1 Jun 2020 - by Morrison & Foerster LLP

Reviewing Contractual Obligations During COVID-19

Due to the COVID-19 pandemic, most countries across the world have enforced some form of ‘lockdown’ and, as a result, the daily ‘normal’ has been significantly altered. Charities and social enterprise operations may have been temporarily ordered to close or to operate with reduced workforces. These organisations are also vulnerable to a number of other challenges, whether it be the cancellation of events or grant funding. As the pandemic endures, operations and supply chains around the world have been disrupted, with organisations experiencing delays and outright failures to perform.

With the length of the disruption remaining uncertain, most organisations’ contractual obligations are in the spotlight. A party’s failure to perform under a contract will, typically, constitute a breach of contract that may provide the non-breaching party with a right to claim damages and/or to terminate the contract. But do the special circumstances of COVID-19 represent a defence against claims of contract breach? How should an organisation assess its risk under its commercial contracts and funding relationships? These issues are especially pertinent to charities and social enterprises that may rely on fundraising events or grant contracts as a major source of income.

The following update explores the challenges that contractual parties may find themselves dealing with and how they can mitigate their contract risks, from an English law perspective.

Force Majeure

The initial commercial contractual reaction to the COVID-19 pandemic ought to be to identify services that might be affected (or relied upon even more in a time of crisis) and what difficulties arise as a result. Under many countries’ laws – especially in the United Kingdom and the United States – what’s most important is what the contract actually says. Organisations should check their contracts and understand what rights or obligations those contracts impose. If in doubt please seek pro bono legal assistance from A4ID’s Pro Bono Legal Services Team at [email protected].

The concept of ‘force majeure’ relates to what happens to a contract if something unexpected happens. A force majeure clause typically excuses one or both parties (temporarily or permanently) from performance of the contract, following the occurrence of certain unforeseen events. The central principle is that a party to an agreement ought to be excused from (or entitled to suspend) performance of its obligations in whole or part upon the occurrence of unexpected events or circumstances outside that party’s control. The ‘excused’ party will not be liable to the other party for its failure to perform the obligations, in accordance with the clause.

Under English law, force majeure has no standardised legal meaning or status as an inherent legal right. For force majeure to apply under a contract, it has to be expressly stated as a contract provision. Then the question becomes: what does that specific contract provision actually stipulate?

A standard force majeure clause may include some or all of the following: acts of God; epidemics and pandemics; sanctions or embargoes or governmental order or direction. Or it may simply define a force majeure event as anything beyond the reasonable control of the parties.

A force majeure clause (or, indeed, any other provision in an English law governed agreement) will be assessed by the English courts in accordance with the usual and well-established rules on contractual interpretation. Force majeure clauses are generally narrowly interpreted. Accordingly, unless events such as ‘pandemics’ and ‘quarantines’ are expressly stated as force majeure events, parties should not assume that a court will interpret catch-all language, such as ‘acts of God,’ to include these risks. It should also not be assumed that the court will include risks into a force majeure clause, which parties were aware of during negotiations or when entering a new contract after the specified risk becomes widely known and foreseeable (e.g. a contract entered into after the COVID-19 situation began). Therefore, it is crucial that force majeure clauses are drafted in clear and unambiguous language.

A customer or recipient of services will prefer a tightly defined clause, listing only certain events, acts or omissions and excluding all other possibilities. Whereas, service providers will typically prefer a broader listing, together with a general sweep-up (‘all acts, events or circumstances beyond the reasonable control of the party concerned’); as it is not realistic to expect to be able to predict all conceivable force majeure events.

Consequences of Force Majeure

A force majeure clause ought to specify the consequences of the force majeure event. Usually, that would be the postponement of all affected performance requirements until the alleviation of the force majeure event – i.e., a right of suspension of performance. But the contract may well also specify that all other services should be performed as usual.

A clause may typically provide that the force majeure event does one or more of the following (but the exact consequences of claiming force majeure ought to be checked against the contract language):

• excuses the affected party from performance of certain obligations under the contract
• allows an extended period to perform the affected obligations
• allows the affected party or the other party the right to terminate the contract
• exempts the affected party from liability for any delays or additional expense incurred

What happens if there is no force majeure clause?

