COVID-19 - What if you can't comply with your contract?
Introduction
COVID-19, and the resulting restrictions on movement of people, has meant that many contractual obligations are either not able to be complied with, or will be significantly more difficult or expensive to comply with.
So what do you do if you will not be able to comply?
Step 1 - Read the Contract
The first step will always be to look to the agreed contractual terms.
Specific terms will obviously vary, but the first things to look for are:
What level of obligation do you actually have?
Is there a Force Majeure clause?
Is there another clause that determines what the consequence of non-compliance will be?
It is very important to keep in mind that as we move through the different COVID-19 alert levels, assessment of contractual obligations needs to be carried out on an ongoing basis. By way of example, if you have an obligation to make reasonable endeavours to supply, then the assessment of what is reasonable and whether or not that obligation has been met, will differ under different COVID-19 alert levels.
Remember that there is no “one size fits all”, and what applies to other businesses may not apply to your business. A business that can continue to run with staff working from home is in a very different position to a business that is reliant on being able to move people around freely. Contractual rights and obligations must be assessed in the context of the impact on your specific business.
Level of Obligation
This will vary across different contracts. Some contracts will provide for an absolute obligation - in other words, you must provide goods or services as required by the other party. However, some contracts may be less onerous and provide for “a best endeavours” or “reasonable endeavours” obligation.
Bear in mind that some contracts, such as supply agreements, may give you a discretion whether or not to accept any particular purchase order with no immediate consequence for you if you choose to reject it.
If your level of obligation is fairly low (e.g. “reasonable endeavours to supply”), then you are unlikely to be in breach of your supply obligation if the reason you cannot comply is directly linked to the government’s COVID-19 preventative measures. However as noted above, this assessment will differ across the different COVID-19 alert levels.
Force Majeure
Most commercial contracts will include a force majeure clause, but the breadth of such clauses and the consequences of triggering them differ substantially. When considering the particular force majeure clause, things you need to consider include:
Does the clause capture a pandemic? Most clauses should capture this scenario, but some do have very restricted drafting and may not extend to health issues such as epidemics and pandemics.
What do you need to do to trigger the clause? Usually written notice is required. Notice provisions must be complied with correctly or you risk a later finding that the clause was not triggered and does not apply.
What are the consequences of triggering the clause? Focus here can tend to be very narrow with parties focusing on the immediate consequence of not being required to meet obligations whilst the force majeure event continues. However, you need to bear in mind what the longer term effect is - usually after a specific time period, parties will have the ability to terminate the contract. Diarise these dates to ensure that you are aware of any potential termination rights which may be close to arising.
Many force majeure clauses will place some obligation on you during the force majeure - the most common of which is to make efforts to reduce the effect of the force majeure. This needs particular care as we move between different levels of lockdown - for example your force majeure clause may apply in level 4, but not in level 1.
Does the force majeure clause allow for partial performance? You may be able to meet some obligations under the contract but not others, and partial performance can be important to enable some ongoing cashflow. If partial performance is not provided for, the counter-party may seek to reject partial performance if you have triggered force majeure.
What if there is no Force Majeure?
If you don't have a force majeure clause then the common law doctrine of frustration may apply.
Frustration requires that performance of the contract has become impossible or significantly different due to external factors outside of the parties’ control. The consequence is that the contract can be terminated.
Frustration is a common law doctrine, not a legislative provision, with a high threshold. It is not easy to show that a contract has been frustrated and careful consideration of all circumstances is needed prior to seeking termination of an agreement on this basis.
Remember the Long Term Consequences
When working through issues in meeting contractual obligations, be mindful of the long term consequences of your approach, especially when dealing with long term business partners or contractual arrangements that may receive industry or public scrutiny. A collaborative approach rather than a combative approach will generally give you the best opportunity to retain business relationships going forward.
Conclusion
Your contractual rights and obligations will depend on the specific wording of your contract. This does mean reviewing the terms of each contract individually to ensure that you are clear on what your rights and obligations are, and what contractual consequences there could be for you if you take certain actions.
It is also essential to keep reassessing contractual obligations as the COVID-19 alert levels change over time.
If you would like to discuss this further, please get in touch with your usual Dawson Harford contact.
During New Zealand’s nationwide lockdown, even though our offices are closed, it is business as usual for Dawson Harford. We are here to support and assist you by phone, email and video conferencing to help keep you and your business going. Stay safe.
Disclaimer: This update is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters it addresses.