Uncertainty arising from the Covid-19 pandemic has led to the greatest fall in financial markets since 2008. This makes it difficult for parties to make decisions about both the terms of their existing and future contractual relationships.
Our 5 top tips
Below are our top tips for businesses who are having to balance managing their ongoing contractual obligations with ensuring long term sustainability for not only their own business but also the businesses of the customers and suppliers on whom they rely.
1. Review existing contracts
In looking for solutions to manage their operational, contractual and financial obligations businesses should not ignore the terms of contracts previously entered into. Businesses should review those contracts now to ensure that they fully understand their rights and obligations. Failure to properly review contracts could result in parties accidentally amending or waiving their rights through their actions and informal discussions. Before those discussions take place businesses need to be certain of how their contracts operate and what the consequences will be of any amendments. This will help inform any operational decisions which are made and hopefully prevent problems in the future.
Businesses also need to be proactive in managing their contractual relationships. Those who actively seek to renegotiate their contractual relationships, in order to reflect the changing market in which they are operating, will almost certainly put themselves in a stronger position than those businesses which delay making difficult decisions. Businesses that are proactive will find themselves operating from a position of strength whereas those businesses that wait until their financial position deteriorates will find that they lose their bargaining power.
Any significant changes to contract terms in light of COVID-19 should be agreed in writing in a legally binding document and not by way of an informal exchange of emails. To fail to record changes properly risks creating problems for the future, especially if one party enters into insolvency and the revised terms under which the parties were operating are not easily identifiable.
Part of any review of existing contracts should include a review of any termination rights which might exist and which counterparties to a contract might seek to exploit in the current situation. These include force majeure provisions and material adverse change provisions as detailed below.
2. Consider whether force majeure provisions apply
Force majeure refers to a situation where unforeseen circumstances prevent a party from fulfilling its contractual obligations. Whilst this "doctrine" creates rights for parties in many jurisdictions, there is no general principle of "force majeure" under English law and so the question of whether a "force majeure" exists will depend on the terms of the contract in question. Where a contract contains no specific force majeure clause, parties should consider alternative rights that might exist.
To rely on a force majeure clause, a party will typically be required to show three things:
1. the occurrence of one or more "events" identified in the contract as giving rise to a force majeure;
2. that their non-performance was due to circumstances beyond their control; and
3. no reasonable steps could have been taken to avoid or mitigate the consequences of that circumstance.
Force majeure clauses will ordinarily stipulate a list of events beyond the control of the parties to which it applies. A standard list will include specific items such as war, natural disasters and civil unrest and these will then be followed by a catch all statement such as "other event or events outside the reasonable control of the parties". Specific references to "epidemic" or "pandemic" will substantially assist a claim that COVID-19 is capable of constituting a force majeure. If not, then it may be necessary to ask whether the situation can fit into another category or a catch all provision.
In general terms, a successful claim for force majeure will enable a party to suspend performance for the duration of the force majeure event. In some situations, or if the force majeure event is sufficiently detailed, it may also grant rights of termination.
3. Has there been a Material Adverse Change (MAC)?
MAC clauses (or Material Adverse Event – MAE) are often included in acquisition agreements where there is a delay between signing and completion such as in M&A transactions. They typically allow a buyer to withdraw from the transaction without incurring any liability.
What constitutes an "adverse" event and the level of risk is usually negotiatied as part of each deal.
In considering whether a party is entitled to terminate a transaction under a MAC clause the courts will consider:
(a) the precise wording agreed; and
(b) what was known at the time the contract was entered into.
The English courts take a narrow approach to interpretation and are reluctant to permit businesses to abandon their contractual obligations if the effect of a MAC is likely to be short lived. This is especially true with M&A transactions which are commonly pursued for long term and strategic commercial purposes. Likewise MAC clauses will not generally cover external economic or market conditions.
It is consequently difficult to envisage how MAC/MAE clauses might be relied on by businesses especially in relation to contracts entered into during the course of early 2020 when COVID-19 was known about and the disruption potentially foreseeable.
4. Know your termination rights
There may still be rights to suspend and/or terminate a contract under the specific terms and conditions of that contract. Many contracts contain termination clauses which set out the reasons why parties may act to bring the contract to an end and the process to be followed.
Termination rights also exist under common law in circumstances where there has been a material breach of contract. Whether or not a breach is serious enough to justify termination depends on a number of factors.
Critically the court will consider whether the breach relates to a term of the contract which is fundamental to its performance or whether the breach is to a minor term which is capable of being compensated in damages. Non-payment will often be considered to be a material breach, so parties need to be alive to the consequences of not meeting their financial obligations without having agreed a contractual variation to cater for these not being met.
In circumstances where parties are unable to rely on force majeure provisions, MAC clauses or other contractual termination rights then the common law doctrine of frustration may provide a remedy.
Frustration requires the following:
1. a supervening event which is not caused by the default of either party;
2. which was not and could not have been reasonably foreseen at the time the contract was entered into and for which the contract makes no provision; and
3. which fundamentally transforms the nature (and not merely the expense or onerousness) of the outstanding contractual rights or obligations.
The effect of a valid claim for frustration is that the contract will be brought to an end.
The threshold for successfully arguing that a contract has been frustrated is a high one, making it more difficult to rely on frustration than on contractual termination provisions, since it must be shown that the obligations that have been affected were fundamental to the contract. This is particularly the case where the contract imposes several obligations on a supplier that can be carried out independent of each other.
Changes in legislation or the cancellation of scheduled events can frustrate a contract. Parties currently in the process of negotiating agreements, however, might be precluded from raising COVID-19 related frustration in the future as the outbreak and its business impact should now be in the reasonable contemplation of the parties.
We hope you have found our top tips useful in considering the impact Covid-19 could have on business relationships. We would encourage businesses to review existing and propose contracts, and insurance cover and what preventative steps you could be taking to mitigate the effect of Covid-19 on your business and those of your customers/suppliers.
If you have any questions or would like advice on how your business can prepare, we have a team of experienced non-contentious and contentious commercial and contract lawyers, both in the UK and overseas, please contact one of our experts below.