Contracts, Frustration, Force Majeure and COVID-19, a quick guide.

The only certainty in present times appears to be uncertainty. There remain however a great number of contractual relationships premised on society and business functioning as usual. Contracts are not often drafted with a specific international crisis in mind; not unsurprisingly, many are seeking advice as to what their rights or liabilities may be if and when their contracts become incapable of performance or would result in something very different to that planned. What follows is a quick guide.

This article was updated on 26 March 2020 to account for the Coronavirus Act receiving Royal Assent, and on 27 March 2020 in response to the Health Protection (Coronavirus, Restrictions) (England) Regulations 2020.

Contractual risk allocation, or frustration.

When external events overtake anticipated performance, contracts generally fall into one of two categories:

  • The parties have agreed (or will be taken to have agreed) where any losses are to fall, and the dispute is resolved by constructing the contract according to the usual principles. This is often with reference to a ‘force majeure’ clause;
  • If (and only if) the contract does not allocate the risk, and performance would be “radically different” from that bargained for, it may be that the doctrine of frustration brings the contract to an end and apportions the losses according to the statutory regime.

What are the potential problems?

The situation appears to be evolving by the day, however at the time of writing key concerns would appear to be—

  • shortages of staff or resources due to illness, self-isolation or redundancy as affecting either the contracting parties, their own suppliers, or those further up the supply chain;
  • the unavailability of key personnel due to illness, self isolation or redundancy;
  • the cancellation of public events (or restrictions causing their happening to become unfeasible in practice), and closure of public facilities; and
  • government mandated closure of businesses and premises.

The Health Protection (Coronavirus, Restrictions) (England) Regulations 2020 came into force on 26 March 2020, revoking the previous regulations and setting down in law the restrictions announced by the Government on Monday 23 March 2020 with which we are all now familiar. Pubs, restaurants, etc must cease selling food and drink for on-premises consumption, and all businesses except those listed in Part 3 of Schedule 2 must close their physical premises. Individuals may not without reasonable excuse leave their homes (including gardens) and cannot gather in groups of more than two, subject to some limited exceptions. Enforcement may be by way of fixed penalty, but prosecution is not excluded. Businesses should of course be aware of the potential for aiding and abetting an offence by another. The prohibitions are to be reviewed every 21 days, with the power to ease the restrictions in part or in whole, and the regulations contain a six-month ‘sunset clause’.

Beyond the immediate powers of the regulations, the Coronavirus Act 2020 received Royal Assent on 25 March 2020, with section 52 and schedule 22 permitting the declaration of a “serious and imminent threat to public health” on the grounds of Coronavirus, which will be published online and in the London Gazette.

Such a declaration empowers the Government to prohibit or impose restrictions on gatherings and events, whether specifically named or as matching a description (the Act anticipates a limit on the number of attendees). Similarly, power is given to force premises to close or restrict entry, again whether specifically named or by description (the Act anticipates reference to capacity, purpose of attendance, and the facilities within such premises). Prohibitions by description must be, rather vaguely, “published in such manner as… appropriate to bring it to the attention of persons who may be affected by it.”

Breach of prohibitions, restrictions and the like issued under the Act would attract a criminal sanction for event organisers, owners/occupiers of premises, those responsible for managing entry, and rather broadly “any other person involved in holding… an event or gathering” albeit mere attendance is insufficient. Although compensation may be payable in response to prohibitions made in Scotland, Wales and Northern Ireland, there is no provision within the Act relating to England.

It is expected that the use will be made of these provisions when a more nuanced approach is required to social distancing.

What does the contract say?

Commercially negotiated or standard form contracts are more likely to make provision for unexpected events, most often by way of a force majeure clause.

Force Majeure

Force majeure as a concept comes from foreign civil law and has no codified meaning within the English legal system; this has not stopped lawyers from negotiating and including clauses under this banner for some time. The purpose of such clauses is specifically to expand and modify the doctrine of frustration which is comparatively narrow and prescriptive.

Common law force majeure clauses are ordinarily made up of two principal parts, one which defines the event and one which describes the contractual consequences.

