Coronavirus effects on contractual obligations – our solicitors discuss some key issues

13th April 2020
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What is the legal position where a business contract or other legal agreement can no longer be honoured by one of the contracting parties as a result of the coronavirus lockdown? To what extent will the COVID-19 crisis provide a legal excuse or defence to a party who is left unable to perform a contract and would otherwise be in breach of contract? Can a party fall back on the concept of force majeure, or rely upon the occurrence of coronavirus in order to terminate a contract or bring a contract to an end under the legal doctrine of frustration?

These questions will now be extremely pertinent to businesses who, affected by the coronavirus lockdown, are reviewing their exposure under legal agreements, or considering making breach of contract claims for contract defaults which are either anticipated, or have already occurred, due to the lockdown.

Below is a summary of some key legal principles that apply where uncontrollable events such as coronavirus impact upon a party’s ability to perform its contractual obligations, including some tips on how to deal with contract disputes in a less confrontational and more practical, economical and non-contentious manner.

What follows is a general guide and each individual case will obviously depend on its own facts. Tailored advice should be sought if possible and our UK and London based solicitors can speak to businesses in more specific detail regarding the impact of coronavirus on their commercial contracts.

Force majeure – a coronavirus lifeline?

Parties to a contract can in some cases be excused from their legal contractual obligations if a force majeure event – such as an event beyond their reasonable control like the coronavirus pandemic – occurs.

Force majeure is a well-known legal term but is often misused and misunderstood.  Crucially, under English law, a contracting party may only rely upon a force majeure type event to excuse contractual performance if the contract itself contains a force majeure clause.

Step 1 – check the contract for a force majeure clause

The contract itself is therefore the starting point. If it includes a force majeure clause, the next step is to look closely at words of the clause itself to determine if coronavirus is covered as a force majeure event.

Conversely, if the contract does not contain a force majeure clause – and most if not all oral agreements will by their very nature fall into this category – then unfortunately affected parties cannot generally imply a force majeure term into the agreement. In this case alternative options, including terminating for frustration of contract (discussed below) should be evaluated.

Nowadays however, comprehensive commercial agreements will generally contain a force majeure clause. The standard clause will typically firstly define what a force majeure event is and secondly set out how the parties’ contractual obligations will be suspended, excused or otherwise altered when a force majeure event actually happens.

Step 2 – interpreting the force majeure clause – does it cover coronavirus?

Having identified the force majeure clause, it is then necessary to look at how a force majeure event is defined in the contract and whether coronavirus falls within that definition. Each contract is different. Many commercial agreements being negotiated and finalised in the current environment will probably expressly include pandemics such as COVID-19 as qualifying force majeure events. For agreements that were concluded before coronavirus, without the benefit of hindsight, the legal position may not be so obvious.

Express references within the force majeure clause to events such as epidemics, pandemics or public emergencies will probably mean that the clause can be activated by the coronavirus lockdown, throwing a potential lifeline to a party who has been left unable to perform its contractual obligations.

Where a force majeure clause does not refer to a specific event that would cover COVID-19, it will be necessary to look at whether “sweep-up” language is used to extend the scope of the force majeure clause to other uncontrollable events not specifically mentioned. Words such as “and all other events beyond a party’s reasonable control” may be used as the sweep up language and, so long as the sweep up language is sufficiently broad, there should be a good argument that the unprecedented coronavirus pandemic is a force majeure event.

Step 3 – ensure the force majeure event is the real cause of the problem

A business potentially facing a breach of contract claim will no doubt be relieved where the contract  contains a force majeure clause that covers the coronavirus outbreak. Before steps are taken to deploy the clause however (see below), a party should ensure that its failure to perform a contract was actually caused by coronavirus. In other words, the contract default has to be solely down to coronavirus, and not down to any other independent cause. Likewise, successfully deploying a force majeure clause is also less certain where the non-performing party did not take reasonable steps to mitigate the effect of the force majeure event. So if a party could have reasonably done something that would have neutralised the force majeure event, allowing the contract to have been performed in any case, that party will not generally be able to rely on force majeure to excuse non-performance of contractual obligations.

