that the Government has banned large gatherings, it seems very likely that certain events which were due to take place during the affected period will be frustrated.
More broadly, frustration in relation to Covid-19 is likely to be based on:
A) frustration of common purpose, due to performance having become impossible at any stage in the supply chain eg source of goods, manufacturing, carriage of goods. If, however, the risk of non-supply has been assigned under the contract, this will militate against frustration. If the contract includes a force majeure clause which catches, or may catch, a pandemic, this may indicate that the parties contemplated an event of this nature so that this would be unlikely to amount to frustration. However, it seems arguable that, although the parties may have contemplated a pandemic they did not anticipate something of the scale of Coronavirus (which seems to be recognised generally as unprecedented in its effect).
Care must also be taken when seeking to rely on frustration of the purpose of the contract. The fact that one party no longer requires or wants the contractual performance is not sufficient in itself. Consider a contract for the provision of office supplies. The customer may no longer require those supplies if its office is closed due to Covid-19. However, assuming that the supplier is still able to deliver the goods and absent any express allocation of risk, the courts may well consider that this risk is one that falls to the customer.
B) Supervening illegality, caused by subsequent legislation rendering performance of the contract illegal. However, if a contract includes a force majeure clause which includes an Act of Government, that would give difficulties in arguing that an Act of Government that creates illegality amounts to frustration.
Covid-19 is unprecedented and so the courts have not had to grapple with many of these issues. However, much will turn on how likely it is that the parties contemplated the world would go into shut down to the extent it has. It seems to us that, in certain circumstances, there is likely to be a strong argument that many of the consequences of Covid-19 were not foreseeable and rendered performance of the contract impossible or illegal.
For more information and updates about the legal implications of Coronavirus, please visit our Coronavirus Business Continuity Hub: here.
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