CONTRACTUAL OBLIGATIONS AND COVID-19

COVID-19 pandemic has caused significant economic disruptions. Governments, in an effort to check the spread of the COVID-19, have implemented policies that have disrupted business operations globally. As a result of emergency measures imposed by various governments, it has or will become impracticable or impossible for many parties to perform their contractual obligations.

A common question in commercial transactions is therefore what happens with performance of contractual obligations. Are parties liable for non-performance? Of course, the answer to this depends on each case taking into consideration the terms of the contract at issue, the particular facts surrounding the non-performance, and the law of the jurisdiction involved.

 

  1. Force Majeure

 

A force majeure provision, also known as (i.e. “Act of God” or “superior force”), excuses a party’s failure to perform some or all of its obligations under an agreement to the extent that such failure to perform is due to a set of specified circumstances outside of that party’s control (such as a natural disaster or an act of terrorism or war).

 

In some jurisdictions, force majeure does not operate automatically under the national laws , and as such, a specific force majeure provision would need to be included in an agreement to allow a party to rely on it.

 

For an event to be interpreted as a “force majeure” three criteria must be satisfied:

 

  1. It must be beyond the reasonable control of the affected parties,
  2. the parties’ ability to perform their obligations under the contract must have been prevented by the event and
  3. the affected party must have taken all reasonable steps to avoid or mitigate the consequences of non-performance.

 

 

 

The consequences of a “force majeure” clause rely on the wording and construction of the contract. Most commonly, events falling under the scope of the “force majeure” clause render the contract as terminated and release the parties from their obligations accordingly.

 

Alternatively, if a contract does not contain a “force majeure” clause, the second step is to check whether this is implicitly implied by the national laws of each jurisdiction.

 

  1. Unforseen and Unpredicted change of circumstances

 

Unlike force majeure a party may raise this defence for non-performance is potentially regardless of whether such clause is  specifically mentioned in the contract.

 

A party may be relieved of any liability under contractual agreement in the event of a breach of a contract, where performance becomes impossible, or radically different from what was contemplated when the contract was made due to events which were outside their sphere of control.

 

The defence cannot arise where performing under the contract would merely occasion financial difficulty or hardship. In addition, the defence is not available where the event that prevented performance was foreseeable and reasonable provision could have been made for its occurrence. The party must be able to prove that applying prudent business sense, it could not have prevented or mitigated the causes leading to the frustration of the contract.

 

This defence takes effect through judicial intervention and not by operation of law. If all requirements are met, the Court has the power, at the request of the contracting party, to order the adjustment of contractual obligations or even the termination of the contract.

 

 

In the case of COVID-19 the various measures taken by governments are making in some circumstances performance of contractual obligations impossible. In such circumstances, the principle of unforeseen and unpredicted change of circumstances would more easily apply, as it is not a case of a merely more expensive way to perform; it is impossibility to perform.

 

  1.  Material Adverse Change

 

A typical material adverse change (MAC) clause would allow a party to terminate a definitive agreement in the event that there is a material adverse change with respect to the target business after the signing date. Whether the pandemic constitutes a MAC will depend on the terms of the provision at issue, as well as the magnitude of the impact on the relevant party’s business.

 

Conslusion

 

Whether or not a termination right will be available to a party will depend heavily on the drafting of the relevant agreement. A party seeking to enforce a termination right in light of the COVID-19 should carefully consider whether the relevant requirements under the agreement to terminate have been met and should also look to ensure full compliance with any other procedural requirements.

 

April 2020

 

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*This article is intended for information purposes only and does not amount to legal advice.