In brief - The doctrine of frustration, and force majeure clauses or MAC clauses in contracts may relieve a party of their contractual obligations in the context of the coronavirus outbreak. However, there is also potential liability for breach of contract for non-performance in the mistaken belief that a contract is frustrated or that a force majeure or MAC clause has been enlivened.
Contracts which may be affected include:
- supply arrangements;
- distribution agreements;
- manufacturing agreements;
- transport agreements;
- insurance contracts;
- travel and tourism agreements; and
- other agreements with cross-border application.
If you are concerned that obligations under a contract may not be met or fulfilled as a result of the current situation, now is the time to seek advice on what avenues may be available. It is possible that the contract is frustrated or that a force majeure clause or MAC clause included in the contract may operate to excuse a party from the obligations.
A contract is discharged for frustration where the law recognises that an unforeseen event makes the performance of the contract impossible, where neither party is at fault. This arises because of the operation of law and not because of anything particular written into the contract. But it depends on a close analysis of what the contract required.
However, frustration is difficult to prove because the event must have severe consequences or resulted in a 'radical change'. Where performance is merely more difficult or expensive, the parties' obligations are not discharged for frustration. For example, if COVID-19 causes a delay or increased costs to either receive or deliver goods, the contract is not frustrated because it is merely more difficult, rather than impossible, for a party to fulfil their obligations. Whether a contract is frustrated will always depend on the specific circumstances of the parties, nature of the contract and the parties' collective ability to perform.
Grounds that may support a claim of frustration as a result of the COVID-19 outbreak, include:
- Unavailability of an essential person to the contract: if the contract dictates that the contract is conditional on a person's continued personal capacity to perform it, that person's permanent or temporary unavailability may frustrate the contract.
- Inability to fulfil essential time conditions: if the contract stipulates a specific time or time period for performance and the time of performance is the essence to the contract, circumstances which radically alter a party's ability to fulfil the contract on time may frustrate the contract.
- Indefinite delay of performance: the contract may be frustrated if an event occurs that would indefinitely delay the performance of the contract so that fulfilment of the contract would involve the parties in something commercially distinct from what the contract originally contemplated.
- Failure of supply or a specific source: a supervening event may make it impossible for a supplier to supply goods, services or facilities, leading to the frustration of the contract.
- Method of performance is impossible: if the contract provides for a fundamental method of performance, it may be frustrated if the method becomes impossible.
- Illegality: the contract may be frustrated if it becomes illegal to perform it.
Bear in mind that the frustration doctrine operates to automatically terminate the contract, which may be disadvantageous to both parties, particularly in long-term contracts. For example, where a 30 year contract to supply LNG is terminated due to a short-term frustrating event, such as a temporary port shut down, the parties will lose the benefit of the remainder of the term and be required to enter into a new deal.
Finally, should if a party stops performing contractual obligations in the mistaken belief that the contract is frustrated, they may be liable to pay damages to the other party for repudiating the contract.
Where performing a contractual obligation is an issue due to the coronavirus, the contract should be reviewed for the existence of force majeure provisions.
The tag force majeure (translated as "superior force") is used to describe clauses in contracts that excuse a party from performing contractual obligations where a defined event occurs, such as an act of God, war, strikes, civil commotions, epidemics or pandemics. Therefore, a force majeure clause may discharge parties from performing their contractual obligations or relieve them from contractual liability where a defined event occurs.
Key to the operation of any force majeure clause are:
- Definitions: exactly what specific events are specified that activate the force majeure clause;
- Effect on obligations: exactly how are particular obligations affected by the force majeure event (eg is there an obligation to take steps in mitigation where the event arises; whether the contract is terminable)
- Machinery requirements: what steps re specified eg does a notice need to be given?
Force majeure clauses vary from contract to contract. The wording of your specific contractual provisions will determine whether the coronavirus outbreak is an event which will enliven the clause. The clause will be construed as a whole, on the basis of the words used and without considering what might have been the actual intention of the parties. Generally the party seeking to rely on a force majeure has the burden of proving that the clause has been triggered.
Clauses specifically extending to 'pandemics', 'epidemics' and 'work stoppages' are obviously more likely to be activated by the coronavirus situation and related mitigation measures.
Provisions that merely refer to 'force majeure' without defining its scope or effects may be void for uncertainty. Common law jurisdictions such as Australia do not recognise force majeure as a standalone, legal doctrine.
On the other side of the coin, some contracts in their drafting specifically try to limit a party being excused for force majeure events.
Even where a force majeure clause is present, it will not necessarily always discharge the parties' obligations or bring the contract to an end because of defined force majeure. Instead, for example, the clause may provide a defence to an action for breach of contract where the circumstances activating the clause arise. Or depending on the words used in the force majeure clause, the clause may:
- justify an application to the other party for an extension of time for performance;
- provide an excuse for failure to perform; or
- suspend or temporarily or finally discharge the performance of a contract.
Parties should be mindful of timeframes to give or receive notice of force majeure events under a clause. Some force majeure clauses may also create obligations to provide evidence of the impact of the event on business activities or the taking of reasonable steps to prevent the event from impacting business activities or mitigate its impact on the contract. So in the pandemic context, parties looking to rely on a force majeure clause may need to show evidence of contingency plans to minimise the impact of the outbreak on the contract or business activities.
Parties to international contracts should be aware that frustration and force majeure clauses can operate differently in other jurisdictions, especially in civil law jurisdictions. For example, in China, the China Council for the Promotion of International Trade can issue force majeure certificates. This certificate allows Chinese companies to provide a form of legal documentation to help renegotiate terms with clients. As of 3 March 2020, China has issued 4,811 force majeure certificates on contracts worth $53.79 billion USD in response to the COVID-19 outbreak. While the certificate may be a persuasive document, it is unlikely to be binding on parties outside of China.
Material Adverse Change (MAC)
Some contracts, often those involving mergers and acquisitions or funding arrangements, contain MAC clauses, which can operate to say, relieve one party of its obligations if there is a MAC as defined by the clause. For example, in the context of financing, a lender may have no obligation to lend where the borrower suffers a MAC. Whether a MAC clause relieves a party of their obligations depends on the definition of the events that constitute a MAC.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Commercial contracts and advice