Is COVID-19 a valid defence for default or delay in performance of contractual obligations by invoking force majeure or has it potentially frustrated contracts? This article captures some of my legal notes on this topic which has provoked many discussions during this pandemic.
In the ensuing weeks and post COVID-19 the tremendous macro-economic impact of the pandemic will be far-reaching and with a potential global recession we will likely see a myriad of defaults and delays in performance of contractual obligations. The restriction of movement, suspension of production, labor shortage, disruption in supply chain, possible increase in costs and shortage of cash flow will likely affect diverse industries.
This has presented real concerns for most businesses particularly on the future of existing contractual obligations. Whether the reality of your business is a difficulty or inability to perform existing obligations or an expectation for the performance of obligations, an understanding of exclusion or limitation of liability doctrines like Force Majeure and Frustration will be relevant at this time.
Below are answers to pertinent queries raised by our clients on the validity of a defence in force majeure or frustration for non-performance or late performance of existing contractual obligations.
What is Force Majeure?
Force majeure is the alteration of contractual obligations and liabilities due to the occurrence of extraordinary circumstance(s) which prevents a party from performing its obligations. It effectively allocates the risk of loss and protects parties from liability in a breach of contract claim if performance becomes impossible, unlawful or impracticable as a result of an uncontrollable event.
The concept of force majeure originates from French jurisprudence. In common law jurisdictions like Nigeria, it is borne from contract and not from the evolution of general common law or statutes. Therefore, force majeure has to be expressly provided for in a contract to be enforceable. Such express provisions, often buried amongst boilerplate terms, are typically called Force Majeure Clauses.
A force majeure clause typically provides specified circumstances (Force Majeure Event(s)), the occurrence of which would relieve a party from contractual liability for default or delay, conditions for application of the clause and the consequences of triggering the clause. The wordings of these considerations in each contract would largely dictate how force majeure applies. There are no generic answers, however there are standard guidelines for establishing force majeure. The enforceability of a force majeure clause would first depend on the occurrence of a force majeure event.
Is the COVID-19 crisis a Force Majeure Event?
Whether COVID-19 would qualify as a force majeure event would depend considerably on the wordings of the clause and its interpretation, the intention of parties and the situation that has arisen. A force majeure event is usually beyond the control of parties and the onus of proof is on the party relying on the clause.
Force majeure events are usually specified in the clause (this list may be exhaustive or non- exhaustive) and in some cases defined only as circumstances beyond the control of parties. A comprehensive draft will incorporate a combination of a specific list of circumstances and a wider, more general criteria.
If this clause lists specific events like “acts or restriction of government”, “plagues”, “epidemic” or “pandemic”, “disease” “outbreak of illness” or similar term(s), it is highly probable that the coronavirus health crisis would qualify. This is easier to prove in countries where the government has made orders restricting movement and travel but less clear in countries where the government only made recommendations of such restrictions.
In the absence of stipulated circumstances closely related to a pandemic, act of government or otherwise related event, a discourse on the interpretation of the clause would have to be undertaken. This is to determine whether the parties intended such a pandemic to be covered. Whether the list of events is exhaustive or non-exhaustive would play a significant role in determining the parties’ intention. If the list is non-exhaustive it would likely be established that the parties intended this unprecedented health crisis to be covered. However, if exhaustive, the incorporation of an unspecified event may be difficult to prove.
Where the clause gives broad criteria for qualification, the determination of whether COVID- 19 falls within the criteria is fact-based and a question of interpretation. Given the unprecedented nature of this crisis in recent times, the courts are likely to be more liberal in their interpretation, especially for parties that show genuine inability to perform or have cogent reasons for late performance. This is likely to also be the case for clauses with a combination of specific and broad qualification criteria. A broad interpretation of this clause would probably be given to include this health crisis even in the absence of a related listed event. This is provided there is sufficient evidence to show the situation was beyond the party’s control and it had genuine difficulties that could not be prevented or mitigated.
Expensive, less profitable, more difficult to perform…is this tenable?
Even if it becomes established that COVID-19 is a Force Majeure Event, the relying party would not automatically be relieved from liability. The impact of this pandemic on the performance of the contractual obligations will be assessed.
Force majeure clauses usually specify the level of disruption an event must have on performance in order to trigger protection from liability under the clause. The clause may state that the event must “prevent” or “delay” performance.
In order to “prevent” performance, the event must have made performance physically or legally impossible. In this instance, the bar is set high. The mere fact that performance has become expensive, less profitable or more difficult to perform may not be enough. It should however be easier to prove if all that is required is that the event “delays” performance. This sets a lower bar and provides some flexibility if performance remains possible but not within the timeframe required by the contract.
In either case, the party must demonstrate that all reasonable steps to prevent or mitigate the event and its consequences have been undertaken. This includes disbursing additional funds, hiring extra workers, seeking alternative manufacturing lines, suppliers or logistics company etc. The absence of any alternate means of fulfilling the contract or timely performance makes for a strong case.
What are the procedural conditions for reliance on Force Majeure?
