25 February 2020

The impact of coronavirus on your contract: remedying where the 'frustration' lies

This article was written by Shane Ogden and Oliver Collins.

While medical researchers across the world race to develop a vaccine to the COVID-19 virus, lawyers and corporate clients are testing for vulnerabilities to trade and other restrictions imposed by governments to mitigate against the spread of COVID-19. What if I cannot meet my contractual obligation to import or export goods to or from China? What if travel restrictions mean I cannot meet certain contractual deadlines? Will my contracts automatically terminate, or will they hold until the restrictions lift?

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. At first glance, a commercial party could easily imagine scenarios that might meet this definition. In practice, 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. Mere delays and increased costs, say, to deliver or receive goods to or from China due to the COVID-19 outbreak may also not frustrate a contract as performance may not be impossible, merely more difficult. But it will depend on the nature of the contract and the performance obligations in question.

The doctrine of frustration is also a blunt instrument. The only remedy available for frustration is the automatic termination of the contract at the time of the frustrating event. 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. Alternatively, a party may not wish for an automatic termination of a long term contract because the reasons for frustration will be temporary. Why terminate a 20 year LNG supply contract due to a 1 month port shutdown? Such a measure may, for example, disadvantage both the Australian party delivering LNG and the Chinese company anticipating delivery.

Enter the force majeure clause (translated as “superior force”). Such clauses are a contractual attempt to overcome the deficiencies of the doctrine of frustration and 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.

A key reason parties often prefer a force majeure clause over reliance on the doctrine of frustration is the ability to manage the fallout so to speak. However, the COVID-19 virus highlights that viral outbreaks leading to government restrictions which block trade are traditionally missing from force majeure clauses. Other commonly defined events, such as embargoes, may indirectly offer protection for some contracts but this will depend on the force majeure clause. As all governments become increasingly sophisticated in how they respond to new viral outbreaks given their significant economic impacts in a globalised world, viral outbreaks may need to become a staple of the precedent force majeure clause. Some parties may also find themselves having to renegotiate existing contracts.

Some of the better force majeure clauses do not merely echo the doctrine of frustration – they clearly define the events to be managed and the way obligations under the contract are to be performed during the force majeure event. This is partly because judges seem to search for a definitive event when interpreting a force majeure clause. If they cannot find that one took place, the judge may hold that the clause has not engaged or that the clause was little more than a contractual expression of the doctrine of frustration.

A major difficulty parties may currently face, or will 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 “public health emergency of international concern”? Perhaps it is a declaration by a national government but then what kind of declaration and does that declaration have any likely impact on the subject matter of the contract?

For example, the China Council for the Promotion of International Trade has issued over 3,000 force majeure certificates to try and assist companies. However, whether such certificates will generally assist parties to contracts governed by Australian law, or the law of other common law countries, is currently an open question. While the certificates may offer some evidentiary support to a party asserting the existence of a force majeure event, each force majeure clause can have its own nuances.

Indeed, a nuance found in many force majeure clauses is the requirement for parties to give notice that a force majeure event is taking place. One of the benefits of a force majeure clause is to improve certainty around when a force majeure event is taking place. If a party does not give notice, that certainty is lost. Conciliatory parties may prefer to negotiate over whether a force majeure event has, in fact, taken place rather than issue a notice but such an approach can destroy the benefit of the force majeure clause. It  may be better to issue notice of a force majeure event and negotiate afterwards. Otherwise, if litigation later ensues, a court properly interpreting the contract will find that the force majeure clause was never triggered and the doctrine of frustration – which the parties had sought to avoid – is all that is available. But, again, the appropriateness of giving notice will depend on the clause and circumstances in question.

Commercial parties with existing force majeure clauses may wish to take the opportunity presented by the COVID-19 outbreak to update their contracts to cope with future viral outbreaks. It may also be a good opportunity to generally revisit whether their existing force majeure clauses are fit for purpose.

See also our analysis of COVID-19 and its impact on Chinese Commodity Sale Contracts.

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