The spread of the Novel Coronavirus, also known as 2019-nCoV, Wuhan Coronavirus and most recently COVID-19 was first reported from Wuhan, China on 31 December 2019 and has led to parts of China being quarantined.
A significant consequence of this lockdown is the inability of many businesses who trade with China to buy and sell goods in the Chinese market, causing them to look to rely upon force majeure and frustration clauses for protection.
Many contracts, and most international trade agreements contain a force majeure clause.
Force majeure is a contractual term permitting parties to a contract to avoid liability for non-performance of a contractual obligation where an unanticipated, exceptional and external situation, condition or event prevents one or more parties from performing its contractual obligations.
In some instances, a force majeure clause may also provide a contractual termination right, usually where the force majeure event continues for a defined period. Where this occurs, the clauses can define if a party is to retain the benefit of monies already paid or work completed under the contract upon termination. Usually, the defined events that trigger the force majeure provisions are matters that are beyond the reasonable control of the contracting parties.
The effect of COVID-19 on contractual force majeure provisions will no doubt give rise to some interesting legal issues. Standard force majeure provisions often stipulate specific happenings such as ‘natural disaster’ ‘war’ and ‘acts of terrorism’, but seldom extend to what is relevant to COVID-19, namely, epidemics, quarantine, biological contamination or entry and exit restrictions.
Unlike force majeure, frustration is a concept recognised by the common law (and in many states in Australia by statute). Frustration operates to bring a contract to an end in circumstances where an intervening, post-contract event, has occurred through no fault of the parties, which:
- make a contractual obligation impossible to perform; or
- transforms a contractual obligation into a fundamentally different obligation.
Unlike force majeure, where a frustrating event occurs, a contract is automatically terminated upon the occurrence of the frustrating event. No special provisions need be incorporated into a contract for the doctrine of frustration to operate. A contract is frustrated where subsequent to its formation, and without fault of the parties, the contract is incapable of performance due to an unforeseen event, resulting in the obligations under the contract being radically different from those contemplated by the parties to the contract.
When a contract is frustrated, the losses ‘lie where they fall’. Neither contracting party can claim damages for non-performance because no party is at fault. Under the common law, where a contract is frustrated, the obligation to perform the contract from the point of frustration ceases, including any payment obligations. This may cause economic and financial outcomes such that parties may seek recovery in restitution.
Contracting parties should carefully assess their existing trading arrangements to understand the risks that may be encountered as a result of the spread of COVID-19. Contracting parties should also be mindful when negotiating and contracting in future of the assumptions underlying and surrounding risk allocations in a range of contracting structures, particularly in the context of closed supply chains and in terms of the ability to access international markets and materials.
Frustration and force majeure provisions properly exercised can have profound impacts, so the exercise of these rights should be carefully assessed. Dealing with or anticipating issues around your contracts or after more information on the clauses such as force majeure and frustration? Give us a call.