Contractual Obligations in the Age of COVID-19: Force Majeure Clauses

As COVID-19 wreaks havoc on health systems and economies around the globe, businesses may find themselves facing unprecedented challenges that interfere with their abilities to perform contractual obligations. Likewise, the counterparties to those contracts may find themselves dependent upon others observing their contractual obligations now more than ever.

This is the first of two articles recapping two key concepts of contract law which may be relevant in the present context: the force majeure clause, and the common law doctrine of frustration. The former is a clause in a private agreement that modifies the obligations in a contract when a specified event affects the ability of a party to perform in the manner originally contemplated; the latter is a default response to such an event, imposed by law, resulting in the termination of the contract.

Force majeure: ‘a superior force’

The duty to perform most contractual obligations is a strict one, such that impossibility of performance, even when caused by a radical change in circumstances, is not ordinarily a defence.[1] A force majeure clause modifies this position. Rather than requiring a party to ensure performance in any circumstances and at all costs, a force majeure clause changes the allocation of risk by providing an excuse for what otherwise might be a breach of contract by an ‘innocent’ party in specified circumstances. Such a clause is part of a family of provisions sometimes referred to as ‘hardship and intervener clauses’[2], or ‘exception clauses’[3] all of which are used by contracting parties to allocate risk in relation to future events.[4]

Which contracts have force majeure clauses?

Force majeure clauses appear in many different types of contract. Like all clauses, they arise primarily because they have been agreed to by the parties. Sometimes they will have been the subject of express negotiation but often they arise as part of the ‘boilerplate’ machinery provisions carried in precedent documents. Where the parties have not expressly agreed a force majeure clause, occasionally such a clause will be imposed or implied by legislation. For example, Article 79 of the Vienna Convention (which has effect under domestic legislation in Australia)[5] provides an ‘exemption’ for the supplier from damages for non-performance in certain contracts for the international sale of goods. Article 79 provides that exemption where breach is proven to be attributable to an ‘impediment beyond [the supplier’s] control’, and where the supplier could not reasonably be expected to have taken into account that impediment at the time the contract was concluded, or to have avoided or overcome it.[6]

Structure of force majeure clauses

Force majeure clauses can vary and may go by a different name. There is no requirement that the words ‘force majeure’ appear. Commonly they:

  • define the relevant supervening event or events to which the clause applies;
  • set out what steps the party seeking to rely on the clause must take;
  • specify the consequences of the event.

Where these elements – particularly (a) or (c) – are absent, the clause may be void for uncertainty.

An exercise in construction

The ordinary principles of contract interpretation apply to force majeure clauses:[7] that is, a court will consider what reasonable persons in the position of the parties would have understood the words to mean by reference to the text of the relevant agreement, the surrounding circumstances known to the parties and the purpose or object of the transaction.[8] The contract must be read in a common sense and non-technical way to give the agreement a ‘businesslike’[9] and ‘commercially sensible’ construction.[10] Regard should be had to all the provisions in the relevant agreement ‘so as to render them all harmonious with one another’[11] and to ensure the ‘congruent operation of the various components as a whole.’[12] Matters such as the identities of the parties (and any prior or ongoing contracting relationship between them), the relevant industry and commercial environment in which the contract was concluded, and perhaps even commercial practices generally may all be relevant. For example, where a pricing clause contains a variation formula that can be characterised as a mechanism to allocate the risk of price fluctuation, even a drastic change in commercial conditions is unlikely to be treated as a force majeure event.[13]

Accordingly, the scope and effect of a given clause must be determined on a case-by-case basis. The balance of this article steps out how that analysis proceeds.

Is the coronavirus pandemic a force majeure event?

COVID-19 has undoubtedly up-ended lives everywhere, but for the purposes of force majeure the relevant question will be whether it, or more likely some other consequence of it (such as quarantine or cordon sanitaire, a government ban on ordinary commercial activity, the closure of borders or a disruption in the usual supply chain) qualifies as an ‘event’ within the terms of the clause. Generally, the onus of establishing a force majeure event rests with the party seeking to invoke the clause.

An ‘event’ in this context is a legal construct requiring precise identification of:

  • What has occurred? This may be a discrete occurrence, a series or combination of occurrences, or a single occurrence that has culminated over time; and
  • Whether the occurrence or occurrences constitute an ‘event’ to which the force majeure clause applies?

