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Impact of COVID-19 on contractual obligations

Contributed by:

Lucy Scott
Senior Assc

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Lucy Scott

With the widespread disruption caused by the COVID-19 pandemic, many businesses will be worried about how this impacts contractual performance.

In particular, the first lockdown, and the recent sudden move to Alert Levels 2 and 3 will have a significant impact on business across the country.

If you or your business is suddenly unable to carry out what was agreed, there are a number of potential options to consider to avoid or mitigate any breach of contract or damages claim.

The first port of call is the contract itself. Is there a force majeure clause, any material adverse change/event clauses or hardship provisions?

If the contract is silent on those points, you may be able to rely on the common law rule of frustration to relieve you of future obligations, however there is a high bar and as a general rule frustration will only apply if it is impossible in the circumstances to carry out what was agreed.

The contract itself

Force majeure (French for ‘superior force’) clauses operate to suspend or excuse non-performance of obligations when certain circumstances beyond the parties’ control arise, making performance commercially impracticable, illegal, or impossible.

Each clause needs to be interpreted on its own terms, but relevant to COVID-19 force majeure clauses may cover unexpected Government intervention (in addition to war, riots, earthquakes, explosions, energy blackouts, lockouts, and strike).

With COVID-19, recent orders requiring travel restrictions, business shutdowns and compulsory self-isolation (both here and overseas) may be a force majeure event, however discretionary decisions to require employees/suppliers to self-isolate generally will not.

It is also worth considering whether the contract offers some other relief with material adverse change/event clauses or hardship provisions. These clauses will be contract-specific and we recommend that you take legal advice specific to your situation.

In all cases, we recommend seeking legal advice and considering whether any notice provisions or mitigation duties apply.

Common law frustration

Frustration occurs when there is a radical change in circumstances outside a party’s control that means the parties are incapable of carrying out their obligations.

Frustration operates automatically to terminate the contract from the time of the frustrating event, however a party may be entitled to compensation for prior or part performance (for which the other party has obtained a benefit) under the Contract and Commercial Law Act 2017.

The threshold is intentionally high. Hardship or difficulty is not enough; the circumstances must have radically altered such that the parties are incapable of carrying on as intended.

With COVID-19, it will generally not be enough to say that relevant staff or supplies are unavailable if you can get alternative staff or supplies, regardless of how expensive or time consuming that might be. Having said this, true unavailability of essential staff or supplies may amount to frustration. For example, unavailability of a concert venue due to fire or safety concerns have both met the threshold of frustration.  Delay in performance may also  amount to frustration if the delay is sufficiently significant. Alert levels 3 and 4 will have caused material delays, however the question is whether the delay is significant enough to render performance impossible. Much will turn on context, including the remaining duration of the contract.

An event will not frustrate a contract if it was contemplated or foreseen by the parties, and/or the risk of that event occurring is allocated under the contract. The exception is where the nature of the event (or its consequences) is so extreme that it falls outside of what was originally anticipated. Again, much turns on context, and it will be relevant whether the COVID-19 pandemic was foreseeable at the time of contracting.

It will be difficult to argue frustration if your contract contains a force majeure clause.

The line between performance being difficult/ inconvenient or truly impossible is not always easy to draw, and we recommend parties seek legal advice before asserting frustration, given the risk of wrongful repudiation/anticipatory breach.

We are advising a number of clients on the consequences of COVID-19 and related impacts on their business. If you have any questions or would like more information, please get in contact.

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