Can you terminate? Should you terminate?
A practical consideration of the effect of the coronavirus pandemic on contracts
Protecting and safeguarding your business has never been more important. With uncertainty about the length of business closures and social distancing policies, we urge individuals and businesses to undertake a thorough analysis of existing contracts to identify their rights and liabilities during these testing times.
Consumers and businesses exposed to financial constraints may think that ending a contract on the grounds of coronavirus will help cut costs. However, unless there is a very clear and applicable force majeure clause in your contract you should be wary about ceasing to act (whether short or long term) or claiming the contract is at an end. The reason for this is that you may not have any contractual or legal grounds to do so, and if that is the case you could be sued for damages for breach of contract.
If your desired outcome is to bring the contract to an end, it is best to begin by checking whether a termination mechanism exists that avoids having to rely on the current pandemic. For example, some contracts may be terminated with notice or in response to a breach. If no such mechanism exists, checking for a force majeure clause ought to fall next on your review. Force majeure clauses aim to excuse one or both parties from their contractual obligations following the occurrence of unexpected events or circumstances outside of the party’s control.
Force majeure cannot be relied on unless it is an express term of the contract. Even when it is, the specific clause must be either specific in catching COVID-19, or wide enough to catch the crisis on the basis that it could for example fall within the definition of a pandemic, epidemic or acts of governmental authorities, such as the closing of businesses. If a force majeure clause appears to apply, reliance on the clause will require a consideration of the specific performance obligations under the contract, the specific facts of each case and will also normally require service of a force majeure notice on the other party.
Not all force majeure clauses give an automatic right to terminate the contract. Instead they may allow extensions of time or suspension of performance whilst the force majeure event continues.
If force majeure does not apply or does not give you a right to terminate, do you have any other options in light of the coronavirus pandemic?
It could be possible to argue that the crisis, which was unexpected and out of the parties’ control, has impacted on the contract so badly that performance is impossible. Alternatively you might be able to argue that the contractual obligations are now radically different to those which were contemplated at the time of entering the contract. This looks attractive, as the pandemic has of course caused businesses to close and created supply chain issues throughout various industries. That said, the fact that a business may incur additional expense in meeting its existing obligations is not itself a ground for claiming frustration, nor force majeure. This means that if you could honour the supply of goods, but at extra expense, the contract is unlikely to be frustrated.
If a contract is frustrated it will be automatically terminated at the point of frustration and future obligations will be discharged. Ordinarily sums due and payable prior to the date of frustration will be legally due, however it may be possible to argue that the other party should account for any value which it received before the contract was discharged.
The other option is to consider any existing performance issues. You can evaluate whether any shortcomings or failures are so serious that they go to the root of the contract and substantially deprive the innocent party of the absolute benefit that the contract was intended to provide. Such repudiatory breaches of contract enable the innocent party to either treat the contract as ended and seek damages, or affirm the contract and seek damages (as keeping the contract in place may be important for other valuable reasons). Repudiation is a complex area of law and something which is regularly litigated and should not be pursued without legal advice.
Suspension, extension, or termination
If these legal options for terminating are not available, or carry too much risk, an alternative practical option would be to speak with the other party and attempt to agree a way forward. It may be mutually beneficial to bring a contract to an end during this crisis. Alternatively, you may be able to suspend performance or extend time for performance. Varying the contract could in the long run be a less risky and cheaper option, but of course relies on an agreement being reached and, crucially, the variation being legally binding.
Wrongful or premature termination of a contract could result in you being in repudiatory breach of contract and therefore it is advisable to seek legal advice before taking any action. Given the uncertainty surrounding the crisis and the likely period of business closure, it may well be difficult to rely on force majeure or frustration. Ultimately the impact of the crisis will vary from contract to contract and a case by case risk assessment will be necessary.
Speak to a contract law specialist
Please do contact your key contacts below if you require advice in respect of your contracts, or our Commercial team for assistance with contract variations.