Contracts and Covid-19

Louis Vouloukos

Understand obligations during pandemic disruption

As Covid-19 continues its rapid spread throughout the globe, it brings with it unprecedented disruption to every aspect of our lives, both personal and business. While our health, undoubtedly, remains our number one priority, Covid- 19 is also bringing about momentous interruption to our businesses. Government restrictions, travel restrictions, cancellations, supply, demand and labour shortages, are all having an adverse effect on most of our businesses.

As a result, many businesses are unable to perform some or all of their existing contractual obligations, either because they or another party to contract has been impacted by the disruption caused by Covid-19. But, is party to a contract excused from performing its contractual obligations because of Covid-19? In this article, we explore contractual terms and legal principles that may be available to excuse performance of some or all of your contractual obligations.

Review your key contracts

If your business is unable to perform its contractual obligations, begin by gathering and reviewing your key contracts to assess whether there are any contractual provisions that may be of assistance. Many, but certainty not all, contracts contain a “force majeure” clause. Force majeure clauses may excuse a party from performance of some or, less often, all of its obligations under a contract. “Force majeure” clauses are typically easily identified in a contract, but sometimes contracts contain other clauses that, while not specifically identified by a heading or reference to the term “force majeure”, contain language that can be characterized as a “force majeure.” Even if your contracts do not contain a force majeure clause or other analogous provision, you may be able to rely on the legal doctrine of “frustration.”

You should also carefully look at the terms and coverage afforded to you by your business insurance contracts. We now explore each these areas in a little more detail.

Force majeure

“Force majeure” clauses may excuse a party from performance of specific or, less often, all obligations under a contract where non-performance of an obligation results from circumstances completely beyond that party’s control (for example, because of “acts of God”) or upon the occurrence of certain specified events (for example, government regulation, strikes, labour shortages, war or terrorism).

Some force majeure clauses may even list an event like a “pandemic”, or “epidemic” as a force majeure event, but that is not as common. Whatever language is used, the commonality among force majeure clauses is that they list events that are completely outside of a contracting party’s control. If your contract contains a force majeure clause, the next step will be to determine if the pandemic — in this case Covid-19 — falls within the language of the force majeure clause.

If you are fortunate enough to have the words epidemic or pandemic listed, the clause may be applicable. If not, your force majeure clause may use the term “acts of God.” The words “acts of God” have been interpreted by our courts, and generally speaking interpreted as a (supernatural) event that is unexpected, unforeseeable and beyond either party’s control or foresight.

Arguably, Covid-19 could be considered an “act of God,” but it remains to be seen how our courts would interpret such a phrase in the context of Covid-19. One thing is certain, however, and that is that each contract and each force majeure provision must carefully be reviewed and interpreted with reference to the entire contract as a whole. If the force majeure clause is applicable, a party would need to demonstrate that the force majeure event is the reason for the non-performance.

There cannot be other reasons for non-performance, such as intentional delay on the part of a contracting party, to name but one example. In short, there must be a clear link between the non-performance and the force majeure event. Even if there is a clear link, if relying on a force majeure provision, you need to take all reasonable steps to mitigate (or lessen) the damages caused or to be caused by the force majeure event, especially in a case where only a specific portion of your contractual obligations is incapable of being performed.

For example, a claim by a party that it cannot perform its supply contract because Covid-19 is an applicable force majeure event that is preventing the supply of an essential component that is needed to complete production of that party’s products.

Whether or not that party will be successful relying on the force majeure clause in this instance, will depend, for example, on whether that party could have reasonably obtained the essential component it requires from other sources, even if at a higher price.

In short, if relying on a force majeure, a party should be able to show that it took all reasonable steps to mitigate its damages. Remember, performance has to be impossible and completely beyond a party’s control. A party also needs to consider the extent to which the force majeure event excuses that party from its contractual obligations. Is the party excused from the contract as a whole, or just a specific contractual obligation?

Further, for what the period of time is the non-performance excused — permanently or is performance simply delayed for some specified period of time (for example, six months), or until the end of the end of the force majeure event that gave rise to the non-performance?

Finally, if relying on a force majeure clause, a party must comply with any notification provisions contained in the contract, and, also, the relevant time periods for notification. Delivery of any force majeure notice should be made in accordance with the contractual provisions and only by methods of delivery permitted by the contract. It is always a good idea to use more than one method of delivery provided for in the contract.

Frustration

What if your contract does not contain a force majeure clause or other analogous provision? In limited circumstances a party may be able to rely on the common law, and, specifically, on the legal doctrine of “frustration.” Pursuant to this doctrine, as enunciated by the Supreme Court of Canada, ”frustration” occurs when a situation has arisen for which the parties made no provision in the contract and the performance of the contract becomes a thing radically different from that which was undertaken by the contract.

While an examination of what constitutes “radically different” is beyond the scope of this article, it should be noted that a contract becoming more onerous or more expensive is not enough to frustrate a contract. It should also be noted that the legal threshold for establishing frustration is higher than force majeure, and, therefore, it is more difficult to establish the requisite elements of frustration as opposed to relying on a force majeure clause. This stems largely from the fact that a contract that has been frustrated results in all contracting parties being discharged of their obligations, whereas a force majeure event is dictated by the language of the contract as agreed upon by the parties and may act to excuse only one party to a contract, or excuse a party from some, but not all, of its obligations. Having said that, it remains to be seen if our courts will “relax” the frustration threshold in light of the novel Covid-19 pandemic.

Insurance

Finally, you should also carefully review your commercial general liability policies and business interruption insurance policies, if any, to determine if they can be relied on to alleviate against some of your businesses lost profits or protect your business from any claims related to Covid-19. For example, if your business is sued by a customer or employee for failing to take appropriate protective measures to prevent the spread of Covid-19, your general commercial general liability policy may contain some protection. Similarly, if your business subscribes to business interruption insurance, determine whether Covid-19 is a peril contemplated by your business interruption policy. If so, you may be able to recover some lost profits because of any losses caused by the Covid-19 pandemic. As insurance coverage is wide-ranging and the specific perils that are covered (or excepted from coverage) varies greatly across business sectors and industries, every case may be different and insurance policies need to be carefully reviewed and analyzed on a case by case, policy by policy basis.

Conclusion

As businesses try to deal with the economic and business disruptions caused by Covid-19, it is essential that business owners gather and review their key contracts to determine if they contain force majeure or analogous provisions that may assist in the event your business is no longer able to perform some or all of its contractual obligations, or if your business receives a notice of a force majeure event from another contracting party. Each case will depend on the facts and the language of the specific contract.

If no force majeure clause has been contemplated in your written contract, you may be able to rely on the legal doctrine of frustration to relieve all parties from their contractual obligations. Insurance contracts may also provide some economic relief against lawsuits or business interruption losses.

As Covid-19 is a novel and unprecedented event, it remains to be seen how flexible our courts or insurance providers will be when dealing with claims of non-performance of contractual obligations or insurance claims related to the disruption caused by Covid-19.

Louis Vouloukos of Brampton, Ont.-based Lawrences, specializes in corporate, commercial and franchise law.

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