China has been in shutdown, and although the daily case numbers are now dropping in China, the coronavirus continues to spread and Norway is now in shutdown. The World Health Organisation has now declared the situation as a pandemic, and the Organisation for Economic Co-operation and Development (OECD) has said that the outbreak could halve global economic growth and that it represents the greatest danger to the global economy since the financial crisis in 2008.
Many businesses are trying to understand the situation and how to react to it. Economists say that the shock is likely to be severe because it is hitting the supply and demand sides of the economy simultaneously and there are mounting fears over the economic effect of the coronavirus.
In the last 10 to 20 years many businesses have become increasingly more reliant on China as a supplier and customer, and since the Chinese New Year holiday, many workers have been homebound, disrupting factories and construction facilities serving a number of different sectors. In all sectors businesses are seeing lower levels of orders/bookings, and suppliers are warning of delays or cancellation of supplies. As a result of broken supply-chains businesses face being unable to perform under their contracts.
As well as broken supply-chains, disrupted manufacturing, empty stores and less demand for products, the situation is affecting consumer behaviour and business sentiment, as people travel less and large public events are cancelled. Governments are implementing steps delay new infections, but the longer this situation continues the more risk that businesses will face serious financial difficulties and business executives will put planned investments on hold and / or start laying off workers. Stock markets worldwide are plunging, which suggests that investors are expecting more bad news.
From a legal perspective what contract terms might be triggered?
Is the coronavirus an event of force majeure? The Chinese body in charge of foreign trade and investment, the China Council for the Promotion of International Trade, has been issuing force majeure certificates to Chinese companies. It is unclear what legal effect these certificates will have, but Chinese parties will probably try to rely on them as supporting force majeure claims. There is no guarantee that a Government certificate will make any difference – and it could give Chinese companies a false sense of comfort, resulting in them claiming force majeure when they are not entitled to do so, and then facing a claim for breach of contract anyway.
Force majeure events are, generally, unexpected circumstances outside of a contracting party’s reasonable control that prevent it from performing its contractual obligations. Generally, these are events which could not have been foreseen at the time the contract was entered into, and could not be prevented by the affected party, and where the affected party has taken all reasonable steps to avoid or mitigate the consequences.
Force majeure is a recognised concept in most legal systems, but it usually does not have a precise legal definition, and that is why many contracts include a definition of force majeure, and sometimes a non-exhaustive list of both illustrative force majeure events and events that do not count as force majeure.
The civil law concept of force majeure is well established in Norwegian law. It is recognised as a contract term, and often included in contracts as a standard boilerplate clause. Variants of force majeure also exist as statutory terms. Common examples of force majeure include both the occurrence of events like natural disasters, severe weather, government actions, war, terrorism, riots and strikes, and legal hindrances such as bans on import or export. Whether global illness, epidemic or pandemic events are covered by force majeure clauses, depends on the wording of the force majeure clause. Since force majeure clauses are most commonly included as standard boilerplate clauses and not subject to any further discussion or tailoring by the parties, it is likely that unique situations like the current pandemic or other events caused by it may not be encompassed by the wording of many force majeure clauses.
In contracts regulated by certain statutes, such as the Norwegian Sale of Goods Act, force majeure-like events may amount to grounds for exemption of liability for economic loss caused by a breach of contract. For this to apply, it must be shown that the breach was caused by a hindrance which was outside the control of the defaulting party, and that the defaulting party could not reasonably be expected to have foreseen the hindrance at the time of entering into the contract, nor avoid or remedy the consequences of it. The determining factor is the effect the hindrance has on the performance of the contract, rather than the nature of the hindrance. It is therefore possible for the coronavirus outbreak or similar global pandemics to give rise to such exemptions from liability under these contracts.
Check the contract: the first thing to check is whether contracts contain specific force majeure terms, and if they also refer to epidemic or pandemic. If not, there may be some other catch-all wording that will suffice or help a party wishing to invoke force majeure. It should also be checked to see if the contract is regulated by statute which exempts liability for events outside of a party’s control.
Check the cause: is the impediment to performance directly caused by the coronavirus, or the indirect consequences of the outbreak, such as restrictions imposed by public authorities or businesses on travel, attendance at large events and conferences, or voluntary or compulsory quarantine. Such steps could be interpreted as force majeure or as a measure taken as a precaution.
If there is a specific force majeure clause which refers to epidemic or pandemic, if could constitute force majeure, but and illness itself is probably unlikely to be interpreted as force majeure. However, restrictions, quarantine, and shut-down of affected areas imposed by public authorities could be interpreted as outside of a party’s control. To rely on force majeure an affected party is required to show that it has used reasonable efforts to prevent, or at least to mitigate, the effects of the situation, and will therefore need to consider what reasonable steps that can be taken to avoid or mitigate the resulting impact. Mitigation might include re-allocation of resources, sourcing supplies elsewhere, and considering other means of transporting goods.
