On this page you can read more about:
1. Financial support for small business owners during the Covid-19 outbreak
2. How to escape contractual obligations and how Force Majeure clauses work
3. How I can help you in these difficult times
Financial support for small business owners during the Covid-19 outbreak
Watch my Live Q&A below to find out more
If you have any further questions – please join my Facebook group and ask the questions in there. Note none of my guidance is legal, financial, tax or any other type of advice.
You may also want to watch my video on the Coronavirus Retention Scheme and furloughing workers:
How to Escape Contractual Obligations
How to escape contractual obligations is a very pressing issue for many businesses at the moment with COVID-19 around the world. Force Majeure is not typically a clause that small business owners come across and for that reason, there is some confusion around what it is and when it can be used.
We also need to consider termination rights alongside Force Majeure clauses and I will also cover those in this article. Lastly, I will discuss the English Law doctrine of frustration, which may also be relevant to some businesses.
What is a Force Majeure clause?
A Force Majeure clause is written in a contract to suspend or remove contractual obligations whilst a Force Majeure event is happening – i.e. something that is outside of a party's control.
Clearly the Covid-19 pandemic is something that is outside of our control, however, because there is no common law right to escape obligations due to a Force Majeure event, it has to be expressly included in a contract for you to be able to exercise your right to use it.
There is no legal definition of Force Majeure, so if you have a Force Majeure clause in your contract but do not specify that a Force Majeure event is an event that is outside of your control and merely refer to “force majeure events” without defining these, then you will be unable to reply on this clause.
If, however, you make reference to ‘events outside of your control’ and define examples of events outside of your control and those events include the current circumstances, this is going to put you in the strongest position to be able to rely on that clause and escape your contractual obligations.
Note that if a Force Majeure clause is expressed as ‘an event outside of your control that prevents you from performing your obligations’, it must be “physically or legally impossible, not merely more difficult or unprofitable”. A downturn in economic conditions even if caused by Covid-19 will generally not be deemed to “prevent” you from fulfilling your obligations. If the Force Majeure clause instead uses wording such as “an event outside of your control that hinders or delays you from performing your obligations’, this will be a lesser test.
So, you must consider carefully your timing in relying on a Force Majeure clause.
Example: you have entered into a contract with a hotel for a conference taking place in three months’ time.
The contract has a Force Majeure clause that says “Should a party be prevented from performing its obligations pursuant to this contract by an event outside of its control including any action or order from the government, that party shall be relieved from its obligations for the continuation of the event.”
In this case, the hotel would need to wait until the actual order from the government has been given to order venues to close before relying on the Force Majeure clause to relieve it from its obligation to host the event. If the government has merely provided non-binding advice for people not to attend large gatherings, it is still physically and legally possible for the venue to perform its obligations and the fact that you have only sold a small amount of tickets does not mean that the Force Majeure clause would apply to these circumstances.
If, however the Force Majeure clause had been written as “should a party be prevented, hindered or delayed from performing its obligations pursuant to this contract by an event outside of its control including any action or order from the government, that party shall be relieved from its obligations for the continuation of the event,” then it would be arguable that the fact that you are only able to sell a small amount of tickets due to Covid-19 and government advice for people to stay at home would “hinder” your obligation to pay for the event.
Remember there are no restrictions on how you negotiate your Force Majeure clauses so you may want to consider this very carefully for future contracts, particularly for those that may be affected by any second wave of the outbreak and include express provisions in relevant contracts.
Example: you are entering into a contract with a hotel for a conference taking place in 12 months’ time. You negotiate a Force Majeure clause that says “if the customer is prevented, hindered or delayed from performing any of its obligations pursuant to this contract by circumstances outside of its control (including without limitation …. see list below…) which result in the customer not being able to sell at least three quarters of the tickets for the event, the customer shall not be in breach of this agreement or otherwise liable for any such failure or delay in the performance of such obligations”.
What are examples of Force Majeure events?
