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Last updated: 19 March 2020

Contractual default force majeure frustration and termination

Introduction

The impact of COVID-19 may mean that a party is prevented or delayed from performing or complying with its contractual obligations. It may also mean that compliance with its contractual obligations will become more expensive.

Businesses should analyse their supply chains and contracts to spot vulnerabilities and whether their suppliers, or they themselves, can comply with their contractual obligations and whether they can (or should):

  • suspend performance of contractual obligations;
  • terminate the contract entirely;
  • seek to vary the terms of the contract, including price.

Each contract and the potential course of action should be evaluated on a case-by-case base, taking into account the potential operational, financial and reputational impacts on the business. As noted in Section 7 (Insolvency) below, specialist legal advice should be sought before precipitously relying on a Force Majeure or termination for default clause, or for any alleged contractual frustration in reliance on COVID-19 related default or delay.

If you are currently negotiating a contract, consider whether the terms of the contract should expressly deal with COVID-19 and its consequences.

Force majeure

There are already reports that parties to resources contracts (particularly, timber, LNG and copper) have sought force majeure relief in recent weeks. Businesses should assess their contracts to determine whether they contain force majeure provisions providing relief from the consequences of non-performance, or delayed performance, in the circumstances. Typically, a force majeure provision will relieve an affected party:

  • that is prevented or delayed from performing its contractual obligations;
  • due to an event or circumstance that is not within the reasonable control of the affected party;
  • where the affected party is not reasonably able to prevent or overcome the event or circumstance by the exercise of due diligence.

Often, the event or circumstance must have arising after entry into the contract.

However, a party's ability to rely on a force majeure provision depends on the terms of the relevant contract. Businesses should consider the following when reviewing force majeure provisions:

  • Is it force majeure?: Whether COVID-19 constitutes an event of "force majeure" will depend on the definition of "force majeure" in the contract. Definitions can range from a list of specified events, which often include "epidemics", "quarantine" and "acts of God", but typically they relate to events that are beyond a party's reasonable control, cannot be prevented or overcome by the exercise of due diligence and actually cause a delay in or failure or inability to comply with contractual obligations. In most cases a lack of finances, lack of funds or the inability to borrow funds will not constitute force majeure.
  • Notices: If COVID-19 is an event of force majeure, the party seeking relief should ensure that it complies with the terms of the contract in claiming relief. Typically, force majeure provisions require notice to be given specifying (to the extent practicable) details of the relevant event, the extent to which relevant obligations are affected and, potentially, the anticipated length of delay that will arise from it. There may also be obligations to continue to provide updated information.
  • Mitigation: The party affected by the force majeure event is usually expressly required to use its reasonable endeavours to mitigate the effect of that event on its ability to continue to perform its obligations under the agreement.
  • Relief and termination: Relief is typically only available for the duration of the actual delay arising out of the event of the force majeure, with termination rights able to be invoked where the affected party is prevented from performing its obligations due to a force majeure event subsisting for an "extended" period of time (that time period being dependant on the circumstances relevant to the contract).

If you are currently negotiating a Force Majeure provision, consider making specific mention of:

  • COVID-19 and its consequences (including advice and guidelines provided by governments); and
  • the fact that the circumstances surrounding COVID-19 exist at the time of entry into the contract and that the existence and continuance of a Force Majeure event at that time will not prevent a party obtaining relief.

Termination frustration and variation

If a contract does not contain a force majeure provision, or the definition of "force majeure" is not sufficiently broad to capture COVID-19, businesses should:

  • review other provisions of the contract, such as any termination or variation provision, that could respond to the event or circumstances. Some contracts will include:
  • a "hardship" provision that will allow a party to terminate the contract if performance has become excessively burdensome;
  • a "termination for convenience" provision that will allow a party to terminate the contract for any reason, or no reason at all; or
  • a "variation" provision that will set out a process under which the price or other contractual terms can be varied. Variation provisions are typically found in construction contracts; and
  • consider whether the contractual doctrine of frustration could apply to relieve compliance. At its most extreme, the parties may argue that the contract is frustrated altogether – that is, that without the fault of a party, the contract is incapable of being performed due to an unforeseen event (or events), resulting in the obligations under the contract being radically different from those contemplated by the parties. Establishing frustration, however, can be difficult as it does not apply to hardship. The fact that the method for performance contemplated by a contract has been affected, or the burden of performance has been increased, by an event or events occurring without fault, does not amount to frustration unless performance in accordance with the contract has become practically impossible. The doctrine of frustration is also applied within very narrow limits. For a party to succeed in claiming frustration, it must show that the parties never agreed to be bound in the fundamentally different situation that has unexpectedly emerged.

Non-contractual solutions

If the terms of a business' contracts and contractual doctrines are of no assistance then businesses should consider whether non-contractual commercial solutions are appropriate.