The COVID-19 pandemic has substantially disrupted the operation of the Australian society and overseas. Supply chains are interrupted due to travel restrictions, the mode of business operation has changed overnight as a result of lock down rules, many countries are at the brink of an economic downturn and the ability for businesses to function “as usual” has been severely impacted. Many affected businesses are finding themselves asking questions regarding their contractual obligations: Can I terminate or re-negotiate an existing contract based on the circumstances brought by COVID-19? Or, how should I deal with breaches of existing contracts by the other party?
Whether a contract caters for the current unprecedented environment will depend on the terms and wording of the contract. There has been much discussion about “force majeure” and the doctrine of frustration, and it is important that businesses are aware of their rights and options when facing these uncertain times.
What is a “force majeure” clause?
Many contracts and agreements contain a “force majeure” provision. In general, a “force majeure” provision in a contract excuses a party from contractual obligations and liabilities as a result of an event or circumstance outside the reasonable control of the affected party during the affected period.
In Australia, a “force majeure” provision is the result of commercial agreement and is not codified in law. Therefore, the scope and effect of a “force majeure” provision is dependent on the wording of the contract and needs to be determined on a case-by-case basis. In the past, case laws have interpreted “force majeure” to include “acts of God”, “natural disasters”, “government action or intervention”, “national emergencies” and “acts of war”. In general, the following elements must be present for an event to be considered a “force majeure”:
- the event must not have been reasonably foreseen by a party;
- the event must be completely beyond the control of a party and the party is not able to prevent the consequences of the event; and
- the event could occur with or without human intervention.
However, a party may not invoke a “force majeure” provision if the event was caused by their own acts or omission.
Does a “force majeure” provision apply to disruptions caused by COVID-19?
Whether a “force majeure” provision applies will depend on the definition of “force majeure” in the contract. If an event does not fall within the definition, the “force majeure” provision will unlikely be applicable. As parties have the ability to negotiate the scope and definition of “force majeure” in their contracts, courts will be reluctant to extend the provision to cover events not expressly provided for in the provision.
For COVID-19, a “force majeure” provision will apply if it specifically refers to “infectious disease”, “pandemic” or similar. It can also be argued that the disruptions brought by COVID-19 may also indirectly lead to the occurrence of other events such as “government action”, “labour shortages”, “lock down” and “national emergency” which may be referred to specifically under the definition of “force majeure”. General catch all wording such as “events outside the reasonable control of the parties” or “act of God” may be construed to cover the current pandemic.
Is economic downturn a “force majeure” event?
If “financial hardship” or words to that effect are explicitly mentioned in the definition of “force majeure”, then, depending on the wording used, changes in a party’s financial situation may be covered. However, in practice, many “force majeure” clauses contain a carve out with respect to payment of monies due, i.e. the “force majeure” provision will not excuse a party from payment of amounts due under the contract during the affected period.
In the absence of specific wording, courts generally have confirmed that a change in economic or market circumstances affecting the profitability of a contract or the ease with which parties can perform their obligations are not “force majeure” events (see Tandrin Aviation Holdings Ltd v Aero Toy Store LLC and another  EWHC 40 (Comm)). The fact that a performance of a contract becomes uneconomical is also not a “force majeure” event (see Gardiner v Agricultural and Rural Finance Pty Ltd  NSWCA 235). A “force majeure” event cannot be merely an economic event, there must be a legal or physical limitation (see Yrazu v Astral Shipping Company (1904) 20 TLR 153). From these cases, it is unlikely that inability to get financing or difficulties or a delay in obtaining supplies due to financial hardship will constitute a “force majeure” event.
What about the Doctrine of Frustration?
If a contract does not contain an operative “force majeure” provision, then contracting parties may look to rely on the doctrine of frustration. However, it is important to consider this carefully as successfully invoking this doctrine will mean that your agreement will be terminated.
The doctrine of frustration is a common law principle. Frustration will only occur if, through no fault of either party, the circumstances in which performance of the obligation is required are rendered radically different from those originally contemplated by the parties under the contract (see David Contractors Ltd v Fareham Urban District Court  AC 696).
The effect of frustration is termination of the contract and all outstanding obligations will be discharged. When a contract has been frustrated, losses lie where they fall. As a result, it is important to note that any expenses incurred or costs paid in the preparation and performance of an obligation prior to frustration cannot be recovered.
In Australia, in the states of New South Wales, South Australia and Victoria, statutory laws come into play when a contract is frustrated. These laws aim to reduce harsh consequences and adjust each party’s rights for a more equitable outcome for all parties as a result of the frustration of a contract.
Can COVID-19 be an event of frustration?
The standard of proof for frustration is very high and are typically higher than circumstances contemplated by a “force majeure” provision. Frustration will usually not occur if there is an existing “force majeure” provision in the contract which operates to cover the circumstances seeking to be deemed a frustration event.
Generally, courts have held that the effects of economic downturn (including delay in supply or reduced earnings) or increased expenses cannot lead to frustration. Foreseeable events and transient circumstances also do not amount to frustrating. Whether a party can rely on frustration will depend on the facts of each particular case and whether COVID-19 has made it impossible (not merely more difficult) for a party to perform its contractual obligations.
Tips for re-negotiation
Businesses who find themselves unable to fulfil their contractual obligations as a result of COVID-19 should first contact the other party to negotiate a compromise. Most contracts provide a means for parties to vary or renegotiate terms. During negotiations, some issues to bear in mind include:
- Know your contract – It is important to familiarise yourself with the relevant agreement as to what your rights and obligations are. What are the mechanisms of amending an agreement? Would an email sent to the other side that is acknowledged constitute an amendment?
- Know your business needs – When renegotiating an agreement
due to changed circumstances, it is important to have a clear picture of what the
business needs (i.e. your goals) and what the business can live with (i.e. your
fall-back position). Parties should be aware of their non-negotiables and
understand what is valuable to their business. Work this out before contacting the other party.
- Understand external factors – Research and understand the
external factors causing the negotiations. This will assist in decisions
regarding what can be expected and what is unreasonable. Gather evidence (e.g.
industry figures) to support your position, so that you are able to readily demonstrate
to the other side your position.
- Force Majeure – If a party wished to rely on the contract’s “force majeure” provision, be familiar with the provision under the contract. A party seeking to rely on a “force majeure” provision will need to establish a causal connection between the event and the party’s inability to fulfil their contractual obligations. The party seeking relief must be able to demonstrate that it had attempted to mitigate the effects of COVID-19. The business must also comply with all the terms of the contract including relevant notice provisions required to trigger the provision.
Lastly, be sure to document all communications during negotiation so that you have a paper trail of what had been discussed and agreed to by both parties. Written records can be used to correct miscommunication and will be helpful if a dispute arises at a later stage. Variations in contracts should also be properly recorded in a legal document to avoid future disputes.