Typical Force Majeure events are:
- acts of God, flood, drought, earthquake, other natural disasters, epidemic or pandemic.
- a terrorist attack, civil war, civil commotion or riots, war, threat of or preparation for war, armed conflict, imposition of sanctions,
- embargo, or breaking off of diplomatic relations,
- nuclear, chemical or biological contamination or sonic boom
- any law or any action taken by a government or public authority, including without limitation imposing an export or import restriction,
- quota or prohibition,
- collapse of buildings, fire, explosion or accident
- any labour or trade dispute, strikes, industrial action or lockouts
- non-performance by suppliers or subcontractors
- interruption or failure of utility service.
Examples of Force Majeure events that might be applicable to what we are currently facing with the Covid-19 outbreak are:
- Act of God
- Government action
- Travel restrictions
If you have included the word “pandemic” in your Force Majeure clause, then it’s going to be a lot easier for you to prove that there is a contractual Force Majeure event occurring that will relieve you from your obligations.
Similarly, if you have a clause that talks about any law or action taken by a government or public authority, you might be able to rely on that to escape contractual obligations in the current circumstances. But ensure that your timing is right and that you aren’t seeking to rely on this before the government action or law has made it “physically or legally impossible” to perform the obligation.
Arguably an Act of God is what we are experiencing at the moment with the COVID-19 pandemic.
When seeking to define examples of Force Majeure events, the courts may interpret a list of examples restrictively so that even if you have included in your contract the wording “including without limitation” or similar, if the list of examples is not similar to the Force Majeure event you are seeking to rely on, if the matter ever went to court, the court may decide that the event was not similar enough and therefore did not relieve contractual obligations.
Additionally, a court would look at the express wording of the contract rather than the intentions of the parties, so it is critical to ensure that you have exactly the right wording in place.
If you need help with bringing your contracts up to scratch in this regard, please contact us for an estimate of our fees in this regard.
When can you escape contractual obligations due to Force Majeure?
If you're the party who is relying on the Force Majeure clause to escape obligations within the contract, then the onus is on you to show that you are prevented, hindered or delayed (depending on what the wording of your Force majeure clause says) from carrying out your obligations due to the event outside of your control.
Even if there is no contractual provision about mitigation, you do need to show that you have used your reasonable endeavours to prevent or mitigate the effects of the Force Majeure. If there is a written Force Majeure clause in a contract, the wording may refer to having to use “diligent and commercially reasonable efforts” to avoid the Force Majeure Event or may go further than this and provide that the benefit of a Force Majeure clause shall only take effect where the party seeking to rely on it has taken all possible steps to avoid the event or the impact of its consequences. What constitutes “reasonable endeavours”, “diligent and commercially reasonable efforts” and what constitutes “all possible steps” will depend on all the circumstances.
Arguably, with COVID-19, it's possible that there may be fewer mitigation measures available to parties than in other potential events of Force Majeure, but an example could be that you need to have followed official guidelines and implemented all reasonable measures to contain or limit the spread of the virus in the workplace to allow contractual performance to continue. Mitigation in relation to the Covid-19 outbreak might include such things as finding an alternative sub-contractor where it is not able to fulfil its obligations due to the impact of Covid-19 and enabling homeworking so that your staff can continue to work and perform the contract.
Example: Your marketing company is unable to fulfil its contract with you for your next magazine issue because staff at the printing company that it uses are working from home to avoid spreading Covid-19 without access to printing machinery. If printing services are unavailable from other sources, mitigation would not be possible and this would clearly be a Force Majeure event. If, however printing services are available from other sources but the quality is not as good and it is more expensive, then depending on the specific wording of the Force Majeure clause, this may or may not be a Force Majeure event. If the clause is silent on the matter of mitigation then “reasonable endeavours” to mitigate are required and arguably in this example, there would be a Force Majeure event. If the contract referred to “all possible steps” then arguably it would not be a Force Majeure event. Continuing with the example, if printing services are available but at such a cost that the marketing company is making a loss then clearly if the wording in relation to mitigation was “diligent and commercially reasonable efforts” or the contract was silent and “reasonable endeavours” to mitigate apply, the marketing company would not need to engage such printing services and it would be a Force Majeure event. If however the wording refers to “all possible steps” then it would not be a Force Majeure event.
