What effect does Coronavirus (COVID-19) have on contracts?

In this Special Notification, our Senior Associate Giovanni Marino examines the impact of Covid-19 on commercial contracts. Specifically, Giovanni looks at the remedies which are available if a contracting party is unable to perform the contract terms.

Special Notification – March 2020

As our readers are well aware, the health impacts of COVID-19 have been devastating and are ongoing.

Without seeking to minimise or set aside the significance and severity of the health effects of the virus, this article focuses narrowly on the effects that COVID-19 may have on commercial contracts.  Specifically, what are the legal remedies available if contracting parties cannot perform their contractual obligations, for example, due to unavailability of personnel (who may be in quarantine or who may be unavailable due to other restrictions), or perhaps due to delays or failures in the supply chain of goods and services.

In such cases, a party to a contract may be able to avoid their contractual obligations pursuant to a ‘force majeure’ clause in the contract, or otherwise under the legal principle of ‘frustration’.

‘Force majeure’ clauses

In the context of commercial contracts, ‘force majeure’ (from the French, ‘superior force’) is associated with ‘acts of God’ or unforeseen events which render performance of a contract impossible.  A doctrine of force majeure is not automatically recognised as a matter of law in Australia in such a way that it would be implied to operate in every contract, but parties to a contract may agree to include a force majeure clause in a contract.  Where a force majeure clause has been included in a contract, the clause will specify certain circumstances in which the contracting parties will be relieved from performing their contractual obligations.

If a force majeure clause is not included in a contract, the parties may still be able to rely on the doctrine of ‘frustration’ (see discussion below).

The scope and effect of a force majeure clause is a question of interpretation and depends on the wording in each contract.

The force majeure clause will usually be drafted to specify certain circumstances or events which are unforeseeable and make contract performance impossible, in which case the force majeure clause will be engaged.  These circumstances may include an ‘act of God’ (e.g. earthquakes, lightning, storm, flood), industrial action, war, revolution, riot, fire, explosion, embargo, epidemic, pandemic, and other circumstances beyond the reasonable control of the parties.

In the case of COVID-19, the key question will be whether the circumstances described in the force majeure clause captures the current circumstances of COVID-19.  This may be straight forward where the clause refers to ‘pandemic’ or ‘epidemic’, but it may be less clear if these circumstances are not expressly referred to.  For example, the clause may refer more generally to ‘unavailability of essential materials’ or ‘lack of transportation’ (as may result from COVID-19), and the party relying on the clause would need to argue these circumstances apply.

If the force majeure clause does cover the COVID-19 circumstances, the next step is to interpret the contract to determine the effect of the clause. For example, in the case of force majeure the contract may allow a party an extension of time for performance, excuse a failure to perform, provide a mechanism for suspension of performance, require the party relying on the force majeure event to mitigate its effects (e.g. take reasonable steps to avoid the effects of the event on performance of the contract), or allow for termination of the contract.  There may also be a specific procedure for providing notice under the force majeure clause.

As each force majeure clause will be different, each clause must be interpreted on a case by case basis to determine the rights and obligations of the parties, including whether there is any relief from performance of the contract.

Generally, a party who seeks to rely on a force majeure clause must prove the occurrence of a circumstance or event described in the clause.  If a party seeks to engage a force majeure clause, it should therefore be satisfied that the relevant force majeure circumstance applies.  If a party claims a force majeure event has arisen without any reasonable basis, for example, where performance of the contract is still possible, then this may cause the party to be in breach of the contract (for failure to perform) and/or the other party may in the circumstances be able to terminate the contract for repudiation (based on the first party’s unwillingness to perform).

Frustration

‘Frustration’ of a contract may occur where, without breach of the contract by either party, a contract has become incapable of being performed because the current circumstances in which performance is required would render the contractual obligations radically different from those which was originally undertaken by the parties.

If a contract is frustrated, the legal consequence is that the contract will be deemed terminated at the time of the frustrating event.  In respect of the COVID-19 virus, for example, the frustrating event could be claimed to be the implementation of travel bans which restricted movement of goods, or the implementation of social isolation measures which restricted use of personnel.  Further examples of frustrating events may include outbreaks of war, or changes in the law which make further performance of the contract illegal.  Termination of the contract at the point of the relevant frustrating event will discharge all obligations under the contact from that point onwards. This means that all obligations owed before the frustrating event occurred still require performance (e.g. monies owed for works already performed).

Whether an event is a ‘frustrating’ event needs to be considered on a case by case basis, looking at the terms of the contract and the surrounding circumstances.

The relevant frustrating event needs to have ‘radical’ or significant consequences and not merely alter the circumstances in which performance of the contract is required (e.g. mere delays may not be sufficient).

The courts have also considered frustration of a contract to arise where a party (who has further obligations to perform) has been deprived of substantially the whole benefit which the parties intended the first party would receive as consideration for performing those obligations.

Events that were contemplated by the contracting parties will as a general principle not be considered frustrating events. For example, in the case of COVID-19, if a contract was engaged in after the virus was known to the parties, and it had specific provisions related to it (such as delay mechanisms), then it is possible that even if the effects of the virus on contract performance were more severe than anticipated this will not be a frustrating event.

Under common law (or judge-made law), if the contract is frustrated, then the contract is terminated from the point of the frustrating event, and in general the parties’ losses lie where they fall, meaning a party would not have recourse to sue the other party for damages for non-performance from the time of that frustrating event.

However, legislation has been enacted in the following States which modifies the rights of parties where there is frustration of a contract at common law:

  • New South Wales – the Frustrated Contracts Act 1978 (NSW).
  • Victoria – the Australian Consumer Law and Fair Trading Act 2012 (Vic) (Part 3.2).
  • South Australia – the Frustrated Contracts Act 1988 (SA).

The legislation operates slightly differently in each State, but the objective of each piece of legislation is to adjust each parties losses and provide a fairer result, for example in relation to any monies paid by a party prior to the frustrating event where the other party was yet to perform its obligations (e.g. in relation to deposit payments).

For example, in Victoria, under Part 3.2 of the Australian Consumer Law and Fair Trading Act 2012 (Vic):

  • a court may allow a party to retain or recover amounts paid or payable under the contract, if it is just in the circumstances of the case (section 37);
  • if a party obtained a valuable benefit (other than payment of money) because of anything done by another party under the contract, then the benefited party is liable to pay that other party an amount that the court considers just having regard to all the circumstances, but not exceeding the value of the benefit obtained (section 38); and
  • if part of a contract has been wholly performed prior to its discharge (the frustrating event) then that part of the contract will be treated as a separate contract, and only the remainder will be subject to relevant ‘adjustment’ provisions in Part 3.2 of the Act (section 42).

Conclusion

The effects of the COVID-19 virus may impact the operation of commercial contracts for some time.

In respect of any existing contracts, parties can identify the potential commercial risks by reviewing existing force majeure clauses (if any) and determining whether the virus impacts will constitute a force majeure event.  If there is no force majeure clause, then consideration is required as to whether the virus will cause a frustrating event.

Going forward, prior to entering any new contracts, having a force majeure clause of appropriate scope, with clear wording to cover any COVID-19 impacts, will mitigate the risks of a party not being able to perform the contract due to these impacts.

If a contract does not include a force majeure clause, the doctrine of frustration may apply, but as discussed above, there is a high threshold for this doctrine being engaged, and the contract needs to have become incapable of being performed.


If you have any questions arising out of this article, please contact Giovanni Marino on (03) 9865 1339, or email Giovanni.marino@healthlegal.com.au.

View our other Covid-19 Resources here.

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