The coronavirus is forcing business owners and entrepreneurs to make changes to their business, sometimes with significant consequences, and at the heart lies a contract.
A successful business owner needs numerous skills, and more than ever, understanding some esoteric legal concepts is fast becoming one of them.
I often say in my seminars that everything a business does involves contracts. Whether it is contracts with customers which may be B2B or B2C. Whether it is the contract with employees, or individuals providing personal services such as freelancers. Whether it is the contract with suppliers which may be one-off small arrangements, alternatively significant long-term arrangements such as an agency, distribution or franchise relationship. Or contracts with investors or partners aka the investment agreement, the shareholders agreement or the partnership agreement. Or the contracts relating to the real property such as the lease or licence to occupy, or the contracts relating to intellectual property such as licensing of copyright, trademarks or patents. Everything is based on contracts.
Assuming, for whatever reason, there is no opportunity to renegotiate a contract, if a party wishes to excuse itself from the obligations under the contract, the question is now how the coronavirus pandemic and government response impacts business contracts.
In this note we will look at the applicability of “frustration” and “force majeure” to contracts. Both concepts are different but both should be understood together. To the extent that neither apply we look at other practical options.
Frustration
A key question is whether the coronavirus is a frustrating event.
The concept of frustration under English law relates to:
- an unforeseen event, which
- arises after the entering into of the contract, and which
- makes further performance under the agreement impossible, illegal or something radically and essentially different.
If frustration applies then the contract is immediately brought to an end and both parties are released from further performance under the contract. In effect, if frustration applies then the frustration will kill the contract, kill it immediately and kill it automatically.
It is possible for frustration to apply to all types of contracts. However, there should be no misunderstanding that the concept of frustration is not a straightforward or easy principle to apply. English courts have set the bar high.
Examples of frustrating events have included:
- A change in the law e.g. a new Act of Parliament. A question will be whether the new Health Protection (Coronavirus) Regulations 2020 will create frustrating events.
- Subsequent illegality e.g. the outbreak of war. A question will be whether the “war on coronavirus” is such as an event.
- Cancellation of an expected event e.g. a contract to hire a room on a particular day to watch a street procession, and where the procession is then cancelled at short notice.
- Delay. But the delay must be abnormal, in cause, effect and duration.
- Death, illness or incapacity. For example for a contract of personal services where a specific person must provide the service and they die or are prevented by accident or illness from performing for example due to self-isolation.
- Destruction of a building. Note that whilst the coronavirus is damaging life and economies, it is not damaging the underlying infrastructure.
The concept of frustration cannot be used in any of the following circumstances:
- The contract already provides for the situation e.g. see below about “force majeure” clause. Note in a lot of contracts, there will already be provision for how different events are to be dealt with.
- The contract can still be performed, albeit more expensively. Frustration cannot be used to get out of what would now be a bad deal.
- There is an alternative way to perform the contract.
- Where a party is only in default, because their supplier is in default.
Whether frustration can be said to apply to any particular contract will therefore vary contract to contract. Each contract will need to be considered based on the nature of the contract, the circumstance relevant at the time it was made, and its terms.
The response to the coronavirus has seen the closure of non-essential businesses, government lockdowns and social distancing. So the coronavirus may constitute a frustrating event for some contracts, but not others. As mentioned there will need to be a radical difference, between the performance that can (if any) be provided, against the original obligation expected, due to the change in circumstances.
Force Majeure
Force majeure is not a legal doctrine like frustration, but rather the label give to a common contract clause relating what happens when a specified event arises beyond the control of the parties.
Force majeure clauses, if they are included in a contract, can be included in a short or long form.
The typical short form clause may refer to “any event” beyond a parties reasonable control, and then set out the consequences for such event. For example, there may be a right to be excused from some performance either indefinitely or for a period of time. There may be a right to suspend or terminate the whole contract.
The typical long form clause will often set out in detail the types of situations which will give rise to force majeure. Most classically this will for an “act of God”. An act of God has been described as an “extraordinary occurrence or situation that could not have been foreseen or guarded against”.
Acts of God have included earthquakes, fire by lightning, extraordinary high tide, unprecedented rainfall, extraordinary floods. However, the long form drafted force majeure contract clause will include many situations, for example epidemics, acts of government and civil restrictions.
Whether a contract includes a force majeure provision which is sufficient to cover the coronavirus, will be down to the terms of the contract. The terms of a force majeure contract would need to be construed quite strictly.
If a contract includes a force majeure provision covered by coronavirus, it is important to also consider the trigger. Is the trigger based on performance being delayed as opposed to performance being prevented?
A force majeure clause may also require an innocent party to mitigate the impact of the problem. For example to use best or reasonable endeavours. So, even if you are an innocent party, it is not a question of being able to sit back and do nothing, you may still be required to take positive steps to reduce damage.
Whether the coronavirus will entitle a party to terminate or suspend a contract due to a force majeure event or defer payment, will again be down to the specific wording of the contract.
Consider frustration or force majeure, contract to contract and situation to situation
Where a contract has gone bad due to the coronavirus, it may be difficult for the parties to know for certain whether they can seek relief by asserting frustration or force majeure. Clearly there will need to be an analysis of each contract and situation, on a contract by contract and situation by situation basis.
Don’t claim frustration or force majeure too quickly
Notwithstanding the emergency situation with the coronavirus, some care is needed not to claim a frustrating event or force majeure too quickly. If a party does, and has got it wrong, then the other party may then have the right to claim damages for repudiatory breach of contract.
Any other practical options
The world is in a state of mitigation in response to the coronavirus. By the very nature of mitigation, this means the damage has already been done. It is too late to stop the problem. The only question is how much damage will be done, and by taking steps to mitigate, to make the damage less bad.
Insofar as contracts are concerned, equally, damage may already have been done, and it is similarly a question of mitigation to make the damage less bad.
There is no real solution here. However, a very practical option is to invite an open dialogue with the other party. Everyone is affected by the coronavirus, and whilst some may seek the contract high ground, a lot of parties may also be willing to take a more long term, reasonable and practical view.
It would, finally, of course be prudent to consider the availability of insurance too.
