16 March 2020
Coronavirus (COVID-19) and force majeure
The coronavirus (COVID-19) outbreak is having a damaging impact on commercial activities around the world (for both supply and demand). Restrictions on travel and gatherings have either been imposed (e.g. in China, USA and Italy) or are at least being considered as next steps (by pretty much all governments). Some businesses have already taken steps to limit business travel and participation in meetings and social events.
The impact of the coronavirus (COVID-19) on business is even more complicated than it would otherwise have been, given: (i) the background of uncertainty around what a Brexit deal might look like and whether there will be one at all, (ii) an oil production dispute causing an unprecedented dive in oil prices and stock market losses and (iii) uncertainty as to the level and availability of lender and government support/forbearance in relation to affected businesses. Reduction in demand in some areas (travel, hospitality) is to a small extent off-set in other areas (streaming of video on Netflix, sale of hand cleanser), but clearly there are many losers.
It is also a movable feast, so that by the time you read this, any of the above could have moved markedly on, in one direction or another, and new factors may have arisen. What we do know is that as people struggle to get to work and commerce becomes more difficult to carry out, parties will find it more difficult: (a) to perform their obligations; and (b) to get performance from their counterparties.
What happens when a borrower says to its bank that it cannot service its debt because the COVID-19 outbreak has meant it is unable to service customers? What if the hotel can no longer host your conference because of an outbreak amongst guests? What if movement of goods across a particular border is stopped or slowed to a crawl?
Consider the governing law
The governing law of your contract will be key, because it determines the interpretation of the contract and the potential legal remedies available. Most commercial contracts will state what the governing law is. If the contract doesn’t, then there are rules that will help determine this. We expect that most contracts involving Jersey or Guernsey entities and people will be subject to Jersey, Guernsey or English law, but equally, there will be a huge diversity of potentially relevant legal systems with e.g. Cayman law trusts, Swiss facility documents, French SPAs, Hong Kong law service contracts or New York law financial instruments. Local legal advice will therefore be important.
The starting point for contracts
A basic principle of contract law is that ‘strict liability’ applies. This means that if you have contracted to do something, you must do it, even if it turns out to be much more difficult or expensive than expected at the time you entered into the contract. There are qualifications to this, as with the doctrine of force majeure (which is where the Jersey law of contract will look, rather than to the English concept of frustration).
Force majeure clauses
Each contract needs be looked at individually. Identify the relevant terms and assess the facts as they impact upon a party’s ability to perform its obligations. Has COVID-19 caused a breach of the contract (or if the COVID-19 outbreak keeps heading in the same direction, is a breach likely?).
For any contract, one should check whether it contains a force majeure clause, and if it does, identify whether it is one that seeks to define what force majeure means–whether via an exhaustive list or via examples of what force majeure can mean-or if there is no definition at all.
For context, this is an example short form force majeure clause:
Neither party shall be in breach of this agreement nor liable for delay in performing, or failure to perform, any of its obligations under this agreement if such delay or failure result from events, circumstances or causes beyond its reasonable control. In such circumstances [the time for performance shall be extended by a period equivalent to the period during which performance of the obligation has been delayed or failed to be performed OR the affected party shall be entitled to a reasonable extension of the time for performing such obligations]. If the period of delay or non-performance continues for [•] [weeks OR months], the party not affected may terminate this agreement by giving [•] [days’] written notice to the affected party.
Such clauses come in various shapes and sizes (the above is but one example), but a force majeure clause normally excuses a breach of contract or failure or delay in performance by a party if it is caused by an event which is outside of that party’s reasonable control. A force majeure clause commonly also suspends the obligation to perform while the particular force majeure event continues. This means that the contract still continues to exist, but (as above) the clause may go on to allow one or either party to terminate the contract if the circumstances persist for a particular period of time.
This makes sense, as commercial arrangements cannot be suspended indefinitely.
Is coronavirus (COVID-19) a force majeure event?
The question is whether COVID-19 is a force majeure event. The answer, predictably, is that it depends.
It depends partly on the wording of the force majeure clause in the contract (if there is one).
Contracts may list natural disasters, earthquakes and floods, fire, riots and other cases of civil unrest, acts of war and terrorism. That list changes over time, with terrorism being added to war, and the 2004 Boxing Day tsunami may have resulted in tsunamis being specified more widely as a kind of natural disaster. The fairly recent 2009 H1N1 influenza (swine flu) pandemic (generally understood to mean the worldwide spread of an infectious disease affecting an exceptionally high proportion of the population within a short period) may mean that disease/pandemic/generic health event wording is specified in more recent contracts.
