Coronavirus and business contracts

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Coronavirus means significant economic disruption, affecting both consumer demand, supply chains and the ability to carry out work.  The situation is developing quickly, and as circumstances change businesses need to consider the impact on their existing and future contracts.

We are working with businesses to help them manage contractual liabilities and stay afloat.  We are also looking at claims which have been wrongly turned down by insurers and fighting the corner for our clients. Contact us for rapid and effective advice to steer you through this crisis.

Getting out of or varying contracts because of coronavirus

In the unprecedented current coronavirus outbreak we have already had many clients ask us what to do about existing contracts. Issues raised include what happens if contracts can’t be fulfilled or contractual rights where a supplier has advised that they want to cancel or vary an existing contract. So, what’s the general position and pitfalls to avoid?

The usual position under English law is that agreed contractual obligations must be carried out, even if a change in circumstance has made performance more difficult, expensive or even impossible.

There are 2 important exceptions to this general principle: force majeure and frustration.

As can be seen below, there may be covid-19 situations, more likely due to contract frustration, which might be available to lawfully terminate a contract but in many others cases, terminating on the basis the contract is frustrated is not lawful.

If you need fast and clear advice on whether you can terminate a contract due to covid-19 or the other party seeks to terminate, please do get in touch.

If either or both parties decide that varying the contract is a better option, there are some key issues and clauses to be vigilant about. These include :-

  • Timing – almost always a key issue in contracts. In most contracts, timing of delivery and possible consequences of non-compliance are vital clauses. Given so much remains unclear about the pandemic, any agreement to extend time should be very carefully thought through and drafted.
  • Payment terms – cash flow is a key consideration at the best of times but in the economic chaos caused by covid-19 it is business critical. Normal rules for your trade or industry may need to changed, such as payment up front as a variation.
  • Possible ability to review and terminate without sanctions at future agreed milestones or dates – in an uncertain environment, if a contract is to be varied by consent, it’s important to comprehensively look at all angles and likely scenarios so that you don’t over commit or lose rights you need if the pandemic goes on for a long period.
  • Reservation of rights – if the other party is already in breach of the contract and requests that you do not enforce or terminate, care is needed to reserve your rights in the future and not to waive the breach of contract.
  • General negotiating position – it may be that 1 party needs the contract to continue more than the other and so relative negotiating positions need to be considered and where an agreement to vary is negotiated, to document it properly.

In this complex and fast moving situation, lawyers may think of problems and pitfalls that clients don’t. At Gannons, we’re highly experienced and agile. Please do gives us a call or email us.

Force Majeure

This only applies to contracts which include a force majeure clause. This clause will determine what happens if the parties are prevented from performing their obligations under a contract by a ‘Force Majeure event’. What events are covered by this depends on the definition in the contract.

The application and effect of a force majeure clause depends on its drafting. For instance, it is not uncommon in supply contracts for the force majeure clause to protect the supplier and not the customer.

After determining a contract includes force majeure provisions which apply to them, businesses will need to consider whether the coronavirus epidemic is included within the definition of force majeure. This might be the case if the definition refers to:

  • Epidemic, pandemic or disease;
  • Acts of parliament or political interference; or
  • General wording which might be applicable, for instance a reference to circumstances beyond the parties’ control.

What is the impact of coronavirus on business contracts?

If a force majeure clause does apply and will enable a business to delay or suspend their performance, they should consider how and when they need to notify the other parties and what (if any) steps they need to take to mitigate loss.

Businesses should determine whether the effect of the clause is to terminate the contract or simply delay performance. Again, this will depend on the wording of the clause.

If you have an existing contract (including long-term service-level agreements) and would like to understand how force majeure may operate to protect you from the negative economic effects of COVID-19, please get in touch.

Frustration of contracts due to coronavirus

The other exception to the general principle that contracts must be performed is the doctrine of frustration. Frustration ends a contract which, due to some unpredictable event, has become impossible to perform. This releases both parties from their remaining obligations under the contract.

Unlike force majeure, frustration doesn’t rely on any provision being included in the contract, but operates at common law. While the courts are usually very reluctant to invoke frustration  it might apply to the unusual situations caused by COVID-19.

The frustrating event

For frustration to apply there must be a ‘frustrating event’ which:

  • Occurs after the contract has been formed;
  • Is so fundamental as to be regarded as a) striking at the root of the contract and b) 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.

The effect of frustration on the contract

The effect of frustration is to release both parties from their remaining obligations under the contract. However, it might also be possible to recover money already paid under a contract which has been frustrated (deposits, for example).

Implications of a breach of contract due to the pandemic

Where they apply, force majeure and frustration can operate to release parties from contractual obligations or delay the timescale for required performance. However, these are complicated legal questions which may need to be determined by a court.

In the meantime businesses face a stark choice; do they break government advice or their existing contracts?

The effect of a breach of contract

The usual position is that a significant breach of contract may give the innocent party the right to claim damages and treat the contract as terminated. To terminate the contract, the innocent party must notify the party in breach that they will treat the contract as terminated.

This is rather confusingly referred to by lawyers as ‘accepting the breach.’  If the contract is not terminated, both parties will remain bound by its terms with rights to claim damages for the breach.