If you are in a supply chain and you have agents, or you're working with subcontractors, the courts may interpret “beyond reasonable control” as also being beyond the reasonable control of your agents or sub-contractors. So, if they're not able to perform their contractual obligations because of COVID-19 or the effects of it, then the court may also interpret that as being beyond your reasonable control.
What is the effect of a Force Majeure clause?
Ultimately, this all depends on how the Force Majeure clause is written in the contract.
Suspension of obligations
Generally, the clause provides for the suspension of obligations during the Force Majeure event.
This would mean for example that during the occurrence of the Force Majeure event, the supplier has no obligation to provide the goods or services and the customer has no obligation to pay for those goods or services. When the Force Majeure event comes to an end, the obligations are re-activated.
Termination of contract
However, some Force Majeure clauses go on to say that if the Force Majeure event continues for a certain period of time (possibly weeks, possibly three or six months depending on the nature of the supply), each party has the right to terminate the contract.
If you want to rely on a Force Majeure clause, either to suspend your obligations or to terminate the contract, you may have to serve notice of the Force Majeure event on the other party. It is very important to ensure that the notice is validly sent so you should carefully check the notice provisions of the contract about what forms of communication are allowable (eg first class post, courier, email), where you need to serve the notice (eg registered office or trading address) and when the notice is deemed served (eg within two days of posting or 24 hours of the sending of an email). If you do not serve notice of termination validly, there will not be an effective termination and if you do not perform your obligations under the contract, this will be a breach and the other party could bring a claim against you.
Non-liability for non-performance
The Force Majeure clause will usually provide for non-liability for non-performance and usually, this is for so long as the Force Majeure event continues. If you do not have a Force Majeure clause in your contract and do not perform your obligations (even because you aren’t able to do so), you will be liable for non-performance unless you can fall under the doctrine of frustration discussed below.
Saying that, during this time of the COVID-19 outbreak, there is a sense of we're all in it together, so I would hope that there will be scope for negotiation between clients and suppliers regardless of the contractual position. However, understanding your legal rights will enhance your legal position (read on…).
When can the doctrine of frustration apply?
Firstly, please note that if there is a Force Majeure clause in the contract, you cannot rely on the doctrine of frustration. The good news is that if your Force Majeure clause is drafted correctly, you have a much better chance of escaping obligations under the Force Majeure clause than you do under the doctrine of frustration, as there is a very high bar for the doctrine of frustration to apply.
If you don't have a Force Majeure clause in your contract, then you may be able to rely on the doctrine of frustration.
Frustration applies if:
- The frustrating event is not the fault of any party,
- The frustrating event occurs after the formation of the contract and was not foreseen by the parties, and
- It becomes physically or commercially impossible to fulfil the contract or transforms the obligation to perform into a radically different
- obligation from that undertaken initially.
All of those three things have to be in place for the doctrine of Frustration to apply. So, where we are now with Covid-19 means that the first and second bullet point apply, but it's the third bullet point that there may be question marks over.
The consequence of Frustration is that the contract automatically ends. Money paid before the frustrating event can be recovered and money due before the frustrating event, but not paid, ceases to be payable.
Everything would depend on the exact circumstances of the case, but if you think you might be able to rely on the doctrine of Frustration then I would advise you to take legal advice – please contact us to find out our fees in relation to how we can help you.
How Termination clauses may help you
If you have termination clauses in your supply contracts then you should carefully review these to see whether you can terminate contracts that are proving too costly or where services or goods are rendered unnecessary due to the current circumstances.
Equally if you are the supplier, you should review your contracts with customers to understand when they can terminate.