COVID-19 appears to fit the ‘pandemic’ description, and this has now been confirmed by the World Health Organisation. The progress of the virus can change quickly, and what is not a force majeure event today, may well be one tomorrow, as the impact of COVID-19 develops. Also, whether or not an event constitutes force majeure will depend upon the nature of the contractual obligation concerned. Only obligations made illegal or impossible are likely to be relevant. Obligations that are simply made more difficult or expensive to perform are unlikely to be ones to which force majeure would apply.
Follow any stipulated notification procedure
If a review of a contract reveals that it contains a force majeure clause and that COVID-19 could be interpreted as a force majeure event, a party wishing to rely on that clause to excuse its non-performance should follow all formalities prescribed under the contract for doing so. The clause is likely to require delivery of a written notice to the other party stating the affected party’s view that the clause has been triggered. Parties should also keep detailed records of the interruption to their business and details of the factors leading to illegality or impossibility.
Material adverse change/effect (MAC/MAE)
The existence of a force majeure clause is not the only important contractual provision to look out for. Whilst force majeure describes external factors or circumstances that impinge on a party’s ability to perform its obligations, ‘material adverse change’ or ‘material adverse effect’ (MAC or MAE) has to do with the state of a contracting party itself or the subject of the contract. A person who has contracted to buy a company might claim that it is released from proceeding with the purchase if the target company is affected by a MAC/MAE; and a MAC/MAE that affects a borrower (and therefore may lessen its ability to service a loan) will often be an event of default under a credit facility.
A force majeure type situation could of course lead to MAC or MAE, because the same external factors or circumstances that party A might see as a force majeure that promises relief from obligations, could from the perspective of party B (e.g. a creditor) result in a MAC/MAE affecting party A, permitting it to accelerate repayment of the debt party A owes.
Despite this, it is not clear that lenders will want to trigger wholesale defaults indirectly caused by COVID-19. Already, the UK press is reporting that banks are offering flexibility on mortgage repayments, increased overdrafts and credit card limits and relief on cash advance fees to personal customers and SMEs. Quite how the banks will police these offers and determine who qualifies due to COVID-19 causes remains unclear.
At a commercial level, banks are also likely to look at customer circumstances on a case-by-case basis. Parties to any type of contract should explore other options (just like the banks mentioned above) including renegotiation, delaying performance, rescheduling or reducing the burden or speed of delivery. There may be contracts of supply or service where it will suit both parties to negotiate amendments to a deal arrived at prior to the emergence of COVID-19, perhaps because both are suffering its effects.
Where there is no force majeure clause in your contract
There is some authority under Jersey law for finding force majeure even in the absence of a written provision to this effect.
In the Hotel de France v CIB (1995) case, the Chartered Institute of Bankers (CIB) contracted for the use of a particular room within the hotel in which to hold their dinner, and a fire at the hotel meant that it was not possible to use that room. Other rooms were available but the court decided that use of the selected room was “a fundamental term” of the contract. The contract did not contain an express force majeure clause, but was interpreted by the court as one that was impacted by a force majeure event, making it impossible for the hotel to perform the contract. The court’s approach was to allow the CIB to treat the contract as at an end–either because of a ‘fundamental breach’ (failure to provide the particular room) or because of force majeure.
Accordingly, even without a force majeure clause in the contract, there may be mileage, given the right factual circumstances, in arguing an effect much like the fire in the Hotel de France case – i.e. that COVID-19 presents a set of circumstances that make it impossible for a party to deliver up or perform that which it has contracted to do. Perhaps the most obvious candidate type of circumstance, given the virus affects humans (either because they get the disease or because they have to be confined due to preventative measures) could be where a contract is for personal services–e.g. one contracts for the services of a particular artist, musician, artisan, adviser, athlete, personality or performer.
- Consider the facts. Is an event or service illegal or impossible to perform? Remember that mere difficulty of performance, or increased cost of performance, or the contract being less lucrative (renting a venue to put on a show that now may sell poorly) will not, in and of itself, be sufficient to invoke force majeure.
- Consider the contract. The terms of each contract and its governing law should be considered. Is there a MAC/MAE or force majeure clause?
- Monitor the situation. Governmental steps to ban gatherings or travel or other steps that have an impact upon a party’s ability to perform may go toward justifying relief.
- Check whether you are insured. An alternative source of relief could be being able to claim on business interruption cover.
- Renegotiate. Is the other party similarly affected by COVID-19, directly or indirectly? Parties may find themselves on both sides of the problem and be open to compromise or rescheduling.
Recent legislation in all of the jurisdictions in which Carey Olsen operates means that many companies need to demonstrate substance in those jurisdictions. This includes holding an appropriate number of board meetings within the relevant jurisdiction in order to meet the economic substance rules. The failure of Flybe in the UK, growing restrictions on crossing of borders (Italy/China), self-isolation and understandable reluctance to transit through airports means that flying to board meetings is unwelcome for new reasons. We can help by sourcing alternate director services and are ready to continue to assist with all substance queries.