The outbreak of coronavirus disease 2019, or Covid-19, means that many businesses will face difficulty in supplying goods or providing services to their customers.
What are the options for a business in circumstances where it is at risk of failing to perform its obligations under a contract?
It may be that the business can be relieved of its obligations, or have those obligations suspended for a period, under a force majeure (‘greater force’) clause in the contract.
If there is no force majeure clause, it may be possible to argue that the coronavirus outbreak has caused the contract to be frustrated, though the legal doctrine of frustration is rarely invoked.
In this note, we examine force majeure and frustration in relation to the position a business may find itself in as a result of Covid-19.
When a business is at risk of failing to perform its obligations under a contract, the steps that should be taken include the following:
- Review the contract to determine whether it has a force majeure clause or other provision relieving a party from liability for failure to perform the contract because of an unforeseen event.
- Determine whether the Covid-19 outbreak qualifies as a force majeure event within the terms of the force majeure clause.
- Consider whether the defaulting party’s failure to perform its obligations is covered by the force majeure clause. This may not be the case if, for example, the business could have performed its obligations despite the outbreak.
- Note the effect of the force majeure clause in the contract.
- Assess the likely consequences of invoking the force majeure clause.
- If appropriate, take any action required by the force majeure clause, such as giving notice to the other party, taking care to comply with the requirements of any notice clause.
- Consider what could reasonably be done to mitigate the effects of the outbreak, and take steps accordingly.
- If there is no force majeure clause, consider whether the contract may have been frustrated by the Covid-19 outbreak.
Before turning to legal remedies, however, it may well be worth discussing the position with the other party to the contract informally, with a view to agreeing a way forward by consensus.
Where a business has a long-term relationship with a supplier or customer, it may prefer to maintain that relationship by allowing the other party to suspend performance for a time, even if the contract does not strictly permit that. Maintaining goodwill in this way may be more valuable to a business, in the long term, than obtaining a financial remedy. This may often be the case for a business that stands in the middle of a supply chain as both a customer and a supplier. It will be a particularly important consideration if insisting on strict adherence to contractual terms could jeopardise the financial health of a key customer.
If this approach is taken, it will be important that any agreed departure from the terms of the contract is properly documented, perhaps in a side letter or a deed of variation.
In any such agreement it should be made clear whether the effect of the arrangement the parties have made will be to extinguish any subsequent claim for breach of contract, or whether the objective is merely to mitigate the effect of the force majeure event without prejudice to a future claim.
It will usually be worth reviewing the contract first, before opening an informal discussion with the other party, so as to be clear what the legal position will be if it should not prove possible to reach agreement.
Many English contracts will contain a force majeure clause. Such a clause will typically provide that, on the occurrence of an event of a kind specified in the clause, the contract may be cancelled (in whole or in part), or a party may be wholly or partly excused from performance of the contract, or a party may be entitled to suspend performance or claim an extension of time for performance.
It is important to note that, in English law, there is no legal doctrine of force majeure. The law does not set out what a force majeure event is, nor what its consequences should be for contracting parties. Instead, it is for the parties themselves to decide, when agreeing their contract, what would constitute a force majeure event and what the effect of such an event should be.
While force majeure clauses are often regarded as standard, or boilerplate, provisions which are included automatically, this is not always the case. When a contract is formulated, the parties may negotiate the force majeure clause to allocate between themselves the risk of an adverse event occurring, according to the strength of their respective bargaining positions.
When a business finds itself unable to fulfil its contractual obligations, therefore, the first step should be to review the contract and the provisions of any force majeure clause, to determine how it will operate in the circumstances of Covid-19. Everything will depend on the wording of the clause in the contract in question.
What is a force majeure event?
Force majeure (‘greater force’) is not a term of art and does not have a fixed meaning. A force majeure clause should therefore include, or refer to, a definition of what constitutes a force majeure event. This could be phrased generically, such as ‘an event or sequence of events beyond a party’s reasonable control preventing or delaying it from performing its obligations under this agreement’, or it could set out a list of the events that constitute force majeure.
However the clause is phrased, a force majeure event will typically include natural events such as fire, flood, earthquake, storm or other natural disasters; war or other hostilities by foreign powers; civil war, insurrection or coup; terrorism; legislative or administrative interference; sanctions or embargos; strikes or lockouts; failure of power supply or other utilities; or epidemic or pandemic.
In general, the more specific and detailed the list of force majeure events is, the greater the presumption will be that an event that is not listed should not be regarded as a force majeure event.
A force majeure clause may also include a list of exclusions – circumstances (such as a party’s inability to pay, a shortage of raw materials, or over-commitment) that will not constitute force majeure. A list of exclusions may have been negotiated by the parties when the contract was formed, and if there is such a list it should be checked carefully.
The clause may also exclude events which would otherwise fall within the scope of the definition if they could have been reasonably anticipated or avoided by the party concerned.
The first step is therefore to determine whether the spread of Covid-19 falls within the scope of force majeure events in the contract. It is worth noting that the World Health Organisation has declared the outbreak to be a pandemic, and this may assist a party seeking to establish that Covid-19 is a force majeure event for them.
Will the force majeure event excuse the defaulting party?
Secondly, it is necessary to consider the operation of the force majeure clause.
If the clause is drafted narrowly, it may provide that a defaulting party may be relieved from its obligations only if it can establish that it is unable to perform them as a result of the force majeure event, or that the event has prevented its performance. In the latter case, the party in question will have to prove that performance has become physically or legally impossible, not merely more difficult or unprofitable.
