As Covid-19 (coronavirus) continues to turn the world upside down, businesses and business owners are looking closely at their commercial contracts to try and understand their obligations and liabilities. Mark Lewis, partner in Lodders’ Corporate and Commercial team and head of Charity Law explains ‘force majeure’ and ‘frustration’ and provides practical advice to help you assess your commercial contracts.
Can we rely on force majeure?
Given the current circumstances, and without the express inclusion of a clause within the contract, force majeure cannot be implied.
Force majeure clauses in contracts usually exclude one or both parties to a contract from performance of the contract due to the occurrence of certain events. The events are usually defined as acts, events, or circumstances that are outside of the reasonable control of the party or parties involved.
For the force majeure clause to be effective it should specifically refer to pandemics, or at the very least diseases. It may be that a reference to a natural disaster is sufficient. The point is that a force majeure clause is interpreted according to its wording and in the context in which the contract was concluded. So it can be argued that if the contract is entered into after the disease had been reported in China the clause may not apply.
Can we rely on the principle of ‘frustration’?
Without the inclusion of force majeure clauses, companies may seek to rely on the doctrine of frustration.
Frustration is the principle under which a contract may be discharged when something occurs after the formation of the contract that makes it commercially or physically impossible to fulfil. It may also apply when the original obligations under the contract are changed to such a degree that it no longer represents the obligation when the contract was entered in to.
In general terms, a frustrating event is an event which:
- Occurs after the contract has been formed;
- Is so fundamental as to be regarded by the law both as striking at the root of the contract and as entirely beyond what was contemplated by the parties when they entered the contract;
- Is not due to the fault of either party; and
- Renders further performance impossible, illegal or makes it radically different from that contemplated by the parties at the time of the contract.
In the current circumstances, the acute spread of Covid-19 may result in businesses relying upon frustration in relation to their commercial contracts, because it has materialised after contracts were entered in to, it was not foreseen that the virus would become a global pandemic, it is not the fault of either party and it may well result in the performance under the contract becoming impossible (or even illegal) to fulfil.
Timing is key for commercial contracts
However, in the context of foreseeability, the date at which the contract was entered into against when the virus became an issue on a global scale must be considered. In other words, if you entered into a contract in February 2020, it is likely that frustration will be difficult to prove in comparison to a contract which was entered in to in February 2019, when Covid-19 did not exist.
In short, the longer that the contract has been in force, the easier it will be to establish that the pandemic was not foreseeable.
What happens if we can prove a contract has been frustrated?
If a party to a contract is able to prove that it is frustrated, there are consequences under both common law and also under the Law Reform (Frustrated Contracts) Act 1943.
Firstly, under the common law, if a contract becomes frustrated then it is automatically discharged and both parties are freed of their future duties and obligations. The contract will be brought to an end but is not rescinded. As it is not rescinded, any obligations incurred before the contract became frustrated will remain binding, and the party concerned will still be bound to perform them. However, because the frustration of the contract is not the fault of either party, neither party is able to claim damages for the other’s non-performance of duties following the frustrating event. This is based on the case of Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd. However, because the common law fell short of the required standard for remedies, the Law Reform (Frustrated Contracts) Act 1943 was passed.
Law Reform (Frustrated Contracts) Act 1943
If the contract in question has become “impossible of performance or been otherwise frustrated”, the Law Reform (Frustrated Contracts) Act 1943 applies. This act provides:
- S1(2) – money paid before the frustrating event can be recovered and that money due before the frustrating event, but not in fact paid, ceases to be payable
- S1(2) – a party who has incurred expenses is permitted, if the court thinks fit, to retain an amount up to the value of the expenses out of any money they have been paid by the other party before frustration; or where money was due and payable at the time of frustration, recover a sum not exceeding that amount for expenses
- S1(3) – the court may require a party who has gained a valuable benefit under the contract before the frustrating event occurred, to pay a “just” sum for it. This is so whether or not anything was paid or payable before the frustrating event.
This act, therefore, provides protection for both parties to a contract, but it needs to be noted that the Law Reform (Frustrated Contracts) Act 1943 cannot apply to insurance contracts, contracts for some perishable goods and some shipping contracts.
If you’d like a chat about your commercial contracts in relation to Covid-19 please do get in touch with Mark by email or on 01789 206135.
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Can I rely on force majaure to cease performing my obligations
The circumstances of every case will be different and force majeure clauses will be interpreted subject to the rest of the contract. Always seek legal advice on your particular case, but, as a starting point, use the flow chart (see image) when reviewing your contract to see if you may be able to rely on a force majeure clause.
Force majeure clauses are not straightforward; if you are concerned you may be unable to fulfil your contractual obligations and would like to discuss your options, please contact Lodders Commercial Dispute Resolution team.