COVID-19 and Force Majeure

Governments and businesses around the world are dealing with a new paradigm and greater uncertainty in the face of COVID-19.  

“Business as usual” as we know it is being impacted by supply shortages and delays, challenged workforces and restricted travel.  It is fair to say we have never seen anything like this before.  

How do these circumstances affect contractual obligations?  Is COVID-19 an event of force majeure?  Does it relieve the affected party from its obligations? What steps can you take when your business or project is affected?

What is Force Majeure?

There is no common law or equitable doctrine of force majeure under Australian law.  It is a creature of contract. 

If a party cannot perform its obligations and the contract does not provide for force majeure, the only analogous common law concept under Australian law is the doctrine of frustration. Frustration is very limited – to establish frustration it is necessary to show the occurrence of an event beyond a party’s control that has so radically changed the situation in which a contract is to be performed that the contract should be regarded as having come to an end. If frustration does apply, a contract is held to have terminated.  There are no other forms of relief arising from the frustration.  Frustration is not a useful remedy if the parties wish to continue with a contract after the delay event finishes.

Given that frustration is so limited, force majeure clauses are often included in contracts to allocate the risk of certain uncontrollable events.  One of the main benefits of a force majeure clause is that only the obligations of the parties that are affected are suspended and only for the period that they are affected.  Any unaffected obligations will continue and the contract can continue in full force once the effects of the force majeure event are over.

Common features of a force majeure clause

The operation of a force majeure clause in a specific contract depends entirely upon the language the parties have used and the commercial risk allocation agreed between the parties.  However, most force majeure clauses will have these elements:

1. the event must be outside of the parties’ control;
2. relevant performance of contractual obligations must be prevented, hindered or delayed; and
3. the effect of the event cannot be avoided or overcome by reasonable efforts to mitigate.

The case law shows a marked tendency to interpret these clauses strictly, no doubt reflecting an assumption by the courts that parties are to be held to their contractual obligations.

Some contracts may have an additional layer which require the test of foreseeability to be met.

It is fairly clear that the outbreak of COVID-19 will satisfy (a) above.  However, (b) and (c) will depend on the particular circumstances of the contract. The question of foreseeability in the context of COVID-19 will also depend on when and how the parties’ obligations are affected by the event. The world is now rapidly coming to grips to COVID-19 and at this point in time, it may be either an event that is foreseeable or the effects of which are foreseeable. 

Further, Government directions are now being issued in response to COVID-19 and it is the effect of these directions which will most likely form the basis of many force majeure claims.

Has performance of contractual obligations been affected?

It is usually necessary to show that the relevant event has actually caused an inability to perform a party’s particular obligations.  Significantly, showing the contract has become uneconomic will not, on its own, be enough .

For example, a purchaser cannot generally claim force majeure to cancel delivery of goods and avoid payment for goods simply because it no longer requires the relevant goods.The purchaser’s primary obligation is to pay money and that obligation has not been affected if the seller is willing and able to supply those goods.

Many long term commodity or service contracts contain “take or pay” clauses which provide the seller with an assured payment stream even if demand drops.In these types of contracts, the payment obligation is not affected by a force majeure event as the buyer takes the market/demand risk.

Similarly, a charterer of a ship cannot claim force majeure and avoid charter hire payments because it no longer has a purchaser for its cargo or passengers for its ship.  A charterer’s primary obligation is to pay for the chartering of the ship and that obligation is usually only waived in very strict circumstances, such as the ship becoming unseaworthy or being in dry dock.  It usually does not matter to the ship owner if the charterer decides not to deploy the ship for cargo or passenger purposes. 

If a force majeure event arises it is important to consider what obligations are actually affected before claiming relief.  If you cease performing an obligation that is not directly affected, you may be in breach of contract, which could allow the other party to claim damages or terminate the contract or both.

What is required by an obligation to mitigate?

Force majeure clauses will often include an express requirement that the affected party uses reasonable efforts to mitigate the impact of the event.  However, even if the force majeure clause does not include an express obligation to mitigate, the courts are likely to imply one.  The courts will generally prefer an interpretation that requires the parties to make a reasonable effort to give effect to their bargain.

It is also not sufficient for a party simply to demonstrate that there has been a failure of its proposed supplier of a product.  The affected party may need to demonstrate that there were no other available suppliers as part of its duty to mitigate. 