Narrowly drafted clauses may only provide a specific, exhaustive list of relevant events covered by the provision. Broadly drafted clauses may be in similar terms to Article 79 of the Vienna Convention noted above. However, catch-all phrases such as ‘anything beyond the party’s reasonable control’ will not necessarily be as broad as they seem. They cannot be allowed to undermine the commercial effect of the contract. And particularly when accompanied by a list of specific events covered or excluded by the provision, it may be held that the legal effect of the broad words is narrower than a literal reading suggests.[14]

The ‘boilerplate’ nature of these clauses can throw up odd results, not well adapted to the specific circumstances. For example, a retail tenant in a major city shopping centre may find themselves with little use for a force majeure clause which only covers bushfires. However, if the words are sufficiently clear, that will be its only application.

What is the impact of the event on the obligation sought to be excused?

The next step is to determine:

  • What is the contractual obligation impacted by the event?
  • What is the causal link between the event and the ability to perform the relevant obligation?

Disputes about the application of force majeure clauses often turn on questions of commerciality. If a party has been prevented from performing in the way originally contemplated, particular attention needs to be paid to alternative means of performance.[15] For example, goods or services may be available from a different source at an increased price for the seller. A significant price increase in the goods will usually not be sufficient to constitute force majeure unless expressly contemplated by the relevant clause.[16] Generally, an ability to perform, albeit on terms that make the contract uncommercial for the seller, will mean force majeure does not apply. Where substitute performance is available – that is, performance in way that is not contemplated by the contract – there may be a question as to how far a party must go. Internal commercial decisions not to perform – even in the most difficult of circumstances – should not be assumed to justify a declaration of force majeure.

Where performance has been delayed, but not wholly prevented, it will be question of construction whether the seller has taken on the risk of that delay, or whether the reason for the delay falls within what is contemplated as a circumstance to which force majeure applies.

Finally, the non-affected party may point to other causes which are wholly or partly responsible for the inability to perform. Allegations of negligence or breach by the non-performing party, or third-party claims, often arise in this context.[17]

What are the necessary procedural steps?

Some force majeure clauses include a statement of what steps the non-performing party must take to invoke the provision. These can be important. If these requirements are conditions, discharge of the condition will be necessary for the force majeure clause to be relied on.  For example, time periods might apply. In a simple case, the relevant clause will require notice to be given within a certain number of business days. In a more complex case, the clause may require notice ‘immediately’ upon the happening of a force majeure event, leaving room for interpretation.

What happens if the clause applies?

If there has been a relevant ‘event’, a causal link to non-performance of a contractual obligation can be established, and any procedural steps are complied with, the next issue is what consequences follow. Parties need to consider:

  • How will invoking a force majeure clause impact the way the parties continue to perform their respective obligations under the contract? For example, is an extension of time required, or must performance be suspended or excused altogether?[18]
  • Does invoking the provision create new obligations – for example, a requirement to pay liquidated damages, or a requirement to keep the other party informed of steps taken to mitigate, minimise or manage adverse effects of the event?
  • Does the contract impose any limits on the procedure following a force majeure event? For example, is there a time limit on the suspension of obligations, after which the agreement may be terminated?

When determining what consequence flows from a force majeure event, parties should remember that the law will still impose the ordinary requirement to mitigate loss, even if the relevant clause does not.[19]

Conclusion

The interpretation and invocation of force majeure clauses is rarely straightforward. In the absence of legislative intervention, parties should not assume that the sweeping effects of COVID-19 will necessarily avail them of an excuse for breaches of their contractual obligations. But in specific cases, a force majeure clause may well apply.

The current circumstances are unprecedented in living memory, and contractual provisions are unlikely to have been drawn with a view to the present pandemic or its consequences. In the next article, we recap how the doctrine of frustration might apply to relieve performance in the absence of an effective force majeure clause.

 

[1]   Paradine v Jayne (1674) Aleyn 26; 82 ER 897. See also Ibbetson, D., ‘Absolute Liability in Contract: The Antecedents of Paradine v Jayne’ in Rose, F.D. (ed), Consensus ad Idem: Essays in the Law of Contract in Honour of Guenter Treitel (Sweet & Maxwell, 1996); Simpson, A.W.B., A History of the Common Law of Contract: The Rise of the Action of Assumpsit (Oxford University Press, 1975), 525-32. However, see e.g. Robinson v Davison (1871) 19 WR 1036; [1861-73] All ER Rep 699 (impossibility of performance of personal service obligations during illness).

