COVID-19 - Key contractual issues for organisations to considerWednesday, 11 March 2020
Organisations are beginning to experience significant disruption as a result of COVID-19, including the cancellation of events, the inability to manufacture due to supply chain issues and significant reductions in customer spend and general confidence in the market. These disruptions have the potential to render organisations, or the parties that they have contracts with, incapable of meeting their contractual obligations with consequent adverse financial implications.
Organisations need to actively consider the contractual and legal issues arising from the adverse impacts they may experience as a result of COVID-19. This planning will necessarily include how to best protect an organisation in respect of both existing contractual arrangements and those under negotiation.
Under Irish contract law the general rule is that an organisation will be held liable for a failure to comply with its contractual obligations. There are certain exceptions to this general rule. In the context of COVID-19, the two key exceptions are “force majeure” (superior force) events and the doctrine of frustration.
1. Force majeure
Commercial contracts will typically make provision for situations where circumstances beyond the control of the parties renders performance impossible by one of the contracting parties. Such a contractual provision is referred to as a “force majeure” clause. force majeure clauses will typically prescribe certain events outside the control of the parties, such as war, significant and unusual adverse weather events, government action or the outbreak of disease as a “force majeure event”. These clauses will outline how the parties’ obligations are affected by such an event. Such clauses will typically seek to exclude liability or excuse non-performance as a result of such an event.
Force majeure clauses differ from contract to contract so each particular contract will need to be considered to ascertain if COVID-19 is a designated “force majeure event” and, if so, what requirements will need to be satisfied to successfully invoke the force majeure clause to protect the interests of your organisation.
2. Key issues to consider
2.1 Is COVID-19 a defined force majeure event?
While COVID-19 is highly unlikely to be specifically referenced in a force majeure clause, it may nonetheless be covered depending on the definition of “force majeure events” as often the events listed will include, for example, the outbreak of disease, pandemic or governmental directions/regulation. Such lists may be “exhaustive”, with an event falling outside of those listed not being included as force majeure events, or “indicative”, which does not limit force majeure events to those listed.
2.2 Could COVID-19 have reasonably been anticipated?
Often a force majeure clause will exclude relief where the event could have reasonably been anticipated. If such a provision is included in a contract, the word “reasonable” will need to be considered objectively. Given that COVID-19 was unknown before the outbreak began in Wuhan, China, in December 2019 it is difficult to see how it could be maintained that the virus could have been reasonably anticipated.
2.3 Is there a causal link between COVID-19 and the non-performance of the contractual obligations?
It will be necessary to show that the non-performance of the contract is solely as a direct consequence of COVID-19. This will again be determined by the exact wording of the clause although, generally speaking, force majeure clauses will only apply where it is impossible to perform the obligations under the contract and will not apply where they are merely rendered more expensive to perform.
Organisations will also need to be mindful of contracting parties seeking to renege on current obligations and citing COVID-19 as the reason.
2.4 Is there an obligation to minimise the effect of the force majeure event?
The party that is seeking to invoke force majeure to avoid its obligations under a contract will usually be required to take reasonable steps to seek to minimise the effects of the force majeure event.
2.5 What are the notice requirements?
A force majeure clause will typically require that the affected party issue a written notice, promptly notifying the other party of the nature of the force majeure event. The notice provisions of a contract will require close examination as often notification will be a condition precedent to being entitled to any reliefs available to the affected party by reason of the force majeure event.
2.6 What are the consequences of the force majeure?
In most contracts, establishing force majeure will either temporarily or permanently absolve the affected party from having to perform their obligations under the contract. This removes the risk of the other party seeking to terminate for non-performance and claiming damages.
The force majeure clause will fall to be examined as to whether it will afford an extension of time to the affected party to perform its obligations and/or it will entitle one or other of the parties to terminate the contract. In addition the clause will typically make provision as to who is to bear the costs arising from any force majeure delay or whether compensation may be payable.
