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COVID-19 and contractual review

Daniela Bassan, QC and Scott Pike

The World Health Organization declared the COVID-19 outbreak as a pandemic on March 11, 2020. Bracing for the strain on health-care systems, authorities have enacted drastic measures designed to slow the spread of COVID-19. The global economy has been disrupted in unprecedented ways.

Businesses are dealing with the resulting uncertainty as the response to COVID-19 develops at break-neck speed. Some businesses are experiencing acute disruptions in their supply chains; others have been forced to temporarily shut down or transition their workforces to remote arrangements. Events, meetings, and conferences have been postponed or outright cancelled.

In these circumstances, businesses are also reviewing their contracts to determine what happens if they or their counterparties are unable to meet their obligations.

Force majeure clauses – general principles of contract

At common law, parties are required to perform obligations agreed under a contract, subject to certain exceptions discussed below.

To mitigate (or allocate) the risks of delayed or absent performance, most contracts contain a “force majeure” clause (loosely translated as “superior” or “overriding” force). This type of clause relieves an impacted party from performing its contractual obligations when performance is prevented or delayed by an event outside that party’s control. If the clause is triggered, the impacted party may typically suspend or defer performance, or be released from its duty to perform, without liability to the counterparty.

Whether the COVID-19 outbreak is covered by a force majeure clause will depend on the express wording of the clause and the surrounding circumstances.

Most force majeure clauses include a list of specific triggering events, along with catch-all language for other eligible events (such as “other events beyond the reasonable control of the impacted party”). For example, a contracting party may argue that the COVID-19 outbreak is covered by specific triggering events such as “epidemic” or “pandemic”. Or a party may argue that the outbreak is covered by general catch-all language or a broader triggering event (such as “government order or law”, in light of the states of emergency declared by several provinces pursuant to statutory powers). Ultimately, if there is a dispute over interpretation, a court or arbitrator will carefully review the contract, the wording of the force majeure clause, and the surrounding circumstances to determine if the clause is triggered.

If a force majeure clause is ambiguous or its meaning is unclear, a court or arbitrator may need to go beyond the wording of the contract. For example, the decision maker could consider evidence of the parties’ intention to decide if the outbreak is ultimately covered by the contract.

Either way, if the COVID-19 outbreak is caught by a force majeure clause, the impacted party must show that the outbreak has directly affected its performance and to the extent required by the clause. For example, there could be a specified threshold as to level of impact. In the absence of a specified threshold, a party may need to show that it is effectively impossible to perform the contract. The impacted party should also consider what type of performance obligations, whether monetary or non-monetary, are included (or excluded) by the threshold requirements.

If the requisite threshold is met, the impacted party should still mitigate the impacts of the outbreak. If the clause specifies mitigation efforts, the impacted party will need to adhere to those requirements. If the clause is silent on this point, the impacted party should still take commercially reasonable steps to mitigate the foreseeable impacts of the outbreak. Otherwise, the party may be precluded from relying on the force majeure clause.

Common law exception to performance – frustration

If there is no force majeure clause, or if the clause does not apply to the circumstances, a common law exception may still be available to excuse non-performance or delay by an impacted party.

Frustration occurs when an unforeseen event happens, without the fault of either party, which makes performance of the contract substantially different than what the parties had bargained for. Frustration differs from a typical force majeure clause in two ways: (1) there is typically a higher threshold for frustration; and (2) a finding of frustration has only one result, namely, to bring the contract to an end.

Where a supervening event makes performance objectively impossible (either absolutely or practically speaking, due to extreme and unreasonable difficulty, expense, injury or loss), it may be easier to make out frustration. Depending on the specific facts and circumstances, the outbreak may give rise to frustration of contract and justify non-performance.

Addressing contractual arrangements in light of COVID-19

As the COVID-19 outbreak progresses, we expect that questions related to non-performance or delayed performance will become increasingly common. The below considerations should generally frame your review, keeping in mind that we remain available to assist:

  • Be proactive and mitigate the impact if possible. Identify your key contracts and assess whether you or your counterparties are at risk of not meeting (or delaying) contractual obligations. If there is a risk, identify the potential problems, be proactive and identify mitigation efforts. Consider taking the following basic steps:
      • Develop a mitigation plan (including any commercially feasible work-arounds).
      • Document the impacts of the outbreak on your business and your obligations.
      • Communicate with your counterparties regarding their mitigation plans. Keep them informed of any unavoidable disruptions, and discuss and/or negotiate with your contractual partners on how to proceed.
      • Keep detailed records related to mitigation efforts and their implementation.
  • Review the (whole) contract for proper context.
      • Is there a force majeure clause? If yes, it may apply. If there is no clause or the clause does not apply, there could still be common law relief for the impacted party. In either case, the contract will need to be reviewed and the specific facts will need to be analyzed.
      • If there is an applicable force majeure clause, adhere to its terms, including any notice requirements, specified thresholds and requisite mitigation steps.
      • Determine the governing law. This update has been prepared with common law jurisdictions in Canada in mind. Each country has its own laws on the interpretation of contracts, including force majeure provisions, so the governing law will be important. There may also be conflicts of law principles to consider on this point.
      • Look for other relevant clauses or contracts related to the same subject matter. Your contract(s) may have dispute resolution mechanisms that may be triggered, releases or indemnities that may provide relief, or representations or warranties with additional risks to be considered. There may also be “material adverse change” clauses that may be triggered by the outbreak and its impacts.
  • Act in good faith in the circumstances. Your contract may include an express requirement for the parties to act in good faith. If not, though the meaning of the duty is still being fleshed out, Canadian courts have held that parties should act honestly and in good faith in performing their contractual obligations. This duty will also be informed by the specific circumstances of your contract.
  • Going forward, draft your agreements with COVID-19 in mind. Agreements entered into after the outbreak will likely be viewed differently than agreements pre-dating the outbreak. Parties with standard or “boilerplate” language for force majeure clauses (or related provisions) should review their templates with more scrutiny going forward.

 


This article is provided for general information only. If you need advice related to your existing contractual arrangements in light of COVID-19, including managing communications with your counterparties, or addressing issues in contracts under negotiation, please contact a member of our team or your usual Stewart McKelvey contact.

 

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