COVID-19: Commercial Contract Considerations
19 March 2020
Given the extraordinary economic events which have been precipitated by COVID-19, many businesses will be concerned with how this will impact on their various commercial relationships. In this note, we will look at how COVID-19 may impact on the contracts governing these relationships, in particular by addressing two key exceptions to the general rule under Irish contract law that an organisation will be held liable for a failure to comply with its contractual obligations, namely:
- Force majeure
- The doctrine of frustration
We will also briefly consider two forms of contract clause which may be relevant depending on the contract in question, specifically material adverse change clauses and price adjustment clauses.
A force majeure clause is a standard “boiler plate” clause which is typically contained in commercial contracts. A force majeure clause provides that in the event of a natural or unavoidable catastrophe interrupting the normal course of events and preventing parties from fulfilling their obligations, the contract will either come to an end or may be suspended until the event has passed. The force majeure event must typically be beyond the reasonable control of the party claiming a force majeure has occurred and the event must make the contract impossible to perform. The fact that the contract is more difficult or expensive to perform will normally not suffice to claim that a force majeure event has occurred.
Force majeure clauses can be drafted differently so it is important to review the particular clause to see if COVID-19 is covered by the clause (while COVID-19 will almost certainly not be referred to in the clause, it may, for example refer to a “pandemic” or an “epidemic” as a force majeure event). Specific legal advice should be obtained to determine if a force majeure event has occurred.
If a force majeure clause is not contained in the contract, the Courts will be very reluctant to imply one into the contract. Also, it is important to note that if such a clause is contained in the contract, the Courts will strictly interpret it and so if there is any ambiguity in its interpretation, the Courts will be unlikely to conclude that a force majeure event has occurred.
If a party claims or wishes to claim a force majeure event, it will be important to review the relevant notice provisions. For example, the force majeure clause may stipulate specific notification requirements to claim a force majeure. Alternatively, if the force majeure clause does not specify notice requirements, then the standard notification requirements in the contract should apply. It will be important that these notice provisions are strictly adhered to if the claim of force majeure is to be valid.
If the contract does not contain a force majeure clause covering COVID-19, a party wishing to be discharged from their obligations under the contract, may seek to rely on the common law doctrine of frustration. A contract may be discharged on the ground of frustration when something happens:
- after the formation of the contract;
- due to the fault of neither party;
- which makes it physically or commercially impossible to perform the contract, or makes performance radically different from that contemplated by the parties at the time of the contract
Generally speaking, a frustrating event is an event that is so fundamental as to be regarded by the law both as striking at the root of the contract and as entirely beyond what was contemplated by the parties when they entered into the contract.
Where the doctrine of frustration applies, it will result in the contract automatically coming to an end. As a result, the threshold for proving frustration is very high. An example of this high threshold was seen in the 2019 judgment in Canary Wharf (BP4) T1 Ltd v European Medicines Agency, where the English High Court rejected the European Medicines Agency’s (EMA) claim that its 25-year lease of premises in Canary Wharf was frustrated by Brexit, so it remained obliged to perform its leasehold commitments. This was despite the fact that the EMA is an EU institution with responsibility for the evaluation, supervision and monitoring of medicines in the EU and therefore must be based in EU.
Notwithstanding the high threshold for frustration, it is conceivable that the threshold may be met in the current circumstances relating to COVID-19 , for example, if the performance of a contract relates to the provision of goods in another EU member state, and performance is now rendered impossible due to border closures in that EU member state.
Material Adverse Change
A material adverse change clause gives a party the right to terminate a contract in the event that business is materially and adversely affected and the impact of COVID-19 on a business may trigger such a claim. If a material adverse change clause is contained in the contract, it will need to be reviewed carefully to see if COVID-19 can be construed as a material adverse change and the procedure for invoking the material adverse change clause will need to be strictly adhered to.
Price Adjustment Clause
If the contract contains a price adjustment clause, a party may seek to adjust the price under the contract, on the basis that the contract has become more expensive and or difficult to perform as a result of COVID-19. If such a clause is contained in the contract, it will need to be reviewed carefully to see if a price adjustment can be validly claimed and the procedure for claiming a price increase will need to be strictly adhered to.
- Organisations should now review their key contracts to ascertain whether a claim based on any of the above points may be made.
- Contracts relating to the industries affected most by COVID-19 are the most susceptible to such a claim, for instance, the transport, logistics, or manufacturing industries.
- It will be important to be clear on the nature of each party’s performance obligations under the contract including in relation to timing, how these obligations may be affected by the circumstances surrounding COVID-19 and what the effects of failure to perform will be.
- It will also be important to ascertain what the consequences of such a claim will be including whether other provisions of the contract will be triggered, for instance, whether the termination provisions in a contract provide for a termination fee.
- Once these matters have been clarified, organisations should consider their optimal outcome, for e.g., whether it is now in their interest to mitigate the risk caused by COVID-19 by seeking to negotiate a side letter to the contract to account for the change in circumstances brought about by COVID-19.
- Parties may not necessarily agree on the applicability of the claims discussed above, and in such instances, regard should be had to the dispute resolution provisions in the contract whether by way of litigation in court, arbitration or mediation.
- In all cases, parties should consult with their legal counsel before taking any action. If the relevant commercial contract is not governed by Irish Law, specific advice from local legal counsel may be required.