Can a contract be suspended or terminated because of the COVID-19 pandemic?

The COVID-19 pandemic is having a significant influence on the responsibility of parties to perform in terms of commercial contracts. Some examples might be:

  • A supplier agreed to supply certain products in terms of a contract, but due to the pandemic stock cannot be obtained to honour the contract.
  • A contractor agreed to construct or manufacture something, but as a result of shortage of material or a lockdown it can no longer complete the contract on time or at all.
  • A company leased a property with the intention of opening a restaurant, but as a result of government restrictions can no longer trade as a restaurant.

In certain situations, the party that can no longer perform the contract may have a right to suspend or terminate the contract.

Generally, the first question will be whether the contract has a force majeure clause and if not, whether it can be said that the contract has been frustrated.

Force Majeure

A force majeure clause is a clause in a contract that protects a party against unavoidable or unforeseen events such as tsunamis, earthquakes, acts of war and possibly against epidemics or pandemics. An example of a force majeure clause is below:

  1. Where a party is unable, wholly or in part, to carry out any obligation under this agreement by reason of an act of god, strike, lockout, war declared, blockage, lightning, fire, earthquake, flood, explosion, governmental restraint, unavailability or delay in availability of equipment or transport and any other cause whether of the kind specifically mentioned above or otherwise which is not reasonably within the control of the party affected (force majeure) and that party:
    1. gives the other party prompt notice of that force majeure with reasonably full particulars thereof, and insofar as known, the probable extent to which it will be unable to perform will be delayed in performing that obligation; and
    2. to use all possible diligence to remove that force majeure as quickly as possible, that obligation is suspended so far as it is affected by force majeure during the continuance of the event.

It will depend on the wording of the clause, whether the party will be excused temporarily or permanently from performing the contract. The force majeure clause will have to be carefully analysed to decide whether it protects a party against an event such as the COVID-19 pandemic. Some clauses may specifically refer to epidemics or pandemics, while others may have more general expressions like “disease or illness”, “quarantine”, “national emergency” or “government action”.

The most basic clauses do not list specific events, but simply refers to circumstances beyond the control of the parties. If the clause refers to events such as an epidemics or pandemics it will likely cover the COVID-19 outbreak, but where the wording is less specific it may be more difficult to decide whether a pandemic event is covered by the clause.

If the force majeure clause covers a pandemic, a party’s obligations will be suspended if the outbreak temporarily prevents it from performing its obligations under the contract. If, however, its performance of the contract is prevented entirely by the pandemic, the party will be released from performing the contract. An example of the latter might include a wedding venue which, due to government restrictions, is no longer able to host a wedding. An example of the former could be a contractor who is temporarily prevented from attending a site to perform the contracted work but can complete the contract as soon as restrictions are lifted.

Force majeure clauses usually require the party which can no longer perform the contract to take certain steps such as notifying the other party and mitigating (i.e., lessening) any damage caused by its non-performance.

If you are wondering whether a force majeure clause in a contract applies in the current climate and to make sure that the terms of the force majeure clause are complied with, we strongly recommend that you speak to a lawyer without delay.

Frustration of the contract

If the contract does not have a force majeure clause, the common law in Australia provides that where performance becomes impossible due to a supervening event that fundamentally or radically changes the parties’ contractual rights, and neither party is at fault the contract may automatically come to an end. This is known as the doctrine of frustration.

Events that have led to frustration of contracts were the destruction of a concert venue by fire, World War I, and the significant earthquakes in New Zealand in 2010 and 2011.

In order to establish that a contract has been frustrated a party will have to show at least the following:

  1. A supervening event that significantly changed the nature (not merely the expense or difficulty) of the outstanding contractual obligations.
  2. Neither party to the contract is at fault.
  3. The parties must not have contemplated the supervening event when they made the contract.
  4. It would be unjust to hold the parties to the original contract.

The contract will not be frustrated if it merely becomes more expensive or difficult to perform. In a number of cases, parties contracted to deliver goods by ship to Europe. The Suez Canal was closed by government order and parties were forced to use a much longer route. Delivery was still possible, but at very little or no profit to the carrier. The courts decided that the closure of the Suez Canal did not amount to a frustration of the contract. Accordingly, if the coronavirus and the recent Government restrictions have made a contract more difficult or costly to perform it does not necessarily mean that a contract will be frustrated.

However, a change in the law or substantial government intervention that makes performance of the contract impossible might very well be regarded as frustration of the contract. For example, the outbreak of World War II led to commercial contracts between British and German companies becoming illegal, because it amounted to trading with the enemy. This was accepted as an event that frustrated performance of existing Anglo-German contracts. The same may apply to contracts that were frustrated due to government-imposed lockdowns or restrictions in response to the current pandemic.

According to the common law, a contract automatically ends at the moment that the event of frustration occurs. A party will be relieved from performing any further obligations in terms of the contract, but not necessarily of obligations that already exist. For example, if part of the contract has already been performed, a party may be liable to make payment for that part of the contract; or if a non-refundable deposit has been paid, the deposit may be forfeited.

If a contract you entered into has been influenced by the coronavirus pandemic or restrictions put in place as a result, you may be entitled to postpone, terminate or treat the contract as frustrated, depending on the facts of your case. If you think this applies to you, we recommend that you get legal advice as soon as possible.

Variation by consent

If the government-imposed lockdowns and restrictions have made it more difficult to perform existing contractual obligations, another option to consider is negotiating with the other party to vary the contract, even in the short-term, to make it easier to perform.

We are already seeing this with some banks offering mortgage relief to borrowers affected by the business downturn resulting from the COVID-19 pandemic.

A contract can usually be varied (or even terminated early) if all parties to the contract agree to the changes.

Conclusion

The COVID-19 pandemic has fundamentally changed the business (and social) landscape across the world, at least for the foreseeable future. If you or anyone you know needs help or advice, please don’t hesitate to contact us.

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