In this Update
- Examine whether the novel coronavirus disease (COVID-19) is a force majeure event under your project contracts.
- Evaluate the consequences of a force majeure event under your project contracts and its potential effect on project financing agreements.
The China Council for the Promotion of International Trade (CCPIT) has issued more than 1,600 force majeure certificates in an effort to protect companies from across 30 sectors from damages arising under their contracts due to the COVID-19 outbreak. According to World Health Organization (WHO): “Coronaviruses are a large family of viruses which may cause illness in animals or humans. In humans, several coronaviruses are known to cause respiratory infections ranging from the common cold to more severe diseases such as Middle East Respiratory Syndrome (MERS) and Severe Acute Respiratory Syndrome (SARS). The most recently discovered coronavirus causes coronavirus disease COVID-19.” The outbreak of COVID-19 began in Wuhan, China in December 2019 and has now spread across most parts the world.
While the certificate from CCPIT may be recognized by some counterparties, the key document for establishing whether COVID-19 is a force majeure event is the specific agreement under consideration. The following are three key points to consider when examining contractual obligations in the context of COVID-19.
Point 1: Definition of force majeure
Typically the contractual definition of a force majeure event includes a laundry list of items which are not anticipated as of the date of the contract, are beyond the party’s control, and are not caused directly or indirectly by the fault or negligence of the party seeking relief. Often, but not always, the laundry list specifically sets out “epidemics” and in some cases “pandemics” as events of force majeure. For example, the Ontario Independent Electricity System Operator’s (IESO) forms of agreement include a specific reference to “epidemics” in the definition of an event of force majeure. This language has been in use since the first power plant procurement by the IESO’s predecessor (the Ontario Power Authority) nearly 15 years ago, and has been adopted by other jurisdictions such as Alberta that have based their forms of agreement on the IESO’s. Since it is generally a good idea for owners to “back-to-back” their force majeure clauses from their supply contracts into their construction contracts, the IESO’s force majeure language has become common language in construction contracts across Canada. As a result, many construction contracts specifically include epidemics as a force majeure event, and therefore may provide relief for impacts of COVID-19.
Some definitions of a force majeure event do not specifically list epidemics or pandemics. For example, this is the case in the Canadian Construction Documents Committee (CCDC) 2 stipulated price contract and the CCDC 5B construction management contract. In those circumstances, COVID-19 could potentially still qualify as a force majeure if the definition includes open-ended language covering any other causes beyond the party’s control (which is the case in the CCDC documents).
In either case, even if COVID-19 does satisfy the contractual definition of an event of force majeure, it is important to also confirm whether any contractual exclusions might apply to the circumstances and if any other contractual requirements have been met. For example, contracts sometimes have restrictions on a party claiming force majeure for something that is impacting its subcontractors or suppliers, but not directly impacting the party. In addition, one common exclusion from force majeure that may become relevant in the coming months for new contracts is an exclusion for events that were reasonably foreseeable at the time the contract was entered into. Parties entering into contracts after December 2019 may be well-advised to turn their minds specifically to COVID-19 and agree how to address any impacts it may have on the parties’ ability to fulfil their contractual obligations.
Usually contracts will have a procedural mechanism to be followed when invoking the force majeure clause, including providing the other party with notice within a specified timeframe. Failure to notify the other party of a force majeure event within the requisite timeframe may result in an exclusion of such event from force majeure relief, so it is particularly important to be mindful of any specified timelines and other requirements to claim force majeure relief.
It is interesting to note that according to the WHO, “the likelihood of an infected person contaminating commercial goods is low and the risk of catching the virus that causes COVID-19 from a package that has been moved, travelled, and exposed to different conditions and temperature is also low.” Therefore, in many cases, it may not be the presence of the disease itself that causes the force majeure event, but if workers are unable to fulfil their duties, because they are either quarantined or ill.
Point 2: Consequences for a force majeure event
Typically, the consequences under a construction contract for a force majeure event include relief from the performance of contractual obligations along with an extension of time for any obligations to achieve milestone dates, such as substantial performance. In the case of a prolonged force majeure event, some contracts may permit one or both parties to terminate without liability. For instance, the CCDC contracts allow for reasonable time extension to contractors or construction managers for delays in the performance of their work caused by reasons beyond their control. The period of time extension in such cases must be more than the time lost as a result of such event, unless the contractor or construction manager agrees to a shorter period.
Whether a force majeure event impacts the contract price depends on the specific terms of the agreement. Some contracts allow for an increase to the contract price for all reasonably incurred costs arising from the force majeure event, some do not allow for any increase, and some may allow for partial compensation for increased costs of performance.
Point 3: Impact on project financing agreements
Borrowers and lenders should review their project financing agreements’ representations, warranties and covenants as well as events of default to determine the potential triggers unique to their project. Particular thought should be given as to whether a COVID-19 force majeure event could have the potential to cause a material adverse effect on the project. If there are “back-to-back" contractual obligations throughout the various material project documents (and the force majeure clauses match or are substantially similar), the likelihood of a material adverse effect may be mitigated by the application of the relief provisions. Other factors unique to each project should be evaluated – for example, if a delay can be overcome by a different manufacturer supplying goods, or the project schedule allows for sufficient slippage or cost overruns, the likelihood of a material adverse effect may be low.
Generally, the financing agreements will: (a) require the borrower to pursue and enforce all potential remedies against its material project document counterparties; (b) contain restrictions on any material amendments to material project documents without the lender’s consent (such as a change in supply schedule or commercial terms); (c) have some form of deadline or drop-dead date by which the project must be completed (which may or may not include relief for force majeure); and (d) have a default regime that picks up any material adverse effect on the project, any breach or revocation of terms of any key material project document (i.e., if a supplier terminates a contract for force majeure), and of course the insolvency of any key material contract counterparty.
In some cases, borrowers may be required to give formal notice of a potential material adverse effect. As always, communication is key to ensuring minimal disruption to the project. Borrowers should consider a proactive approach with regard to lender relations and understanding their counterparties’ contractual restrictions or practical limitations for recovering from a COVID-19 force majeure event. Where a COVID-19 force majeure event has occurred or is likely to occur, it may be prudent to engage the independent engineer to run various scenarios and the possible effects of each, along with giving a view on any potential mitigation plan, which might include replacement of the affected party, an updated delivery schedule, and/or a change of commercial terms. With this information in hand, the parties will be well positioned to have a “Plan B” in the event of any long-term issues arising.
Ultimately, borrowers and lenders will have to evaluate the overall likelihood of the occurrence of a material adverse effect, the practical ability to mitigate the effects of any force majeure provisions in the material project documents and the potential resulting defaults under the financing agreements. The optimal outcome will be for borrowers to provide a plan to mitigate any disruption to the project and for lenders to evaluate such proposal (with the assistance of the independent engineer) on a reasonable basis. Going forward, the parties will need to consider the application of force majeure within the financing framework.
As the global reach of COVID-19 outbreak continues to expand, parties must carefully examine their project documents to ascertain the impact of closures or delays and plan for their course of action in the upcoming weeks in light of their project schedules. If in doubt about the application of the force majeure provision, the relief sought under that clause or the potential corollary effect under the project financing agreements, we recommend seeking legal advice prior to taking any action or sending any notices. In light of the lessons being learned from the COVID-19 outbreak, it is also advisable to reexamine the force majeure provisions for future projects.