In the coming months, it is likely that many commercial contracts will be delayed or altered to take into account the effects of coronavirus. In many cases, this alteration will not be formally negotiated, but will be inferred from the behaviour of the parties.

Innocent parties should be wary too

Innocent parties should be wary of relying on a breach of contract by the other party caused by coronavirus as justification for seeking damages or termination of a contract.

For one thing, it is possible that a court will find that there is no breach, because of the operation of Force Majeure or contract frustration.

Even if a party is clearly in breach of contract, the other party is under a duty to mitigate their losses. This might be complicated because the government is  asking all non-essential workers to stay at home which may impact the ability to mitigate loss

If projects can be suspended, it is likely that suspension is the legally and commercially sensible approach.

There is also a question of whether damages incurred as a result of a breach caused by coronavirus will be sufficiently foreseeable to be recoverable. Depending on the nature of the contract and when it was entered into, the nature of the losses may have been so far outside the contemplation of the parties that they cannot be recovered under the contract.

How should businesses mitigate their loss if the other party breaches due to covid?

Where possible, businesses should seek an open dialogue with their suppliers and customers.

In a situation where everyone is facing challenges, if a contractual counterparty is unwilling to amend a contract in line with reasonable suggestions this can be evidence that they failed to mitigate their own losses, protecting you in the long term.

This is a complex area which brings together commercial and legal considerations. If you are in any doubt you should seek legal advice. As well as exploring the application of force majeure and frustration, legal advisors can help you to mitigate losses under contract.

We can advise you on how to negotiate with contractual counterparties without inadvertently waiving your right to claim for damages.

Industry and sector specific coronavirus related contract problems

Construction

Construction contracts generally contain provisions requiring damages to be paid in the event of delayed performance, which is one of the reasons construction companies have been so reluctant to down tools.

This is compounded by the large number of self-employed people working in the construction industry, who so far have not received the same level of support as that promised to PAYE employees. Many construction firms have asked the government to step in, believing if they are expressly forbidden from working, it is less likely that they will be liable for damages for breach of contract.

Service sector contracts

Aside from in the hospitality and retail sectors (which have obviously been extremely negatively impacted by the shutdown) many service workers have been able to continue working remotely.

However, it is likely that the lasting economic impact of the Coronavirus outbreak will present significant challenges to the services sector, as clients seek to cut costs wherever they can. Where customers seek to escape contracts to save money, it is likely that disputes will pivot on whether or not coronavirus caused the difficulty they face.

Supply chains

Businesses who rely on international suppliers were some of the first to be affected by the COVID-19 outbreak, and they will likely face further challenges in the future. Given that different countries may be dealing differently with the pandemic and international trade may be far more uncertain, contract clauses will almost certainly be needed for several scenarios.

Property transactions 

There are likely to be considerable delays in all property transactions for the foreseeable future. It would be wise for contracts currently being negotiated to include provisions which contemplate these delays.

Elsewhere, commercial landlords are likely to see requests that rents be reduced or suspended to offset some of the economic damage of the shutdown. Again, there are likely to be questions as to whether coronavirus really caused the financial difficulties experienced by tenants.

It is likely that many landlords will need to take the commercial decision to reduce rents to retain tenants in the face of a gloomy economy.

Future contracts – clauses about epidemics, pandemics and public health issues

Force majeure is usually one of the clauses people ignore; part of the incomprehensible jargon between the payment terms and the signatures. However, when a situation such as COVID-19 emerges, those clauses can become very useful.

If you are currently negotiating contracts relating to things which need to happen in the next few months, it would be wise for you to consider how coronavirus might impact things. If you need advice on how to draft an effective force majeure clause, Gannons can help.

Covid contract risks – waiver

Given the cashflow and contract performance risks faced by so  many businesses at the moment, few businesses will not have a customer or supplier approach them asking for more time to pay, a delay in making payment or seeking some other form of temporary assistance or forbearance.

The danger this creates in legal terms is that if you agree to such requests you may later find that the other party claims you have agreed to formally vary the contract. An argument may  also be made that you have waived breaches of contract such as time for payment or other contractual obligations of the other party.

The way to protect yourself legally in these situations is to ensure you do not waive any breaches with an express written proviso that any agreement not to enforce a contract breach is not  a waiver and is on strictly agreed terms. The same principle should apply to any more permanent variations to an existing agreement due to covid so that any variations are expressly agreed as not impacting on any other established contractual terms.

Review your existing contract terms

We strongly recommend that all businesses look closely at existing contracts and reassess risks due to covid. For example, you are likely to want to look closely at payment terms and possibly tighten these up so that you want to require faster payment, possibly part or all payment up front or some form of security from clients or customers.

With any existing contract neither party can make unilateral changes so care is required in any approach to counter parties with existing contracts. This problem does not apply with new contracts, for customers or suppliers. If you need solicitors to advise on changes you should consider in the current environment or need new clauses drafted please do get in contact with us.

How we can help

We are highly experienced contract and commercial lawyers. Speed and agility are likely to be more important than ever. As a niche firm we can provide the services you need.

We are highly experienced contract and commercial lawyers. Speed and agility are likely to be more important than ever. As a niche firm we can provide the services you need.

Please get in touch. 020 7438 1060.