As the 2019 Novel Coronavirus (COVID-19) continues to spread across the world, and governments and health authorities work tirelessly to defeat it, its impact on commercial arrangements is a serious concern for businesses.
Necessary quarantining measures have drastically disrupted supply chains, sales and consumer confidence have declined markedly, and international trade and travel has reduced considerably. For its part, Australia has introduced various travel bans. Meanwhile, Australian commodities markets are being hard hit.
Amid this, commercial actors are looking to rely upon force majeure provisions in their contracts to either temporarily suspend their performance obligations under contracts and protect themselves against failures to deliver goods or perform services, or even to wholly extinguish their contractual arrangements. By the same measure, the separate common law doctrine of frustration may now take on increased importance.
This alert focuses on force majeure and the doctrine of frustration in Australian law. A global guide to force majeure and international commercial contracts can be accessed here.
Force majeure in Australian law
Force majeure (FM) is a creature of contract in Australia. It is a civil law concept that has no settled meaning in the common law. It must be expressly referred to and defined in a contract. Parties are free to agree on the allocation of risk between them when their transaction is affected by circumstances beyond their control and to determine what circumstances are to be treated as a "FM event".
A FM clause may relieve a party from liability arising from their inability to fulfil their contractual obligations due to circumstances beyond their reasonable control. The circumstance must be unforeseeable, unavoidable and must make performance impossible. Performance is usually suspended for a short period or the duration of the FM event. If the FM event is prolonged or permanent then the clause may allow either party to terminate the contract.
FM clauses are interpreted strictly by reference to the specific wording of the clause and the specific factual circumstances. Typically, an FM clause will provide:
- a definition of FM, which may be exhaustive or non-exhaustive, often with a list of examples which may or may not include "epidemics", "pandemics" or "acts of government;"
- that the FM event must have been beyond the reasonable control of the parties - the clause may also require that the event was unforeseeable, unavoidable or irresistible, or that the parties must not have been able to prevent its occurrence;
- that the FM event must make performance of the contract impossible, not simply more difficult or more expensive, unless the clause expressly provides for a threshold;
- that the FM event must not have been directly or indirectly caused by the party relying on the FM clause, which may include both wilful and negligent acts or omissions by the party relying on the FM clause - if not expressly stated, then this requirement may be implied into the clause;
- that notice of the FM event must be given within a certain time frame of the FM event occurring or the party affected becoming aware of the FM event; and
- that the affected party must take steps to mitigate the impact or consequences of the FM event on its performance of the contract.
Does COVID-19 constitute a FM event?
A definitive answer will depend on the definition of FM in the specific contract. A simple reference to "force majeure" does not provide certanity as to what is covered and has been construed in the context of particular contracts to cover: acts of God (such as earthquakes, volcanic eruption, flood or cyclone), war, strikes, embargoes, certain government actions or decisions, and abnormally bad weather.
However, FM is usually defined in the contract. The definition may be exhaustive or non-exhaustive. It may also include a list of examples. That list may expressly refer to "epidemics", "pandemics" or "acts of government". Contracts may also include a list of events that are expressly excluded from FM.
In the context of COVID-19, it is pertinent to determine whether "epidemics", "pandemics", or equivalent language are included as express examples of an FM event (or expressly excluded as potential FM events).
Without express reference, a party may argue that an epidemic or pandemic is an "act of God" or otherwise captured by the definition of FM. Alternatively, government measures taken in relation to COVID-19, such as forced quarantine or travel bans, may constitute "acts of government". However, whether a court will adopt such interpretations in any given case is unclear; especially as a court will interpret each FM clause within the text, context and circumstances of the specific contract.
Example of a non-exhaustive force majeure definition
Force Majeure means the happening of an event or circumstance which:
(a) is beyond the reasonable control of a party and prevents or delays that party from performing any of its obligations under this contract; and
(b) could not have been avoided or overcome by that party by the exercise of reasonable foresight, care and due diligence; and
(c) includes, but is not limited to:
(i) an act of God including but not limited to earthquake, flood, fire, explosion, landslide, lightning, action of the elements, force of nature, washout, storm or storm warning or natural disaster;
(ii) strike, lockout, boycott, work ban or other labour dispute or difficulty; and
(iii) acts of terrorism, civil disturbance, blockade, embargo, sabotage, insurrection, riot, malicious damage or epidemic; but
(i) hardship due to currency fluctuation; and
(ii) change in market conditions or market prices.
What is the impact of COVID-19 on contract performance?
Performance is usually suspended for a short period or for the duration of the FM event. A corresponding extension of time for performance (and a "holiday" from consequences for non-performance) may then be granted automatically or by agreement. If the FM event is prolonged or permanent then the clause may provide for termination of the contract by either one, or both parties to the contract.
If the FM clause provides that the event must "prevent" performance, it is necessary to demonstrate that performance is legally or physically impossible and not just difficult or unprofitable. If the clause refers to "hinder" or "delay" then the threshold may be lower.