The conditions for invoking force majeure is usually stated in the clause. These conditions typically include a requirement that formal notice(s), informing counterparties of the occurrence of the force majeure event and invocation of the force majeure, is sent within a stipulated time frame. The modalities of service may also be prescribed.
It is prudent for every business seeking to rely on force majeure to adhere strictly to its procedural requirements, even if it is still in a re-negotiation phase. This is to prevent a situation wherein the defence is lost or dismissed due to a procedural technicality.
What are the consequences of invoking force majeure?
The outcomes that are expected when a force majeure clause is triggered would typically also be stated in the clause. Once the clause is successfully invoked, the following may ensue:
- total or partial non-performance or late performance of obligations is excused and liability does not flow to the defaulting party;
- performance is suspended for the period that the effect of the event continues;
- parties are given a right to postpone performance for a specific period;
- parties are given the right to terminate the contract for prolonged delay or non- performance.A combination of two or more of the above remedies may be provided in varying degrees.
How would costs already incurred or payments made under the contract be awarded?
The remedies obtainable in a successful force majeure defence are usually provided in the clause. If the Clause is silent as to the position of costs already incurred, or payments made by either party, they would typically not be recoverable. In such instances, businesses may need to look to available insurance claims they can access or consider the doctrine of frustration which puts the parties back to the same position they were in prior to the contract been formed.
Force Majeure Clause absent, are there any other defences or remedies?
If a force majeure clause is not provided for in a contract, a careful review of the contract may reveal other provisions that may help alleviate performance difficulties or mitigate potential business liabilities. In the absence of such provisions, the last resort may be to look to the doctrine of frustration for reprieve.
Historically, a successful reliance on frustration is difficult to establish. However, this concept does not stem from contractual provisions and is available regardless of the absence of express provisions or even a written contract. This makes the determination of frustration entirely subject to the discretion of courts.
To establish a defence in frustration:
- an unforeseen event beyond the parties’ control must have occurred after contract formation
- this event must have made the obligations impossible or unlawful to perform
- this non-performance could not be prevented or mitigated by alternative measures.The difficulty in proving frustration lays in establishing that the event was unforeseen and performance impossible. Whether the current pandemic is unforeseeable would receive much consideration. The occurrence of recent prior epidemics like Ebola and SARS and previous warnings from top officials world-wide of the possible occurrence of future epidemics will likely weigh heavily in favour of the argument that the COVID-19 crisis should have been contemplated. However, this would be strongly countered by the argument that the global, wide-reaching and almost unprecedented impact of this health crisis could not be contemplated given the limited or regional scale of previous outbreaks.To establish frustration, the mere fact that performance has become more difficult, expensive or commercially unviable does not suffice. Instances in which the contract would be frustrated includes when: the subject matter of the contract is destroyed, performance has become impossible, illegal or something radically different from the contemplation of parties at contract formation.
A successful defence in frustration renders the contract void by operation of law and all contractual obligations cease to exist. Parties revert to the position they were in prior to the formation of the contract (as if the contract never took place). This means that all sums paid pursuant to the contract but before the frustrating event can be recovered and there is no liability to pay any money due at the time of the event. Also, costs incurred in performing the contract prior to the frustrating event and the value of benefit from the other party’s actions may be recovered.
Sample Checklist for Defence
- Ensure your contract has a legally enforceable force majeure clause and review its terms.
- A force majeure event beyond the control of the parties must have occurred subsequent to contract formation.
- The qualification of this circumstance as a force majeure event must be derived from the precise wording of the clause or a reasonable interpretation of these words. The question of interpretation is highly fact- based, so the facts of your case must be properly analyzed.
- Once established that a force majeure event has occurred, it must be proved that this event (not negligence or malfeasance) prevented or delayed performance. Reliance on increased cost, or less profitability, of the performance should not be made.
- The inability to perform or delay in performance must not be capable of been mitigated or prevented by alternative means that does not involve a breach of other contracts or illegality.
- You must consider whether alternative means of avoiding this non- performance or minimizing loss to the other party is available. If available, it must be pursued.
- If non-performance or late performance is unavoidable, ensure the counterparties are properly served with all notices required under the contract within the stipulated time frame.
- Keep a record of when the force majeure event occurred, its impact on the performance of obligations (did it delay or render performance impossible?), steps taken to source alternatives and mitigate loss to the other party and action plan on next steps (pursuant to the clause).
- In the absence of a force majeure clause, consider other provisions of the contract that can ameliorate the difficulties of performance and possibly help amend or re-negotiate contract terms.
- If all is lost, investigate reliance on the doctrine of frustration but ensure that performance is truly impossible and consider how the strict requirements of the doctrine will be established.
- Claims on Insurance policies, if available, may also be pursued to cushion losses due to business interruption.
Conclusion
A part of the strategic plan of businesses to manage the impact of COVID-19 crisis should include a careful consideration of whether they or their counterparties will be able to continue to perform their contractual obligations. If performance may be significantly affected it is crucial to review all impacted contracts to understand the business’ rights and obligations. This would allow for better scenario-planning and a strategic approach.
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