Introduction
The outbreak of COVID-19 has seen the sharpest rise in contractual non-performance since the Second World War, following unprecedented measures taken by governments to contain the virus.
Much has already been written on the remedies available to contracting parties who find themselves unable to perform their contractual obligations – or are on the receiving end of a force majeure (FM) notice. In this article we look beyond COVID-19 to how the lessons learned might be applied in the future. First, we address how contracting parties should approach drafting relief mechanisms such as FM, variation and change in law clauses going forward. We then consider the pitfalls to avoid where contracting parties are trying to find a commercial solution to problems caused by COVID-19, and the potential for dispute avoidance to ensure a smooth working relationship going forward.
Force Majeure - Drafting to cover or exclude Covid-19
General Terms
Boiler plate FM clauses typically contain lists of undefined and broad terms to cover a variety of unforeseen circumstances. Recently, we have seen parties attempt to stretch the meaning of these to cover the COVID-19 outbreak with varying prospects of success. Terms are of course construed according to their context but on their natural meaning the following are unlikely to cover a future pandemic:
- "Embargo" – this would likely be limited to trade restrictions put in place between sovereign states rather than applying to the various social distancing measures introduced.
- "Biological Contamination" - would probably be construed as the presence of the virus on a worksite itself rather than infected workers. As the virus cannot survive for long without a human host, this would probably not apply.
- "Act of God" - has been held to mean an extraordinary natural event which could not have been anticipated or provided against. We consider it arguable that such a term could be invoked to cover the present outbreak of COVID-19. However, timing is all. There is a strong argument that a second wave of COVID-19 or another pandemic would have been in the parties' contemplation when concluding contracts post-COVID. Parties should therefore not hope to rely on "Act of God" to cover future pandemics merely because there may be precedent from the current outbreak.
Pandemic/Epidemic sub-clause
For parties who do wish to put in place pandemic FM options, they should address these FM events in a detailed "Pandemic/Epidemic" sub-clause.
- It is useful to define pandemic as specifically as possible to provide certainty and limit scope for dispute regarding the starting point of the pandemic. Referencing an authoritative public body such as the WHO to determine whether a pandemic is in existence can help prevent abuse of the mechanism by a counterparty.
- In general, most difficulties have resulted from governments' responses to COVID-19 rather than the direct effect of absence of staff due to illness. The drafting should therefore reference restrictions imposed as a result of pandemic. If parties are able to identify particular restrictions from the current outbreak likely to cause performance issues, the drafting could contain granular detail of these.
- Parties also need to consider the wording which determines the required impact on performance to trigger FM:
- "prevention" - this is the highest threshold and means complying with obligations must be physically or legally impossible. It is not enough for parties to show that performance was made more difficult or economically unviable;
- "hindrance" - where performance would put the affected party in such a precarious position that it would endanger the business or prevent them from performing contracts with other parties; or
- "affect" or "delay" - this lower bar would be suitable for parties who want to build in flexibility if performance remains possible but uneconomic at the time required.
- Some clients may favour more sophisticated impact triggers to take into account economic hardship. For example, many contractors might seek to rely on FM as they are unable to procure sub-contractors to complete works at an appropriate price. Such an FM clause could be drafted to take into account these market changes as a result of pandemic.
Other common FM wording
Other standard form FM wording could also affect future pandemic relief:
- "Unforeseeable" - there is no implied term under English law that an FM event must be unforeseeable if the clause is silent on this. As a future pandemic is now unfortunately foreseeable, those seeking to cover it should avoid this wording. Those hoping to exclude it should not assume FM will not apply to a listed pandemic event, such as a COVID-19 second wave, because it is foreseeable and should expressly exclude it.
- "Beyond reasonable control" - recent case law has held that an event will be within the party's reasonable control if non-performance was within the control of any party further up its supply chain. If a party does not wish to be exposed to the risk of a supplier voluntarily closing as a result of a pandemic, the FM clause should explicitly state that such an event constitutes FM.
- "Including but not limited to" - without this wording it is open to argument whether any list of events is exhaustive. In the interests of certainty it is best to state whether a list is limited or not. The choice depends on whether the parties want to build in the flexibility to argue an unlisted event constitutes FM.
Force Majeure - Drafting Pitfalls
The pandemic has resulted in increased scrutiny of FM clauses and parties need to be mindful of how to overcome some common pitfalls seen in some boilerplate FM provisions.
Notices and time frames
Notice requirements can act as pre-conditions to relief and failure to meet those requirements might preclude a party from relying on FM. It is, therefore, important to be aware of exactly what they provide for and ensure they are not overly onerous or impractical. Common notice requirements include:
- an obligation to provide notice within a particular time period;
- an obligation to report periodically;
- a requirement to provide full particulars of the event and its impact on performance of the contract, an estimate of likely duration, and steps taken to mitigate the impact of the event; or
- requirements as to service of the notice.
Before inserting these requirements into your clause, consider whether they are necessary and/or practical.
For example, the form of service might not be practicable in certain situations. The circumstances of COVID-19 have shown that hand delivery, or even postal delivery might not be possible. Parties should therefore consider agreeing to electronic delivery instead.
If time frames are required to be adhered to for the giving of notice, it is better to be clear on what the time frame is: avoid vague drafting, such as "prompt" notice, and instead agree a specified time limit (e.g. within three months of a specific event).
Termination rights
Typically, an FM clause will suspend the performance of the affected party's obligations while the impact of the FM event continues. The aim is that, wherever possible, the contract will resume when the FM event ceases to impact the performance of the contract and both parties can then perform their obligations as they originally intended.