Any contract governed by English law requires strict performance. A contract party whose performance or operation is adversely affected by the COVID-19 pandemic is required to perform its obligations as written in the contract, and will be potentially liable to the other contract parties for a failure to do so. The non-breaching party may also be able to terminate the contract, depending on the breach.

There is no automatic or implied right to claim force majeure as some sort of legal equivalent of a ‘get out of jail free card’. As is so often the case under English law, the legal position comes down to what the contract says.

Termination and Suspension Provisions

Termination provisions may provide contractual relief for one or more parties. Parties should check to see whether provisions specifying any of the following grounds for termination exist:

• upon notice (i.e., for convenience)
• on insolvency of the other party
• for a prolonged force majeure event or period of suspension
• for material adverse change (see Other Alternatives: Material Adverse Change)

Parties should carefully consider the effect of terminating the contract on the business before actually terminating, as terminating an important contract may be more disruptive in the long run. Additionally, any wrongful termination of the contract would result in a repudiatory breach of contract by the terminating party, the financial consequences of this are usually significant.

It should be noted that the absence of a termination provision for termination at law (i.e. under the doctrine of frustration) does not exclude this right.

A contract may also provide for suspension of performance in certain circumstances, this may be under a force majeure clause or a separate clause. Any rights to suspend performance, will be dictated by the plain wording of the clause in the contract. Further, as mentioned above, a prolonged period of suspension, may also give rise to a right to terminate a contract.

The Doctrine of Frustration

Sometimes, if the express contract terms do not help you, you might wonder whether it is possible to get-out of the contract because performance of the contract has become impossible or, as lawyers say, the contract has been ‘frustrated’. The doctrine of frustration is a common law principle, which has limited application to protect parties to an English law contract from an inability to perform.

However, frustration only applies in certain limited circumstances where performance has become impossible; it is not enough if performance has merely become more difficult or expensive than originally anticipated.

The doctrine of frustration also only offers limited remedies. It results in termination (plus recovery of monies paid under the contract before it was ended, subject to an allowance for expenses incurred by the other party, at the court’s discretion) and the parties being excused from further performance. To qualify, an event must:

• be unforeseen
• not be in existence at the time of entry into contract
• have occurred without fault of either party
• either make contract performance impossible or destroy the fundamental purpose of the contract

English courts have imposed a high bar on parties seeking to claim a right not to perform due to impossibility or contract frustration. It is conceivable that the COVID-19 pandemic could result in some valid claims for frustration (for example, where the contract requires performance in a country or region that is subject to a government-imposed lockdown). However, frustration ought to be seen as a fall-back or secondary option – and most parties to an English law-governed commercial contract will need to work out the extent to which they are protected by an express force majeure clause.

Other Alternatives: Material Adverse Change

Certain contracts may obtain a clause providing for termination or suspension in the event of a ‘material adverse change’. These clauses are designed as a ‘sweep up’ to cover termination events (or events of default) that are not expressly included in the agreement. In some circumstances, depending on the scope and looseness of the drafting of the clause, this introduces a degree of uncertainty as to whether the clause has been properly triggered, and this can leave any enforcing party in the unfavourable situation of having breached the contract itself, if it is later found that the conditions for the clause have not been met.

Contract law is often viewed as one of the more ‘black letter’ areas of law, where the wording of the contract is said to govern all future consequences. However, the elimination of ambiguity, no matter how well a contractual clause may be drafted or constructed, is nearly always impossible as not every conceivable scenario could possibly be foreseen. For many charities and social enterprises, the stakes could be quite high, and whether a particular interpretation prevails could make the all the difference between survival into the post COVID-19 era, or not. In this area of law in particular, seeking expert legal advice is strongly encouraged.

Information in this update has been provided by A4ID’s Legal Partner Morrison & Foerster LLP and does not constitute legal advice. If you require specific legal advice arising from the matters outlined in this update please contact the Pro Bono Legal Services Team at [email protected].