COVID-19: What is its impact on different types of contract?

By Alex Haddad

Principal Associate

The outbreak of COVID-19 has seen many countries take drastic steps to contain the coronavirus and the impact on economies, supply chains and workforces is well known.    

For anyone left struggling to fulfil their obligations under a contract it is worth checking if the agreement includes a so-called force majeure clause which allows obligations to be suspended if the pandemic has made performance impossible. In certain cases it may even be possible to terminate a contract on the ground of frustration but the courts are generally reluctant to find that a contract has been terminated if the interruption is for a short period relative to the term or duration of the contract.  

What is a force majeure clause?

A force majeure clause gives parties the opportunity to suspend a contract if an unforeseeable and supervening event makes performance of the contract impossible. This type of clause must be included in the contract and cannot be implied. There is no set wording or structure to a force majeure clause. Some force majeure clauses are very prescriptive and set out long list of events which may suspend a contract and whilst others simply refer to an unanticipated event which temporarily makes performance impossible or substantially more difficult. 

Given these variations in drafting each force majeure clauses needs to be considered individually but in the context of the COVID-19 outbreak words such as epidemic, outbreak, pandemic, quarantine or Government intervention will clearly be very helpful although this list is by no means exhaustive. If the force majeure clause does not include a long list of events then any reference to a supervening or extraordinary event could be sufficient to suspend the contract. The following factors are important when considering the effect of a force majeure clause:

  • To what extent does the event prevent or delay fulfilment of the contract?
  • Can all parties to the contract rely on the clause?
  • Does the event excuse liability entirely or does it simply allow an extension of time to perform specific obligations?

If the parties can make reasonable modifications to the way they perform the contract then the force majeure clause might not take effect. A reasonable modification is likely to be one which does not substantially increase the cost of performing the contract. 

What about frustration?

If the contract does not contain a force majeure clause, the principle of frustration may excuse the parties from fulfilling the contract. Frustration could arise if circumstances make performance of the contract impossible or radically different from what was envisaged when the contract was agreed. If one of the parties still has to fulfil their side of the bargain it is useful to consider if circumstances prevent them from doing what is required to obtain payment or another benefit under the contract. If there is an absolute impediment to performance then the contract might be capable of being terminated due to frustration.

Acts of God, such as COVID-19, are events which are capable of frustrating a contract. It is important to note that the pandemic must have the effect of making the contract impossible to perform or radically different from what the parties initially envisaged. The contract will not be frustrated simply because it would be more expensive or more difficult to perform and if there is an alternative way of performing the obligations then the parties will be expected to make reasonable modifications. Frustration is difficult to invoke and it is worth considering how it might apply in the context of different contracts. 

Leases & Licenses

Some types of agreement are more likely to be capable of frustration than others. There have been cases where very short-term leases or licences granted for one-off events might be capable of frustration if the event is cancelled as a result of an Act of God. If, for example, a lease or licence is granted to allow someone to watch or attend a sporting fixture or exhibition then the cancellation of the event might result the lease or licence being frustrated.

By contrast, leases with a longer term will be much harder to frustrate because the premises will be available for after the lockdown has been lifted. If a tenant occupies a warehouse for a term of five years but its remains empty for several months due to the pandemic then the underlying purpose of the lease will not be frustrated because the tenant will retain the space for storage once it can go back into occupation.

The length of the interruption in the context of the term of the lease is likely to be a key factor when considering if a lease has been frustrated but it is not the only consideration. The courts are also likely to look at whether the lease could be assigned to a new tenant which could find a use for it or whether the existing tenant might be able to obtain permission for an alternative use.

Loans

The outbreak of COVID-19 is very unlikely to be enough to frustrate a loan agreement. If the loan monies have already been advanced a court is unlikely to accept that the economic problems caused by the pandemic make repayment impossible. It might be difficult to repay the loan but it would be open to the borrower to take measures in relation to its business to at least attempt to repay the lender and consequences of the pandemic do not make repayment an absolute impossibility. Many borrowers during the lockdown will be able continue making loan repayments. 

Once the borrower defaults this will be a breach of the loan agreement and might prompt the lender to commence court proceedings or take other enforcement action. Whilst it might not be possible to frustrate the loan there may be solutions available to ease the short-term cash flow issues and the following are potential solutions:

  1. Negotiating the deferment of the scheduled payments
  2. Injecting cash either by third party funding or equity
  3. Restructuring either the loan or the business

If you have had loan funding withdrawn then it might be possible to insist that loan monies are advanced in spite of the impact of the pandemic on the economy. There are conflicting views on whether a court might order a lender to advance loan monies but this appears to be more likely if there is an existing loan facility or the refusal to advance the loan would result in the business becoming insolvent because this loss cannot easily be compensated.

Insurance Contracts

There are many different types of insurance contracts but most of them are likely to provide cover for the types of insured event which are most readily associated with the person or thing insured. For example, most travel insurance will cover flight delays, holidaymakers’ illness etc but not many of them will cover for a global pandemic and certainly not one caused by a virus such as COVID-19 which was not previously known. 

The same applies with business insurance where eventualities like fire, flood, etc. may be covered but not the losses associated with a lockdown. Many insurance policies are unlikely to include comprehensive cover for pandemics because the potential losses could not be insured on commercially viable terms but if your policy includes business interruption cover or provision for loss of perishable stock then you might be able to bring a claim. Some insurers can arrange interim payments whilst a claim is being processed which might be sufficient to sustain a business through the lockdown and its aftermath.

Supply Contracts

These types of contracts often include a force majeure clause but if it is to have effect then close attention will need to be paid to its wording.  If there is no force majeure clause then the contract might be capable of being frustrated depending on the goods to be supplied. If it is physically impossible to supply the goods due to import restrictions or the goods have perished because of limitations on movement imposed as part of the lockdown then frustration might be available but if it is simply the case that demand for the goods has fallen because of the pandemic then the contract is much less likely to be frustrated because demand can fall for any number of reasons.

If the supply of the goods has an international dimension enforcing the contract could be difficult if any dispute has to be determined in a foreign court or the other party has no assets in England which can be enforced against. There will often be an entire supply chain involved in supplying goods and breaking one link might have a far greater impact than negotiating extensions of time. Buyers and suppliers rely on goodwill and risking reputations during pandemic might also have greater consequences than trying to rely on strict legal rights. Many contracting parties are conscious of this and are opting to compromise and agree alternative arrangements for performing contracts.

Conclusion

Whilst it is difficult to argue that a contract has been terminated due to frustration many contracts will contain some form of force majeure clause. Not all force majeure provisions will be capable of being relied upon during the pandemic but it is always open to the parties to agree to perform the contract in a different way during the pandemic.  

If you need any advice about a contract including those not mentioned in this article please feel email enquiries@nockolds.co.uk or by phone on 0345 646 0406.