How Majeure?

Civil law tradition dictates that a force majeure event amounts to circumstances beyond either of the parties’ control which are serious, unpredictable and unavoidable.  Within civil law territories, statute or civil code governs the force majeure regime, oftentimes entitling a state to ‘declare’ an event as force majeure (as the Chinese Government have done with COVID-19) although the impact of such declarations is unreliable and based on the legislative approach adopted. 

In England and Wales it is up to the parties to contractually define the contemplated events, which can be much broader than the civil law regime; this approach requires careful initial drafting.  The Courts have occasionally been asked to interpret force majeure definitions but not within the context of a pandemic; expect that to change very soon.

In more general case law, the Courts have looked to the ordinary rules of contractual construction to give effect to the Parties’ intentions when entering the contract.  Care should be taken to consider the wording used within a relevant force majeure clause. A pandemic is likely to be caught by the often included ‘act of God’ but it may be that  ‘Government action’ or ‘legal prohibition’ also fall for consideration; where these contemplated events are expressly included or excluded from the force majeure definition the applicability of the clause will be modified accordingly.  There are plainly arguments to be had here given the loose wording often employed in standard form contracts.

Future Contracts

Note that while it may not classically be ‘force majeure’ in the civil law context, there is nothing stopping clauses in contracts governed by the law of Engaland and Wales from incorporating wider contingencies including (for instance) the short availability of labour or materials, or the cessation of a form of transport and / or method of physical delivery.  The Courts have previously had little trouble in finding that the severe restriction of raw materials during a national crisis is sufficient to meet clauses adequately contemplating the same.

Although it is less likely that contracts drafted prior to the COVID-19 pandemic will include such contingent terms, there is nothing stopping newly negotiated contracts including more specific terms suspending performance or varying the price on occasion of changes in the cost or availability of materials, or a specific clause which adequately contemplates changes in the ‘cost of doing business’ as it applies to each commercial situation. This approach is all the more important given that parties entering into new contracts will be unlikely to rely on force majeure events relating to the COVID-19 pandemic, since the wide ranging socio-economic effects of the crisis are known to the parties at the time of contractual formation.

These specialist clauses will be outside of the scope of force majeure, but better protect parties from finding themselves in what may become deeply unprofitable contracts at the worst possible moment.

The Effect of Force Majeure

Once it is established that the force majeure clause is operative, the party relying on the force majeure event must show it was prevented or restricted in performing its contractual obligations as result of the event, that the event was beyond its control, and that the event was unavoidable.

Attention returns to the contract and the second part of the force majeure clause, describing the contractual consequences.  Unlike frustration, often this will be the mere suspension of performance for the duration of the force majeure event, with consequential elongation of any term of the contract; in essence allowing the contract to survive a time-limited force majeure event.  With that said, relevant clauses can include provision to terminate the contract immediately or after a prescribed period of suspension.

Two arising obligations are often found drafted into force majeure clauses: the requirement to notify the other party on an ongoing basis and the requirement to mitigate. In any event notification and mitigation are good practice and should litigation later arise, parties will be judged on their respective approaches.

Contracts without a Force Majeure clause

Even where no provision explicitly deals with force majeure or the outbreak of disease, the Court will still look to the broader terms of the contract to ascertain if the risk is allocated by implication. The test is what the parties objectively intended to occur; often the party taking on an obligation is also deemed to take on the risks; however, other relevant factors include—

  • whether the contract was made at a time when the present outbreak in the UK was a reasonably foreseeable prospect; and
  • whether there is allocation of risk for other types of loss or other generally unusual events, and how broadly these clauses are drafted.

Although the provisions of Unfair Contract Terms Act 1977 the Consumer Rights Act 2015 may strictly be invoked, unless an exclusion clause is drafted so as to exclude all liability, the unusual nature of the outbreak is unlikely to fall foul of the underlying objective of preventing unfair surprise.

