On March 11, the World Health Organization (WHO) officially declared the coronavirus outbreak (COVID-19) a global pandemic. In just a matter of days, countries introduced restrictive measures that impacted the ability of companies and organisations around the world to maintain their business operations and fulfil their existing contractual obligations. The widespread disruption brought on by the COVID-19 outbreak has spurred companies to consider invoking “force majeure” clauses — a provision that exempts them from contractual obligations. At first glance, this might seem like an attractive option. In practice, the threshold for establishing force majeure is high.
The aim of this article is twofold: first, to outline the considerations parties should have when invoking force majeure clauses; and second, to highlight the concept of “frustration” – an alternative common law basis for non-performance where contracts are silent on the issue of force majeure. This article will refer to the English law position on these topics, as a number of African countries’ legal systems follow English common law principles (examples include Kenya, Tanzania and Uganda).
FORCE MAJEURE
A force majeure event occurs when unforeseeable circumstances, such as natural catastrophes, prevent one party from fulfilling its contractual duties, absolving them from penalties.
In order to use force majeure as a basis for non-performance, parties would have to take into account the following considerations:
1. There must be an express force majeure clause in the contract. This is because except for the doctrine of frustration (which is discussed below) or the rare occasion that legislation implies it into contracts, English common law does not have a general concept of suspension of contracts due to force majeure, and it cannot generally be implied into a contract.
2. Even if the contract does contain a force majeure clause, invoking it successfully to protect parties against claims of non-performance is not guaranteed. Force majeure clauses are interpreted narrowly by the courts, and so the precise terms of the contractual clause would have to be carefully construed. Parties should determine whether the specific event that prevents a party’s performance is listed in the force majeure clause. Extending the events captured in a force majeure clause will be limited by the ejusdem generis (Latin for “of the same kind”) rule. For example, parties should check if their clauses expressly contain words of the same kind like “epidemic”, “plague”, “disease” or “pandemic”. If the clause does not, there is a possibility that a term such as “act of God” referred to in the clause, or some other catch-all term, will be sufficient to cover the COVID-19 pandemic. However, that would also require further consideration.
3. The party claiming force majeure would generally have to show three things:
(a) a force majeure event has occurred which is beyond its control; and
(b) the occurrence of this event has prevented, delayed or hindered its performance of the contract; and
(c) it has taken all reasonable steps to avoid the event or mitigate the event’s consequences.
English courts are aware that a recalcitrant party may seek to avoid performance for economic reasons as opposed to a legitimate force majeure event. As such, case law is clear that just because a contract has become more expensive, burdensome or economically unfavourable, that will not be sufficient to amount to a force majeure event. Parties must show that they have explored all other avenues of performing the contact, and performance as a result of COVID-19 is impossible. There is also an obligation to mitigate any of the consequences that have arisen as a result of the COVID-19 outbreak. This is especially since force majeure will not alleviate the reliant party’s obligations to pay.
In the event that a party has been able to show all the above, parties should look at the force majeure clause in the contract to consider the consequences flowing from declaring force majeure, for example: whether the parties’ agreement includes notice obligations before declaring force majeure event; a declaration of force majeure may not confer an immediate entitlement to terminate the contract, but it may just suspend the obligation to perform for a period of time. Performance would then need to be resumed as soon as the effects of the force majeure event have passed, though the contract may include a provision entitling the parties to terminate the contract if the force majeure event subsists for over a certain period of time. Written notice of a force majeure event setting out all the relevant facts, including when the force majeure moment arrived, is critical. The notice cannot be an afterthought.
FRUSTRATION
If a contract is silent on force majeure, the common law defence of frustration is an alternative. Under the right circumstances, frustration can be employed to attempt to excuse or modify performance under a contract.
Under English law, when an event occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract, or transforms the obligation to perform into a radically different obligation from that undertaken at the moment of entry into the contract, a frustration event has occurred. The purpose of frustration is to avoid injustice where there has been a significant change in circumstance and neither party is at fault.
However, the threshold for establishing frustration is a high one.
In order to assess whether the COVID-19 outbreak will frustrate a contract, parties need to carefully consider the terms and background of each of their contracts individually. The main question would be to assess whether the COVID-19 outbreak makes performance of a contract impossible or only more difficult. The latter will not result in frustration.
For example, in one English case Party A agreed to build 78 houses for Party B at a price of £85,000 and the work was to be completed in eight months. Due partly to bad weather, but also to an unforeseen shortage of labour caused by the unexpected lag in the demobilisation of troops after the war, the work took 22 months to complete, and cost the builders some £17,000 more than they expected. Although Party A was paid the contractually agreed price, they claimed that the shortage of labour and the delay had frustrated the contract, so that they were entitled to sue for the £17,000 on a quantum meruit (i.e. for services rendered or work done when the amount due is not stipulated in a legally enforceable contract). The court held that there was no frustration because the delay was not caused by any new and unforeseeable factor or event: the job proved to be more onerous but it never became a job of a different kind from that contemplated in the contract and the delay in question was within the commercial risks undertaken by the parties. To frustrate a contract, the delay must be abnormal, in its cause, in its effects, or its expected duration, so that it falls outside what parties could reasonably contemplate at the time of contracting.
