How can I manage contracts during the ongoing COVID-19 pandemic?
We understand that in the COVID-19 pandemic many businesses have had to ask themselves:
- What can we do to get out from contract obligations that have become onerous or even practically impossible to perform?
- What can we do if others we are in a contract with are unable to perform?
Dan Sherlock and Sara Nazir of Rix & Kay’s Dispute Resolution team have prepared some answers focusing on business-to-business contracts (B2B) since those involving consumers have distinct statutory rights that often produce different outcomes.
The extreme nature of the current economic upheaval is straining supply chains, cash flow, the availability of credit and affecting staff resources. These factors in isolation or in combination are causing businesses to have to plan for non-performance or non-payment, for varying delivery time or credit terms.
In serious situations this is requiring decisions to be taken on suspending or even terminating specific aspects of contracts or the entire deal altogether. Contracts that have run smoothly, perhaps for years, and which have never had to be reviewed for what happens when a dispute arises are now being looked at closely to establish just what happens when things go wrong and breach is imminent or has occurred.
Establish what is in the contract
The first thing to understand is that breaches of contract, and their remedies, are governed by the agreed terms. This might include any of the following:
- A single document setting out the terms;
- A series of communications that, when pieced together, show the key elements of a workable contract in force at that time;
- A history of dealings or industry standard terms, codes or practices that have been adopted; and
- Statutory rules that compliment or can supplant agreed terms where those terms are unlawful e.g. The Supply of Goods and Services Act 1982 and, for construction, The Scheme for Construction Contracts 1998
Whether breach occurs due to COVID-19 or any other reason is for the most part immaterial as the contract governs liability in the event of default.
Outcomes when there is breach – ending or varying contracts
The law allows flexibility in a contract if the parties agree that there should be some but it also imposes liability where breach occurs. In the event that the promised performance is not possible there are a variety of outcomes:
- The contract continues with a claim for damages or for the price arising;
- Suspension under a force majeure clause;
- Variation by agreement;
- The contract ends through frustration;
- Release by mutual agreement; and
- Termination for breach (with a claim for damages).
Breach and claims for damages
Whilst the reason for breach could be a decision in hindsight not to perform a bad bargain, it is more likely a fundamental supply chain problem or an individual, but severe stress, suffered by that business.
It is long-term commercial common sense to deal with these problems quickly before they get worse. Seek legal advice on your remedies as soon as breach appears likely as your contract can be a trap for the unwary where they require actions to be taken and conditions to exist to trigger those rights. Many parties who think they have correctly terminated as the wronged party can have a nasty surprise and face unexpected claims for being in breach of contract themselves.
Suspension: what is force majeure and is there such a clause in the contract?
These clauses alter parties’ obligations and/or liabilities in a situation where an event or circumstance outside of the parties’ control prevents performance.
For parties to benefit, there must of course be such a clause within the contract although it need not be labelled “force majeure”. What it will do is anticipate a supervening event beyond the control of the parties which determines how an affected party is excused from performing some or all obligations, entitling them to suspend or claim an extension of time or even giving a right to terminate.
Is COVID-19 such a qualifying event?
Such clauses generally approach situations in either of two ways. First, the clause might list specific events, and where it has listed an epidemic or pandemic then it is likely you are covered. An act of government could amount to the same thing where it imposes restrictions, but the position will not be so clear where these are merely recommendations or guidance without the imposition of orders through the use of legal powers. If a non-performing party has not complied with government guidance or did so but did not otherwise try its best, this may prohibit relief under the clause.
Where the event is not in the list mentioned it will be a question of interpretation whether the parties intended such an event to be covered. If the list is stated to be complete (exhaustive) then its omission is going to be a problem.
Secondly, the clause may give broad criteria which are said to be beyond the control of the parties. Whilst the courts might be generous with their interpretation if they can, a vague clause could well be void for uncertainty and it is also still going to be a strict requirement to show that late or even non-performance was truly beyond your control.
