Commercial contracts in the menace of COVID

23 March 2020

Commerce axiomatically relies upon confidence. Confidence in this commercial context takes many forms. It is knowing that one’s creditors can pay tomorrow what one sells to them today. It is signing a multi-year lease and employing staff. It is investing in new technology. The crux of confidence is being able to predict the future with reasonable certainty.

In addition to the illness and death consequences of COVID-19, the pandemic has wreaked havoc on the commercial world in a way that no one could have seen coming.

How does the law respond?

Force majeure

Force majeure translates from French as superior force. It is the name given to a species of contractual clauses that allocate the risk that the continued performance of commercial contracts may be delayed or prevented by factors outside the control of the parties.
The first thing to understand is that force majeure is not a doctrine applicable to all contracts. It only applies if the contract contains a term to that effect. In the absence of a force majeure clause, the general law position is that the defaulting party is liable for all breaches, even if it is beyond the party’s control, unless the event causing the default amounts to frustration. I deal with frustration below.

The scope and effect of a force majeure clause depends on its terms, which are construed in accordance with the text, context and purpose of the contract as a whole.

Generally speaking, the force majeure clause has the following characteristics.

First, the clause defines the circumstances in which it will respond.

Second, the clauses specifies the consequences on the contract in the defined circumstances.

Third, the clause creates a causal nexus between the defined circumstances and the specified consequences.

The causal nexus warrants further discussion. Generally, proof of a causal nexus requires proof of the causal nexus itself, but also the elimination of any alternative method of performance. By way of example, say a retailer sourced a widget from its supplier in China at $1 and sold them to its customers for $5. The Chinese supplier could not supply the widget, but a local supplier could, but at $100. Force majeure would not respond because the retailer can perform the customer contract by sourcing the widget from the local supplier. The fact that it is unprofitable to do so is irrelevant.

Frustration

Frustration is a doctrine applicable to all contracts, subject to the terms of the contract itself.

It occurs when, without the default of either party, an obligation has become incapable of being performed because in the circumstances are such it would render performance radically different from that which could have been contemplated at the time of contract.

Hardship, inconvenience or material loss is insufficient to found frustration. Radical difference is an exceptionally high threshold. However, COVID-19 is exceptional. By analogy to history, contracts were frustrated because of the Great Depression and World War Two.

There is no uniform answer to frustration. Each contract and the circumstances affecting it must be assessed on a case by case basis. The following inquiries are necessary.

First, does the contract provide for the circumstances? Parties will be bound to their agreement on the consequences should the certain circumstances come to pass.

Second, is the default caused by either of the parties? Frustration requires the circumstances to arise without the default of either party.

Third, what is the effect of the circumstances? Is performance impossible or merely more difficult? If it is possible but difficult, how much more difficult is it? In other words, how radically different are the circumstances?

The effect of frustration on the contract is that the contract is automatically terminated from the date of the frustrating event. Accrued rights and obligations survive termination.

It is important to understand that frustration brings an automatic end of the contract. This must be considered before asserting that a contract is frustrated.

Get advice

The circumstances of COVID-19 are complex and evolving. So are the legal consequences. The parliament may yet pass legislation to deal with some of those legal consequences.

Expert legal advice allows business owners and operators to make informed decisions and increases their prospect of safely navigating the consequences of COVID-10.

Contact your Mahoneys relationship partner today. This article is written by Mitchell Downes.


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