The foreseeability requirement: It is normally a requirement that the event or circumstance causing the hindrance to performing was not foreseeable at the time when the contract was entered into. For existing contracts entered into before the outbreak it can be argued that the situation was not foreseeable, but for new contracts being entered into after the outbreak was confirmed as a public health emergency this will not be the case – against the background of the outbreak it might be deemed in the future that the possibility of disruption due to a new global illness or disease should always be considered as foreseeable.
If the contract is regulated by a statute which exempts liability for events outside of a party’s control: The situation is similar as far as mitigation and foreseeability is concerned. If the contract is subject to a statute which exempts liability for events outside of a party’s control, and the pandemic event has indeed prevented performance under the contract, there are three criteria to be considered. First, assess whether the event made performance under the contract sufficiently difficult – if the event was of a nature which could not be reasonably expected to be avoided or overcome. It must not be impossible, but it needs to be extraordinarily burdensome. Next, the event, for instance a disturbance in the supply-chain as a result of the pandemic, must not have been reasonably foreseeable. And lastly, the event must also have been outside of the affected party’s control. What a party is deemed to have control over must be assessed retrospectively and strictly. It may, however, be argued that the pandemic itself or government actions resulting from it would fall outside the scope of the party’s control.
Formalities for invoking force majeure: A party that receives a notice of force majeure from a counterparty will need to consider whether to accept or reject it, or to work with the counterparty to avoid force majeure by trying to agree compromises, such as extra time to perform. A party receiving a formal notice of force majeure will need to consider its response carefully, and assess if the affected party has taken all reasonable steps to overcome or reduce the effects of the situation.
A party intending to invoke force majeure should make sure notice in given correctly. Notice should be given within a reasonable time, together with information about the likely consequences and expected duration. If the contract includes specific force majeure terms there may be strict procedures for giving notice, and if these are not followed the right might be lost.
Mitigation: Affected businesses will need to implement steps to mitigate the effects of the situation, including re-allocation of resources, sourcing supplies elsewhere, and considering other means of transporting goods.
What other legal implications might there be?
The outbreak is already having a devastating impact on the travel and tourism industry as people cancel plans to travel and hesitate to make new bookings. The shipping industry is being affected in a number of ways, with disruption to voyages, delayed cargo with logistical and insurance consequences, and delays at shipbuilding yards with the resulting impact on planned employment for vessels. It is starting to be clear that the knock-on-effect will be big and will affect all business sectors.
It is not just force majeure terms that are relevant to consider. The consequences of the outbreak are likely to result in financial problems for many businesses which can trigger other contractual terms, such as a breach of a financial covenant, a payment default or the failure to perform an obligation. Businesses should also be reviewing their credit and financing agreements. These usually include wide information, financial and other undertakings. If a loan is not fully drawn, the parties should be looking at whether the situation will result in a draw-stop, particularly if force majeure has been triggered under key contracts for the business or project which is financed. In construction financings events of default usually include abandonment or suspension of construction works, or failure to achieve construction milestones or to progress the works.
Many commercial contracts also include material adverse change clauses. Ultimately whether or not the impact of the outbreak constitutes a material adverse change for the purposes of a representation and warranty, condition or event of default is a matter of contractual interpretation. Material adverse change clauses are not standard – some relate only to a material adverse change in the ability of a counterparty to meet its obligations under the relevant contract, others are far more extensive and are triggered by a material adverse change in a counterparty’s overall financial condition or in its business prospects.
What practical steps should businesses take?
Carefully analyse the situation before force majeure is invoked, to avoid liability if the contract, statute, or the background law give no basis for relief. Even if force majeure is not formally invoked, businesses should keep their counterparties updated, and consider whether a general notice of potential delays should be given, reserving their right to invoke force majeure. Ongoing analysis will be required to see if an event of default or other contract term has been triggered.
As well as investigating the contractual implications, effective work health and safety systems and strategies for workers, sites and the wider community should be put in place to preserve business interests and to ensure the safety of workers. Plans for business continuity should also be implemented to allow for the recovery of operations if required. Risk assessment should be carried out, and customers of affected suppliers should try to find out when the supplier can reasonably be expected to resume full production again, and catch up with back-logs, and what the knock-on effects of the situation are likely to be. Insurance arrangements should also be reviewed.
A brief comment on the position under English law
Apart from the concept of «frustration» which is difficult to establish, English common law has no general concept of force majeure. A party to a contract will only be able to invoke force majeure to excuse non-performance if there is a force majeure clause in the contract, and force majeure cannot be implied into an English law contract. Many international trading contracts are governed by English law, and it is hard successfully to rely on a force majeure clause to avoid contractual responsibility under English law.
Even if the contract does contain a force majeure clause, it is still not certain that a party will be able to rely on it to protect against claims for non-performance as a result of the difficulties caused by unexpected events or circumstances. Because of their serious impact on the parties’ rights and obligations, force majeure clauses are interpreted strictly by the English courts – so it will be necessary to consider the precise terms of the specific clause.