Force majeure and COVID-19 – what you need to know now

COVID-19 has already had an unprecedented impact upon business and the economy.  

Supply chains have been disrupted, business arrangements have been altered and there is a real uncertainty in the community about how to respond to the event.

So what do you need to know and what do you need to do immediately to manage this issue?

This article sets out the basic knowledge that every business manager, director and in-house legal team should know.

It steps you through the concepts that you need to understand and suggests five key questions that you should be asking now to address issues that can confront you. 

The starting point - “Frustration of contract”

Under the common law of contracts, there is a doctrine of “absolute liability”.

That doctrine states that if a party voluntarily enters into a contract, that party must perform all its agreed obligations.

Obligations must be met even if performance is impossible, and failure to perform would render the non-performing party liable to compensate the other party.^[1]  

A strict application of this doctrine can mean that performance becomes impossible through neither party’s fault.

Courts have acknowledged this approach created hardship.^[2] They invented the “Doctrine of Frustration” to deal with this hardship.

The doctrine states that there should be an automatic mutual discharge of the contract where performance becomes impossible. That discharge requires a situation where:

• neither party is at fault
• meeting the obligations under the contract become “radically different” from those contemplated by the parties to the contract.

The legal consequence of a contract found to have been frustrated in this way is that the contract is automatically terminated at the point of frustration.

The contract is not void ab initio ("from the beginning"), it is only future obligations that are discharged. This means that, after the point of frustration neither party can demand further performance by the other.

At common law, obligations which fell due for performance before the frustrating event are valid, and if the obligation is not performed the innocent party can seek a remedy.

Furthermore, contractual promises that were not conditional upon further performance of the contract may remain enforceable, as may terms in the contract that are clearly intended to be operative after termination (whether or not by frustration). An example of this is an alternative dispute resolution process which, if drafted correctly, always binds the parties after termination.^[3]

A contract will not normally be found to be frustrated in the following situations:

• construction delays, shortage of materials, and shortage of skilled tradespersons as these are inherent risks in construction, and therefore reasonably foreseeable.^[4]
• a supervening event that was contemplated by the parties, even if the parties fail to anticipate the severity.^[5]
• self-induced frustration.^[6]
• hardship, inconvenience or a bad bargain.^[7]

If COVID-19 results in any of the above events in a contractual relationship, there is a good argument that could be mounted that the contract involved had not been frustrated.

But each situation must be analysed on its facts. It is important to not make any assumptions about whether the contract is, or is not frustrated, just because of the COVID-19 issue now confronting us. One of the problems is that failure to properly define whether a contract has been frustrated may radically affect the relief available to the parties under the contract.

Under the common law doctrine of frustration, losses lie where they fall. An example is where a venue hire deposit has been paid for an event for this Saturday night, but the venue burns down the day before the event. Under the common law, the contract has been frustrated, and all obligations from the point of frustration will cease for both sides. However, usually, the deposit would be forfeited.

In Australia three jurisdictions have created legislation to reduce this harshness: 

• NSW (Frustrated Contracts Act 1978)
• South Australia (Frustrated Contracts Act 1988)
• Victoria (Australian Consumer Law and Fair Trading Act 2012)

Each statute operates slightly differently however the overarching aim is to provide a fair result where, for example, in the case of the venue hire referred to above, the deposit would be repaid.

A key issue for the review of all contracts is to check whether the contract jurisdiction clause includes the law of NSW, South Australia or Victoria. In that case regard should also be made to the legislation in those states.

Force majeure clauses

To overcome the limited application of the doctrine of frustration, a “force majeure” clause is often used.

This is an express agreement in the contract as to how risk is to be allocated should part or non-performance occur as a result of certain specified events.

It operates to exclude liability where a party's failure to perform is caused by forces (either natural or human) beyond its control, and usually goes beyond “Acts of God” (for example tornado, flood, tidal wave etc.).

However, under the principles of ‘freedom to contract’ parties are free to define it and set its parameters as they see fit.

Under a contract, parties cannot normally invoke a force majeure clause if they are relying on their own acts or omissions.

The effect of a force majeure clause is that it enables the non-performing party to escape liability for failing to perform as a result of the force majeure event.^[8]

Generally there are three essential elements to force majeure clauses when they are prepared:

• it can occur by forces either natural or human
• it cannot have reasonably been foreseen by the parties
• it was completely beyond the parties' control and they could not have prevented its consequences.^[9]

Is COVID-19 something that falls within that definition of force majeure? The answer really depends on the drafting of the clause.