The cancellation of an expected event can, in exceptional circumstances, operate to frustrate a contract. For example, in one case , Party B hired a flat from Party A for the sole purpose of viewing King Edward VII’s coronation procession. The price agreed was £75 for two days. Party B paid £25 deposit. Due to illness of the King the coronation was cancelled. Consequently, Party B did not use the flat. Party A sought to claim the outstanding £50.The court held that the contract was frustrated as the coronation procession was the foundation of this contract and that the non-happening of it prevented the performance of the contract.
In summary, mere delays and increased costs, say, to deliver or receive goods to or from another country due to the COVID-19 outbreak, may not frustrate a contract as performance may not be impossible, but merely more difficult. Likewise, if the COVID-19 outbreak results in tenants being unable to occupy their premises temporarily, say for 2-3 months, it is unlikely that the tenants will be able to argue that their lease has been frustrated.
SHOULD PARTIES DECLARE FORCE MAJEURE OR FRUSTRATION?
Both force majeure and frustration offer contractual parties relief from their obligations. But there is a crucial difference: a force majeure event may not result in the contract being terminated (it may simply relieve a party from complying with their obligation to perform the contract till the force majeure event passes), whereas frustration is a blunt instrument: it results in automatic termination. This means parties are excused from their future obligations, but if a party incurred obligations before the frustrating event, it is still bound to perform them because no party is at fault. However, neither party will be able to claim damages for the other party’s non-performance. It is important to note that the contract is not rescinded i.e. reversed as if it never existed and puts the parties back in their original position had the contract not been entered into. Courts do not have the power to allow a contract to continue and adjust the contractual terms to the new circumstances. Unlike force majeure, there is no requirement to put the other party on notice of the frustrating event, but it is sensible to do so.
A party may not wish for an automatic termination of a long term contract because the reasons for frustration will be temporary. For example, it would not be commercially astute to terminate a 20 year oil supply contract due to a one month port shutdown. Such a measure may disadvantage both the party delivering the oil and the company anticipating delivery.
Parties should also be careful not to stop performance on the basis of a frustrating or force majeure event without consulting their lawyers because a mistaken assertion of force majeure or frustration could have severe consequences. For example a wrong assertion of force majeure or frustration may amount to an anticipatory or repudiatory breach of the contract, which may result in the counterparty itself terminating the contract and claiming damages. Additionally, as mentioned above, businesses should also be aware that force majeure will generally not excuse non-payment.
Parties should also consider the potential costs of dispute resolution and/or litigation when evaluating whether they should declare force majeure or frustration. Parties seeking or faced with the declaration of force majeure or frustration should consider the impact of this on other agreements and obligations.
Lastly, parties should consider whether force majeure events are covered by the parties’ insurance policies, and if so, what conditions the party must comply with for its claim to be satisfied.
ARE PARTIES INVOKING FORCE MAJEURE?
According to the China Council for the Promotion of International Trade, China has issued 4,811 force majeure certificates as of Mar. 3 due to the COVID-19 pandemic. These certificates have covered contracts worth 373.7 billion Chinese yuan ($53.79 billion) . These certificates are issued by the government to companies that apply for them.
Although the issuance of these certificates may help companies which are claiming against one another in China itself, it remains to be seen whether the issuance of these certificates will hold weight in the international arena. This is because, as mentioned earlier, force majeure clauses are interpreted very narrowly. For example, the French oil giant Total has already rejected a force majeure notice, based on COVID-19, from a liquefied natural gas buyer in China. Unless the contract in question provides that the certificates are conclusive to prove the existence of force majeure, courts or arbitrators will have the difficult question of deciding whether the COVID-19 pandemic will constitute a force majeure event.
While there is likely to be a long legal debate about interpretation of force majeure clauses and frustration of contracts, commercial considerations may outweigh the need to declare these events. If businesses wish to maintain relations and continue working together in the future, especially in situations where no party is at fault, collaboration (reinforced by a solid understanding of the contractual position), rather than confrontational legal battles, may be the way forward.
Commercial parties with existing force majeure clauses may wish to take the opportunity presented by the COVID-19 outbreak to reconsider whether their existing force majeure clauses are fit for purpose and if not, update their current contracts to deal with future viral outbreaks.
To discuss further, contact Nikhil Desai (ngd@jmilesarbitration.com) or Arooj Sheikh (azs@jmilesarbitration.com)