Force majeure clauses might cover COVID-19 and partially excuse contractual duties
By Robert Martz, Andrew Sunter and Paul Beke
On March 11, 2020, the World Health Organization declared COVID-19 to be a pandemic: "an outbreak of a new pathogen that spreads easily from person to person across the globe". Businesses need to know if this pandemic will relieve them from performing their contractual obligations under a force majeure clause or otherwise at common law. Generally, force majeure clauses give relief when an unexpected, irresistible intervening force makes it impossible for a contracting party to perform a contractual obligation. Natural disasters and wars commonly appear in force majeure clauses.
In this case, force majeure clauses might commonly come into play with supply chain issues arising in connection with the distribution of goods, including as inputs into other products. They are also typically found in performance contracts, particularly in the construction industry.
Partial relief from duties will depend on your clause and the impracticality of your situation
Force majeure clauses are commonly included in contracts to protect parties that cannot fulfill their obligations under the contract due to extreme or extraordinary events that are beyond their control to prevent. As such, they relieve the party affected by the event from having to perform some or all of their obligations under the contract and from all or some of the liability that could arise from the delay or default in the obligations.
Generally, a force majeure clause might be invoked on the basis of COVID-19, if:
- the wording of your clause is broad enough to cover COVID-19 according to contractual interpretation principles; and
- if COVID-19 prevents, hinders, or makes impossible (depending on the wording of the contract) your fulfillment of the contractual duty.
However, even if these conditions are satisfied, you will still have an obligation to reduce the harm to the other contracting party to the extent possible.
Contractual interpretation depends on context and the ordinary meaning of words
There is wide variation in the content of force majeure clauses. While most start with the broad general principle that refers to 'causes beyond the control of the parties', these can be followed by an illustrative list of examples. It is important to assess whether the list of examples is, in fact, an illustrative list, or whether the list (or any of the items listed) exist independently of the broader principle. Attention should also be paid to the exceptions. If "the inability to pay" is specifically excluded as an event of force majeure, then that needs to be taken into account. The question of whether the COVID-19 pandemic constitutes force majeure in a particular contract is a question of fact particular to that contract.
Courts will look at each force majeure clause to determine when it may be triggered. Because force majeure clauses are contractual in nature, courts (and arbitrators) determine their meaning according to contractual interpretation principles. This focusses on finding the joint intention of the parties when they made the contract. The general approach in Canada is to "read the contract as a whole, giving the words used their ordinary and grammatical meaning, consistent with the surrounding circumstances known to the parties at the time of formation of the contract".
If the law of another jurisdiction governs the contract, the principles of contractual interpretation may be somewhat different (foreign law may apply if the contract does not identify the law of the contract as that of a Canadian jurisdiction and if a foreign jurisdiction has a closer connection to the contract than Canada). For example, there are significant differences between Canadian, American, English and Chinese law in regard to force majeure (this article covers only Canadian law).
No blanket answers are possible given the differences between force majeure clauses and you will need legal advice on your particular clause and your particular barrier to performing the contract. However, generally:
- Force majeure clauses might refer to specific disasters and "causes beyond the party's control"
- Only new force majeure clauses will refer to COVID-19 by name, but some clauses, especially those developed after the SARS outbreak, might refer to terms like pandemics, epidemics, public health emergencies, communicable disease outbreaks, quarantines, government action, failure of suppliers or transportation shortages
- The definition of "pandemic" appears to apply, but for other terms, local (not global) conditions would be what matters
- If the only term in a force majeure clause that might apply is a broad term like "other events beyond the reasonable control of a party" (or "including, but not limited to"), then according to the contractual interpretation principles, the rest of the clause and the rest of the contract will be interpreted in that broad manner
- How local, provincial and national governments have classified the COVID-19 pandemic will also be important, including any declarations of emergency under federal or provincial legislation.
Is the contract impossible to perform?
In commercial contexts, the generally accepted test is whether the contract will be impossible to perform. However, in Alberta, there is some support for a lower standard of being commercially impracticable or unreasonable and, depending on the language of the contract, a lesser standard of 'prevent' or 'hinder' may apply.
Among the circumstances where COVID-19 may make it impossible or impractical to perform a contract include:
- Disruption to travel, shipping, delivery, or supply chain restrictions vs. alternatives;
- Quarantine of employees vs. alternatives; and
- Other economic effects.
However, there will have to be a direct connection between the pandemic and the impossibility of performance. This will depend on a wide variety of factors including, in a supply chain situation, whether other options for supply exist. Even if the alternative source of supply comes at a substantially higher cost, it is unlikely that higher cost will satisfy the requirement that satisfaction of the contract is impossible. Typically, agreements with a force majeure clause will exclude force majeure on the basis of a lack of funds.
There is a requirement to mitigate
Even in circumstances where a force majeure clause may be invoked, the party invoking it must still attempt to mitigate or reduce the harm to the other party.
Force majeure clauses often include specific language about the duty to mitigate or to try to reduce the effects of the force majeure event on the other contracting party, which is not an obligation to resolve the force majeure itself. Even without specific language of that sort, general language referring to "beyond a party's control" will very likely indicate a duty to mitigate, since you will generally be capable of mitigating effects within your control. You would need to take "commercially reasonable" steps to minimize the effect on the other party.
Typically, this will include finding alternatives that allow the contract to be performed in some way and to some extent. As the COVID-19 pandemic spreads, it will be important to analyze how it may affect things like workforce, workplace, supplies, production, inventory, insurance coverage and government assistance, and what alternative measures might reduce its impact.
Force majeure clause often only delays performance during the event
As mentioned, the context of the whole contract is relevant to interpreting the force majeure clause. Other clauses may also be critical in setting how extensively you are excused from performance. For example, any liquidated damages clause will be relevant to potential damages for non-performance and a termination clause will be relevant to terminating the contract entirely. The wording of the force majeure clause may excuse non-performance during the force majeure event.
Follow all notice requirements
If a force majeure clause does cover your performance in the face of COVID-19, you will need to follow whatever requirements the clause sets for giving timely notice to the other contracting party.
If no force majeure clause applies, the doctrine of contractual frustration might apply
In exceptional situations, even without a force majeure clause, the law can operate to postpone or excuse the performance of a contract. This can occur if intervening circumstances nullify the principle purpose or root of the contract: "It essentially involves an unforeseen change in circumstances underlying the contract, through no fault of the parties, that renders the contract incapable of performance. The change of circumstances must be fundamental in nature, such that it goes to the root of the contract. It is not enough that performance has become more difficult; performance must be impossible." The bar is very high for such a remedy, but it may succeed in exceptional cases.
Practical suggestions for clients
In order to be prepared for different scenarios that may arise given the fluid nature of the pandemic, it would be prudent for companies to take certain proactive steps, including:
- Review any contracts that include force majeure provisions to determine whether the language is broad enough to include the pandemic;
- Consider whether there are aspects to the contract that are impossible to perform for any of the contracting parties in these circumstances;
- Consider what measures you have taken to mitigate the effects of the pandemic on your business. Should you have to invoke a force majeure clause, it may be important to be able to show that you have taken reasonable steps to avoid any disruption. For this reason, documenting mitigation measures may be important; and
- Review the notice requirements for the force majeure clause and ensure that any notice strictly conforms to the requirements of the contract. Many force majeure clauses may have strict time limits on notice that must be adhered to.
Other areas that should be reviewed include financing or other financial documents that may require notice provisions in regard to actual or potential force majeure claims and any potential insurance claims, including coverage for business interruption.
Article references can be found in the attached PDF.