2.7 What are the dispute resolution provisions?
Parties should be aware that disputes can often arise as to whether an event such as COVID-19 comes within the defined force majeure events in a contract or what the consequences of such an event are on the performance of the contract. Parties should be aware of what mechanisms are in place to resolve such disputes if they arise. Parties should also carefully consider the overall contractual relationship before invoking force majeure. If invocation of a force majeure clause was disputed by another party, or deemed incorrect by the courts in later litigation, this could seriously damage the parties’ contractual relationship and could constitute a repudiatory breach of the contract.
2.8 What should organisations do?
Given the issues identified above, where a force majeure event exists, it is important for organisations to engage in discussions with their contractual counterparties sooner rather than later. See the “Practical Tips” section further below for practical tips.
2.9 What about transactions/contracts currently under negotiation?
In relation to transactions/contracts currently under negotiation, organisations should consider what impact COVID-19 may have on the organisation’s ability to perform its obligations. Having identified the risks to the organisation, provision should be made in the contract to seek to insulate the organisation from the occurrence of these risks.
Where a party cannot avail of a force majeure clause, they may be entitled to relief from their obligations under the contract where they are unable to perform their contractual obligations under the doctrine of frustration of contract. Frustration arises where a party from its contractual obligations where there has been a supervening event, through no fault of the parties to the contract, which makes it physically or commercially impossible to perform the contract or would render performance radically different. A party will not be absolved from performance merely because this has become more expensive, more difficult or even proves to be impossible. The Courts have confirmed that the circumstances where frustration can be invoked are narrow. The contact as a whole must be looked at as if the contract has provided for the situation which has arisen the terms of the contract will govern the situation.
The high bar to establish a frustrating event has been seen to be difficult to overcome. The recent English decision in Canary Wharf (BP4) T1 Ltd v European Medicines Agency shows how difficult it can be for a party to successfully invoke frustration to discharge a contract. In that case, the European Medicines Agency (“EMA”), sought to claim that the lease of its headquarters in Canary Wharf was frustrated by Brexit. Despite the fact that the EMA is an established EU institution governed by EU regulations with responsibility for the evaluation, supervision and monitoring of medicines in the EU and therefore must be based in EU, the High Court in England determined that the lease could not be frustrated by Brexit.
Nonetheless, the high threshold for frustration may be met in some scenarios relating to COVID-19, for example, where performance of the contract requires the provision of services in a region that is subject to a state-imposed lockdown such as tourism packages to Italy. In many other instances, parties will need to refer to contractual force majeure clauses.
4. Other contractual considerations
Organisations should be aware that their contractual counterparties may seek to rely on COVID-19 as a basis to invoke other contractual provisions, for example:
4.1 Price adjustment clauses
Parties may seek to rely on COVID-19 as a mechanism to adjust contract prices due to increased costs (for example due to delays/difficulties in the supply chain).
4.2 Limitation or exclusion clauses
If a party cannot rely on a force majeure clause, the parties may seek to utilise limitation or exclusion clauses in a contract to limit or exclude liability for non-performance where available.
4.3 Material adverse change clauses
A “material adverse change” clause gives a party the right to avoid performance under the agreement or even to terminate the agreement where there has been a material adverse change on the business. COVID-19 could potentially trigger a material adverse change clause in a contract, where available. The ability to invoke this provision, and repercussions for doing so, will depend on the wording of the clause, and how the clause is construed.
Organisations should take a prudent approach to this developing situation and undertake the following actions:
Identify the key contracts for review, such as:
Have those key contracts assessed in relation to:
Take care to:
Consult with insurers in relation to relevant policies, such as business interruption policies, and to confirm if invoking force majeure would affect any policies held (we will be publishing further information on this point in the coming days).
Mitigate any risks possibly in collaboration with a counterparty (for example, by mutually agreeing a side letter to amend the contract so as to avoid a breach).
Monitor the situation as it develops in relation to COVID-19.
Seek prior legal advice if a force majeure clause may need to be invoked and do not rashly invoke force majeure clauses.
Please note that the content of this summary does not amount to professional advice. Legal and tax advice should be sought in respect of specific queries. The COVID-19 situation is evolving rapidly and this update is provided on the basis of information available as at 11 March 2020.