Performance has become incomplete, delayed or more expensive
Check the clause as it might specify the impact the event must have on performance such as “prevented”, “hindered” or “delayed”. Prevent might have to mean performance is impossible whereas the other phrases are lesser standards such as a shortage of raw materials leads to price hikes or a slowdown in the supply chain causes temporary interruption. A drop in the expected profit is unlikely to excuse non-performance.
What is the effect of reliance on force majeure?
This requires attention as the usual remedy in a force majeure clause is to be excused from obligations and/or liability without any damages being payable. Some force majeure clauses provide for extension of time, suspension of time, or termination in the event of continued delay or non-performance. A right of termination could be commercially important as it may provide leverage in renegotiations.
Some clauses also determine which party bears the burden of additional costs incurred due to the inability to perform or perform on time. If not, then it is likely that costs will be borne by the party that has incurred them as there would need to be a contractual provision to override this.
Where there is no force majeure clause in the contract
The contract is always the starting point as courts will not impose terms where they were not agreed and it follows that force majeure is never implied. Look at what other routes might be open to you but otherwise you might have to rely on frustration. This is problematic as the test for frustration is difficult to meet. Again, delayed or more expensive performance is not enough and it has to be the case that what stops performance has prevented or permanently and so fundamentally distorted the very essence of the bargain so as to make it unconscionable to uphold it.
Be careful with how you define performance as for example from the perspective of a clothing manufacturer, it can and should still perform its production and delivery of an order even if the retailer who placed the order has been prevented from opening its stores to sell them. In that case the manufacturer needs to ensure it does not place itself in breach and give the retailer an excuse to claim it is the innocent party and terminate, together with withhold payment that it was possibly unable to have paid if delivery had taken place. The parties would be well advised to anticipate these legal issues and traps that await each of them and set out to renegotiate for mutual benefit as soon as this issue arises.
Frustration and Release by mutual agreement
As stated above, frustration is rare and when it occurs it will be governed by the contract. It may be created by a change in the law that effectively prevents the contract going ahead. Howsoever it arises it instantly and automatically terminates the contract without giving either party the option to keep the contract alive and without affecting accrued rights. There may be limited financial remedies but no damages.
A release by accord stems from the principle that a contract that is formed by agreement may also be terminated by agreement. You should take legal advice on how this can be achieved in a way that makes it binding.
Amidst the COVID-19 pandemic, understandably many parties will need to closely review contracts and either their ability to perform or the steps they must take to ensure they are not held liable for breach. Rix & Kay have a dedicated team of commercial solicitors able to guide your business through these issue during this time.
Tips for using force majeure and avoiding adverse effects of breach
1. Check the trigger events and the requirements of the force majeure clause such as deadlines and forms of notice to be given. Some clauses require minimum notice periods and updates.
2. Prepare your arguments, keep records and act as soon as you know you have a problem in performing and explore alternatives; Expect opposition to the argument that you are covered for non-performance as the burden is always going to be on the party trying to avoid performance to show that the facts fall within the scope of the clause.
3. You must be prepared to show how you were unable in all the circumstances to perform the contract and that it is truly beyond your control.
4. You still have a responsibility to do your best to avoid or mitigate the consequences of non-performance; Explore alternative means of performing, reducing delay, or minimising any loss to the other party. This may require considering alternative suppliers, or alternative methods of delivery, even if at higher cost.
5. Check if you have insurance that will cover losses in this situation or if other contracting parties might have it and allow claims for your benefit. A typical business interruption policy is likely not to give you much comfort, but always check; Consider what emergency funding your business may be entitled to or what lines of credit exist to overcome rises in cost or a problem caused by cash flow.
6. If there is no force majeure clause, consider frustration, but be aware of the high bar for establishing that a contract has been frustrated.
7. Consider other routes and remedies, either under the contract or through agreeing binding variations to contracts with other parties.
8. If even after all other options are considered you wish to terminate for breach, make sure you comply with any express obligations you have agreed before doing so and that you expressly notify and give reasonable time to the other party to remedy their failure to perform.
Rix & Kay have a dedicated Dispute Resolution team that are experienced in managing and resolving all types of contract disputes. For an informal chat about how we can help contact Dan Sherlock e. email@example.com t. 01732 440855