When drafting a force majeure clause it is important to define what is meant by an event of “force majeure”. In addition to stating that the clause relates to acts beyond the reasonable control of the parties, specific events should be defined. Examples include electricity supply strikes, insurrections, riots, and wars. Key terms which have a degree of imprecision such as “Acts of God” should be defined and, with natural events, can be defined as including floods, bushfires and earthquakes.^[10]

It would be astounding if anyone had drafted a definition of force majeure in any contract entered into before December 2019 which referred to COVID-19 as an act of force majeure. Before that time, people did not know COVID-19 existed.

But is it possible to fit the event of COVID-19 within the existing definition of a “force majeure clause”? It really depends on an analysis of the contract itself.

As force majeure clauses are creatures of contract, their interpretation will be governed by:

• the agreed width of the clause. For example, the vendor will want to use the words “…and include, but not limited to …” but the purchaser will want to narrow the width by seeking to remove these words
• the normal rules of contractual construction:
  • according to the contra proferentem rule, the clause will be construed strictly and in the event of any ambiguity the clause will be interpreted against the interests of the party that drafted it. The parties may contract out of this rule
  • according to the ejusdem generis rule, when general wording follows a specific list of events, the general wording will be interpreted in light of the specific list of events. In this context it means that when a broad "catch-all" phrase, such as "anything beyond the reasonable control of the parties", follows a list of more specific force majeure events, the catch-all phrase will be limited to events analogous to the listed events. Wording such as "including, but not limited to,..." seeks to subvert this rule.

 Again each situation must be analysed on its facts. It is important to not make any assumptions about whether the force majeure clause is, or is not operative, just because of the COVID-19 issue now confronting us.

Also for consideration is what happens when a force majeure clause becomes operative. The contract should identify the obligation, how it will be affected by the force majeure event, and be clear as to the:

• obligations on the parties arising when a force majeure event occurs. For example:
  • will there be an obligation of mitigation?
  • whether the buyer can engage another party to do the work if the seller cannot perform it due to a force majeure event, and whether the buyer can then charge the seller
  • will payments to the vendor continue notwithstanding the delay?
  • what will be the duration of the force majeure temporary period, for example 30 days, and then what happens after this maximum temporary period ends, that is after the 30th day? Will the contract be terminated or terminable by notice?
  • what will happen to payments that ordinarily would have been incurred for late or non-delivery?
  • will the agreed number of units still need to be supplied, or is the contract terminated or terminable?
• obligations on the parties after the force majeure event ceases. For example what does the non-performing party need to do to catch up with its obligations? 

Further,  the agreement should contain a requirement that the party unable to perform must advise the other party as soon as reasonably possible about the force majeure event, the expected duration of non-performance and what, if anything, can be done to ensure continuity of supply for the buyer (if the party unable to perform is the vendor).

The effect of a force majeure clause is that it enables the non-performing party to escape liability for failing to perform contractual obligations as a result of the force majeure event.

Parties cannot invoke a force majeure clause if they are relying on their own acts or omissions.

Five key questions to ask now

1. Has COVID-19 now made your contract impossible to perform or is it merely harder? For example, does it involve:

• construction delays, shortage of materials, and shortage of skilled tradespersons as these are inherent risks in construction, and therefore reasonably foreseeable?
• a supervening event that was contemplated by the parties, even if the parties fail to anticipate the severity?
• self-induced frustration?
• hardship, inconvenience or a bad bargain?

2. Is your COVID-19 issue covered by legislation in NSW, South Australia or Victoria?

3. Do you have a “force majeure clause” in the contract or similar “hardship clause”?

4. Is the clause drafted widely enough to cover a COVID-19 event?

5. Does the operative part of the clause cover the consequences of a COVID-19 event?

The answer to each question depends on a case by case analysis of the contract in light of the principles referred to above.

A timely review of these clauses could substantially benefit your business in determining a pathway to deal with the issues that arise due to COVID-19.

Authors: Paul Venus & Scott Alden

^[1] Paradine v Jane (1647) 82 ER 897.
^[2]  Taylor v Caldwell (1863) 122 ER 309.
^[3]  Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337.
^[4]  Davis Contractors Limited v Fareham Urban District Council (1956) AC 969.
^[5]  Claude Neon v Hardie (1970) Qd R 93.
^[6]  Maritime National Fish Ltd v Ocean Trawlers Ltd (1935) AC 524.
^[7]  Tsakiroglou & Co Ltd v Noblee Thorl Gmbh (1962) AC 93.
^[8] Matsoukis v Priestman & Co (1915) 1 KB 681.
^[9] Lebeaupin v Richard Crispin & Co (1920) 2 KB 714.
^[10] The Commissioner of Railways (WA) v Stewart and Others (1936) 56 CLR 520.

Disclaimer
The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this newsletter is accurate at the date it is received or that it will continue to be accurate in the future.

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