Covid 19, Supply Chain Issues and Force Majeure
The Covid 19 pandemic is creating significant supply chain risks for many businesses. In particular a contracting party may have concerns as to whether it can meet its obligations or worry that the other party will be unable to do so.
Reviewing key contracts
Given the impact of the Covid 19 pandemic on supply chains, businesses should review their key contracts to assess:
- the likelihood and impact of breach
- what if any pre-emptive measures might be taken to lessen the impact
- the pros and cons of engaging with key customers and suppliers at any early stage and thereafter during the crisis period and
- the presence and scope (or absence) of force majeure clauses.
Breach of contract
Ordinarily where one party fails to perform its contractual obligations causing the other loss, the other party can allege breach of contract and claim damages in recompense. However, if failure to perform is principally caused by the Covid 19 pandemic, it might not be possible to bring a successful claim for breach and damages as:
- a force majeure clause may excuse non-performance; or
- the doctrine of frustration of contracts might apply.
A force majeure clause typically excuses one (or both) parties from contractual performance for a period of time following the occurrence of certain events or circumstances.
There is no such thing as a standard force majeure clause and indeed not all contracts may have one. As the content of force majeure clauses vary markedly between contracts, each such clause needs to be considered carefully.
As a starting point businesses should check whether a pandemic is covered by the definition of force majeure in the applicable contract. If it isn’t covered but the definition of force majeure includes the phrase “…events beyond a party’s reasonable control…” then this may be sufficient to cover pandemics. However, much will depend upon the wider drafting, general context and the intention of the parties.
The second point to consider is the mechanics of the force majeure clause. For example if it provides that the force majeure event must actually “prevent” performance, then the non-performing party has the burden of proof in showing that it was impossible to perform and not just that it was more difficult, costly or unprofitable to do so.
It also worth noting that:
- a force majeure clause may often oblige the non-performing party to show that it has used its reasonable endeavours to prevent, or at least mitigate, the effects of the force majeure; and
- where a force majeure clause is included in a party’s standard terms and conditions, then it may be subject to the reasonableness test under the Unfair Contract Terms Act 1977; especially where a party seeks to include events in the force majeure definition which are really within its control.
Frustration of contracts
After force majeure the next point to consider is the doctrine of frustration of contracts.
A contract may be discharged under the doctrine of frustration when a subsequent event occurs:
- which renders it impossible to fulfil the contract, or
- which transforms the obligation to perform into a radically different obligation from that existing on entering into the contract.
As such depending upon the background circumstances the Covid 19 pandemic could in theory lead to the frustration of a contract.
However, in general the courts are reluctant to find that a contract has been frustrated. Express provision in the contract addressing the subsequent event in question, (i.e. in a force majeure provision) will typically prevent the contract from being frustrated. Further a contract will not be frustrated simply because the affected party finds that it has becomes more difficult or expensive to perform or because it has been let down by a subcontractor or supplier.
When a contract is frustrated, the parties are permanently excused from any further performance and they are not liable for damages for non-performance. The Law Reform (Frustrated Contracts) Act 1943 generally applies and this permits the recovery of monies paid under the contract before it was discharged.
The Covid 19 pandemic will undoubtedly put a great strain on many contractual relationships; and issues will arise where a party is unable to perform its contractual obligations as a result.
However, a party should not automatically assume that a force majeure clause or the doctrine of frustration of contracts will always excuse non-performance. This is an area where the devil is very much in the detail and legal advice should be taken in all cases.
Further businesses should also review their standard terms and conditions and update them as necessary. Many businesses are likely to supplement their force majeure clauses so as to expressly include pandemic and epidemics, as alas, Covid 19 is unlikely to be the last such outbreak.