When might the contract be frustrated

Frustration is described as a seldom-upheld remedy, however present circumstances are so unusual that the chances are not as low as previous discussion may suggest. It applies where, generally speaking, without the fault of either party an obligation becomes incapable of performance because such performance would be “radically different” from that bargained for. Importantly, the cause must not be the decision of either party even if taken under pressing financial or other constraints.

First, it is generally recognised that difficulties in sourcing labour, materials and the like are unlikely to render performance “radially different” – it will instead be simply more expensive or onerous, take longer than anticipated, or require performance by a different method. An outright unavailability of a necessary ingredient to the contract would usually only lead to a delay. The only possible exception may be if performance is particularly time-critical (however in such circumstances it is likely that construction of the contract would place the risk on the performing party and the doctrine would not apply).

A situation that may frustrate the contract would be the death, serious illness leading to incapacity, and probably PHE advised self-isolation of a party to a contract. However, this is almost certainly limited to agreements construed as requiring “personal service” – i.e. it is not just performance that has been agreed, but performance by a specific individual. This is more likely in the context of trades and professions, but is not guaranteed. The potential for future performance is also a relevant consideration, it being unlikely that future scheduling difficulties following a short period of illness or self-isolation would suffice.

Second, the cancellation of public events is unlikely to frustrate contracts unless the occurrence of the event underpins the entire contractual venture. The law in this area is complex and conflicting, but the prevailing view appears to be that only a joint assumption by the parties that the event will go ahead is sufficient. If one party is simply taking advantage of the opportunity to profit from increased business, this is unlikely to be enough – the common example being the taxi driver who has little concern over whether the Epsom Derby will or will not take place, only that there is increased custom in the locality.

Finally, supervening illegality is recognised as a circumstance giving rise to frustration depending on the extent and length of the prohibition. It is important to note that the provisions within the Coronavirus Bill are relatively open-ended albeit limited to the Government’s view of public health requirements.

When (and it seems when) a declaration is issued so as to make an event or gathering unlawful, this may frustrate contracts pertaining to it depending on whether performance at a later date would be a viable option. The same applies to other circumstances and scenarios rendered unlawful. At the time of writing, the prevailing view appears to be that broad restrictions are likely to be short-lived, and that the pandemic is not an indefinite state of affairs.

The Effect of Frustration

Should a contract have been frustrated, there are two principal effects:

  • The contract terminates;
  • The statutory provisions, if not disapplied by agreement, will apportion loss.

The statutory provisions under Law Reform (Frustrated Contracts) Act 1943 will apply unless the contract makes alternative contingencies. It will only apply to the specific contract that has been frustrated, and will not affect severable (i.e. separate) obligations that have already been performed.

As to the payment of money under a frustrated contract, the Act provides that:

  • Future sums cease to be payable;
  • Sums already paid must be refunded, subject to the Court’s discretion to allow a “just” sum to be retained to compensate for expenses already incurred in anticipation of performance.

The general effect is a financial ‘undoing’ of the contract, and parties would be well advised to be prepared to justify their expenditure and how it relates to the part of the contract that cannot be performed.

As to the provision of services, the Act provides that where these have already been provided and the recipient has obtained a “valuable benefit”, a “just” sum must be paid to the provider by way of compensation. The amount of this “just” sum will depend on the expense of providing that service (and whether money has already been offset under the other provisions to account for these) and how valuable these services are in light of the frustrating event, but cannot exceed the value of the benefit itself. Unfortunately, there is very little authority on how the Court will approach this exercise, and such authority that exists has been heavily doubted.

Unless the contract or statute required the parties to have been insured in respect of performance, the Court will not take account of any insurance monies received when making the above calculations.

Finally, supervening illegality is recognised as a circumstance giving rise to frustration depending on the extent and length of the prohibition. It is important to note that the provisions within the Coronavirus Act are relatively open-ended albeit limited to the Government’s view of public health requirements.

As always, this article is only a basic guide and is not offered as advice for any specific factual situation. Mike Blitz and Adam Griffiths, the authors of this article, both practise in Chambers’ specialist commercial team, and are able to assist with any queries arising from the article.