Covid-19: The virus that doesn’t attack your software but can be just as damaging to your business . . .
Can you de-risk your business?
On 30 January 2020, the Director General of the World Health Organisation announced that the outbreak of the coronavirus (officially named Covid-19) met the criteria for a Public Health Emergency of International Concern.
With the epidemic spreading throughout China and the number of cases confirmed outside of China increasing daily, the coronavirus is impacting lives across the world in immeasurable ways. Our thoughts go out to all of those affected. As the world’s largest manufacturing territory, the coronavirus has not only had a devastating effect on human health in China, but the practical implications have caused major disruption to commercial operations and markets across the globe.
Facilities have been shut down, international business employees have been evacuated, travel restrictions have been put in place and production has been curtailed. As practical, health and security measures are being implemented across the world, we take a look at ways in which you can protect your business from the risk of contractual breach and substantial financial loss.
How can you minimise the impact of this outbreak on your business?
One contractual mechanism available is a declaration of “Force Majeure”. Force majeure is a contractual term which cannot be implied, it arises solely on the basis of the provisions which are included in a contract. Where a force majeure provision applies it may allow a contracting party to avoid liability where the delay or failure to perform is due to an event outside its control.
There is no standard definition of ‘force majeure,’ and the scope of such a clause will depend on its construction and interpretation. Contracting parties should therefore carefully consider the language used in force majeure clauses in their contracts having regard to the remainder of the contract when determining the protection the clause affords.
Force majeure clauses in contracts usually provide for a non-exhaustive list of unforeseen events or circumstances which would qualify, however, some may set out an exhaustive list of qualifying events.
Provisions most likely to succeed in the context of the coronavirus epidemic are those which specifically reference disease or which envisage such an outbreak. However, in circumstances where there is no specific reference to disease, epidemic or quarantine, the same may be caught by ‘Acts of God,’ ‘Acts of Government’ or by general wording such as ‘other circumstance beyond the parties’ control.’
Cause of Default
In addition to the relevant event being specifically covered or generally captured, the general requirements for force majeure must also be met.
Performance of the contract must have been prevented, hindered, or delayed due to an event not within the reasonable control of the party seeking to claim force majeure. It is also usually necessary to establish that performance has become legally or physically impossible and mere difficulty or unprofitability will not be sufficient.
Furthermore, the relevant event (e.g. the outbreak of the coronavirus) must be the only effective cause of default or delay. The recent English High Court case of Classic Maritime Inc v Limbungan Makmur SDN BHD outlined that it must be clear that, if the force majeure event had not happened, the contract would not have been breached. Therefore, in order to rely on this protection, the force majeure event must not only cause the contractual breach, but it must be the only cause of the contractual breach.
Any business which, after taking the appropriate mitigation steps, makes the decision to seek to enforce a force majeure clause, should carefully follow the notification process in accordance with the terms of the contract. For a party seeking this protection, following any such process is critical.
Effects of Force Majeure
A force majeure clause, if effective, will usually suspend the affected party’s obligations and remove their liability for any breach caused by the force majeure event where that party has taken all reasonable steps to overcome or mitigate such event and avoid operation of the clause.
In the context of the ongoing health crisis, businesses should also be aware of extended force majeure clauses which may include the right for the non-affected party to terminate the agreement if the event continues for a certain prolonged period of time, giving that party the ability to move to an alternative supplier.
In some instances, the inclusion of such a termination right may actually deter a supplier from triggering a force majeure clause. This is likely to be the case where continuation of the contract is otherwise profitable to the business or in circumstances where the cost of complying with contractual obligations triggered by a claim of force majeure exceeds the cost of temporarily engaging, for example, more expensive local suppliers
If “Force Majeure” is not available are there other ways to de-risk?
Doctrine of Frustration
In the absence of a force majeure clause, contracting parties may seek to rely on the doctrine of frustration. This provides for the termination of a contract in situations where, through no fault of either party, there is an unforeseen event that renders that contract either impossible to perform or radically changes its underlying purpose.
While this may sound like an appealing alternative to relying on the force majeure clause, which does not typically apply to “fundamental” obligations or require them to be as heavily impacted, it is worth noting that the threshold for a successful frustration claim is high. The courts are generally reluctant to find that a contract has been discharged on this basis and the fact that a contract has simply become more difficult or expensive to perform is unlikely to be sufficient.
Termination for Convenience
In cases where such protections do not apply or in instances where a contract is silent on force majeure, other helpful mechanisms may be available. Some contracts contain a right for either party to terminate for convenience on notice and others may not impose restrictions on a customer which could impact its ability to purchase from other suppliers.
Price Variation Mechanism
Contracts may also contain additional protective measures in clauses which allow the contracting parties to vary the selling price under certain conditions. It is important to review any such price variation mechanisms in contracts at this stage and, if present, whether difficulties arising from the virus outbreak, will trigger such provisions.
It may also be worthwhile incorporating such provisions in your businesses standard Terms and Conditions.
“Softer” Contract Management Mechanisms
Every business should also consider “softer” provisions which may be embedded in your contracts e.g. change control mechanisms. While these will not relieve a party of liability in circumstances such as a virus outbreak, they may compel an obligation to engage in good faith discussions on changes which should be made to the contract in light of any difficulties affecting the supply chain. At the very least, these mechanisms should bring the contractual parties to the table and kick-start a resolution process.
What can you do now?
As international market disruption is set to continue in light of the increased risk of global health crises, to minimise potential risk and protect ongoing relationships, businesses should:
- Review contractual obligations with customers or suppliers to assess supply chain impact on employee engagement and other risks;
- Engage with customers early to mitigate the impact of potential supply chain issues;
- Avoid supply chain disruption by investigating and planning for the use of multi-sourcing models;
- Consider alternative contractual and other legal protections where appropriate in the event that the extraordinary event makes it difficult for your business to meet its obligations to customers; and
- Take practical steps now to ensure your business will be able to continue to meet its obligations to customers and/or suppliers or seek appropriate relief from obligations.
For more information on the content of this Insight, please contact:
Gillian Keating, Partner | E: email@example.com | T: +353 21 480 2712
Maria Walsh, Solicitor | E: firstname.lastname@example.org | T: +353 1 6054236