15 Mar COVID-19 and your Contract
Unless you have been living under a rock as they say (which to think of it sounds like a good idea right about now), you are no doubt aware of the outbreak of a respiratory disease caused by a novel (new) coronavirus that was first detected in China and which has now been confirmed in more than 100 locations internationally. The virus has been named “SARS-CoV-2” and the disease it causes has been named “coronavirus disease 2019” (abbreviated “COVID-19”).
The virus’ human impact has been reflected on a global scale.
The impact was felt acutely in China almost from the onset- car plants across China have been ordered to remain closed following the Lunar New Year holiday, thwarting global automakers from restarting operations in the world’s largest automobile market. According to S&P Global Ratings, the outbreak will force car manufacturers in China to cut production by about 15% in the first quarter. There has been a clear risk to global supply chains. Qualcomm (QCOM), for example, the world’s largest maker of smartphone chips, warned that the outbreak was causing “significant” uncertainty around demand for smartphones, and the supplies required to manufacture them. The global drag will likely extend into the next quarter even as China recovers, and the unwavering threat of a global pandemic has arguably replaced China spill over effects as the main downside risk to the global outlook for 2020. In this regard, the outbreak has weighed on global financial markets and is expected to heavily impact business and travel.
As the global impact continues to reverberate across sectors, we may likely see an increase in contractual defaults as counterparties become unable to perform their obligations either at all, or in a timely manner. As the virus impacts more countries, supply chain disruptions may be more and more common and should have businesses reviewing their contracts with vendors and customers to see what remedies they have if shipments are delayed or cancelled.
This gives rise to an examination of the operation and applicability ever present but perhaps less thought of contractual clause of “Force Majeure”. “Force majeure” (from the French “superior force”) refers to an event that contracting parties agree could occur but whose timing and impact they cannot control. It is a way of agreeing, in advance, what will happen if disaster strikes and as a result, the parties cannot perform. To invoke a force majeure clause, the non-performing party must establish that it could have performed its contractual obligations if the force majeure event had not occurred. This may be a challenge for a party impacted by the coronavirus, because while a typical force majeure clause will refer to “acts of God,” “war,” “terrorism,” and “disaster,” there may not be explicit references to “disease,” “epidemics,” or “quarantines.” Courts may interpret force majeure clauses narrowly and limit “acts of God” to earthquakes and floods, and catch-all phrases, like “any other emergency,” to emergencies stemming from the events expressly described in the force majeure provision. Without a specific reference to disease, therefore, a force majeure clause may not excuse a party who cannot perform.
The law can offer another remedy when force majeure is no help to a defaulting party. There is no duty to perform an obligation if performance becomes impossible or impracticable due to an unforeseen supervening event. Courts will also apply the doctrine of “commercial frustration” to excuse a delay if performance, although not impossible, would become so costly that the value of the contract consideration is effectively devastated. In this regard, a contract is frustrated when the nature of performance of the contract has fundamentally changed since it was agreed, and it has become impossible to perform. You might be able to easily imagine scenarios that might meet this definition. However, in practice, the threshold for establishing frustration is a high one. In this regard, circumstances that prevent performance, but which were reasonably foreseeable at the time the contract was entered into will not frustrate a contract. Mere delays and increased costs to deliver or receive goods to or from China due to the COVID-19 outbreak may also not frustrate a contract as performance may not be impossible, but simply more difficult. However, this will depend on the nature of the contract and the performance obligations in question.
The contemplation of the potential effects of COVID-19 on your business can now force you to really review contractual clauses such as force majeure particularly in your next commercial negotiation. For current contracts, it is important to be mindful of any notice provisions under the contract as well as specific additional obligations existing which can either compel performance or mitigate damages should COVID-19 affect your business expectancy. Practically speaking, you may want to consider business solutions to legal issues to encourage full performance if you find your business impacted. In this regard, sitting back down at the bargaining table to negotiate a compromise may achieve the desired result.