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Managing the effects of COVID-19 - force majeure and frustration

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By Simon Brew

In light of the dramatic events of the last few weeks, many companies will find themselves in a position where they are no longer able to perform contracts or alternatively have counterparties claiming they are in that position. If you find yourself on either side of that situation you should check your contract for the existence of a force majeure clause.

What is a force majeure clause?

  • A force majeure clause is a clause in a contract which typically excuses one or both parties from performance of their part of the contract in some way following an unforeseen circumstance or event;

  • Typically a force majeure clause will include events such as ‘acts of God’, wars, law or action by government, epidemics and the like. The definitions vary from contract to contract but where specific events are listed, ‘epidemic’ is usually included (which would cover COVID-19).

Contractual position

  • If you are a party to contract which is or may be affected by COVID-19 then the first step is to check whether the contract includes a force majeure clause and whether the term ‘epidemic’ or ‘pandemic’ is listed within the definition of force majeure events. Additionally, government measures as a result of COVID-19 may also fall under wording covering ‘government sanctions’ or ‘law or action taken by government’ or some similar catch all wording.

  • Consider the notice requirements of the clause. In order for a force majeure event to be successfully declared, the notice requirements usually need to be followed precisely.

  • On the other hand, if another party to a contract seeks to rely on the force majeure clause (and you do not consider it justified) then do not simply accept the notice as it might be difficult to change your position in the future.

Requirements and practicalities

If a party to a contract declares there to be a force majeure event then it will need to:

  1. Prove that COVID-19 prevented performance;

  2. Be specific on the part(s) of the obligation that cannot be performed; and

  3. Show that the force majeure event could not have been avoided or mitigated by the exercise of reasonable diligence.

If it is agreed that there has been a force majeure event, usually each party will bear its own costs in relation to it. It is then wise for a timetable to be agreed with updates and communications, once the force majeure event is lifted, performance of the contract should be resumed. If there are parts of the contract that can still be performed in the meantime, they should be.

The threshold to successfully declare a force majeure event will in many cases be high and it may lead to undesired relationship consequences between the contracting parties. Before declaring a force majeure event it might be worth considering other avenues such as variations, suspension for convenience and termination.

If the contract does not contain a force majeure clause, the common law doctrine of frustration may be available.

Frustration

Contractual frustration is a legal concept that can operate to end a contract where something occurs to render performance of the contract impossible or substantially different from what was initially intended. This may be the case for many businesses dealing with cancellations arising out of COVID-19. Frustration will not occur where the contract deals with the apparently frustrating event, so where a force majeure clause covers pandemics (for example), a pandemic will not end the contract through frustration.

The effect of frustration can differ from the effect of a force majeure clause; the contract is deemed at law to have ended and any outstanding obligations are excused. The effect of the termination on payments made will depend on the applicability of Law Reform (Frustrated Contracts) Act 1943 (the Act).

If the Act does apply, there are rules that allow prepayments to be returned to the paying party, as well as for the performing party to have expenses accounted for in certain circumstances. If the Act does not apply, the legal position is that ‘loss lies where it falls’, which can mean that prepayments may not be recoverable.

Conclusion

The application and effect of force majeure or frustration will vary depending on the wording of the clause, the obligations in question and, often, the actions of the parties and so can be difficult to discern.

If you are party to a contract and affected by COVID -19, please do not hesitate to get in touch with Simon Brew, Partner in Dispute Resolution, or Jamie Berry, Partner and Head of Business Law, who will be happy to assist you at these challenging times.


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