As the warning signs of an imminent global recession increase, investors are struggling to comprehend the true scale of the coronavirus crisis. Whole sections of the economy have been shut down, but nobody knows for how long. We are facing dramatic economic realignment and an unprecedented wave of bankruptcies. But where will the losses ultimately fall?
Supply chains should ideally be built with back-to-back contracts and pay-when-paid clauses that allocate the losses across the chain, or to the insured parties within the chain. Unfortunately, such arrangements are far from typical.
Losses are often borne by the weakest link in the supply chain. Likewise, joint venture agreements and investment agreements are coming under pressure as parties seek to exit due to increased risk or find that they can no longer perform their contractual obligations due to the crisis.
As the coronavirus crisis deepens, disputes relating to commercial contracts have increased markedly. What remedies does the English law allow when the performance of a contract becomes impracticable or impossible? Is a party liable for breach of contract if they simply cannot comply? If a ‘force majeure’ clause exists, when and how can that be invoked? Investors and businesses are asking themselves such questions with increased urgency as the crisis deepens by the day.
Legal concept of ‘frustration’
Where contract terms do not provide a let-out, the legal concept of frustration may assist. A contract is frustrated if something happens after the date of the contract that is not the fault of either party, but which is so fundamental that it strikes at the root of the contract.
The event must render further performance impossible or illegal or make the obligations radically different from those contemplated by the parties when the contract was entered into. Frustration brings the contract to an end immediately and relieves both parties of any unperformed obligations.
Under the Law Reform (Frustrated Contracts) Act 1943, money already paid is normally recoverable, less any expenses incurred by the other party. A party who has gained a valuable benefit under the contract must pay a fair sum for that, and a party who has incurred expenses may charge them to the other party.
The coronavirus pandemic is certainly capable of creating circumstances that amount to frustration. That said, frustration does not occur if there is another way of performing it. Frustration also does not occur if difficulties arise due to an issue that has been contemplated by the parties, such as supplier failure.
Employment contracts are unlikely to be frustrated, except in the sad event of the death of the employee. Emergency legislation has now made statutory sick pay payable from day one, and the Coronavirus Job Retention Scheme provides a subsidy of up to 80% of pay for employees who agree to be “furloughed”.
There is no automatic right to suspend or stop paying staff if workplaces are closed or customers stop buying. Any cuts to the workforce, other than the scheme, would have to follow usual redundancy procedures.
‘Force majeure’ clause
A force majeure clause may mean the contract is not frustrated because, if the agreed terms deal with a particular situation, that situation will not frustrate the contract. Force majeure clauses can relieve the parties from performing obligations if they cannot be performed for specified reasons beyond the parties’ reasonable control. They may suspend performance for a period or allow the parties to terminate the contract without incurring liability.
Issues such as industrial unrest or transport disruption may be listed as force majeure events. The force majeure event must be the main cause of the disruption. Whether a public health emergency amounts to a force majeure event depends on the wording of the clause.
The force majeure event must be beyond the control of the affected party. Unlike frustration, force majeure may apply to the obligations of one party only. It can grant a temporary suspension or delay.
While the impact of the coronavirus crisis will spread across the economy, the losses will not be evenly distributed. Some investors and businesses will suffer disproportionate pain. The English law relating to frustration and force majeure will not restore order or fairness. They can, however, be used to help suspend or end contractual obligations that have become unrealistic.
Chris Robinson is a specialist corporate lawyer at Excello Law