The coronavirus pandemic has, for important public health reasons, led to a large-scale shutdown of a significant proportion of the economy.
Many businesses have been forced to close their doors. Most businesses have been required to shut by Government order. In other cases, even where closure has not been ordered staff may be unavailable or trade may have completely ceased.
Many businesses will be parties to contracts which would, but for the pandemic, require them to provide products or services.
The status of these commercial agreements will be a second order priority for most businesses and firms will be forced to close whatever their legal exposure. However, a question for many businesses is whether they are in breach of their contractual commitments if they are forced to close for reasons which are outside of their control.
Even if a business is forced to close, there is an understandable concern that they could be subject not only to the cost and disruption of being forced to close, but also to a damages claim for being in breach of their contract commitments.
There are two concepts which may assist a business which is forced to breach the terms of a contract requiring the ongoing provision of goods or services – the existence of a 'force majeure' clause and the doctrine of 'frustration'.
Contracts often have 'force majeure' clauses. These seek to deal with circumstances which prevent a party from performing their obligations under a contract for reasons outside of their control.
Force majeure will only apply if there is a specific clause in the contract which deals with this concept. The clause does not need to include the words ‘force majeure’ and there is no set form of wording.
Each force majeure clause is different, and the effect of the clause will depend on the wording, most force majeure clauses require that the event is the cause of the failure to perform. This means that the party seeking to rely on the clause (i.e. the party seeking to avoid their contractual obligations) will normally have to demonstrate the occurrence of a force majeure event outside of their reasonable control that prevented their performance.
Force majeure events
A force majeure clause will usually set out a series of events which qualify as events which release a party from its obligations. Sometimes a contract will include a list of events which qualify, such as fire, earthquake or civil disobedience. Often a force majeure clause will also include some wording to cover a wider set of circumstances, such as events outside of the reasonable control of the parties.
Normally these words will be given their everyday meanings, although the interpretation of any more general wording might be limited to events similar to those listed. If the clause is limited to a narrow and specific list of events relating to property damage then a Court may determine that only events in the nature of property damage are captured by the more general wording.
The force majeure events usually do not have to arise after the contract is entered into. In the case of any contracts entered into now, if 'pandemic' is included as a force majeure then it might still qualify as a force majeure event.
A standard form of wording provides for a force majeure clause to only apply where a party is unable to perform its obligations. The effect of this wording is that the party seeking to rely on the clause has to show that the event in question has prevented performance.
This means that if it is still possible to perform a contract, but that this has become more expensive or inconvenient, then the event may not qualify as a force majeure event. This means that the effect of coronavirus/COVID-19 will not be the same in all cases. Although in many cases it effectively prevents performance, in many others it will simply make performance more difficult.
A party seeking to rely on a force majeure clause may also need to show that the force majeure event was the only reason for failure to perform the contract. A force majeure clause will not necessary be a 'get out of jail' card if a party would in any event have been unable to perform the contract.
If a force majeure event has occurred and is the reason for the failure to perform, then the clause should describe what the effect of that is on the relevant obligations.
The most common effects of force majeure are:
- obligations suspended - if a party is unable to perform for a force majeure reason then some or all of its obligations are suspended or modified for a given period or until the event passes (for example there would be no liability for a delay to a building project as a result of force majeure)
- liability excluded - liability for failure to perform is excluded if the failure arises for a force majeure reason
- termination - after a given period the contract can be terminated without liability
- mitigation - in many cases the clause will require a party relying on it to take steps to mitigate (minimise the impact of) the event and the resulting disruption, which might require the perform the contract in some more limited way or to mitigate the impact of non-performance
Many force majeure clauses will combine elements of these to reflect the parties' allocation of risk under their contract.
Some force majeure clauses also deal expressly with advance payments and would, for example, require reimbursement of fees paid in advance and/or costs incurred in expectation of contract performance.
If the clause does not deal with costs or payment in advance then there is no automatic right to receive reimbursement. However in these circumstances the doctrine of frustration may assist (see below).
The doctrine of 'frustration' applies to a contract if it becomes impossible to perform.
If a contract is 'frustrated' then neither party is obliged to perform their obligations.
An important point to note is that the contract must be impossible to perform, not simply extremely difficult. Frustration accordingly applies to a narrower range of events that would be covered by a standard force majeure clause.
In order for an event to frustrate a contract the event must:
- occur after the contract was entered into
- not arise as a result of the fault of either party
- make performance impossible, illegal or radically different to that contemplated
- be so fundamental as to go to the heart of the contract
For certain contracts (for example gatherings or events to be held on a specific date which are now illegal) the coronavirus/COVID-19 pandemic is likely to be a frustrating event. Other contracts might have become much more difficult to perform, but may not be frustrated.
Effect of frustration
The effect of frustration will be that the contract is discharged and the parties released from their future obligations (but are not released from their obligations up to the point of frustration).
Under the common law, the parties are not automatically put back in the position they would have been if there had been no contract (i.e. the contract is not rescinded). On this basis, advance payments are not automatically repayable and there is no automatic reimbursement for costs arising before frustration.
The unfairness which can arise as a result of there being no automatic right to reimbursement of advance payments is addressed in the Law Reform (Frustrated Contracts) Act 1943 ("the Act") a piece of legislation entered into at a time when war-related disruption was having an impact on contract formation.
The Act applies to English Law contracts, although it excludes some contracts like insurance and shipping contracts and can be excluded by agreement between the parties (this is relatively rare in practice).
If the Act applies then advance payments made before the frustrating event can be recovered by the paying party, and any payments which are due before frustration but not yet paid are no longer payable.
If a party who has received an advance payment has incurred expenses prior to frustration they may be able to deduct a reasonable amount from the advance payment before repaying the advance sum to the other party and if a party has received value from the contract before frustration then they may be required to pay a reasonable amount for the benefit they have received. Both rights are subject to the discretion of the court and do not apply automatically.
The Act can also apply to part of a contract if part of a contract has been frustrated.
Interaction of frustration and force majeure
The interaction between force majeure and frustration can be complex.
The Act expressly states that a force majeure clause in a contract will take precedence over the Act, and the Act will only be applied if the Act is consistent with the express terms of the force majeure clause in the contract. As such frustration and the provisions of the Act cannot override an express agreement to deal with the risks arising from the frustrating event, if these are covered by a force majeure clause. However in many cases a force majeure clause will not apply or will not thoroughly address the relevant risks.
Accordingly the doctrine of frustration and the Act may in some cases come to the aid of a party who has paid sums in advance or who is seeking to recover costs even if there is a force majeure clause in the contract, provided that the force majeure clause makes no express provision for these risks.
Force majeure clauses are one of those contract clauses which are often given little attention as 'boilerplate' and they will be examined much more carefully in the future, at least until memories fade once again.
In the current crisis, many parties are reviewing their force majeure clauses to see if the relevant issues are addressed and will be arguing in many cases that contracts have been frustrated.