Termination clauses tend to fall into three categories that may be relevant in the current circumstances:
- Termination on notice for convenience
- Termination for breach
- Termination for insolvency
Termination for convenience
You may have a termination for convenience clause in your contract that allows you to terminate on a specific notice period – anything from one week to 12 months or more depending on the nature of the contract. Do ensure that the notice provisions in the contract are followed exactly so that you have served an effective notice of termination.
If a contract doesn't include a clause for termination for convenience, there might be an implied term to be able to terminate on reasonable notice where it is obvious or necessary to give the contract business efficacy, depending on the circumstances of the case. So if, for example, there were no termination rights in your agreement or if you have an oral, ongoing agreement, then you may be able to argue that there is an implied term to terminate on reasonable notice.
However, if you have a fixed-term contract, even if it's oral, or if you have a contract that contains express termination provisions, there is unlikely to be an implied term to terminate on notice.
How long is a reasonable notice for termination for an implied term?
What is a reasonable notice for termination where you are relying on an implied term depends on all of the circumstances at the time the notice is given, not when the contract was made.
Relevant factors could include:
- how long the terminated party would need to replace the lost contract,
- how much the terminated party depends financially on the contract,
- the party’s commitments,
- when the notice is given,
- whether the relationship was formal, which suggests that longer notice is needed or informal when shorter notice would be needed,
- whether notice periods were discussed or suggested even if they weren't agreed,
- notice periods in previous agreements between the same parties, about the same subject matter, and
- whether the notice was unexpected, or whether there had been some prior warning.
Termination for breach
Typically, if there are termination provisions in a contract, these will include the right to terminate for breach of contract. You have to look at the wording of the contract very carefully because it might have restrictions about when you can terminate for a breach of contract.
The contract may restrict the right to terminate for breach to those breaches that are a “material” breach. Occasionally what is a material breach will be defined but more often than not it is not defined and there will often be arguments over what is a “material” breach. Arguably, non-payment and non-performance of the main obligations would be a material breach.
The contract may also restrict the right to terminate for breach by providing that the defaulting party has a certain period of time in which they can remedy the breach, often anything from 7 up to 60 days, depending on the nature of the contract. You cannot terminate your contract during that period that they have stated to remedy the breach, or if they do go on to remedy that breach.
You also need to read a termination for breach clause alongside any Force Majeure clause in the contract, because the Force Majeure clause may say that the obligations are suspended during the period of the Force Majeure clause and therefore you would not be able to terminate for the breach.
Are there common law rights to terminate for breach?
Common law (that is law that applies to your contract even if there isn’t an express written term) gives the right to terminate a contract on the grounds of the most serious breach, known as “repudiation”.
Repudiation applies in the following circumstances:
- where there is a breach of condition
- where there is a serious breach of an intermediate term
- where performing the contract is impossible
- where the other party has renunciated the contract
In relation to a breach of condition, it is quite hard to prove that terms within contracts are conditions. Most terms will not be conditions unless the contract makes a clear contrary intention. A clause saying that time is of the essence with regard to delivery or performance of obligations is likely to be a condition. However, an “essential payment provision” was found not to be a condition in one court case.
In relation to a breach of an intermediate term, most terms are intermediate unless stated to the contrary. You may terminate for breach of an intermediate term where there is a “serious” breach of such term where the breach deprives the aggrieved party of substantially all the benefit the parties intended that party to get under the contract.
A failure to supply, for example, where the main benefit of the contract is the supplier supplying something to you and they’re not able to do so, would likely be a breach of an intermediate term and you would be able to terminate.
Whether a breach justifies termination is judged at the time of termination, not when the contract was made or when the breach was first committed. So, you need to think very carefully about the timing of termination.
In relation to impossibility to perform, this arises where one party has by its own act or default, which need not be deliberate, rendered itself unable to perform its contractual obligations in some essential respect or prevented completion of the contract by the other party. This contrasts with the doctrine of Frustration, where there is no fault of either party.
