COVID-19 Impact on commercial contracts - Part 1

Unless you have a written contract with specific terms which permits termination of the contract by either party without cause, under English law there is no automatic right to terminate or cancel a contract regardless of your reasons for doing so.

With the spread of COVID-19 now having a significant impact on commercial contracts in many industries, we take a look at what parties can do if they are unable to perform their obligations under a contract.

Non-contractual relief?

If you have entered into a written contract, a review of those terms is an obvious starting point. However, seeking to rely on formal written terms is only one way of managing a business agreement. Depending on the nature of your relationship with the other party, and if you do not have a written contract, it may well be worth speaking to the other party to discuss the best way to handle the impact of COVID-19. Having an open dialogue may allow both parties to work collaboratively to find a solution in the best interests of maintaining the relationship.

Written contract

If open dialogue does not result in a workable solution and/or you do not feel this is an option in your particular circumstances and there is a written contract then the next step is to review the contents of the same. Whether you will be able to rely on any term or terms in your contract to avoid compliance with your obligations under a contract will vary in each case dependent on the scope of the terms and the wording of the same. We set out below, some examples of terms that we would normally expect to see included in commercial contracts and the potential effects thereof.

Force majeure clause

Force majeure clauses essentially free both parties from liability or obligation when an extraordinary event or circumstances beyond the control of the parties or an event considered to be an act of God prevents one or both parties from fulfilling their obligations under the contract. In practice, a party’s obligations are only suspended for the duration of the force majeure event.

The spread of COVID-19 will not automatically mean that parties can rely on force majeure clauses to avoid fulfilling their obligations under the contract. Generally, it will not apply if the event was ongoing or in the contemplation or knowledge or the parties at the time of entering into the contract. The point of impact of COVID-19 is therefore going to be a matter for consideration for each individual contract. Where you are trading with an overseas company, particularly if that country had already imposed measures to try to stop the spread of the disease at the time of formation of the contract, is also likely to affect that determination.

As indicated above, the individual wording of each force majeure clause is going to need to be reviewed. Wording that includes reference to a health crisis or pandemic is likely to be supportive of COVID-19 as would reference to mandatory Government restrictions, depending on the timing of imposition of those restrictions and the scope of them. However, wording which simply refers to, for example, an act of God may be less likely to result in COVID-19 being a force majeure event.

The question of mitigation on the party seeking to rely on the clause will also be relevant. It is possible, for example, to employ temporary workers to cover for employees who are off-sick or prevented from being at work for self-isolation reasons? Could you source goods or services from an alternative supply outlet if your usual supplier’s ability to do so is affected?

Lastly, it is important to ensure that you comply with any provisions set out in the clause as regards notifying the other party and invoking the provisions of the clause. Where there are no specific time provisions, parties should act reasonably towards each other.

Termination

If your contract does not have a force majeure clause and/or the wording of the same is not sufficient to cover COVID-19 consider the question of termination. Does your contract have a termination clause? If so, you will need to review whether you have the right to terminate the contract.

Oral contracts & other non-contractual relief

So what if, having reviewed your written contract, you cannot find any clauses to assist you and/or you have entered into an oral contract so have no formal terms? In these circumstances, parties will need to consider other potential avenues.

Frustration

Frustration of a contract occurs if, after the contract is formed, an unforeseen event occurs which renders it impossible to perform obligations under the contract and/or the obligations are transformed into something radically different than was originally envisaged/agreed. For a contract to be frustrated the unforeseen event must not have been caused by either party’s conduct.

Frustration brings the contract to an end and both parties are released from any further performance under the contract.

Frustration of a contract is a common law right. There is no requirement for any written contractual term.

Other considerations

Many contracts impose a liability on one of the parties to ensure they have insurance in place to cover an inability to comply with their performance obligations under the contract. Depending upon the wording of the contract, it may be that, even if the other party was unable to perform its obligations under the contract, it would still be liable to you for payment of your charges as this should be covered by the insurance policy.

Even if the contract does not impose any formal obligation on either party to have insurance, a review of your own business’ insurance should be undertaken as you may well have cover to assist not only with your losses but any damages that the other party seeks to recover from you.

Exclusion and/or limitation clauses

Does your contract contain exclusion and/or limitation clauses? If it does, then, depending on the wording of the clause(s) you may be able to limit and/or exclude in full any liability that the other party may seek to recover from you as a result of any losses alleged to have been incurred as a result of your failure to perform your obligations under the contract.

Repudiatory breach

If the other party does not have a common law and/or contractual right to suspend or terminate the contract, they may be at risk of being found to be in repudiatory breach of contract.

A repudiatory breach of contract is a breach of contract by one party which goes to the very heart of the contract. 

A repudiatory breach entitles the innocent party to:

• Accept the breach with the result that he is treated as having been discharged from any further obligations under the contract; or 
• Elect to affirm the contract, i.e. treat it as continuing.

Where an innocent party seeks to accept the repudiatory breach, acceptance must be clear and unequivocal. Mere inactivity or acquiescence will generally not suffice. Once accepted, the acceptance cannot be withdrawn. Acceptance of a repudiatory breach bringing a contract to an end entitles an innocent party to claim damages against the offending party for their alleged losses. This is, however, subject to a duty on the part of the innocent party to mitigate their losses.

Where, on the other hand, an innocent party opts to affirm the contract and treat it as continuing, affirmation may be express or implied. Mere inactivity after a breach does not of itself amount to affirmation. An innocent party will not be held to have elected to affirm the contract unless, first, he has knowledge of the facts giving rise to the breach, and, secondly, he has knowledge of his legal right to choose between the alternatives open to him. Once the innocent party has elected to affirm the contract, and this has been communicated to the other party, then the choice becomes irrevocable.

Conclusion

Whilst COVID-19 is undoubtedly going to have a practical and financial impact on businesses for many weeks and probably months to come, the terms of a written contract or in default, the common law, are likely to offer some options to business to minimise their financial losses and to allow their businesses to trade through these very difficult and unprecedented circumstances.

We should conclude by stressing once again that your ability to be able to suspend your obligations under a contract or terminate all together are going to vary on a case by case basis and consideration will need to be given in each case to the wording of the contract (if applicable) and the specific circumstances and performance of the contract in question. We hope, however, that this note provides you some useful guidance to assist you in the coming months.