Step 4 – deploying the force majeure clause

Lastly, it will be essential for a party who cannot perform a contract due to COVID-19 to properly exercise its rights under the force majeure clause. More often than not written notice will need to be given to the other contracting party/ies of the fact that one party has been delayed in, or prevented from, performing its obligations under the agreement due to coronavirus force majeure. If notice is not given, not given in time, or not given correctly, a party may lose the benefit of the clause and still be liable in breach of contract.

Once any required notice is properly given, the force majeure clause will take legal effect and typically this will mean one or more of the following:

  • contractual obligations are temporarily suspended whilst the force majeure event is continuing (and those obligations will resume at a later date, when the event is over);
  • a party that would have been in breach of contract will be excused from liability for failing to perform the contract; and/or
  • if the force majeure event continues for a specified period (usually a given number of weeks or months), the parties may have the right to terminate the agreement, that is, bring the contract to an end, in which case they will be relieved of any further obligations under the agreement (except any obligations that are expressed as surviving termination).

Determining the point at which coronavirus comes to an end as a force majeure event is a separate question, but we would imagine that in many cases the answer would depend upon relevant announcements and decisions of the WHO and UK Government about the progress of COVID-19 and when lockdown restrictions can be lifted.

A review of the relevant contractual terms and any force majeure clause should therefore be one of the first ports of call for businesses who are struggling to perform contractual obligations due to the coronavirus pandemic.

Frustration of contract and coronavirus

If force majeure is not an option – or even if it is – a party having difficulty honouring a legal agreement due to coronavirus could look at whether the legal concept of frustration can excuse them from contractual obligations.

The doctrine of frustration allows parties to be discharged from any further obligations under an existing contract when an event occurs that means performance of the contract is no longer possible. Could the coronavirus pandemic be an event allowing a contract to be discharged by frustration?

Frustration of contract explained

To illustrate how the doctrine of frustration works we can hark back to the 1863 English High Court case that started it all. In Taylor v Caldwell, one party entered into a contract with a concert hall owner to stage a series of concert nights at the hall. The concert hall burnt down after the contract was signed but prior to the scheduled concert dates. Despite this, the hirer (Taylor) decided to sue the hall owner for failure to make the venue available. The Court decided in favour of the concert hall owner. The Court reasoned that, as performance of the contract depended upon the physical existence of the venue, the perishing of the venue made performing the contract impossible, which therefore excused the concert hall owner from contractual liability.

So the essence of frustration is that an event occurs which makes performing the contract impossible. Although the Taylor v Caldwell concert hall case concerned the destruction of something that made contractual performance physically impossible, 160 years on the legal doctrine of frustration has developed somewhat. Nowadays a contract can also be discharged by frustration where performing it becomes commercially impossible – although that is not as easy to prove as it perhaps may sound.

The modern-day legal test for frustration of contract is generally propounded as follows:

  • an event occurs after the contract is formed which is not the fault of one or other of the parties to the contract
  • that event changes the nature of the remaining obligations under the contract so significantly from what the contracting parties originally contemplated, that it would be unjust to hold them to those original obligations, such that the parties can be discharged from them

Coronavirus as a contract frustration event?

Because of the drastic legal effect of frustration, namely the complete discharge of a contract, the cases in which a contract can be discharged by frustration are relatively rare.

COVID-19 and the resulting lockdown is however an event unprecedented in modern history, for which no contracting party will be to blame. Situations where a party may be able to successfully argue that the coronavirus pandemic event has frustrated a contract could include:

  • where the laws imposed surrounding the coronavirus lockdown – for example enforced closures of premises and businesses – make performance of a contract illegal or physically impossible
  • where a contract is based around an event – such as large public festival, sporting event or other gathering – which has been cancelled or delayed

But a court will always look carefully at the terms of the relevant contract itself and the context in which it was formed. From this a court can form a view on what the parties contemplated when the contract was made, so a judgment can then be made on whether coronavirus frustrated the contract by radically altering what the parties originally had in mind. As far as contracts that have been turned on their head by coronavirus are concerned, there will be arguments either way.