[2]   See Schmitthoff, C.M., ‘Hardship and Intervener Clauses’ [1980] JBL 82. Examples of such clauses include ‘reopener’ or renegotiation clauses, take-or-pay provisions, price escalation and rise-and-fall clauses, material adverse change provisions and quantity terms.

[3]   See, e.g., Matsoukis v Priestman & Co [1915] 1 KB 681; Lebaupin v Richard Crispin & Co [1920] 2 KB 714.

[4]   See Robertson, D., ‘Force Majeure Clauses’ (2009) 25 Journal of Contract Law 62, 67-68 (discussing generally the institution of contracting under uncertainty).

[5]   Or ‘CISG’: the United Nations Convention on Contracts for the International Sale of Goods, Vienna, 11 April 1980. Approximately 85 countries are signatories, including the USA, China, Singapore, Russia, Germany and Canada, although notably, not the UK. The Vienna Convention is applicable in each Australian State and Territory by the Sale of Goods (Vienna Convention) Act 1987 (Vic) (see now Goods Act 1958 (Vic), ss 84-88); Sale of Goods (Vienna Convention) Act 1986 (NSW), the Sale of Goods (Vienna Convention) Act 1986 (Qld), Sale of Goods (Vienna Convention) Act 1986 (SA), Sale of Goods (Vienna Convention) Act 1986 (WA), Sale of Goods (Vienna Convention) Act 1987 (Tas), Sale of Goods (Vienna Convention) Act 1987 (NT), and the Sale of Goods (Vienna Convention) Act 1987 (ACT). Note however that parties may choose to expressly exclude the application of the Convention. In international commercial contracts, regard should also be had to the UNIDRIOT Principles of International Commercial Contracts, especially Articles s 6.2 (hardship), 7.1.7 (force majeure).

[6]   See Schlechtriem, P., and Schwenzer, I., Commentary on the UN Convention on the International Sale of Goods (CISG) (Oxford University Press, 2nd ed, 2005), 814-8, 822-6.

[7]   Hyundai Merchant Marine Co Ltd v Dartbrook Coal (Sales) Pty Ltd (2006) 236 ALR 115, [62].

[8]    Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451, 461–2 [22]; Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165, 179 [40]; Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd (2015) 256 CLR 10, 116 [47]; Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640, 656 [35].

[9]   McCann v Switzerland Insurance Australia Ltd (2000) 203 CLR 579, 589 [22]; Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522, 528–9 [15].

[10] Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640, 656–7 [35].

[11] Australian Broadcasting Commission v Australasian Performing Right Association Ltd (1973) 129 CLR 99, 109.

[12] Wilkie v Gordian Runoff Ltd (2005) 221 CLR 522, 529 [16].

[13] See Thames Valley Power Ltd v Total Gas & Power Ltd [2005] EWHC 2208 (Comm).

[14] For example, under the ejusdem generis principle, where a clause contains a list of particular words that form a class, or kind or genus, followed by more general words, the general words may be read down as limited to that class or kind or genus.

[15] European Bank Ltd v Citibank Ltd (2004) 60 NSWLR 153.

[16] The Super Servant Two [1990] 1 Lloyd’s Rep 1; Tennants (Lancashire) Ltd v C S Wilson & Co [1917] AC 495, 510; Thames Valley Power [2005] EWHC 2208 (Comm). Compare the position in the United States.

[17] See, e.g. Lebaupin v Richard Crispin & Co [1920] 2 KB 714, 721 (breach of contract for the supply of tinned fish due to defective tins supplied by a third party).

[18] See, e.g., European Bank Ltd v Citibank Ltd (2004) 60 NSWLR 153; [2004] NSWCA 76 (involving a force majeure clause providing for the suspension of obligations under banking arrangements); and Ringstad v Gollin & Co Pty Ltd (1924) 35 CLR (relevant clause operated merely to extend the time for delivery rather than discharge the relevant obligation).

[19] See B&S Contracts and Design Ltd v Victor Green Publications Ltd [1984] ICR 419.

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