Typically, payment obligations are not suspended as a result of a FM event, notwithstanding that the counter party may be prevented from performing its obligations under the contract. The amount of payment required to be made during the period of the FM event will depend on whether payments are calculated based on work performed, or a fixed monthly sum.
Generally, the party relying on the FM clause has the burden of proving the FM event, including producing evidence of the impact and effect of the event. The affected party is also generally required to use reasonable endeavours or diligence to overcome or mitigate the impact and effects of the FM event.
How is a force majeure clause invoked?
Usually, the FM clause requires the party affected by the FM event to give a written notice of the FM event to the counter party. The clause may even provide that such notice must be given within a certain time limit of the occurrence of the FM event or the affected party becoming aware of the FM event.
If notice is required and a notice is not given in accordance with the clause, then it may be difficult for the affected party to rely on the FM event.
Often it is necessary to give a FM notice before an assessment of the FM and its potential impact has been completed. This may be because of a time limit in the FM clause.
Whilst it may be necessary to issue a FM notice to protect legal rights under the contract, proactively engaging with the counter party in a cooperative and reasonable manner may assist with finding a practical and acceptable commercial solution without resorting to formal dispute resolution mechanisms.
Example of key elements in force majeure clause:
1. Suspension of obligations: Where a party's performance of this contract is affected by an FM Event, that party's obligations under this contract are suspended for the period that the FM Event prevented or delayed that party from performing its obligations under this contract.
2. Termination of obligations: Where a party's performance of material obligations under this contract is prevented or delayed by an FM Event for 12 consecutive months then either party may by notice to the other party terminate this contract.
3. Notice: If a party's performance of this contract is prevented or delayed by an FM Event and they seek to suspend or terminate their obligations, they must notify the other party as soon as possible of the particulars of the FM Event, including the commencement date of the FM Event, its effect on the affected party's obligations, the mitigating steps proposed by the affected party, and an estimate of the length of the FM Event.
4. Mitigate: A party whose performance of this contract is prevented or delayed by an FM Event must use reasonable efforts to avoid or abate the occurrence of the FM Event, mitigate its effects on the performance of the contract, and resume as soon as possible performance of the contract once the FM Event ceases.
5. Automatic extension: If a party's obligations under this contract are suspended by an FM Event, then the contract's term will be automatically extended by a length equivalent to the period that the FM Event prevented performance.
Frustration in Australian law
The doctrine of "frustration" may also apply to similar circumstances that would trigger a force majeure clause. The doctrine of frustration in Australia is the same as England. There must be a supervening event ("frustrating event") that is not the fault of either party, significantly changes the nature of the contractual rights and/or obligations and makes it unjust to hold the parties to the contract. It is not sufficient if the event makes it more expensive or onerous or impracticable to perform the contract, nor if an alternative method of performance is available.
Whether an event constitutes a "frustrating event" depends on the terms of the contract and relevant circumstances of the case. Notably, the event must have severe consequences and there must be a "radical"change. Cases which have discussed the doctrine refer to an event which:
- causes further performance to become something substantially different to what was contracted;
- creates a fundamentally different situation; or
- deprives a party from performing substantially the whole benefit of the contract which was the intention of the parties as expressed in the contract.
In Australia, the doctrine has been applied to many types of contract, such as construction contracts, contractual licences, employment contracts, contracts for the sale or lease of goods, and trading agreements.
The fact that the parties to a contract have included a FM clause may oust the operation of the doctrine of frustration, as the FM clause may demonstrate that the parties have already considered the issue and determined how the risk of the frustrating events is to be allocated.
Frustration results in the termination of the contract, and the terms of the contract cease to operate. In some instances, if a term is to operate after frustration, the parties must have expressly or impliedly intended this to be the case. The common law provides that if a contract is frustrated, losses lie where they fall. New South Wales, Victoria and South Australia have each enacted legislation to provide a fairer result where, for example, payment was made but the corresponding obligation was not performed before the contract was frustrated. In such cases, the payment is to be returned.
The precise impact of COVID-19 on many commercial contracts is presently uncertain. The specific wording of the FM clause will be critical. We recommend that you:
- review your existing contracts to identify any potential commercial risks and the potential commercial impact of COVID-19;
- review the FM clause in your contracts and consider whether or not it may apply;
- consider amending the FM clause to be incorporated into future contracts;
- identify any notice requirements relating to existing FM clauses and consider the timing required for issuing notices;
- consider measures that may be taken to mitigate any potential consequences of COVID-19 in compliance with obligations under FM clauses;
- review the dispute resolution clause in your contracts and consider developing a commercial strategy to try to resolve disputes that may arise as a result of FM events; and
- if your contract does not include a FM clause, consider whether the doctrine of frustration may apply.
The unforeseeable disruptions resulting from COVID-19 are likely to influence how parties approach contractual negotiation and risk allocation in the future.