Effect of COVID-19 on contracts

Litigation & Dispute Resolution 23 March 2020

On 21 March 2020 we published an article entitled “Coronavirus – protecting your businesson our website which provided an overview of the concerns businesses face as a result of the international spread of the coronavirus (COVID-19) and briefly touched on the impact of COVID-19 on contracts.

Since publishing that article, the Prime Minister, the Hon. Scott Morrison MP, on 22 March 2020, announced new measures to protect Australians from coronavirus (COVID-19).

With the recent imposition of widespread restrictions on social gatherings including limitations on the operation of pubs, clubs, gyms, cinemas, casinos, restaurants, cafes and religious gatherings (which Australians can expect to be in place for at least 6 months) there will be a drastic change not only in the way we live, but also in how businesses are able to operate.

In particular, many business owners will be impacted by COVID-19 (and the associated measures to protect Australians) as their supply and service contracts will be significantly affected.  For instance, the impact of COVID-19 may mean that a party is prevented from performing or complying with its obligations under a contract as performance may become considerably more expensive, if not, impossible.

This article seeks to supplement the information contained in our previous article and explain, in further detail, the ways in which contracts can be affected by COVID-19.

Force Majeure

Many contracts contain “force majeure”’ provisions.  Force majeure provisions:

  • seek to deal with the impact on contracts of events which are out of the reasonable control of the contracting party; and
  • govern the relief that is available to a party when it is not able to perform its obligations under a contract.

To successfully invoke a force majeure clause, performance of the contract must be impossible.  It is not sufficient that performance may simply become inconvenient or too expensive.

Contracts which include a force majeure clause will generally define the events that will trigger the operation of the clause.  In this regard, the contract may contain references to defined events such as, for example, natural disasters, Government intervention, quarantine, acts of God, epidemics and even pandemics.  Therefore, the starting point when considering the impact of COVID-19 on the performance of a contract, is to examine the terms of the contract to determine what is needed for COVID-19 to trigger the relief contained in any force majeure related clause.

Alternatively, if the contract does not define the events that trigger the operation of the force majeure clause, then the scope to rely on the clause is potentially far broader.

If you intend to rely on a force majeure clause in seeking to terminate a contract, the onus of proving that COVID-19 has rendered your contract impossible to perform will lie with you.  This is significant as prematurely or incorrectly relying on a force majeure clause in terminating a contract could have unfortunate consequences under the contract including, in certain circumstances, amounting to a repudiation.  This could have significant consequences for both you and your business.

Accordingly, before seeking to rely on a force majeure clause, you should;

  • assess your contract to determine whether it contains a force majeure provision which provides relief from the consequences of non-performance or delayed performance;
  • have regard to any notice provisions in the contact which require notice to be given to the other contracting party specifying (to the extent practicable) details of the relevant event and the extent to which the relevant obligations are affected; and
  • carefully consider all of the available options for completion of the contract including any possible alternatives to mitigate any loss which may be suffered by the parties as a result of termination. This will likely involve considering whether the entire contract is affected or whether there are parts that can still be completed.

Termination, Frustration and Variation

Alternatively, if your contract does not contain a force majeure clause or your contracts force majeure clause is not triggered by the impact of COVID-19, you should: 

  • firstly, examine the other clauses in your contract to assess whether they can apply to the COVID-19 related circumstances. For example, your contract may contain clauses in relation to hardship, termination and/or variation which will allow a party to vary the terms of the contract (including, for example, the contract price) in particular circumstances or terminate the contract if performance becomes overly onerous; and
  • secondly, consider whether the contract has been “frustrated” altogether.  The contract will be frustrated where, through no fault of either party, and due to an unanticipated event or circumstance which could not have been contemplated or intended by the parties at the time of entering into the contract, the contract has become significantly different to that which was originally anticipated by the parties and, as a result, is no longer able to be performed by the parties. The burden of establishing frustration is high as the Courts do not typically have regard to factors such as, the fact that the contract has become significantly more difficult to perform or the fact that the contract will need to be performed in a substantially different way to that which was initially contemplated by the parties. Rather, the doctrine of frustration can only be relied upon if performance of the contract has become impossible, in that a party is able to establish that the parties never intended to be bound by the situation that they have unexpectedly found themselves in.

Recommendations

Having regard to the above, we recommend that businesses review their contracts to assess whether they contain:

  • force majeure provisions which provide relief from the consequences of non-performance or delayed performance; or
  • hardship, termination or variation clauses which respond to the COVID-19 related circumstances and allow them to either suspend performance of their contractual obligations, terminate the contract in its entirety, or negotiate to vary the terms of the contract.

As each contract will contain different terms, each contract and the potential course of action will need to be considered on a case-by-case basis taking into account the potential operational, financial, and reputational impacts on the business.

Accordingly, if you are considering relying on a force majeure or termination clause in your contract as a result of a COVID-19 related default, you should seek specialised legal advice prior to doing so to ensure that your interests are adequately protected.

If your business needs help understanding the effect of COVID-19 on the performance of contractual obligations or any other contractual matters, contact our experts today.

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