As the COVID-19 situation continues to develop, the areas of challenge for most businesses are wide ranging. For many, the management of contracts with suppliers and customers is a very real concern.
Businesses may well be able to resolve short-term problems through practical dialogue and working together to overcome problems, but this may not always be possible. In addition to endeavouring to find a workaround, and assuming there is no legislative intervention on how contracts are going to be affected, the parties need to look carefully at their contractual position to consider whether they need or are able to change, suspend or even end their contractual obligations, depending on the issues they face. They must ensure that any steps required by contract are taken in order to protect themselves (such as service of any appropriate notices). For businesses tending to use longer term supply contracts, some of these are going to be:
The contractual commitment itself – does the contract actually require the business to supply/buy or is this in some way discretionary or capable of being rolled over? For example, framework arrangements may require each order to be agreed by the parties on an order by order basis. Conversely, there may be hard minimum purchase/supply guarantees which need to be adhered to.
Timescales – are there hard timescales that must be met or is there a procedure dealing with permitted delay or rescheduling? If the terms of the contract allow for extensions of time, follow the mechanism and procedures set out in the contract.
Prices – for suppliers faced with increasing costs, is there a relevant price adjustment mechanism that can be used? Often this is a feature of a longer term supply contract, where known price risks have always been anticipated, but for many “standard” contracts such a mechanism may simply not have been included, because no such risk was perceived at the time.
Payment delays – struggling customers may seek to negotiate extended credit terms to cover the short term, and suppliers may experience significant payment delay. Unpaid suppliers will need to consider any security they have such as guarantees and whether to exercise rights under these and whether any additional payment security is realistic. In a late payment situation, suppliers can be tempted to suspend supplies or other performance, but care is required as, in the absence of a contractual right, there is no general ability to suspend performance and doing this unilaterally may risk legal action from customers.
Prioritisation – can a business prioritise key customers? Again it depends on the commitments given and a supplier may find it has commitments to all customers. Where this is the case, prioritising some customers may only be achievable by terminating contracts with others. Businesses need to be aware, however, that terminating a contract is not always straightforward. There may be clear and obvious rights of termination, for example, the ability to terminate without cause on notice. In long term agreements this is often not the case and the parties will need to look much more carefully at whether there are grounds for termination such as for the material breach of the other party, and these grounds may simply not exist. It is also advisable to consider whether there are non-contractual issues associated with prioritisation or termination. For example, refusal to supply can in certain circumstances infringe competition law if a business is ‘dominant’ or if the decision on who to terminate is based on problematic criteria (say a decision only to terminate habitual discounters).
Can insurance help? Business interruption cover is perhaps the most relevant cover, where businesses carry it, but the Association of British Insurers has just issued guidance to the effect that many standard business interruption policies will not respond and the position is further confused by the message given by the Government as at the date of this article (the Government is suggesting people stay away from pubs and restaurants, but is not requiring them to close). Consider also other insurance policies that might be relevant, such as credit, professional indemnity, property, and environmental insurance policies, amongst others. In all cases, it is essential that where a policy might respond, the insurers are notified in compliance with the notification clauses in the policy.
Performance Excusing Clauses – inevitably and often seen as a last resort, parties are having to look closely at clauses that might excuse performance in all their guises. In some cases, commercial contracts include “material adverse change” type clauses to the benefit of one or both parties which may also help if linked to termination rights, or as triggers to renegotiate other terms such as pricing. The use of all such provisions is likely to be contested and their exact language and effect will inevitably come under close scrutiny. Always remember that unless the contract provides otherwise, a party is not able to suspend or delay performance of its contractual obligations. The most frequently occurring performance excusing clause is the Force Majeure clause, and so it is worth considering this type of clause in greater detail.
Considering Force Majeure
As the term has no specific legal definition under English law whether the current COVID-19 outbreak and its effects amount to Force Majeure under a contract will depend on the wording of each specific clause. Although these clauses often superficially are quite similar, the detail can be extremely varied not just in terms of how Force Majeure is defined, but also the extent to which the parties are excused, whether it triggers a termination right and the procedures that must be adhered to.
For suppliers, a widely defined definition of Force Majeure is most helpful and commonly Force Majeure clauses will, in addition to lists of particular events, refer to events “beyond the parties’ reasonable control” and the like. In the current situation, when considering if the clause applies, it is clearly helpful if there is specific reference to pandemic/wide spread illness and similar terminology, but general wording alone may cover the position.
Contracts normally require not merely that a force majeure situation exists, but also that the Force Majeure event has actually caused the failure to supply (or other contract failure) so this needs to be established. In this regard, some clauses require the party affected to be “prevented” from performance. This is a high hurdle and will require parties to demonstrate that performance is legally or physically impossible, not just difficult or unprofitable. Broader wording such as “hinder” or “delay” are likely to be given a wider interpretation and such clauses are more likely to apply where performance has been made significantly more difficult as opposed to impossible.
Often Force Majeure clauses are framed as being of mutual benefit to both the supplier and purchaser under a supply contract. In practice, purchasers made find it hard to rely on “conventional” force majeure clauses as it may be difficult for a purchaser of unwanted goods or services to be able to establish that its performance of the contract has been prevented, hindered or delayed by the Force Majeure circumstances where the position is that the purchaser simply does not need the supplies anymore.
For these situations, a right of termination may be more helpful whether pursuant to a notice clause as referred to above, or linked to some kind of material adverse change clause to give a clearer route out of the obligation.
It is also important to follow the contractual procedures in these clauses, as failure to do so may mean you are unable to rely on them. There may well be an obligation to notify of the Force Majeure situation affecting one’s business immediately or within specific timeframes. There will often be an obligation to take reasonable steps to mitigate the effects of the Force Majeure and in any event, this may well be implied by law. There is also the interplay between Force Majeure clauses and other positive obligations to have and implement business continuity or disaster recovery plans. Often parties will not be able to rely on Force Majeure clauses if they do not have these plans in place or do not seek to implement them as fully as possible.
A word on frustration – most recently dusted down in the context of Brexit and the effects that may have on contracts, businesses are also asking whether contracts might be treated as “frustrated”. This limited legal doctrine arises from the law rather than the terms of any specific contract, so businesses may in particular be considering how it applies where they do not have a force majeure (or similar) clause they can use. It is quite a complex area, with a mixture of case law and WW2 statutory provision, but essentially the frustration doctrine only applies where performance becomes impossible or illegal for reasons beyond the control of the parties; the frustrating event is so fundamental it strikes at the heart of the contract and is beyond what the parties contemplated when the contract was made. It will not apply where the contract has actually provided for the frustrating event – so the inclusion of a Force Majeure clause may mean that the frustration doctrine cannot be invoked.
If established, frustration basically brings the contract to an end. Establishing frustration is difficult, but where other contractual routes and remedies are not available it is worth considering.
As with other areas considered in this article changes in practical circumstances may have a considerable impact on the availability of a particular contractual remedy. For example if the government changes its current position of merely advising citizens not to engage in certain activities, to requiring this as a matter of law, frustration of certain contracts may be easier to establish.