Recovery of money under the Law Reform (Frustrated Contracts) Act 1943

Finally, although frustration of contract is often thought of in the context of the parties being discharged or excused from any future contractual obligations, legislative provisions also allow parties to recover money paid under a contract before the occurrence of the frustrating event.

Under section 1(2) of the Law Reform (Frustrated Contracts) Act 1943, all sums paid by a party prior to being discharged from the contract due to frustration are recoverable from the receiving party. The Act does not apply to all contracts – certain contracts are excluded – however where the Act does apply a party is more likely to be restored to a financial position that is closer to the position they were in before entering into the contract.

Coronavirus, force majeure and contract frustration: summing up

The question of whether contracting parties can be excused, or at least temporarily relieved, from legal requirements under business contracts and agreements due to coronavirus should be answered after careful consideration of the terms of the contract in question and the particular circumstances of each case.

As a first port of call an affected contracting party should review the terms of the agreement for a force majeure clause and if one exists, the clause should be analysed to determine if it defines coronavirus as a force majeure event. If it does, a party can potentially be excused or temporarily relieved from its contractual obligations in the way set out in the force majeure clause.

If the relevant contract does not contain a force majeure clause, a party in danger of committing a breach of contract can alternatively consider whether it can be discharged from the contract and all future obligations under it via the doctrine of frustration.

If the legal doctrine of frustration can be invoked by coronavirus then the parties will no longer be bound by the contract. However, it will not always be possible to successfully argue that a contract is frustrated by the pandemic when all the facts and circumstances of the case are taken into account. In such a case, parties who are struggling to perform agreements should look at ways of restructuring their contractual obligations by negotiation and amicable agreement (see below).

Practical tips – negotiations and variations of contract by amicable agreement

The wide, almost universal, reach of the coronavirus pandemic and lockdown will in some cases lead to a more understanding and sympathetic approach by business, meaning contractual obligations will not always be strictly and aggressively enforced in favour of less confrontational alternatives. Indeed, litigation may not always be the best solution and a business undergoing economic hardship due to coronavirus closures and supply chain interruptions may not relish having to incur the legal costs of litigation.

Thus, although contracting parties should take advice to understand their legal rights under a contract that has been affected by the pandemic, a strict black letter law approach to enforcing those rights may not always be the answer.  Ways of dealing with contractual performance problems amicably and cost effectively should be considered. For example:

  • Without prejudice negotiations could take place between the parties to see whether, by amicable agreement, one party’s temporary inability to perform a contract can be forgiven, or whether the contract generally can be suspended without consequences, to resume again once the coronavirus lockdown ends. For contractual obligations that involve the payment of money, this could include a payment holiday of agreed duration. The ‘without prejudice’ nature of such negotiations would mean that, if an amicable solution cannot ultimately be reached, the candid and frank admissions made by one or both sides during the negotiations cannot be used against them in subsequent court proceedings.
  • Variations to a contract. The terms in the original agreement can be varied or adjusted to cater for the coronavirus interruption, with the agreed variation recorded in a legal document such as a deed of variation or side letter. A contract variation agreement will often be the outcome of successful without prejudice negotiations.
  • Mediation. Like negotiation, but taking place more formally, with the parties convening in the presence of a mediator who will assist the parties in their attempts to find an out-of-court settlement. Clearly, mediations taking place during the coronavirus restrictions will need to follow the Government guidance on social distancing, which will generally mean that meditations will occur by telephone or video link.
  • Insurance policies. Insurance cover, such as business interruption insurance, is sometimes taken out by businesses to cover lost income where business cannot be carried out due to an event covered by the insurance policy. Policies of business insurance should therefore be checked, although it has been reported in recent times that common insurance industry practice since the SARS outbreak in the early 2000’s has been to exclude business interruption cover where the losses are caused by infectious diseases.

We hope you find this information useful. South Bank Legal can provide your business with cost effective legal advice on how the coronavirus could alter obligations under commercial contracts.  Please reach out to one of our London dispute resolution solicitors at info@southbanklegal.com, by phone on 0203 1266 584, or via our contact page.

Contractual Obligations