As national governments take measures to contain the coronavirus and the COVID-19 epidemic it is important to assess the potential impact on your business. We have outlined the essential points to consider in reviewing your supply chain and contractual relationships and five steps you can take to try to mitigate the uncertainty caused by COVID-19.
Coronavirus and Force Majeure
Most commercial contracts contain a force majeure clause.
A standard force majeure clause will generally excuse a party from a delay in performing its obligations where it is prevented from doing so by factors outwith its control.
Clauses will often expressly define what “factors” qualify as force majeure. Others may rely on only a general definition such as “an Act of God, war, or conflict”. On 11 March, the World Health Organisation declared that COVID-19 is a pandemic, which may be relevant to contractual interpretation.
It is crucial that each contract is reviewed to understand whether the COVID-19 epidemic could feasibly qualify as force majeure event, and what steps a party needs to take before relief can be claimed. For example, if a force majeure event is limited only to events outwith “reasonable” control, to what extent is it incumbent on an organisation to mitigate the impact of anticipated disruption? Is there a time limit on relief, after which one or other party can terminate? How does the clause interact with any obligations in relation to business continuity?
If relief for force majeure does not apply, and a supplier cannot perform, what then? The doctrine of frustration can operate to terminate a contract automatically. While the doctrine has a narrow scope, it’s important to assess whether it might apply.
Frustration occurs when an event arises which makes a contract either:
- impossible to perform;
- illegal; or
- radically different from what the contracting parties contemplated.
In order to meet the test, parties must show that:
- the event was not caused by either party’s default;
- the contract does not make provision for the event; and
- the event must have so significantly changed the nature of the obligations from what was considered when the contract was entered into that it would be unjust to continue performance.
If the test is met then the parties are released from their contractual obligations.
Considering the COVID-19 pandemic, any government advice and legislation could, on the face of it, make the contract seem impossible to perform, or radically different. However, the full provisions of the contract will be assessed and interpreted in entirety. However, each contract will need to be reviewed on its facts and requires detailed assessment of the obligations and the events or factors that make them impossible to perform.
Given the effect of a contract being frustrated, the doctrine is interpreted very narrowly. For example, the European Medicines Agency sought to argue that its lease of office premises in London had been frustrated as a consequence of Brexit requiring the EMA to relocate to another EU member state. The court rejected that argument.
Those who wish to terminate by frustration should first check the contract for the existence of a force majeure clause. If there is one, consider whether the clause makes full and complete provision for the event in question, and its effect. If it does, the force majeure clause will exclude parties abilities to enforce the doctrine of frustration.
Business Continuity & Disaster Recovery
Maintaining and implementing a business continuity and disaster recovery policy is key to mitigating the risk of business interruption. This includes dealing with issues such as coronavirus.
Many outsourcing and supply contracts will include specific obligations on suppliers in relation to business continuity and disaster recovery. It’s important that organisations understand how their suppliers’ plans interface with their own internal business continuity and disaster recovery plans, and that these plans are regularly reviewed and tested.
Look at the plans that your suppliers have in place. What sort of incidents do they cover? Are they focused solely on IT systems, or do they deal with availability of staff, premises and goods? Have you checked whether the plan is fit for purpose? Often, a supplier’s plan will be generic, rather than specific to the needs of a particular customer.
Do your suppliers have in place systems to enable staff to work remotely? Do those systems work?
Business continuity also means looking at your wider supply chain arrangements. Is your business dependent upon a single supplier or source for any goods or services? Can you put in place alternative suppliers or does your contract contain exclusivity provisions? Are you at risk that your suppliers focus on other customers at your expense?
Now is the time to check this and think about what can be done to mitigate any risks that are identified.
Additional Contractual Consequences
COVID-19 may impact on your commercial contracts in other ways:
- Change of Law: Change of law clauses may be invoked in the event of national governments taking legislative measures to combat the outbreak rendering the performance of some contracts illegal/impossible. Understand what your key contracts say, so you can assess the risk.
- Limitation and Exclusion: in the absence of force majeure/change of law clauses, suppliers may look to avoid liability by relying on limitation and exclusion of liability clauses. What do your contracts say about loss of business and revenue? The construction of these clauses is extremely important when seeking to rely on them.
- Price Adjustment: COVID-19 may lead to an increase in costs to suppliers. Suppliers may therefore seek to invoke price adjustment clauses or mechanisms to renegotiate the price for the supply. Even if there is no formal mechanism, organisations may find that they have to choose between agreeing a temporary change in prices (to cover increased costs to the supplier) or the supplier claiming relief under force majeure.
Businesses should also review their insurance to determine whether their current policies provide for loss incurred from the disruption caused by COVID-19. The insurance industry has already flagged that business interruption insurance may not cover disruption caused by COVID-19.
It is important to review each policy to understand any additional requirements such as an obligation to notify the insurer of loss within a specific time limit or having to take steps to mitigate any loss.
With disruption to business seeming increasingly inevitable, organisations need to take action now to identify and mitigate risks to their business.
Here are our key recommendations:
- Review – review your key contractual relationships to understand whether COVID-19 may have an impact on you or your supplier’s ability to perform.
- Assess – assess your internal disaster recovery and business continuity procedures and supply chain resilience and how these interact with those of your suppliers.
- Check – where your suppliers are required to maintain business continuity procedures check that these are in place, have been stress tested, and are fit for purpose.
- Plan – consider what action you need to mitigate the risk to your organisation.
- Monitor – continue to monitor the impact of COVID-19 and keep your plans under review.
To discuss how COVID-19 may affect your supply chain and commercial contracts, the risks to your organisation, and the steps that you can take to mitigate those risks, please get in touch with me or your usual Brodies contact.
On March 10, 2020