COVID-19 Will the effects of the coronavirus allow you to avoid contractual obligations?

6 March 2020

The first months of 2020 have seen the new coronavirus, COVID-19, grow in its scale and impact, including in New Zealand. The World Health Organisation has declared a Public Health Emergency of International Concern, and New Zealand has activated its pandemic response plan.

The commercial impacts are likely to be significant,​​ with the US Federal Reserve slashing interest rates in the first emergency rate cut since the global financial crisis, tech giants like Apple, Microsoft and Google looking to move production out of China to mitigate losses, and global airlines expecting revenues to fall by USD$4-5 billion in the first quarter of 2020.

Closer to home, the virus is affecting New Zealand's export, tourism and education sectors, with key supply chains and other sectors and markets likely to be affected.

As a result, we expect that many New Zealand companies and individuals will be assessing the impact of the virus on their contractual obligations. A number of​​ potential issues arise, including whether the virus excuses a party from their obligations under a force majeure clause or the doctrine of frustration.

The coronavirus and force majeure clauses

A force majeure clause excuses a party from their contractual obligations and liabilities if they are prevented from acting because of a specified event. Importantly, there is no independent doctrine of force majeure. A force majeure clause only applies if the parties have specifically agreed to such a term in the contract. Accordingly, the wording of the particular clause at issue will be critical in assessing whether it applies.

The courts have said that a party seeking to rely on such a clause faces a “comparatively high hurdle". There are typically four key considerations in assessing whether a force majeure clause applies.

  1. Specified event: A force majeure clause often lists specific events that must occur for the clause to apply. Commonly specified events include natural disasters, wars and strikes. The coronavirus may be covered if the specified events include “disease" or similar. It arguably could be covered if one of the named events is an “Act of God". In addition, the coronavirus could lead to travel or import/export restrictions that may qualify as “Acts of State" or “governmental restrictions". Some clauses go further than a list of specific events, and generally apply to all events that “could not have been reasonably prevented by the affected party". As a result, it is essential to closely review the relevant wording.
  2. Prevented performance: If there is a qualifying event, the clause will often require that event to have “prevented" performance by the affected party. This is a high standard. The courts have ruled that it is not enough that the event has made performance more difficult or expensive. Instead, performance must be legally or physically impossible. Some force majeure clauses may have a different standard. For example, a clause may require the event to have “hindered", “delayed" or “adversely affected" a party. These set a lower standard than “preventing" performance. This is an important distinction when considering the impact of business or travel restrictions that are officially recommended, but not legally required. Following self-quarantine and travel restrictions may be prudent and responsible, but it may not be sufficient to engage force majeure protections.
  3. Party's control: Typically, the clause will require that the failure to perform was due to circumstances beyond the party's control. If the clause is silent, the courts may read in this requirement.​
  4. Mitigation: Finally, there must be nothing that the party could reasonably have done to avoid or mitigate the event or its consequence.

Given that a high standard typically applies, contracting parties should carefully review the wording and application of a force majeure clause before seeking to rely on it. If the party seeks to rely on such a clause and it later turns out that the clause did not apply, that party may have wrongfully repudiated the contract, and may be liable for damages resulting from that repudiation.

The coronavirus and the doctrine of frustration

If the contract does not contain a force majeure clause, the common law doctrine of frustration may apply. It releases the parties from their contract where, by no fault of either party, an intervening event makes performance impossible or radically different than what the parties agreed.

Examples of frustration include circumstances where:

  • A change of law or government directive makes performance illegal,
  • The subject matter of the contract is unavailable (for example, the person providing the services is permanently indisposed), and
  • The purpose of the contract no longer exists (for example, the contract relates to an event that has been cancelled).​

However, if the terms of the contract deal with such a risk, the doctrine of frustration will not apply. ​Even if the contract does not address the risk, the courts have still set a very high threshold for the doctrine to apply.

Accordingly, the effects of the coronavirus must be so significant as to make performance of the contract impossible or radically different for the doctrine of frustration to apply. Again​, parties should be careful in asserting frustration. If the doctrine​ does not apply, the party refusing to perform on this ground may have wrongfully repudiated the contract.

The coronavirus and other potentially relevant provisions

When reviewing a contract to assess the potential impact of the coronavirus, you should also consider a range of other clauses that may potentially be relevant. For example:

  • Material adverse change: Facility agreements, sale and purchase agreements and supply agreements might contain “material adverse change" or “material adverse effect" provisions that allow a lender or other party to cancel the contract if triggered. In some circumstances, the effects of the coronavirus may meet this threshold.
  • Cessation of business: Some agreements, including leases, can contain provisions requiring a party to continue business at a certain rate or at certain times, with remedies on default. If the coronavirus causes a party to cease business, these provisions may apply.
  • Financial covenants: Many financing documents require borrowers to maintain certain financial covenants, such as for cash flow or earnings. The coronavirus may cause a borrower to breach a covenant, leading to an event of default.
  • Change in law: Contracts might include a change in law clause that requires a party to give notice if one or more of their obligations has been made unlawful because of a change in law. The consequences of a change in law clause will vary depending on the terms of the clause, but may include suspension of an obligation to perform, a duty to use best endeavours to find alternative means to achieve a similar result, or a right to terminate.
  • Termination: Parties should also be mindful of the termination provisions of their contracts, and whether any termination rights might arise as a consequence of the coronavirus.

It will be important for businesses to carefully review all potentially relevant clauses against the impacts of the coronavirus on their particular business.

If you would like assistance in assessing how your contractual obligations might be affected by the coronavirus, please get in touch with the contacts listed or your usual Bell Gully advise​r.​​

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Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.