Some key considerations for those businesses analysing their contractual position
by Julian Wilson, 11KBW
The Problem:
- We cannot perform our obligations: is there a legal basis for excusing our non-performance?
Possibilities:
- Have we a Contractual Excuse: is there a Force Majeure clause or a Material Adverse Change/Event clause (“MAC clause”)?
- Can we rely on the doctrine of Frustration to discharge our obligation to perform?
- Does the doctrine of Supervening Illegality prevent performance?
Common themes:
- A high threshold must be met if you are to be excused from performance.
The key analytics required in considering each possibility:
- Obligation: what exactly is the unfulfilled obligation?
- Casual link:
- is the Coronavirus Pandemic or the control measures made under The Health Protection (Coronavirus Restrictions) (England) Regulations 2020 (“the Regulations”) the real reason for non-performance?
- How exactly have the Coronavirus Pandemic or the Regulations, prevented performance?
- Could performance not occur/ have occurred if mitigating steps had been taken?
- Effect: is performance being delayed or is it prevented?
Contractual Excuse:
- Express Terms: Does the contract contain an express term which contemplates the occurrence of a supervening event beyond the parties’ control in the nature of a Force Majeure clause or MAC clause?
- If there is such a clause, given that suchclauses tend to be restrictively construed, are the terms of the clause wide enough to cover circumstances where the cause is one related to the Coronavirus Pandemic?
- If the clause is wide enough, excuse will become a question of interpretation of the contract rather than application of the doctrines of frustration or supervening illegality because the parties have regulated the effects of the events by the terms of the contract itself.
- Burden: the party seeking to rely on a Force Majeure clause must prove:
- the interpretation and applicability of the clause to the Coronavirus event;
- that non-performance is outside its control/ there were no reasonable steps that could have been taken to avoid or mitigate the Coronavirus event or its consequences. For more detail on this aspect, see the related paper by Stephen Kosmin on the decision in Seadrill Ghana Ltd v Tullow Ghana Ltd[2018] EWHC 1640 (Comm) here.
- If the wording of the Force Majeure clause excludes foreseen/foreseeable events, that the contract was made before the emergence of the virus.
- Effects: Force Majeure clauses usually act to suspend contractual performance temporarily but may by their terms otherwise provide.
The Doctrine of Frustration:
- Theory: further performance of the obligation may have become discharged because the pandemic control measures amount to, or have led to, the occurrence of an unforeseeable supervening event outside the contemplation of the contract which has destroyed the fundamental basis on which the agreement was made.
- Essential Test: Performance of the contract must by reason of the pandemic, the control measures or their consequences, have become legally or physically impossible or changed into something radically different (and not just economically different or more onerous) from that intended at the time of contracting.
- Effects: Frustration discharges the contract thereby relieving the parties from further performance but not unwinding the consequences of past performance. The Law Reform (Frustrated Contracts) Act 1943 (which excludes Sale of Goods and Insurance contracts) provides that parties are able to recover monies paid under the contract before it was discharged.
Supervening Illegality – performance becoming contrary to statute:
- Theory: Where further performance of the contract has become illegal because the law prohibits it, the contract is discharged.
- This is a distinct form of Frustration where lawful performance has become impossible.
- Limit: The law must forbid the performance contemplated by the contract rather than merely hindering it or making it more onerous.
- Application:
- The Regulations forbid the opening and use of certain business premises and the carrying on of certain business and services (paragraphs 4 and 5) and restrict certain types of movement (paragraph 6) and gatherings (paragraph 7).
- The central issue is likely to be whether such prohibitions prevent performance of the contractual obligation in question.
Relevance of the duration of the supervening event compared to the period for performance:
- The approach of the Hong Kong courts, which dealt with cases resulting from the SARS virus, suggests that courts will weigh the likely period of interruption against the outstanding period for performance under the contract with a view to determining whether there has been frustration, see: Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754 in which a tenant, who was subject to a 10-day SARS isolation order when 13 months into a 24-month lease, sought to invoke the doctrine of frustration to discharge the lease. The court rejected the tenant’s application on the basis that the isolation order was only of a short duration in the context of the entire lease.
- Note that under paragraph 3(2) of the Regulations, which came into effect on 26 March 2020, the Secretary of State must review the need for the restrictions and requirements imposed at least once every 21 days, with the first review being carried out by 16th April 2020.
- And under paragraph 3(3) as soon as the Secretary of State considers that any restrictions or requirements are no longer necessary, the Secretary of State must publish a direction terminating that restriction or requirement.
Barristers in the Business Law group at 11KBW are ready and available to offer further practical and legal advice
