24 June 2020

NEXT: Coronavirus, cancellations and contracts

This article was written by Justin McDonnell and Shane Ogden.

Closing for public benefit may not get businesses out of contractual obligations. Negotiating to keep them alive may be to our long-term benefit.

Health Ministers have exceptional powers to take action against COVID-19 and to give such directions considered necessary to deal with public health risks. The existing orders have had a significant impact on Australian organisations and the Australian economy. Australian employers generally have an obligation to ensure the health and safety of its workers and others in the workplace as far as reasonably practicable and they have responded to COVID-19 in a number of ways. There have been travel restrictions, office closures with working from home arrangements, and offers to pay casual employees sick leave which they might typically not have received. Large events were also cancelled – both the hosting of and the attendance by employees at such events – even before the Health Ministers started to issue formal bans. Large client meetings, symposiums, event sponsorships, and the like.

However, Australian organisations need to be mindful that the measures they took did not lead them to breach contracts and that they may have suffered from a breach of contract caused by another organisation’s COVID-19 response. A general sense of fairness may mean most breaches will be settled by agreement, but will that always be the case? And how much protection against a breach of contract will a public health order, or similar government action, offer?

At the moment, there are more questions than answers. However, common law countries like Australia, the United Kingdom, the United States, and many others recognise the unfairness of requiring parties to uphold contracts where they have been ‘frustrated’. A contract is frustrated when the nature of performance of the contract has radically changed since it was agreed, and it has become impossible to perform. A commercial party could easily imagine scenarios that might meet this definition. For example, an organisation hosting a paid annual event for over 500 people might have a large number of cancellations from corporate ticket holders with some seeking refunds. The cancellation of the Melbourne Grand Prix may be a high profile example. Alternatively, perhaps a company can no longer meet its goods delivery obligations because it has become unsafe for its delivery people to make those deliveries.

In practice, however, the threshold for establishing frustration is a high one. Circumstances that prevent performance, but which were reasonably foreseeable at the time the contract was entered into, will not frustrate a contract.

Delays and increased costs, say, to deliver or receive goods may also not frustrate a contract as performance may not be impossible, merely more difficult. Is a contract frustrated simply because there is an increased risk of exposure to COVID-19 when there are reasonable preventative measures that could be taken instead?

A major concern in seeking to rely on the doctrine of frustration is that the only available remedy is the automatic termination of the contract at the time of the frustrating event. However, this is not always useful. A party may not wish for an automatic termination of a long term contract.

Why terminate a contract measured in years when the steps to limit the spread of COVID-19 may be measured in months?

There is also a risk of misuse of the doctrine. If a party incorrectly believes that there is a frustrating event – and the court later disagrees – the mistaken party may have repudiated an otherwise effective contract and become liable for damages.

For some organisations, there may have recourse to a more sophisticated contractual mechanism for dealing with otherwise frustrating events in their existing contracts. Such a mechanism is known as a force majeure clause (translated as “superior force”). Such clauses are a contractual attempt to overcome the deficiencies of the doctrine of frustration. They reflect an agreement, made ahead of time, about how the parties are to respond to specified but uncertain events that might otherwise frustrate a contract. Common events covered by a force majeure clause include earthquakes, nuclear radiation, civil unrest, nationalisation, strikes, and government action but, effectively, any event can be covered including a viral outbreak.

A key reason parties often prefer a force majeure clause over reliance on the doctrine of frustration is that they give the parties an ability to manage the fallout so to speak. However, viral outbreaks are not necessarily a traditional element in standard force majeure clauses so Australian organisations may need to review their existing contracts. Other commonly defined events may indirectly offer protection in the case of COVID-19, such as embargoes or government action, but whether these are effective will depend on the circumstances and the contract.

A major difficulty parties may face, or need to consider when including viral outbreaks in future contracts, is what exactly constitutes the force majeure event when it comes to a viral outbreak? Is it the emergence of the virus even though, initially, its emergence may have no economic impact? Is it the declaration by the World Health Organisation of a “pandemic”? Perhaps it is a declaration by the Australian Government but then what kind of declaration and does that declaration have any likely impact on the subject matter of the contract?

Even in the case of a public health order, does the content of the order matter?

Why should a public health order banning large events trigger a force majeure event under a delivery contract for coal or steel? Is the declaration of a state of emergency enough on its own or must there be some more specific direction? Also keep in mind that the States and Territories issue their own public health orders or directions so, for contracts with national implications, can a force majeure event be issued for obligations in one State but not others? These questions and more may come to be tested over the next few months or years.

A common issue that also arises when seeking to apply existing force majeure clauses is when should a party give formal notice that a force majeure event is occurring? Most force majeure clauses require formal notice before they are trigged, and it is not uncommon for parties to neglect to give notice because they are cooperating at the time of the event. However, by not giving notice at the right time, a key benefit of a force majeure clause – to improve certainty around when a force majeure event is taking place – is lost. After the event passes or when the costs of cooperation become too high, a failure to have issued a formal notice can lead to difficulties. A court properly interpreting the contract may find that the force majeure clause was never triggered, and the doctrine of frustration is all that is available. For some, this will be an unsatisfactory outcome.

At least, these are some of the issues Australian organisations may wish to factor into their pandemic plans. Certainly, some costs will be borne by organisations as the price for protecting the health and safety of their workers and as the cost of complying with public health orders. However, the longer the impact of COVID-19 exists and as the quarantine related costs increase, it is not unreasonable to anticipate disputes arising between currently cooperative parties.

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NEXT: Business, the Environment and Safety today

Businesses are facing the weight of community, investor and regulatory expectations amid the greatest upheaval of modern times associated with the COVID-19 pandemic.

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