On the other hand, if the clause provides that a party may be excused if the force majeure event merely hinders its performance, then it will operate more broadly. A force majeure clause may also provide that the defaulting party is required to make certain efforts (perhaps exercise reasonable endeavours) to avoid or minimise the consequences of the force majeure event.
In some cases, there will be more than one reason why a party has not fulfilled its obligations under the contract. If the clause requires the default to result from the force majeure event, then the defaulting party may not be relieved from liability if it would not have performed the contract even if the force majeure event had not occurred. We have considered this point in more detail in a note on a recent case:1 the force majeure event should normally be the only reason for the default, rather than a concurrent clause, unless the force majeure clause provides otherwise.
If the definition of force majeure requires that the event in question is beyond the party’s control, it may be necessary to consider whether the party’s own actions have contributed to its failure to perform. For example, a business might not be able to rely on a force majeure clause if it could have ensured continuity of service during the coronavirus outbreak by enabling its staff to work at home but took no steps do so.
Depending on the wording of the clause, the occurrence of a force majeure event may relieve a party from liability if it is delayed in performing its obligations, as well as if it is completely prevented from performing them, and the clause may provide that its obligations will be suspended for the duration of the force majeure event. Such a provision may well be relevant to a business facing difficulties because of Covid-19.
A contract may provide that, in order to benefit from a force majeure clause, a defaulting party will have to comply with certain procedures within a certain period of time.
For example, it is common to require a party seeking to rely on force majeure to give notice to the other party, within a certain period, that a force majeure event has occurred. This is particularly the case if the force majeure clause has the effect of suspending the affected party’s obligations under the contract as long as the force majeure event persists.
The affected party may also be obliged to use reasonable endeavours to minimise the effect of the force majeure event, and to keep the other party informed of the status of the event and its effect on the performance of the agreement.
Such a requirement may function as a condition precedent. If this is the case, the defaulting party will not benefit from the provisions of the force majeure clause if the requirements are not complied with.
Recent case law confirms that notice provisions in contracts are to be construed strictly, so care should be taken (and advice sought, if necessary) to ensure that the provisions of any notice clause, as well as the force majeure clause, are complied with.
Force majeure and standard terms
If, in a business-to-business contract, one party is dealing on the other party’s standard terms, and those standard terms include a force majeure clause, then it may be possible for the clause to be challenged under section 3 of the Unfair Contract Terms Act 1977.
This provides that, when standard terms are used, a party cannot use a standard term to exclude or restrict its liability for breach of contract, or to claim to be entitled to render a contractual performance substantially different from what was reasonably expected (or no performance at all), unless the term in question satisfies the requirement of reasonableness.
The requirement of reasonableness is that the term shall have been a fair and reasonable one having regard to the circumstances in the reasonable contemplation of the parties when the contract was made. Relevant factors include the relative strength of the parties’ bargaining positions and whether the customer knew or ought reasonably to have known of the existence and extent of the term.
If a party considers that a force majeure clause in the other party’s standard terms is being used against it unfairly, therefore, it may be possible to argue that the clause is unreasonable. In such a case, the burden is on the party claiming that the term is reasonable to show that it does.
Different considerations apply to consumer contracts, on which see our separate note.2
Consequences of force majeure
Again, these will be as set out in the force majeure clause, which may provide that the defaulting party is wholly or partly relieved from performing its obligations under the contract, or that it is relieved from liability for breach of contract, or that one party or the other, may, if they so choose, terminate the contract (in whole or in part), or that the contract is brought to an end automatically.
Before invoking a force majeure clause, careful consideration should be given as to the likely consequences, especially if the effect is that the contract is terminated.
Other clauses in the contract
The force majeure clause may not be the only relevant clause in the contract, and it is possible that the most relevant clause may not be headed ‘force majeure’.
The contract may, either in the alternative or in addition to a force majeure clause, include a clause excluding a party from liability for breach of contract in certain circumstances. Such a clause could be headed ‘Exceptions’, or ‘Exclusions from liability’, and should be reviewed carefully in case it may assist.
There may also be other provisions setting out what is to happen if certain specified adverse events arise.
The headings used for the clauses are not usually important. What is important is to review the contract as a whole so as to ensure that a relevant provision is not overlooked.
If the contract in question has no force majeure clause, or if the force majeure clause does not cover the circumstances that have arisen, it may be possible to argue that the contract has been frustrated.
Frustration occurs if an unforeseen event occurs after the contract is formed and, as a result of that event, the contract becomes impossible to perform or the obligations under the contract are transformed into something radically different. The doctrine will only be invoked if the contract does not contain a clause intended to deal with the unforeseen event and if the unforeseen event has not been caused by the conduct of either party to the contract.
The effect of frustration is that the contract will be immediately brought to an end and both parties will be released from any further performance.
As to payment obligations, under the Law Reform (Frustrated Contracts) Act 1943, the paying party may be able to recover monies already paid to the other party (less any expenses incurred by the payee before the contract was discharged). The paying party may also be relieved of any liability to make payments which were due before the contract was discharged but have not yet been made, though the payee may be able to recover expenses that it has justly incurred. Where no money has been paid or was payable before the frustrating event, however, the payer will not be liable to make any payment.
We have examined the doctrine of frustration at greater length in a note on a recent case.3 Since the doctrine is interpreted strictly and kept within narrow limits, and many contracts will contain a force majeure clause, it is relatively unusual for a party to succeed in contending that a contract has been frustrated.
Nonetheless, where a contract has no force majeure clause, it will be worth considering whether the outbreak of coronavirus disease could be regarded as a frustrating event that will bring the contract to an end.