COVID-19: Impact on Contractual Obligations

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Canada is facing an unprecedented slowdown as a result of the novel coronavirus (Covid-19). Schools and businesses are shutting down, borders have closed, and global supply chains have been disrupted. As the nation prepares for Covid-19 and its down-stream effects, questions have arisen as to ongoing contractual obligations of businesses in times of unforeseen and wide-ranging economic disruption.

In this article, we consider the application of force majeure clauses in contracts and the common law doctrine of frustration. These are legal avenues a business may be able to rely upon in the event it finds itself in a situation where it is no longer able to comply with its contractual obligations.

Force Majeure

Many commercial contracts contain a “force majeure” clause, which suspends a party’s contractual obligations when an unforeseen event, beyond the control of either contracting party, prevents a party from fulfilling the terms of the contract. A party’s ability to claim relief under such a clause depends on the terms of the contract and, in particular, the wording of the Force Majeure clause.

These clauses are often drafted to list specific events that qualify as force majeure events (e.g. acts of war, famine, floods, earthquakes, and acts of terrorism), which may be followed by general “catch-all” wording to capture unlisted events that would fall within the concept. The clause may also explicitly exclude instances, such as a market downturn or lack of funds, as events not falling within the scope of force majeure.

The common theme amongst force majeure clauses is that they provide relief to a party that is not able to perform its obligations due to unexpected intervening events. While Covid-19 was certainly unexpected, the application of a force majeure clause is not so clear cut — generally speaking, the affected party would have to demonstrate that:

  1. Covid-19, or its knock on effects, is captured by the force majeure clause;
  2. The impact of Covid-19 was unavoidable and beyond the control of the affected party; and
  3. Such impact prevents the affected party from performing its obligations under the contract.

Canadian courts have set a high bar in enforcing force majeure clauses, to the point where a party must demonstrate that it would be impossible to perform its obligations under contract as a result of an intervening event. A contract that has become commercially impractical, inconvenient, or expensive to perform as a result of Covid-19 would unlikely surpass the threshold required for relief under a force majeure clause.

The availability of relief is highly context specific and may differ depending on the language of the contract and the unique way Covid-19 impacted the business. If the threshold is met, the relief available to the affected party would flow in accordance with the terms of the contract, which may include: (i) the requirement of notice to be given; (ii) a grace period in which some or all of the obligations are suspended until the circumstances can be dealt with or revert to normal; and (iii) a point at which the obligations are terminated, or an option to terminate is made available, if the circumstances persist for a certain period of time.

Frustration

The legal doctrine of frustration may be available for those parties who are bound by a contract without a force majeure clause. Simply put, frustration occurs when an unforeseeable intervening event, through no fault of either party, so significantly changes the core of the contract that it would be unjust to hold the parties accountable to the strict contractual terms in light of the new circumstances. Unlike the operation of a force majeure clause, a successful claim of frustration ends the relationship between the contracting parties rather than suspending the contractual obligations.

The doctrine of frustration is flexible and may, depending on the circumstances, take into consideration a variety of factors, including: (i) whether performance of strict contractual terms has been made impossible; and (ii) whether the underlying purpose of the contract has been destroyed by the intervening event. Notwithstanding the flexible nature of frustration, an affected party faces a heavy burden to prove all elements of the doctrine in order to obtain the equitable relief.

Frustration applies in circumstances where there has been no contractual allocation of risk. In cases where such allocation has been agreed to, such as a force majeure clause, courts will have little reason to impose another allocation through the doctrine of frustration.

Mitigation

Parties to a contract will be obligated to mitigate any losses as a result of Covid-19 despite there being, at first glance, the availability of a force majeure clause or the doctrine of frustration. This means that parties should continue to seek alternate methods of complying with their contractual obligations. This is especially prudent as the availability of relief under a force majeure clause or the doctrine of frustration will not be certain until it has been settled through court or an alternate dispute resolution process.

Final Words

As the impact of Covid-19 continues to cause closures, delays, and confusion, businesses must prepare a plan to navigate this storm by examining their contractual obligations, identifying risk, and considering contingencies. Only by doing so can businesses appropriately position themselves and build resilience in times of such far reaching economic uncertainty.

That being said, the sobering reality of Covid-19 is that it presents a new and unique challenge that all businesses are facing. The uncertain and ever changing fallout of Covid-19, compounded by an already uncertain legal system, represents a daunting obstacle course to those that seek to protect their business. Tempering strict legal principles with pragmatism may be the wisest option in the face of Covid-19. Simply put, seeking a mutually agreeable resolution for contractual issues caused by Covid-19 is likely the most practical way of establishing certainty in an increasingly uncertain landscape.

To summarize, the key steps to take at this time are:

  1. Review your contracts for force majeure clauses;
  2. Take whatever steps are available to mitigate losses and seek alternative methods of performing your obligations;
  3. If your contract contains a force majeure clause and you are unable to perform your obligations, review and follow the contractual process of triggering the force majeure clause. This may involve the delivery of notice to a listed address;
  4. If your contract does not contain a force majeure clause, consider whether the doctrine of frustration applies;
  5. Document how Covid-19 or the knock on effects impact your ability to perform. If a dispute arises, you want to be prepared with detailed evidence; and
  6. If you choose to negotiate with a contract counterparty, be careful that you do not undermine your ability to subsequently rely on a force majeure clause or claim frustration. You should, if possible, reserve your right to claim all legal rights and remedies.

Please contact any of the Private Company Transactions Group lawyers at Clark Wilson LLP for further information.