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Limelight 04/20

COVID-19 Toolkit: FAQ: COVID-19 (Coronavirus) Contract relief – force majeure, frustration and government intervention – updated

Many of our clients have been severely affected by the coronavirus (COVID-19) pandemic.  Those in industries which have been shut down due to government orders have been the worst hit.  Moreover, effects on business are not limited to businesses that are directly covered by government orders, with demand running up through supply chains.

This FAQ / information sheet covers questions that we are being asked by our clients on managing and obtaining relief from their obligations pursuant to contracts, and it is part of Gilchrist Connell’s COVID-19 Toolkit.

Please note that the information in this sheet does not constitute legal advice. To keep it as short as possible, it is also not a complete description of the matters it covers or all possible scenarios. Rather, it is guidance of a broad and general nature only and should not be relied upon for specific cases. For information or advice about your particular business or contract, please contact us directly using the details at the end of this document.

The COVID-19 pandemic is preventing me from fulfilling obligations under a contract. What can I do?

The first step is to contact the other party in an effort to negotiate a compromise.

Our experience in negotiating on behalf of our clients suggests that parties are usually open to negotiations in order to “spread the pain”, even in the absence of specific government legislation or direction affecting the business in question.

At a commercial level, our experience has also been that negotiations tend to be more successful when parties are armed with an “offer”, which takes into account both parties’ respective situation and financials.

If an agreement is reached, it is best to document it, by way of a deed of variation.

The other party is refusing to negotiate. Can I rely on my contract’s “force majeure” clause to obtain relief?

As discussed, force majeure provisions operate to remove liability from a party that fails to perform their obligations under a contract due to unforeseeable or unpredictable events (force majeure events, often known as “acts of God”) which are beyond that party’s control, and allows the party relying on the clause to be excused from performance or to obtain an extension of time to perform its obligation, without frustrating a contract.

Typical force majeure clauses in contracts list natural disasters, epidemics, pandemics, wars, riots, acts of terrorism, government embargoes as force majeure events.

However, the devil is in the detail, as not all force majeure clauses are created equal, and they might not capture all of the same types of events.

In addition, certain force majeure clauses might be deemed void or unfair if (for example) the force majeure clause is drafted to cover events which are, arguably, within the reasonable control of the parties.

How do I exercise my rights under a “force majeure” clause?

Each contract will provide for a specific set of steps for the trigger of a force majeure clause. Generally, these steps are as follows:

  • within a particular timeframe, notify the other party that a force majeure event may, is or has impacted you in such a way that it will prevent you from performing your obligation (with details provided);
  • a requirement that the party claiming relief under the force majeure clause provide regular updates as to how the force majeure event continues to affect that party’s ability to perform the contractual obligation(s);
  • a requirement that the party seeking relief provide details on how that party has attempted to mitigate the impact of the force majeure event; and
  • consent (in writing) from the other party that the force majeure provision applies with agreement on next steps.

Is COVID-19 a valid force majeure event?

Yes, if your contract includes a force majeure clause, and that clause includes a reference to “epidemic” or “pandemic” in the definition of force majeure event.

If the definition does not refer to epidemic or pandemic, but if you are in an industry which has been the target of a government shutdown, then also arguably yes, if the definition of force majeure event includes a line item similar to “government embargo” or “lockdown”.

My contract does not include a force majeure clause. What can I do?

You might be able to argue that a contract has been “frustrated”.

A contract is said to be “frustrated” when the performance of a contract becomes impossible because of something neither party has control over, for example:

  • an unforeseen or supervening event or events occur;
  • that is not caused by, nor is it the fault of, either party;
  • that renders the contract radically different than what was intended by the parties;
  • it would be unjust to hold the parties to their original contract terms in the circumstances.

Some examples of frustration from case law include:

  • the subject of a contract has been destroyed by fire;
  • the performance of obligations under a contract becomes illegal;
  • where performance depended on an event which did not happen, eg a major sports event is cancelled for the year;
  • where war has broken out and the ability to fully perform obligations has been disrupted.

Could COVID-19 be considered an event of frustration?

