As we see an increase in the number of Coronavirus (COVID-19) cases in the UK and worldwide, more and more businesses have decided to implement ‘work from home’ systems; public events from Glastonbury to sporting fixtures are being cancelled; and supply chains in many industries continue to be disrupted. As a result, parties are now starting to ask if there is risk to them of liability for not being able to meet their contractual obligations.
To assist clients through this challenging period, we consider the contractual and legal issues arising from this situation.
English law contracts and the obligations they impose are, in theory, absolute. A party is required to perform its contractual obligations (notwithstanding any problems COVID-19 may cause) and will potentially be liable to its counterparty for failure to do so. There are, however, two key exceptions to this rule that may assist in avoiding liability under a contract.
Force Majeure Clauses
In the first instance, parties should see whether they can rely on any contractual force majeure clauses. These will deal specifically with how the parties’ obligations are affected by an event that hinders one of the party’s ability to perform.
The wording of the clause will have to be checked to see whether the pandemic is specifically covered as a force majeure event or whether it falls under more general wording – for example, “outbreak of disease”. Even if the situation is covered by a force majeure clause, other requirements may still need to be satisfied to constitute force majeure.
The effects of a force majeure clause may also be moderated by other clauses in the contract. For example, obligations relating to business continuity and disaster recovery may limit the scope of the force majeure clause, and parties may also be under a contractual obligation to mitigate the effects of a force majeure. If the latter applies, documenting internal decision making processes will be crucial to demonstrate a parties’ compliance.
In the absence of a force majeure clause, parties may have to rely on the doctrine of frustration. If the criteria are met and a contract is deemed to be frustrated, the contract is automatically terminated and the parties are released from any future obligations.
In order to claim that a contract has been frustrated, an individual must show that there has been a “frustrating event”. Broken down into its constituent parts, this requires the event to:
- Occur after the contract was formed; This will depend on the date that each individual contract was made, but should be easy to determine by reference to the contract.It is important to note that whilst the first reports of coronavirus were made in December 2019, parties may argue that the contract must have been formed prior to 11 March 2020 – the date when the World Health Organisation declared the outbreak a pandemic.
- Is so fundamental that it goes to the root of the contract and is entirely beyond what was contemplated by the parties at the time of contract formation;
- Is not the fault of any contracting party; and
- Renders the performance of the contract impossible, illegal or makes it radically different from that contemplated by the parties at the time of contract formation.
So, what is a frustrating event?
Decisions of the Courts are often helpful to determine what is considered a frustrating event. Applicable in COVID-19 situations may be:
- Where a cancelled or postponed event means that the commercial purpose of the contract is lost.
This argument was relied on by parties following the postponement of King Edward VII’s coronation in 1902, where hire agreements for properties and balconies in order to view the coronation procession became effectively useless; the commercial purpose of the contract was therefore lost. Parties may therefore seek to rely on this precedent if supply contracts were entered into solely to provide goods or services for a specific event which has since been cancelled as a result of COVID-19.
- Where there has been an unexpected delay in performance as a result of an unexpected event or change in circumstance. The delay must be abnormal (in terms of cause, effects or duration) so that the event falls outside what the parties could have contemplated at the time of contract formation. This is assessed objectively. We expect that contracts relating to the sporting industry may well rely on this line of case law as Premiership Rugby and the organisers of Euro 2020 (now Euro 2021!) have decided to postpone the season by months or even years as a result of the pandemic.
In terms of COVID-19, commentators have suggested that a frustrating event will occur if the contract requires performance in a region that is subject to a state-imposed lockdown. We may therefore see case law arising out of this in the coming months and years, especially if the UK Government decides to impose compulsory isolation.
A difficult case to argue…
A party is unable to claim that a contract has been frustrated if an alternative method of performance is available. So, if a sportsperson is able to play a game behind closed doors rather than to the public, or a service can provided online rather than face-to-face, the employment and service contracts respectively will not be frustrated.
Parties may encounter a similar obstacle if the contract includes a risk allocation clause. These clauses provide a way for the parties to get around problems caused by an unforeseen event, removing the element of “completely beyond the parties’ contemplation” which is key to any frustration argument. A similar clause proved problematic in the 2019 case of Canary Wharf v European Medicines Agency  EWHC 335 (Ch) where the High Court held that even Brexit did not constitute a frustrating event permitting the parties to terminate a lease.
Therefore, it is important to note that frustration is a very difficult argument to run and is rarely successful; contracting parties are often much better served by relying on a contractual force majeure clause.
What are the effects if a contract is deemed to be frustrated?
If frustration does apply, the contract is automatically terminated and the parties are released from any future obligations. Note, however, that if a party has incurred contractual obligations before the frustrating event, it remains bound to perform them. For example, if a business is required to pay a sum of money in monthly instalments or to pay an employee a weekly wage, all payments that have fallen due up to and including the date of the frustrating event must be paid as normal. The paying party is only entitled to recover pre-payments if there has been a total failure of consideration.
As frustration is ‘no-fault’, no party is entitled to damages.
Furthermore, for many commercial contracts where performance of the contract has become impossible, the consequences are set out in the Law Reform (Frustrated Contracts) Act 1943. As neither party will receive a benefit from the contract, the statute provides for recovery of monies paid before the contract was discharged, subject to an allowance (at the Court’s discretion) for expenses incurred by the other party.
How we can help you
Should you require advice or support regarding contractual force majeure clauses or have concerns relating to your business’ ability to comply with its contractual obligations as a result of the COVID-19 outbreak, please contact Adam Kendall, Head of Bevan Brittan’s Litigation, Advisory and Regulatory Team.
For further support and advice relating to the impact of COVID-19, please view our COVID-19 Advisory Service page.