Coronavirus (COVID-19) and contracts: an act of God?

Coronavirus (COVID-19) and contracts: an act of God?

Nicola Nygh, Harley Milano and Johnson Man discuss how businesses can be relieved of their contractual obligations – in circumstances where they are no longer able to perform a contract due to the coronavirus – through “force majeure” clauses and the common law doctrine of frustration.

The coronavirus pandemic is having an unprecedented impact on trade and commerce. Governments, both in Australia and worldwide, are rapidly imposing drastic public health measures in a desperate bid to stem the spread of the disease – such as quarantines, travel bans, restrictions on gatherings and school and work closures.

Many businesses will find that they are no longer able to perform contractual obligations. For instance, the Australian Government’s ban on gatherings of more than 500 individuals has forced organisers to cancel numerous events. This poses a question as to whether parties have a right to terminate a contract in circumstances where they are no longer in a position to perform the contract.

Two mechanisms by which parties can seek relief from the performance of a contractual obligation in such situations are:

1. force majeure clauses; and
2. the doctrine of frustration.

Force majeure suspends contractual obligations for a certain time, while frustration extinguishes those obligations. The availability of these options will depend on individual circumstances.

Force majeure clauses

Businesses should review their commercial contracts to determine if they include “force majeure” clauses.

Typically, a force majeure clause lists a wide range of circumstances which would prevent the performance of contractual obligations in a commercial contract. Examples of events which may trigger a force majeure clause include “acts of God”; industrial action; actions by government agencies; and native title claims. The purpose of a force majeure clause is to relieve a party of liability to discharge its contractual obligations due to circumstances beyond that party’s reasonable control.

In civil law jurisdictions force majeure can be implied even in the absence of an express force majeure clause. In Australia, force majeure only applies if there is an express clause in the contract and will be interpreted strictly according to the clause.

If the contract has a force majeure clause, it will be necessary to look to the precise wording of that clause to determine if coronavirus-related disruptions fall within its scope. For instance, restrictions on public gatherings or work stoppages may well fall within a force majeure clause, depending on its wording.

Depending on the precise wording, a force majeure clause, when relied upon, can be used to suspend certain obligations within a contract for a period of time or to terminate the contract entirely. The onus will be on the party seeking to rely on force majeure to prove that the force majeure event has prevented the performance of the contract.

Doctrine of frustration

If a force majeure clause does not exist or is not applicable to coronavirus, businesses can instead rely on the doctrine of frustration to be relieved of performing a contractual obligation.

A contract is frustrated where:

  1. without fault by either party,
  2. a contractual obligation has become ‘…incapable of being performed because the circumstances in which performance is called for        would render it a thing radically different from that which was undertaken by the contract’[1] (emphasis added).

This test was affirmed by the High Court of Australia in Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337. Importantly, frustration is a common law doctrine, meaning it can apply to any contract in the absence of an express clause providing for it.

Examples of frustration that have previously been recognised in law include illegality of the performance of the contract (due to a change in law), delay, death or incapacity of a party and destruction of the subject matter.

Importantly, frustration is not easy to establish and has a narrow scope. It depends upon the proper construction of the contract. A contract will generally not be frustrated if:

  1. there already is an operative force majeure clause that can deal with the issue;
  2. the impossibility of performance is the fault of either party;
  3. performance has only become more onerous or expensive;
  4. the change is only temporary or transient. In Hong Kong during the SARS epidemic, a tenant subject to a 10-day isolation order sought unsuccessfully to invoke frustration to discharge his lease, with the court holding the isolation order was only a short duration in the context of the whole lease;[2] or
  5. the event in question was foreseen by the parties.

Upon the occurrence of the frustrating event, the contract is automatically terminated. No party can claim damages for non-performance. In addition, future obligations or promises are discharged. Further, in NSW, the Frustrated Contracts Act 1978 (NSW) will apply to certain contracts so that among other things a claim for damages for breach of contract before the contract was frustrated can still be maintained.

In the context of coronavirus, if the Government were to order a mandatory shutdown of certain businesses, any contracts which require performance during that shutdown period may likely be frustrated.

Conclusion

Given the Australian Government has invoked sweeping emergency powers under the Biosecurity Act 2015 (Cth) by declaring a “human biosecurity emergency” as of 18 March 2020, it is increasingly likely that businesses will be further disrupted by the coronavirus pandemic. Businesses should consider how best to handle their contractual obligations during this period and seek appropriate legal advice.

 

References

[1] Davis Contractors Ltd v Fareham Urban District Council [1956] UKHL 3

[2] Li Ching Wing v. Xuan Yi Xiong [2004] 1 HKLRD 754

Photo by Fusion Medical Animation on Unsplash

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