How might COVID-19 impact contracts and obligations?

Protective measures and restrictions introduced to manage the COVID-19 pandemic are causing significant disruption to commercial activities both in the UK and globally. Many businesses will struggle to meet their contractual obligations; some will argue that they have a valid excuse exempting them from liability for breach of contract.

As with many legal issues, there isn’t really a one-size-fits-all answer. The position depends on the terms of the contract and the specific circumstances.

On the face of it, a party that does not perform its contractual obligations could be liable to its counterparty for breach of contract. But there are two key exceptions to the rule: the operation of any force majeure clause in a contract; and the concept of frustration of contract.

Force Majeure Clauses

A force majeure clause typically excuses one or both parties from performing their obligations after specified unforeseen events that are outside their control. Examples include natural disasters such as a storm or hurricane, a major political event including war, acts of government or a serious health crisis such as a general epidemic. The COVID-19 outbreak might well fall into one of the categories outlined in a force majeure clause.

Force majeure clauses vary so it’s always necessary to examine the specific wording to determine whether they apply. However, in general terms, a party wishing to rely on a force majeure clause will have to prove that:

  • the COVID-19 pandemic is covered by the wording of the clause;
  • the party seeking to rely on the clause has been prevented, hindered, or delayed from performing the contract by reason of the COVID-19 pandemic;
  • non-performance was due to circumstances beyond its control; and
  • reasonable steps have been taken to mitigate or avoid the effects of the COVID-19 pandemic or its consequences.

Generally, force majeure clauses set a high threshold: they require performance to have been rendered impossible, rather than more difficult or not commercially viable.

In most contracts, a force majeure clause will typically suspend performance of the affected party’s obligations with the intention the contract will be resurrected when the event is over. If performance is suspended for extended periods, this can lead to a right for one or more parties to terminate the contract.

Frustration of Contract

In the absence of a force majeure clause in the contract, parties may be able to rely on the common law doctrine of frustration instead.

A contract will terminate automatically when a “frustrating” event occurs, i.e. one that is unexpected, beyond the parties’ control, and that makes performance impossible, illegal or radically different from that intended when the contract was entered into.

The doctrine has a very narrow scope, but it is likely it could apply in some circumstances related to the COVID-19 outbreak. Most obviously, legal restrictions on travel, or public events may render performance of the contract illegal. On the other hand, it will not be enough to show that the outbreak and government advice in response to is has rendered the contract unprofitable for one of the parties.

If a contract is terminated by frustration, the parties will not be required to perform their future obligations but may have to perform obligations incurred before the time of frustration. They may also be required to return benefits received under the contract pursuant to the Law Reform (Frustrated Contracts) Act 1943.

Breach of Contract

If there is no force majeure clause in the contract and the doctrine of frustration isn’t applicable, the defaulting party may face a claim for breach of contract.

The principal remedy for breach of contract is an award of damages.

If the breach is fundamental in nature the innocent party may be entitled to terminate the contract by ‘repudiation’, and claim compensation for the loss suffered.

In some cases the innocent party may seek an order from the court for “specific performance” – i.e. an order that the defaulting party performs the contract – or an injunction restraining an anticipated breach of contract. These are discretionary remedies and are only available in limited circumstances where damages would be inadequate.

In summary, there are high thresholds for establishing that a contract has been frustrated or that a force majeure clause is applicable, but it is likely that they will be met in some circumstances arising from the COVID-19 outbreak.

This is not legal advice; it is intended to provide information of general interest about current legal issues. If you would like specific legal advice then please contact Claire MacMahon by e-mail cm@grantsaw.co.uk or call 0208 858 6971.