In relation to renunciation of the contract, this occurs where one party, by words or conduct, conveys an intention not to perform, or expressly declares that it will not perform its obligations under the contract in some essential respects. Again, this needs to be considered in light of any Force Majeure clause. But certainly, if a supplier is indicating that it cannot fulfil its main obligations under the contract and there is no Force Majeure clause, then you would be entitled to treat that as a renunciation and terminate the contract.
Once a repudiation has occurred, it cannot be undone. There is no option for the defaulting party to remedy the repudiation.
Termination for insolvency
There is no common law right or implied term to terminate for insolvency. But you may be able to claim a repudiatary breach if your supplier is not performing its main obligations under the contract due to insolvency.
Often termination clauses for insolvency are written referring to a party being unable to pay its debts as defined in the Insolvency Act.
Under the Insolvency Act, a company is deemed unable to pay its debt if at least one of the following conditions is met:
- The company has not paid, secured or compounded a claim for some exceeding £750, which is due to a creditor within three weeks of having been served with a written demand in the prescribed form,
- If a creditor has unsuccessfully attempted to execute a judgment against the company,
- It is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due (known as the cashflow test),
- It is proven to the court that the value of the company's assets is less than its liabilities (known as the balance sheet test).
If you have a contract with a person as opposed to a corporate entity, then if there is a bankruptcy provision in the agreement, a person will be deemed unable to pay his debts if he fails to satisfy a statutory demand for at least £5,000, or if a creditor petitioning for bankruptcy has unsuccessfully attempted to execute a judgment against him. There is no equivalent in bankruptcy of the cashflow test or the balance sheet test.
I would always recommend that you take legal advice if choosing to terminate using these rights because if you try to terminate a contract illegally then you could be sued – please contact us to find out our fees in relation to advice in this regard.
What is the effect of termination?
The main effect of termination is that primary obligations (e.g. to provide goods or services and to pay for those goods or services) end. But certain terms and accrued rights survive the termination of the contract.
So, if you're the customer and you have received certain of the goods or services before you terminate, but you haven't yet paid for them, you would still be liable to pay for such goods and services because that is an accrued right to the supplier before termination was effected.
Certain other terms within the contract might continue, such as indemnities, confidentiality clauses, restrictive covenants, choice of law and jurisdiction clauses.
Are there any other important points about termination?
If you delay in exercising a termination right, you may lose it, so it's important to act quickly if circumstances occur that give you the right to terminate.
You need to strictly comply with notice provisions to make sure that any notice of termination is served effectively.
If you terminate the contract without the correct legal ground or without providing the correct notice, you will be breaching the contract and the other party could in theory sue you.
Please note though that none of these clauses are straightforward. If you are considering relaying on termination clauses or force majeure clauses, please get in touch with us for an estimate of our fees to advise you on this.
Aside from considering insolvency in relation to termination provisions, you should also be looking at your contracts now and making any commercial adjustments that you need to, in order to reflect this period of financial uncertainty. For instance, if you are the supplier, renegotiating them to ensure that you are getting paid more regularly, or that you're getting deposits upfront and maybe change your billing from monthly in arrears to monthly in advance.
Equally, if you are the customer, then you need to be keeping an eye on the solvency of your supplier. You should be looking at staggering payments so that you will only pay for the work or products that you've actually received.
If you're a supplier and your customer enters insolvency and they haven't yet paid you for goods or services that you've performed, you are likely to be an unsecured creditor. If they go into administration or insolvency, you will be very unlikely to receive your money back.
Equally, if your supplier enters insolvency and you paid for goods or services in advance, then chances are you won't receive those goods or services and you're unlikely to receive your money back.
How I can help you
If you’re worried about your contracts, now or for the future, I have put together some special packs that are very affordable:
I hope that this information has helped you to feel more at ease with how your business may stand in these current times. Please do join my Facebook group called Remote working during Covid-19 where we are discussing support for small business owners, ways to work from home more effectively in these times, moving to new business models, putting new software in place etc. So please come and join us there and I hope that you stay well and profitable!