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COVID-19 and contracts: How does the pandemic affect my rights and obligations?

Gene Schirripa

08 Apr 2020

Topics

  • Business Law
  • Commercial Disputes
  • COVID-19
contract

The COVID-19 pandemic has created panic and uncertainty in all facets of society. Government-enforced lockdowns will make it hard – even impossible in many cases – for businesses to continue trading. For many businesses, the pandemic presents the following question: What happens to current contracts and the rights and obligations flowing from them? In this article, Gene Schirripa and Gemma Butler look at this issue.

Is there relief from contract obligations?

For some, due to the impact of the COVID-19 outbreak, it may be appropriate to rely on force majeure clauses (these clauses apply when unforeseeable events prevent parties from performing their obligations under a contract) or other contractual rights for relief from the performance of certain obligations.

However, if a dispute under a contract arises, the two opposing lines of argument are likely to be:

  • parties enter into agreements and should be held to meet the obligations for which they have contracted, notwithstanding the current circumstances
  • it would simply be unfair to hold parties to their obligations because the current situation was so unexpected, could not have been within the reasonable contemplation of the parties and performance of obligations has been rendered impossible.

Which side a business sits on will depend on the circumstances of each contract and potentially the relationship between the parties.

To help you navigate this uncertain and difficult time, this article will consider what you need to do to protect your business from such a dispute and how such a dispute is likely to play out before the courts.

What do you need to do?

1. Review your contracts

The first step is to review any commercial contracts you have. When you are reviewing your contracts, look out for force majeure clauses and consider whether these clauses might be triggered as a result of coronavirus.

If you are unsure as to whether your commercial contracts include a force majeure clause, it is important to seek advice.

2. Check your insurance  

If you think your contractual obligations are impacted by the pandemic, to avoid litigation, businesses should contact their insurance brokers and carefully review policies to ascertain whether they are covered in the current circumstances. However, business insurance usually covers interruptions to businesses caused by prevention of access to premises or damage to adjacent properties, and so it is possible that delays or interruptions caused by outbreaks of disease will not be covered.

3. Minimise risk

In these unprecedent conditions, it is important that you take steps to reduce your risk and mitigate potential ongoing negative implications. Businesses should consider the following, if appropriate:

  • Invite open communication with your suppliers or customers regarding the impact. Be as open and forthcoming with the impact so both you and the other party can reach an agreement that mitigates disruptions.
  • Invite open communications with other parties relating to contractual obligations.
  • Seek legal advice regarding whether a force majeure event applies to your contracts and what relief may be available to you.
  • Consider how the risks arising from this outbreak can be mitigated into the future. Take this time to reflect on your business model, your current and future contracts, and think about ways that these aspects of your business can be modified to reduce future risk.   

What is the legal position?

The relevant legal principles are force majeure and frustration.

Force majeure

Force majeure (meaning superior force) derives from common law and refers to unforeseeable events that prevent parties from performing their obligations set out in a contract. Often, contracting parties will include a force majeure clause into their contracts, rendering the contract null and void should such unforeseen events arise. A force majeure clause will normally prescribe what parties must do next.

A force majeure clause cannot be implied in a contract – which means that there needs to be an express clause in the contract covering what happens if an unforeseen event occurs. If there is a force majeure clause, it will be interpreted strictly and is confined to the contractual relationship that exists between parties.

The onus is on the party seeking to rely on the force majeure clause to prove that an event is captured by the force majeure clause, and that the event has prevented, hindered, delayed or affected the performance of the contract. In determining whether a force majeure clause covers the coronavirus pandemic, a court will consider the precise wording of the terms and agreement, allowing it to determine which risks the parties considered.

If there is no force majeure clause in your contract, or the impact of the coronavirus pandemic falls outside of its scope, then parties need to consider frustration.

Frustration

The common law doctrine of frustration applies where an event arises, such as a pandemic, that the parties have not contemplated in their contracts and that makes performance of the contract impossible (but not the result of a breach by any party).

The legal consequence is that the contract will be taken to have terminated at the point of frustration. Obligations that were due before the frustrating event are still to be performed, with only future obligations being discharged.

The key issue then becomes, at what point did the ‘frustrating event’ occur. This will largely be determined by directives from the Federal Government and the various stages of social distancing measures imposed. Different stages will present different challenges for various industries. In determining whether a ‘frustrating event’ has occurred, the courts will take into account the commercial purposes of the particular contract.

In Codelfa Construction Pty Ltd v SRA of NSW (1982) 149 CLR 337, in determining whether a contract had been frustrated, the High Court of Australia examined whether the circumstances imposed by a purportedly frustrating event were fundamentally different from the situation contemplated by the contract. The true question then becomes in these circumstances, does the virus create a situation in which the contracted work could only be performed in a manner radically different than the manner contemplated in the contract. Often, in the current circumstances, the answer will be yes, and the contract will be void.

However, it is important to note that parties cannot rely on the doctrine of frustration simply because they have experienced hardship. That will not be enough. The key tests as outlined above must be satisfied.

What does all this mean?

Contract disputes arising because of the current pandemic will turn on the doctrine of frustration and/or the operation of force majeure clauses. However, parties should take active steps to mitigate risks and avoid protracted disputes in what is already a difficult and challenging time.

How can we help?

If you would like more information about your contractual obligations, now or at any time, please contact the Business Services team at Snedden Hall & Gallop on 02 6285 8000 or by email.

*The content of this article is provided for information purposes only, and we do not accept any liability for reliance upon the information contained in this article.  This information cannot be relied upon as legal advice.