Yes, if COVID-19 and laws and government directions associated with it cause a frustration of the contract. However, bear in mind that arguing frustration should really be a last resort. The application of frustration is narrow. It is only meant to be applied if it can be shown, by a process of construction of the contract, that the parties never agreed to be bound in the circumstances which have unexpectedly arisen.  Courts will not decide that a contract is frustrated merely because to require performance of the contract is unjust or unreasonable, or because a party has simply struck a bad bargain, or faces inconvenience, hardship or loss.

Also, frustration will not be found if it can be proved that the relevant event has been, or reasonably could have been, foreseen by the parties. It may be difficult for parties to allege that COVID-19 was an unforeseen event if they entered into the contract after that party became aware of the potential spread and impact of COVID-19.

The precise moment a contract becomes frustrated must also be identifiable. This too may be difficult for businesses to establish.

The event must have severe consequences, and not merely be unfavourable to one or both parties. This would suggest that a sudden drop in demand is not enough to claim frustration. Something more would be required, such as a change in government policy and international events triggering the frustration.

With this in mind, businesses in hospitality, entertainment and fitness which have been required to shut down on a temporary basis, may be able to successfully argue COVID-19 as an event of frustration, but equally, it is important to remember that each case falls on its own facts and circumstances.

What happens to the contract if frustration is found to apply?

If a party can establish frustration, and terminate the contract on that basis, they may be:

  • relieved of their obligations;
  • eligible for reimbursement if funds have been exchanged but performance has failed;
  • able to defend a demand for payment.

Businesses should be wary of terminating their contracts on the basis of frustration.  This is because:

  • the criteria determined by common law has created a high bar to overcome;
  • the business could risk inadvertently repudiating (rejecting or refusing to perform the remainder of the obligations under a contract) without a proper basis and, thereby, triggering default and compensation provisions under the contract;
  • there are requirements under state-based legislation (ie the Frustrated Contracts Act 1978 (NSW), Frustrated Contracts Act 1988 (SA), Australian Consumer Law and Fair Trading Act (Vic)) that would need to be considered;
  • the possibility that the government will enact intervening COVID-19 legislation that has the effect of enabling the parties to perform their obligations under contract.

I am about to enter into a new contract. Can I still rely on its force majeure clause or the principle of frustration to obtain relief because of COVID-19?

 COVID-19 is no longer an unforeseen event, so it is part of the context for any new contract. This makes it difficult for a party to seek relief because of it.

If you are about to enter into a new contract, and if you can envisage issues arising because of COVID-19, we recommend expressly addressing this in the contract, both in the commercial terms (eg allowing for a ramp-up period for 6 months) and legal drafting (eg a specific clause which deals with poor performance or non-performance due to COVID-19).

Government intervention

The Australian government has offered support for businesses in the form of loans, tax relief, income support, asset write-offs and other measures, but has yet to announce whether obligations under commercial and consumer contracts (including leases and mortgages) will be temporarily suspended.

It may be just a matter of time, as the US has announced it will suspend evictions and foreclosures; Italy has announced it will suspend debt payments; and major banks in Australia have announced they will offer support by deferring repayments on loans.

On 23 March 2020, a new bill titled the Coronavirus Economic Response Package Omnibus Bill 2020 was introduced. If passed, the new law will, amongst other things:

  • enhance instant asset write-offs;
  • boost cash flow for employers;
  • by legislative instrument, excuse certain classes of people from complying with the Corporations Act, where it would be unreasonable to expect compliance due to the impact of COVID-19;
  • provide temporary relief for directors from their duty to prevent insolvent trading under the Corporations Act;
  • (under the Bankruptcy Act and Regulations, and the Corporations Act and Regulations) provide temporary relief for businesses and individuals in financial distress by temporarily increasing the statutory minimum amount for creditor to issue statutory demands on companies from $2,000 to $20,000, and temporarily extend the time for companies to respond to statutory demands from 21 days to 6 months.

We are keeping abreast of all these developments to assist our clients accordingly.

Where can I get legal advice about contract relief?

If you are unable to rely on a force majeure clause or if you are uncertain about whether you will be able to meet the criteria for frustration, we ask that you contact us.

This publication constitutes a summary of the information of the subject matter covered. This information is not intended to be nor should it be relied upon as legal or any other type of professional advice. For further information in relation to this subject matter please contact the author.