How will my commercial contract be affected by COVID-19?
We are all aware of the impact of COVID-19 on our health system and social interactions, however it is also important to consider the effect of the pandemic on business. Quarantine measures and shutdown directions have seriously disrupted travel, retail and hospitality businesses, as well as the provision of services and supply chains. This article considers how these disruptions affect our contractual obligations – whether they arise under a licence agreement, or an agreement for the provision of services. What happens when one party can no longer fulfil their obligations under the agreement?
If you or your business is unable to fulfill their obligations under a contract as a result of restrictions imposed as a result of COVID-19, the first port of call is to try and negotiate a mutually acceptable solution with the other party to the contract. However, if this is not successful, you should look at the terms of the contract and, with legal advice, work out whether the contract includes any terms or conditions which cover the current situation.
Force majeure clauses
Some commercial contracts include force majeure clauses, which have the effect of either terminating the contract or suspending a party’s obligations under the contract, and protecting a party from liability for a failure to comply with the terms of the contract due to a force majeure event. A force majeure event means an event or circumstances which are beyond the parties’ control.
Depending on the wording in each contract, a force majeure event usually means an event which is unforeseeable, unavoidable and one which renders performance of the parties’ contractual obligations either temporarily or permanently impossible. Most clauses require that the force majeure event must not have been directly or indirectly caused by the party relying on the clause, and there are also usually notice provisions governing when it can be triggered.
However, when considering whether COVID-19 constitutes a force majeure event, you will need to review the actual wording in the contract – it is important to note that the definition of force majeure and the wording of the force majeure clause is different in each contract, and must be considered and interpreted on a case by case basis. Simply referring to force majeure, without a clear definition, does not provide clear guidance as to what is covered. Force majeure clauses have been interpreted as covering acts of God (e.g. earthquakes, floods, or cyclones), as well as very bad weather, war, strikes and government regulations.
Without a clear reference in the force majeure definition to “epidemic” or “pandemic”, a court will interpret each clause in the context and circumstances of the specific contract.
What if COVID-19 is interpreted as a force majeure event?
If, as a result of the impact of COVID-19, you have obligations under a commercial contract that you are no longer able to fulfil, and you decide to either suspend performance of those obligations or terminate the contract, you must ensure that you comply with all of the provisions in the agreement which relate to the force majeure event. For example, usually a party is required to give notice to the other party of the details of the event, the extent to which the contractual obligations will be affected, as well as the possible length of delay. Again, the terms of each contract will set out the requirements to be complied with.
In addition, the party seeking to rely on the clause to “get out of” their obligations will usually be required to make all reasonable efforts to mitigate or minimise the effect of the force majeure event on their ability to perform their obligations under the contract. For example, a failure by an employer to insist on social distancing measures in its workplace could be seen as a failure to mitigate the impact of COVID-19.
What if your contract does not include a force majeure clause?
If your contract does not have a force majeure clause, or the definition of force majeure is too narrow to include COVID-19, you could potentially rely on other clauses to either vary or terminate the contract, including:
- a termination provision which allows a party to terminate the contract for any reason, without penalty;
- a variation provision whereby the parties may, in certain circumstances, vary the terms of the contract (e.g. varying a price due to foreign currency fluctuations);
- a provision which allows either party to terminate the contract if performance becomes too difficult.
Alternatively, you could consider whether the doctrine of frustration applies. Frustration means that a situation or unforeseen event has arisen which means that the contract is incapable of being performed. An example of a contract which was terminated as a result of frustration was where a theatre was destroyed prior to the date when it was hired for a performance. The court determined that because the theatre was destroyed due to a terrorist act, the hire contract was frustrated. If frustration can be established, then the contract is automatically terminated. However, the contract is not deemed to be void from the start – it is only future obligations that are terminated. Thus, although neither party can demand further performance from the other party, any obligations which were on foot before the frustrating event are still valid, and a party can claim a remedy if those pre-frustration obligations are not performed as required under the contract.
In some states (including Victoria and New South Wales), legislation has been enacted whereby any contractual pre-payments must be repaid if the contract is frustrated (e.g. the Australian Consumer Law and Fair Trading Act 2012 (Vic)). For example, the cancellation of the Melbourne International Comedy Festival resulted in the refund of all pre-purchased tickets.
However, the bar to establishing frustration is high – the fact that performance of the obligations under a contract has been made more difficult, or the burden of the obligations has increased, does not mean that the contract is frustrated. For a claim of frustration to be successful, the parties must be able to show that the parties never agreed to contract in the fundamentally different or altered circumstances which have arisen.
What should you do next?
- try to negotiate with the other parties to either vary or terminate the contract;
- if negotiations are not successful, ask your legal adviser to review the dispute resolution and termination provisions of the contract in order to work out your options with regards to ending or suspending the contract;
- seek legal advice as to whether the contract includes a force majeure clause, and whether it could be relied upon to either terminate or suspend the contract;
- identify whether any notice or other requirements must be complied with to rely on the force majeure clause;
- consider whether future contracts should include a force majeure clause, as well as the appropriate definition of force majeure; and
if the contract does not include a force majeure clause, ask for advice as to whether the contract is frustrated.
Author: Naomi Fink (Special Counsel)