The outbreak of the Coronavirus (COVID-19) pandemic has disrupted people and businesses around the world. This unprecedented crisis is leading to supply disruptions, delays, government restrictions, export or supply bans, and a general adverse impact on the ability to perform under a contract, amongst other matters.
The pandemic has resulted in parties reviewing their contracts, in particular force majeure (FM) provisions, to manage the impact on their contractual and business relationships.
In the world of public private partnerships and large energy and infrastructure project contracts (project contracts), which generally involve complex, high-value and long-term arrangements, sophisticated provisions have been in use for some time to allocate the risk of supervening events, such as a pandemic, and to allow the management of such contracts in an orderly manner.
There are several helpful lessons from these Project Contracts that can provide insights for the future.
This analysis is largely provided in accordance with English law and should be considered accordingly. However, its commercial application can of course be much wider.
FM and Frustration: Why Include FM Clauses in Your Contracts?
A brief recap on why FM clauses are recommended.
English law does not recognise FM as a matter of law, unlike some civil law jurisdictions. To claim FM under an English law contract, the contract should expressly include an FM clause.
If a contract does not include an FM clause, the common law doctrine of “frustration” may apply. Briefly, a frustrating event is an event which:
Occurs after the contract has been formed
Is so fundamental as to be regarded by the law both as striking at the root of the contract and as entirely beyond what was contemplated by the parties when they entered the contract
Is not due to the fault of either party
Makes further performance impossible or illegal, or makes it radically different from that contemplated by the parties at the time of the contract.
Under English law, frustration generally only applies in extreme scenarios and then for a very narrow set of events. An event that deprives a party of its expected benefits under a contract from its actual performance is generally not sufficient to claim that the contract has been frustrated.
What Is FM?
There is no standard definition of FM. However, FM can be generally defined as “an exceptional or supervening event or circumstance beyond the reasonable control of the parties that prevents (or delays, obstructs or hinders, which are lower standards) a party from performing its obligations and which could not reasonably have been provided against, avoided or overcome”.
The parties typically supplement the definition of FM by expressly including a non-exhaustive list of events that the parties agree are FM events (if the prescribed tests are met) and which often expressly include “epidemic” or “pandemic”. However, even if an “epidemic” or “pandemic” is not expressly included, a party should be able to claim these as FM events under other heads, such as “events beyond the reasonable control of the claiming party”, “government action”, “quarantine”, “emergency” or “shut down”. In certain other categories of projects, however, such as healthcare and prisons, there may be public policy reasons for deliberately and expressly excluding “epidemic” and “pandemic” from the FM events. In such circumstances, it may be prudent to provide for recovery plans and other supervening events.
If an FM event occurs, a party is protected from its failure to perform its obligations under the contract. However, a party cannot automatically claim FM relief: the claiming party would need to establish causation between the FM event and claimed non-performance or breach and follow the prescribed process to claim FM relief under the contract.
A party seeking to rely upon an FM provision will usually also have to show that it has taken reasonable steps to avoid or mitigate the event and its consequence, and that there are no alternative means for performing under the contract. What constitutes a reasonable mitigation measure, in the circumstances, will depend upon the nature of the contract in question and the surrounding facts.
Generally, an event that makes a contract more expensive or onerous to perform, such as an economic crisis or a change in the market or economic conditions or an obligation to pay, is unlikely to qualify as an FM event.
Consequences of Frustration
In the absence of FM clauses, there is the added and higher risk of a contract being frustrated. The consequences of frustration are set out in the Law Reform (Frustrated Contracts) Act 1943 (LRA), which generally applies to commercial contracts with a few exceptions. The LRA:
Permits recovery of money paid before the frustrating event
Does not permit recovery of money due before the frustrating event, but not in fact paid
Subject to an allowance, at the court’s discretion, permits recovery of expenses incurred before the frustrating event
Requires a party who has gained a valuable benefit under the contract before the frustrating event to pay a “just” sum for it.
This may not be the intention of the parties, who may prefer that the contract itself lays down a road map for dealing with such events.
If the parties have made express provision for the consequences of a particular event which has occurred, such as an FM clause to deal with an event, then the contracts have been held not to be frustrated. This also provides greater clarity and certainty to the parties.
What Can We Learn from the Project Contracts?
Several historical lessons could be learnt from the manner in which FM clauses are used to allocate risks between the parties and to ensure that the contractual relationship continues, despite the relevant supervening event. For example:
Detailed FM definition: Draft a detailed definition of FM and qualify it with the prescribed standards, which could include:
– The FM event is not within the reasonable control of the claiming party.
– The claiming party could not prevent the FM event despite exercising reasonable care and diligence and acting in accordance with Good Industry Practice (this standard also being defined in the contract).
– Such FM event materially and adversely affects the claiming party’s ability to perform its obligations under the contract.
– The claiming party has taken all reasonable precautions, due care and reasonable alternative measures to avoid the effect of the FM event.
List of FM events: Supplement the definition of the FM event with an illustrative (but not exhaustive) list of events that the parties consider to be FM, which could be further categorised into “natural” and “political/government” FM events.
