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Suspending contractual performance in response to the coronavirus outbreak

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The recent outbreak of the coronavirus has quickly developed from a local to a global threat with tragic human losses that overshadow contemplations of its economic impact. However, the disease is likely to have a profound impact on business and underlying contractual relationships. It has been highlighted frequently that scenarios like the one we are currently witnessing bring the concept of force majeure into play (see here). As a vital mechanism to excuse a party's non-performance or justify termination of a contract, the question is: does the coronavirus constitute force majeure?

 

Force majeure

Force majeure can be (or in the case of English law, must be) a creature of contract. Also, certain civil law systems recognise the concept statutorily or in their jurisprudence. 

For this reason, in most cases, the requirements for invoking force majeure and the consequences of so doing will depend upon the precise terms of the contract in question. Accordingly, the first step for any company considering suspending contractual performance, or any company faced with a counterparty who has suspended performance, is to study carefully the terms of the contract.

Generally, where force majeure clauses are included in contracts, that clause will specify:

(a)    the events which enable either party to declare force majeure;

(b)    how a party should notify its counterparty about the occurrence of a force majeure event; and

(c)    the consequences which flow from declaring force majeure

Insofar as the events justifying force majeure are concerned, it is common that the occurrence of force majeure is in itself disputed among affected parties.1 There are two broad approaches typically seen in contracts. The clause might include a list of specific events which entitle a party to declare force majeure. Alternatively, or in addition to a list, the clause might provide that a force majeure event includes anything that is beyond the parties' control.2

Irrespective of the approach taken, the clause will generally also specify the extent to which the event must have impacted performance in order to qualify as a force majeure event. Various approaches are possible in this regard: at one end of the spectrum, it would be necessary to show that has "prevented" performance entirely and, at the other end of the spectrum, it may only be necessary to show that the event as "hindered" or "delayed" performance.

Accordingly, when assessing whether there is a qualifying force majeure event, two questions must be asked:

  • First, what is the specific event relied upon? For example, in the context of the coronavirus outbreak, the event could be either: (i) the outbreak itself; or (ii) something related to the outbreak (such as governmental restrictions imposed to contain the outbreak)?
  • Second, does the relevant event meet the relevant contractual (or statutory) test? Depending on the clause (and the applicable law), this could require an assessment of whether the event: (i) falls into a category of defined events; (ii) was beyond the parties' control; and/or (iii) has impacted performance to the extent required (e.g., prevented or hindered performance). In this regard, it is worth noting that the China Council for The Promotion of International Trade ("CCPIT") has announced on 30 January 2020 that it would now issue force majeure certificates to qualifying applicants. Legitimate documents, including proof of delays or cancellation of transportation, exports contracts and customs declarations are required to secure respective certificates.3 On 6 February 2020, the CCPIT issued the first such certificate to an auto parts manufacturer in Huzhou, China.4 However, affected parties must bear in mind that even such certificates will mostly indicate, but not prove the occurrence of force majeure. The CCPIT has thus rightly explained that they "can help enterprises minimize liability for contracts that can't be fulfilled due to the epidemic and safeguard their legitimate rights and interests."5

Once it has been determined that there is a force majeure event, it is important to ensure that any notification procedure is complied with fully.6 For instance, the contract may require that the party declaring force majeure must notify the other party within a certain number of days of the relevant event. Alternatively, the contract may prescribe that the notice has to be delivered by a particular method or to a particular address. 

Finally, the consequences of invoking a force majeure clause should be considered. Typically, the clause will specify that neither party is liable for a failure to perform its contractual obligations where that failure is caused by the force majeure event. Importantly, it is also common for clauses to require the parties to take steps to mitigate the effect of the force majeure event. This requirement should not be overlooked: a failure to take steps in mitigation may undermine a party's ability to rely on the force majeure clause. Of course, the ability of a party to take mitigation steps (and the nature of those steps) will be highly dependent on the factual circumstances, including the nature of the event in question.

Ultimately, as noted above, whether a force majeure clause can be invoked, and the consequences which follow, will depend on the proper interpretation of the clause and the applicable law governing the contract.

 

Frustration

Even where a contract does not include a force majeure clause, it may be possible (under English law) to argue that the coronavirus outbreak has frustrated the contract. However, there are many important differences between force majeure and frustration. For present purposes two of the most significant are:

(a)    The test is generally stricter than that included in a force majeure clause. A contract is frustrated where an event results in it being physically or commercially impossible to fulfil that contract.7 In determining whether this test has been satisfied, a complex assessment of all relevant factors is necessary. These factors include: (i) the terms of the contract; (ii) the factual background to the contract; (iii) the parties' knowledge and expectations about risk when entering into the contract; and (iv) the parties' calculations as to the ability to perform the contract in the circumstances which are said to have frustrated the contract.8

(b)    The consequences of frustration are more radical than force majeure. Rather than suspending performance, frustration results in the contract being automatically discharged by operation of law. As a general matter, any rights that had accrued prior to the frustration will remain enforceable once the contract has been discharged. Conversely, subject to certain exceptions,9 any rights which had not accrued as at the date of frustration will be unenforceable once the contract has been discharged.

 

Mistaken assertions of force majeure or frustration

The consequences that flow from a valid assertion of either force majeure or frustration have been addressed above. However, companies considering asserting force majeure or frustration must also be cognisant of the serious consequences which result from a mistaken assertion of either of these legal rights. In particular, an incorrect assertion of force majeure or frustration may amount to a breach (or anticipatory breach) of the contract. Depending upon the severity of that breach, the aggrieved counterparty could be entitled to claim damages or even to terminate the contract.

For these reasons, prior to asserting either the occurrence of a force majeure event, or that a contract has been frustrated, it is very important to take legal advice.

 

Find out more about business response to the Coronavirus outbreak:
Coronavirus: Managing business impact and legal risks

 

1 See, for example, National Oil Corporation ν Libyan Sun Oil Company, ICC Case No. 4462, First Award on Force Majeure, dated 31 May 1985, p. 58 (para. 3) extract available at: www.trans-lex.org/204462, where both parties agreed that the force majeure clause was the correct starting point to determine their common intent, but completely disagreed on the meaning and the consequences arising from the clause.
2 See, for example, the force majeure clause considered in Tandrin Aviation Holdings Ltd v Aero Toy Store LLC [2010] EWHC 40 (Comm) at [8].
3 https://www.reuters.com/article/us-china-health-trade/china-trade-agency-to-offer-firms-force-majeure-certificates-amid-coronavirus-outbreak-idUSKBN1ZU075.
4 http://en.ccpit.org/info/info_40288117668b3d9b017019772b5706b0.html.
5 http://en.ccpit.org/info/info_40288117668b3d9b017019772b5706b0.html.
6 A two-stage process generally applies to assessing the compliance of a notice with contractual requirements under English law: (i) first, one must construe the notice in order to determine its meaning; and (ii) second, the notice must then be judged against any formal requirements in the contract (such as service at a specified address). See Trafford Metropolitan Borough Council v Total Fitness UK Ltd [2002] EWCA Civ 1513, para. 49.
7 "[a] contract may be discharged on the ground of frustration when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract"; Chitty on Contracts (Sweet & Maxwell, 31st edition, 2012), paragraph 23-001.
8 The Sea Angel [2007] EWCA Civ 547 at [111].
9 For example, where one party has partially performed the contract (such that the other party has obtained a valuable benefit) prior to the frustration. In such cases, the party who has partially performed may be entitled to payment for that work.

 

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