Contractual rights and obligations in the context of COVID-19
The significant disruption caused by the global COVID-19 pandemic brings threats to stable contractual relations and the economic expectations that come with them. Below are pragmatic and legal next steps that organizations can take.
All organizations should:
- Proactively assess risks related to contract failure and begin discussions with contractual partners to understand and resolve business critical failures and delays
- Review and rank contracts by significance and likelihood of failure
- Determine what qualifies as a force majeure event under your contracts - there is no common law right to invoke force majeure, and whether COVID-19 (or its consequences) qualifies as a force majeure event will be determined by factors related to the specific agreement
- If COVID-19 qualifies as a force majeure event, determine what the specific agreement requires to invoke the provision
- Consider whether other contract provisions or insurance coverage could mitigate the risks
As the impacts of COVID-19 widen, Canadian organizations in a wide variety of contexts increasingly risk being unable to meet their contractual obligations. The risks include:
- Government-imposed restrictions
- Employee shortages
- Project closures and cancellations
- Supply chain disruptions, delays and defaults
Goal: To resolve challenges through discussion
All organizations will wish to manage this extraordinary risk to their businesses. With respect to goods and services contracted to support organizations, the goal should be to understand the risk related to contract failure and whether the risk can be discounted or incorporated into planning. Where the organization is a supplier, a realistic assessment of whether supply to customers will slow or be disrupted is essential. In either case, cautious but productive discussions with contractual partners to understand and resolve business critical failures and delays will go a long way to helping all parties manage risk. A dialogue can also assist parties in mitigating damages, which can be valuable to both parties and is an obligation on a party that might have claim later on for beach of contract.
Prioritize and review contracts and agreements – what are the protections and allocations of risk?
Organizations should rank their contracts by significance and likelihood of failure. The contracts with the most serious impacts and highest likelihood of failure should be tackled first. A first step is to proactively review these agreements to determine how risks of non-performance or delayed performance are allocated. Is there a force majeure clause, and is it triggered? Are there obligations with respect to business continuity that should now be in effect? Are there mechanisms to access additional assistance or conversely wind-down certain services or supplies not currently needed? Are there termination rights that can be exercised if need be? Having a full understanding of the legal position will give parties insight into how to conduct discussions and negotiations to safeguard their interests.
Force Majeure Provisions
Osler has recently discussed force majeure in the context of infrastructure projects here: Is Coronavirus a force majeure event under your project contract?. While force majeure clauses vary from contract to contract, a force majeure event is typically an event beyond the control of a party which prevents or delays that party from contractual performance. There is no common law right to invoke force majeure where none is provided for in the governing agreement. Force majeure clauses explicitly set out the terms under which a party who is unable to perform contractual duties as a result of such an event may be excused and avoid contractual remedies (e.g. damages) and termination under the clause allowing termination for breach of the agreement generally (although the force majeure clause itself may have termination right for lengthy disruptions).
Qualifying: Whether COVID-19 is a force majeure event will be determined by the specific agreement under consideration, the force majeure clause, the agreement taken as a whole and the factual matrix behind the agreement. Where a contract includes a force majeure provision, parties often list qualifying events which may be determinative or an inclusive list of specific examples of events “beyond the reasonable control” of the party. The content of the list and whether it is an open or closed list can be significant. The following events are commonly listed:
- Pandemics, epidemics or public health emergency – COVID-19 is all of these things. Note since the SARs event, the inclusion of these items has been a point of discussion and many agreements specifically exclude them. This is particularly true for any agreement servicing health care.
- Changes in laws or regulations – State action such as bans, lockdowns or forced closures could constitute qualifying events.
- Default or failure of suppliers – The Coronavirus outbreak could result in supply chain disruption.
- Acts of God or events beyond the reasonable control of a party – Parties could argue that the COVID-19 outbreak falls within catchall provisions for extreme events.
However the real question is typically: Is performance of the contractual obligation actually prevented by the event?
Invoking: Experiencing a force majeure event is only the first step in determining whether a party to a contract is eligible for some relief in performing their duties. As with the nature of a force majeure event, the required steps to invoke a provision will depend on the specific wording of the contract itself. The most common requirements to invoke a force majeure provision are:
- Demonstrating that the force majeure event caused a sufficient impact to an actual contractual obligation – force majeure provisions will often specify the level of impact on a party’s ability to perform its contractual duties that is required – a difficult business environment will typically not be enough;
- Providing notice – contracts typically require parties to give written notice when the provision is invoked; and
- Mitigation – parties are generally required to mitigate the impact of the force majeure event.
What if you don’t have a force majeure provision? Where parties lack applicable force majeure contractual provisions or they do not apply, there is little relief available under the common law. Common law protections or excuses for parties who cannot perform their duties under a contract are exceptional and those that exist are narrowly interpreted and applied.
Parties impacted by COVID-19 and unable to rely on contractual provisions are limited to potential common law defences for non-performance, such as frustration. Frustration occurs when an event renders contractual obligations radically, substantially or fundamentally different from those contemplated by the parties for reasons beyond a party’s control. As in the case of force majeure events, frustration is distinguished from situations where performance has become merely onerous, inconvenient or prohibitively expensive.
While COVID-19 might result in frustration or impossibility, the bar for claiming that a contract is frustrated or impossible is high. It should also be noted that common law remedies, unlike typical force majeure provisions, ground a termination of the entire contract, as opposed to a more tailored solution such as permitting delay or relieving a party of specific obligations (while leaving it obligated to perform the remainder).
Other contractual provisions
Beyond force majeure provisions, many contracts will address temporary disruptions – for example, providing that a supplier may skip a shipment of commodity on notice and with compensation if applicable. Depending in the circumstances, such a disruption may not constitute material breach under termination clauses. Every contract will be different in this respect – and contracts should be fine-combed with an eye to any temporary ‘out’ clauses.
Business interruption insurance
Finally, companies with business interruption insurance should review their policy for coverage or exclusion of business losses as the result of an outbreak or pandemic. Business disruption insurance generally covers losses of income as a result of physical damage to property, but may also cover disruption specifically due to pandemics or due to closures ordered by public authorities. Review for required notice periods and any procedures required to make claim.
For further reading about the interpretation and application of force majeure clauses in the Canadian and international contexts, Force Majeure Clauses in Comparative Perspective co-authored by Osler’s Geoffrey Hunnisett.