How Does COVID-19 Affect My Contractual Obligations?

Wednesday, March 25, 2020

The effects of COVID-19 have rippled throughout the world, placing immense strain on public health providers and businesses of all sizes. While developing a way to contain and control COVID-19 is of upmost importance, it is also necessary for individuals and businesses to understand their contractual rights and obligations during this time.

This update is aimed at helping business owners understand how the outbreak of COVID-19, and the preventative measures being taken, may impact their ongoing contractual obligations. We will provide you with a brief overview on:

1. force majeure clauses and the doctrine of frustration; and
2. practical considerations for handling the effects of COVID-19.

Force Majeure Clauses and the Doctrine of Frustration

Force Majeure Clauses

It is always a possibility that business transactions may be rendered impossible to complete due to extreme and unavoidable events that are beyond the control of the transacting parties. Such extreme and unforeseeable events are often referred to as “force majeure” events. Examples of events typically captured under the umbrella of “force majeure” include wars or acts of terrorism, lockouts, strikes, shortages of energy supplies, and other events commonly referred to as “acts of God” for which no person can be held responsible (i.e., natural disasters).

Force majeure clauses can be negotiated to include a list of specific events that will trigger the provision, whereas others may be drafted broadly, leaving it to the parties to prove or otherwise agree that a “force majeure” event has occurred. While the language in force majeure clauses is unique to each contract, such clauses typically contain the following elements:

1. language excusing one or both parties from performing the contract if a force majeure event occurs;
2. a list of force majeure events which are typically negotiated by the parties;
3. obligations of the impacted party when a force majeure event occurs (i.e., notice and mitigation obligations); and
4. prescribed remedies.

Regardless of its specific details, a force majeure clause generally only addresses events that are unexpected and beyond reasonable human foresight and skill.

As we navigate how to manage the effects of COVID-19, it is without question that many business owners are engaged in extensive contract review of force majeure clauses and considering how such clauses will apply in light of this crisis. Business owners should be advised that in order for the COVID-19 pandemic to trigger the operation of a force majeure clause, the general rule is that the impacted party will have to show that the pandemic was: (i) unforeseeable; and (ii) that it has made the performance of its contractual obligations impossible.

A key element in this analysis is whether it is actually the COVID-19 pandemic itself that has made it impossible to perform contractual obligations, or if such inability of a party to perform contractual obligations is due to prior decisions or actions made in light of the crisis at hand. Proving this causal link requires the impacted party to provide strong evidence that the performance of its obligations has been hindered or delayed as a direct result of the pandemic.

When trying to rely on or invoke a force majeure clause, it is also important to recognize that such clauses typically contain a duty on the impacted party to mitigate the effects of the force majeure event. The standard of mitigation is that of commercial reasonableness. Accordingly, a party relying on a force majeure clause should be able to demonstrate that there are no commercially reasonable alternatives available to mitigate the effect of the event and its corresponding impact on the affected party.

Those relying on such clauses should be further advised that, if successful in invoking a force majeure clause, it will only forgive or postpone obligations that are directly affected by the COVID-19 pandemic, not all obligations under the contract.

What if my contract does not contain a force majeure clause? – the Doctrine of Frustration

When negotiating the terms of a business transaction, parties can be consumed by the big picture items of the transaction and fail to consider what could be classified as boilerplate provisions. As a result, a contract may be silent as to how to proceed in the face of extreme and unforeseeable events. Whether or not transacting parties explicitly chose not to include a force majeure clause, or simply forgot to do so, the current practice of the Courts is to not read-in a force majeure clause into the contract. In these situations, a party that is unable to perform contractual obligations due to a force majeure event will have to argue that the contract has been frustrated.

The common law doctrine of frustration may apply when a supervening event causes a contracting party’s principal purpose for entering into a contract to be destroyed or prevented. It is important to note that, unlike invoking a force majeure clause, a party arguing that the doctrine of frustration of contract should apply is not claiming that performance of its contractual obligations is impossible. Rather, it is a higher-level argument that the impacted party’s reason for entering into the contract no longer exists. Case law has suggested that a party claiming frustration of contract must satisfy the following:

1. the impacted party can no longer accomplish its purpose for the transaction;
2. all parties to the contract knew of the impacted party’s principal purpose for entering into the contract; and
3. a qualifying supervening event caused the frustration.

A successful argument of frustration of contract would put an end to the contract; however, the above test sets a high threshold, which is often difficult to prove.

Frustration of contract is commonly used in employee-employer agreements when, for instance, an employee’s place of work is destroyed and the purpose for the employee’s hire no longer exists.Another example is where a property is sold for a specific purpose and after the contract is entered into a municipality passes a zoning by-law prohibiting such purpose. In light of the COVID-19 pandemic, a party seeking to rely on the doctrine of frustration will have to ask itself whether: (i) the pandemic has affected the foundation of the agreement; and (ii) that foundation still exists. More practically, the impacted party should ask themselves whether the COVID-19 pandemic qualifies as an intervening event which has rendered the contract radically different than what was agreed to. Although this route might prove to be complicated, difficult and costly, in light of a crisis, it might be the only option for a struggling business.

While the above principles provide a useful guide on how force majeure clauses or the doctrine of frustration may apply to contractual obligations affected by the COVID-19 pandemic, business owners are encouraged to pay attention to the specific details of their contracts and consult with their legal counsel  if such claims are being made.

Practical Considerations

While legal analysis is often helpful, we want to remind our readers that in times like these, there are also practical considerations that could save time and money when confronting these unforeseen issues.

Communicate

We encourage business owners to use communication as their first tool when negotiating their way through unexpected changes and constraints. All businesses are experiencing the impact of COVID-19 on a global scale and it is likely that all parties to a contract are coming to the table with similar concerns. It is hoped that having an open line of communication and discussing the wording of the contract in light of practical realities will lead to amicable negotiations, reduced costs and creative solutions.

Start Discussions Early

If you know this crisis will affect a contract that you are entering or have already entered into, start the discussion now. Some force majeure clauses will contain notice requirements, but in the absence of such guidelines, it is always best to act with good faith by notifying the other party of the anticipated issues as soon as possible. Given that provincial and federal governments are enacting preventative measures on a daily (or even hourly) basis, it is important to be patient and pay attention to the timing of your requests and how they might be affected by evolving political measures.

Learn from Experiences

We will all learn from this crisis and anticipate that parties will pay more attention to crisis-prevention measures in their contracts going forward. Recognizing and recording what works best during this time will make businesses better prepared for managing extreme and unpredictable events in the future.

If you have any questions with respect to this legal update, please contact Dan Shapira ([email protected]), Tommy Sorbara ([email protected]), Jessica Coco ([email protected]), or any other member of Wildeboer Dellelce LLP.

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.