Exclusions from FM events: Specify the list of events that the parties pre-agree are not FM events to avoid any discussion or dispute later. These exclusions could include:
– Change in market or economic conditions or a financial crisis
– Failure to make a payment
– Normal wear or tear of equipment and materials.
Insurance: require parties to obtain appropriate insurance cover for FM events. Insurance cover is often available for natural FM events, but there are categories of natural FM events that may not be insurable on commercial terms. Insurance cover may be more difficult or expensive to obtain for “political/government” FM events.
Staggered reliefs: Prescribe relief depending on the category of the FM event. Typically:
– Different categories of events, contract delays or breach caused by FM events can be excused and an extension of time for the performance of the contract can be granted.
– For natural and/or insurable FM events, the claiming party is expected to rely on its insurance cover.
– For natural and/or uninsurable FM events, the claiming party is often compensated for its loss (within limits).
= For political/government FM events and where insurance is not available, the claiming party is often compensated for its loss (within limits).
– The FM relief mechanism would also depend on the industry standards and the respective bargaining position of the parties.
Notification: Prescribe detailed requirements for issuing of an FM notice and require the claiming party to periodically provide detailed updates. These notice requirements could include requiring the claiming party to provide details of:
– The FM event
– How the FM event has prevented it from performing its specified obligations under the contract
– The specific obligations that have been affected because of the FM event
– An estimate of the expected duration of the FM event
– The measures and steps that the claiming party is taking to mitigate the impact of the FM event
– All evidence reasonably required to support the existence of the FM event and its impact on the claiming party.
Mitigation: Require the claiming party to mitigate its losses. Where possible, be specific as to the mitigation measures that are expected of the claiming party.
Alternative measures: Require parties to discuss and agree in good faith any alternative measures and methods which could be used to comply or perform the contract without affecting the economic balance or equilibrium of the contract.
Longstop date: Provide for a longstop date for continuation of the FM event beyond which any party would be entitled to terminate the contract.
Resumption of performance: Require the claiming party to resume performance as soon as the FM event ceases to prevent it from performing its obligations.
What If the Contract Does Not Include an FM Provision?
If it is an international contract, check if any mandatory provision of local law would apply to grant relief in the same manner outlined above.
If a contract is silent on FM and the doctrine of frustration cannot apply, it is worth considering what other remedies may be available. In the absence of legal protection, the parties may also consider renegotiating the contract.
Other Contractual Reliefs?
In some project contracts in other sectors, other relief measures, analogous to FM relief measures discussed above, may be available in certain circumstances.
Compensation Events (compensation payable for breach which results in delay or increased costs of service delivery)
Relief Events (one party bears the financial risk of increased costs and reduced revenue but is relieved from full performance and termination)
Excusing Cause provisions that disapply provisions for certain recourse, e.g., deductions or penalties
Step-In by a sponsoring party to deal with a particular emergency or set of circumstances.
Ultimately, FM and other relief regimes are risk allocation and mitigation structures to manage the effect of supervening events by allocating the risk to the party who is in a better position to manage it.
The parties to a contract may need to take a fresh look at their contract and in particular any FM and relief provisions. COVID-19 has caused a substantial disruption in the ongoing performance of contracts for all parties to a contract, and it is important to learn from this situation. Experience of project contracts FM and relief provisions could provide a basis upon which such issues are dealt with in all or most contracts, and could be used for the wider industry and other sectors to better manage future interruptions and supervening events on their business and affairs.
What do Businesses and Individuals need to do to claim FM relief for COVID-19?
Assess the impact of COVID-19 on your non-performance under the contract.
Carefully review the contract to check the scope of the FM clause and any protection or relief that you can claim under the FM clause.
Diligently follow the process to claim FM relief as set out in the contract. This is likely to include promptly sending an FM notice to the counterparty setting out:
– Express declaration of the FM event
– Details of the FM event, e.g., COVID-19
– Details of the impact that the FM event has had on the actual or anticipated performance of the claiming party’s obligations under the contract
– Current estimate of the expected duration of the FM event
– Evidence reasonably required to support the existence of the FM event and its actual or anticipated impact on the performance of the claiming party
– Mitigation measures that the claiming party is taking (even if the contract is silent on mitigation, parties are still subject to the general duty to mitigate their losses under English law)
– Outline of next steps.
Some of the steps noted above may appear to be excessive, but it is important to follow the letter and spirit of the contract, including any formal requirements regarding format, content and timing of the FM notice.
Provide regular written updates to the counterparty as per the frequency and other requirements set out in the contract. In particular, set out the mitigation measures that you are taking.
Keep detailed records of the impact of the FM event.
Take reasonable measures to mitigate or avoid the effects of the FM event.
Review insurance policies to explore a potential claim. Note that insurance policies typically have strict notification requirements, duties to mitigate loss and an obligation to consult with the insurers before making a formal claim.
Continue to perform those provisions of the contract that are unaffected by the claimed FM event.
If the contract is part of a chain of contract, check that each party in the chain can claim FM relief from its respective counterparty (typically, this risk of a “broken” chain is addressed by drafting a consistent set of FM clauses in each contract and ensuring that the contracts are on a “back-to-back” basis).