Some contracts provide for a right to terminate after a specified period of time. This might be advantageous in situations where the FM event is continuing to impact the performance of the contract indefinitely. Parties should, however, draft such termination rights with care. For example, ensure that there is a reasonable time period specified before the termination rights crystallise. Ensure also that the wording of such a right is clear as to whether the FM event must impact the performance of the contract for a particular period, or whether the FM event need only exist for a certain period of time. Equally, it is advisable to specify whether the time period is cumulative and allows for periods in which performance is not impacted, or whether it is sequential and restarts if there is a pause.
Parties might also consider whether to allow for the right to source goods or services from elsewhere after a particular period of time.
Mitigation
Parties are usually explicitly required to mitigate against the impact of an FM event and the drafting here should reflect whether mitigation:
- is an ongoing obligation;
- needs to be evidenced;
- is required to a standard of reasonable or best endeavours. Case law has shown that even a reasonable endeavours obligation imposes a heavy burden on the FM claimant to show for example that it could not have performed by seeking alternative supplies.
In the absence of express language there is authority that an obligation to mitigate can be implied if the clause defines FM as beyond the reasonable control of the party. The implied standard is the same as an explicit reasonable endeavours obligation.
Variation clauses
A well drafted variation clause could be used as an alternative mechanism to FM to build in flexibility in the event of a pandemic. For example, parties might consider inserting a variation clause which allows one or more parties to unilaterally amend their obligations so as to mitigate the impact of an event that affects performance of the contract in the future. This might be particularly useful in supply agreements. Also with respect to supply agreements, buyers (or suppliers depending on the circumstances) might consider inserting a clause that provides for no minimum volume with respect to supply in particular circumstances.
Change in Law Clauses
Although there may be scope for the English law doctrine of frustration to apply where performance of the contract has been made illegal by a change in law (CIL), the bar for this is high and would be of little assistance if it applied only to a few obligations rather than the contract as a whole. CIL clauses are designed to fill the gaps and allocate risk at the outset by allowing one party to claim relief if a CIL satisfying certain stipulated criteria occurs.
CIL clauses are common in construction contracts. They may overlap with an FM clause listing government restrictions as an FM event and the contractual consequences may be similar. However, while FM will typically allow for suspension from obligations to comply with a timetable, CIL usually allows for compensation for the need to comply with new unforeseeable standards. The key elements of the drafting of these clauses are as follows:
- The breadth of the definition of law. This can range from very narrow, including only acts of Parliament and statutory requirements, to all types of decisions, regulations or measures. Two particular aspects have been brought into focus by COVID-19.
- Whether a law is required by the clause to have "force of law". Although on its face, the government's Coronavirus guidance, such as the "two metre rule", is non-binding and so unlikely to be encompassed, the guidance's legal status is highly ambiguous. The Health and Safety Executive has indicated it may prosecute employers who fail to comply with the guidance as a breach of the Health and Safety at Work Act 1974, leaving scope for argument that the guidance does in fact have "force of law".
- The status of legislation in different parts of the UK given the disparities in the responses of the UK's devolved bodies to COVID-19.
Future drafting therefore needs to specifically address whether "soft law" guidance is included in the definition and take into account whether the law of England, Scotland, Wales or Northern Ireland is relevant.
- The scope of CIL which qualifies as an employer-risk event. For example, the clause may stipulate that the law "specifically refer" to construction premises for the provision of certain services.
Moving forward with Covid-19 - Finding a balance between commercial relations and reserving rights
Given the uncertainty of the current situation, most parties are adopting a "wait and see" approach to contentious issues arising from non-performance. Maintaining business relationships and reducing the risk of counterparty insolvencies through constructive negotiation should rightly be the priority to resolve any dispute. The fact that the root cause of any breach is likely to be COVID-19 rather than fault on the part of either party should encourage this.
Even if initial negotiations fail there is no need to immediately hit the contentious proceedings button. Other forms of ADR such as mediation, which can be conducted remotely, will likely be more conducive to long term business relationships and may be more readily available given the case overload of the courts and arbitral institutions. Such an approach is consistent with the government's and Construction Leadership Council's guidance on responsible contractual behaviour, which encourages parties to act responsibly and fairly and protect jobs and the economy. Although non-binding, this guidance encourages maintaining contractual performance where possible, thereby avoiding disputes and insolvencies and generally ensuring that economic activity can continue once the outbreak ends.
However, at the same time, parties should ensure that they reserve all rights in case amicable relations break down. Inaction or informal undocumented negotiation can create uncertainty as to the parties' positions and could inadvertently result in loss of rights:
- Waiver: If one party makes a representation that they will not insist on the enforcement of their rights and the other party acts on it, performance on those terms is waived. Unless there is a contractual exclusion clause, waiver can be inferred from conduct and in contrast to variation, there is no requirement for consideration. Failing to respond to FM notices could be construed as waiving the right to reject FM; even if the FM clause does not expressly require a response, where FM is not accepted a clear rejection should be sent, including a reservation of rights.
- Estoppel: Offering to accept reduced performance such as lower payments can give rise to promissory estoppel. This doctrine prevents the promisor reneging on their promise while the circumstances causing difficulties persist.
Documenting what has been agreed is the best approach to avoid any uncertainty. The drafting should cover some key elements:
- whether the modification of contractual rights is intended to be permanent;
- how long any temporary arrangements will last. This might be referenced to the end of pandemic related government restrictions or whenever one party gives notice;
- whether any contractual changes will be revived in the event of a second lockdown;
- whether the counterparty is required to make good any deficiency once the temporary arrangements end;
- whether the seller is free to sell the goods to others in the meantime, for example on the spot market;
- if payments are to continue without services what benefit will be received and will account be taken of the government's furlough scheme.
With special thanks to Ed Davies for his contribution.
