Breaking contracts because of Covid
Covid-19 and the resulting Government restrictions continue to have a significant commercial and operational impact on businesses and organisations across all sectors of the UK economy. The charity sector is no different, with charities now having to consider their long term plans for events and the effect this will have on their ability to attain and support charitable objectives.
Local or regional lockdowns are likely to be the norm for some time while the roll-out of vaccinations will not mean a return to pre-Covid-19 in the immediate future. This means that charities are required to review their contractual arrangements and the extent to which it is possible to exit existing contracts. Exiting an otherwise legally binding contract is no easy feat and charities must be cautious so as not to expose themselves to an allegation of wrongful termination and a claim for damages. So, what options are potentially available?
Force majeure
There is no general concept of force majeure in English law; it is entirely a contractual remedy that arises from the written terms of the contract itself. In the absence of an express term in the contract, there is no general right to rely on force majeure to excuse non-performance of a contractual obligation.
A force majeure clause is a term that allows one or both parties to delay performance or potentially terminate the contact upon the occurrence of a specified event. For a party to successfully rely on such a term, it will generally need to prove:
- That a force majeure event within the meaning of the clause has occurred.
- That the event has prevented, hindered or delayed performance.
- That the event was outside the affected party’s control.
- There is nothing that the affected party could have reasonably done to mitigate the event or its consequences.
If a charity is considering relying on such a term, the first question it will need to ask is whether the event qualifies as an event of force majeure. The starting point is the clause itself. Does it include words such as “pandemic”, “disease” or “acts of government”? Or is there catch-all wording such as “any other events beyond a party’s reasonable control”?
Whilst it is impossible to say that Covid-19 will constitute an event of force majeure in each and every case, it is likely that these words will be sufficient to cover Covid-19 and its consequences. Ultimately, it will depend on the express words used by the parties and, in the event of ambiguity, how those words are to be construed. The factual background and the actual impact it has had on the ability of the parties to perform their contractual obligations will also be very relevant.
Charities attempting to assert force majeure will often need to show that the event has prevented, hindered or delayed performance of their contractual obligations. Prevented means performance has become physically or legally impossible. This is a very high bar.
Hindered means performance has become substantially more difficult and continued performance is likely to have an adverse impact on the affected party. This is still a relatively high hurdle.
Delayed means the event has made it substantially more difficult for parties to perform their obligations within the time frame set out in the contract.
The affected party needs to consider the impact Covid-19 and/or the Government imposed restrictions have or will have on its ability to perform its contractual obligations. The fact that it may be more difficult to run an event, there may be reduced attendance or be less financially viable is unlikely to be sufficient.
It is also necessary to show that the event being relied upon is outside the charity’s control. This means that a charity cannot rely on an event of its own making. Furthermore, the charity needs to show that it has taken reasonable steps to mitigate the event or its consequences. If there are options that can be explored which may allow the contracted event to take place, make sure those options are considered before relying on contractual rights.
A charity seeking to rely on a force majeure clause must also ensure it complies with any notice provisions in the contract. Does notice need to be served by a particular method or on a particular person? Does it need to be served within a certain period of time of the event being relied on? Compliance with any notice requirements is important, as failing to do so may mean the right to rely on the force majeure clause is lost.
Consideration must also be given to the effect of the clause once it has been triggered. Does it simply suspend performance for a period of time or does it allow the charity to terminate the contract altogether? The right to terminate may not be immediate; it may only apply once the charity has been unable to perform for a defined period of time.
Also, what about any costs incurred by the parties? Again, this will come down to the wording of the contract, but if it is silent (which is not unusual) any costs incurred up to that point will often not be recoverable. Business interruption insurance may assist here, but reports of insurers seeking to deny cover are common place (although the recent High Court decision in the test case brought by the Financial Conduct Authority may assist with challenging attempts to deny cover).
Frustration of the contract
The law of frustration operates to automatically bring a contract to an end in certain circumstances. It may not be available where the contract already provides for the consequences of the particular event in question, e.g. a force majeure term. Equally, charities will not be able to rely on it where the frustrating event was reasonably foreseeable (essentially, it is unlikely to be available for any contracts entered into after the pandemic became public knowledge).
To successfully argue frustration, a charity needs to show that there has been an unforeseen event outside the control of the parties that has resulted in a) the contract becoming physically, commercially or legally impossible to perform or b) the outcome of the contract being so radically different that it would be unjust to hold the parties to it. This can be a very high bar, which explains why the number of cases where frustration has been successfully argued remains relatively small.
It is unclear if Covid-19 will be held to be an event of frustration. There is no English law authority on the point. It is unlikely that Covid-19 itself will be held to be an event of frustration in the majority of cases. Pandemics are, unfortunately, not unusual – H1N1 was declared a pandemic in 2009. The courts will also be wary of opening the floodgates, notwithstanding any judicial sympathy for the parties involved, However, it is perhaps more likely that the restrictions imposed by the UK Government in response to the pandemic may be held to be a frustrating event in the right circumstances.
If a contract is found to have been frustrated, it will come to an end and both parties will be released from their obligations going forward. In most cases, parties will also be able to recover amounts paid out before the frustrating event, such as deposits or down-payments under the Law Reform (Frustrated Contracts) Act 1943.
Other factors to consider
In May 2020 the Government issued guidance on responsible contractual behaviour in the context of Covid-19.
The basic premise of the guidance is that parties should work together to find a solution. This may include extending time, varying obligations or not insisting on strict adherence to payment obligations.
Parties are also encouraged to make use of alternative dispute resolution procedures where an agreement cannot be reached, e.g. mediation.
It is important to stress that the guidance is not legally binding. The guidance can, however, be a useful bargaining chip when a dispute arises. Charities could look to refer to the guidance if a venue or supplier is resisting any requests to vary or terminate the contract.
Careful consideration
Whilst there are mechanisms in place that may potentially allow a charity to exit a contract affected by Covid-19, the tests that need to be met are fairly high and complex. Charities must therefore give careful consideration to the individual circumstances of their case before embarking on a particular course of action. It cannot be assumed that a force majeure clause will apply, or a contract will be frustrated, due to the existence of Covid-19.
Failure to give such careful consideration may potentially expose a charity to a claim for damages for breach of contract on the basis that the contract has been wrongfully terminated. Furthermore, charities should not lose sight of the importance of open communication and negotiation to resolve contractual issues.