In the Queensland Court of Appeal decision of Yara Nipro Pty Ltd v Interfert Australia Pty Ltd [2010] QCA 128, even though the parties has expressly included in the contract that “non-supply to Interfert of Product” was a force majeure event, Interfert could not claim force majeure just because of the failure of its supplier.  The court said that Interfet had to go further and demonstrate it could not obtain replacement product from an alternate source.

The case of South32 Aluminium (RAA) Pty Ltd v Alinta Sales Pty Ltd [2015] WASC 450 involved an explosion at the Varanus Island gas processing plant that rendered the gas processing plant inoperable.  Alinta purchased its gas requirements from the owners of the gas processing plant and on-sold that gas to South32. Alinta sought relief from its obligations to supply gas to South32 on the basis that the explosion was a force majeure event.  However, the court held that Alinta was not entitled to relief because it failed to show that the explosion prevented performance.  Alinta had not shown that it could not supply South32 from alternative sources. 

What if the alternate supplies are more expensive or substantially more expensive?  It is likely that a party is still obliged to make use of the alternate supplies.  The courts have indicated that a party will not be excused from performance by a force majeure event if the sole consequence of that event is to drive them to buy from another supplier at a higher price. Some force majeure clauses expressly seek to provide a limit on that duty to mitigate so that the supplier is not held to an uncommercial bargain.

What if a shortfall in supply means it is possible to fill some, but not all orders? The trend in the case law is that allocation to spread the available resource among the affected customers is permitted and that the allocation basis chosen must be one that is reasonable, having regard to the nature of the industry in which the parties operate.  That may require an allocation which is pro-rata, chronological (i.e. based on order of entry into the relevant contracts) or on some other basis.  There is, of course, the risk to the supplier that it selects an allocation method which a court later determines was not reasonable.

Notice requirements

Force majeure clauses usually require a party which wishes to claim force majeure to notify the other party as soon as possible/practicable after the force majeure event has occurred.  Therefore, it is important to seek prompt legal advice if you think you may be able to claim force majeure relief. 

Responding to force majeure notices

Recipients of force majeure claims must also take care in responding to such claims. For example, in a construction context, it is important to avoid giving directions in response to a force majeure notice that will have the consequence of turning a force majeure event into a contract variation which requires the principal to compensate the contractor for its additional costs.  Particular attention should be paid to responding to a party’s proposed mitigation actions.  It may be prudent to point out that a party is not fulfilling its mitigation obligations, rather than to request that a party undertakes specific actions (which the party claiming force majeure relief may argue is a direction to vary its work).

Insurance

Parties on both sides of a contract may have insurance for losses arising from force majeure events.  However, care needs to be taken not only in establishing that the non-performance and associated loss is directly related to or caused by the force majeure, but that the loss is correctly allocated to the relevant entity involved and during the period of the effect of the force majeure or “peril”.

Care also needs to be taken in giving notification to the insurer in time and on behalf of the correct party where several corporate entities may be involved. 

At the board level, directors should also check their D & O policies and cover for securities claims or shareholder actions to ensure there are no carve outs for losses relating to force majeure or pandemics.

Broader commercial context

In some ways the effect of COVID-19 is different from a typical force majeure event.  Rather than the effects being limited to a geographical area or specific industry, business as usual (and indeed everyday lift) around the world is being disrupted.  In addition, ordinarily a force majeure event will only continue for days or weeks.  How long we will all be affected by COVID-19 is not really known and it may be for many more months.

Ordinarily, parties will look to enforce their strict legal rights in response to a force majeure event.  However, there is a limit to how much economic disruption a party can bear. As a result of COVID-19 many contractors and principals, sellers and buyers, owners and charterers and other parties are going to suffer severe economic impact.

In many cases, it may be in the best interests of all parties to a contract to consider solutions outside the relevant express terms of the contract.  For example, is it better to restructure payments, adopt a demobilisation and remobilisation plan, restructure timing obligations or enter into some other new commercial arrangements to so that the parties can share the burden of the force majeure event to assist all parties to weather the storm. Finding this compromise will be one of the challenges for industry over the coming weeks and months as there is clearly a tension between protecting an immediate hit to the bottom line against protecting longer term value in a continued contractual relationships including allowing some cash flow to continue to enable parties to retain key staff, critical material orders etc.

Overall approach

The best responses to COVID-19 will be multifaceted.  It will be important to understand your legal rights, what is actually affected and how to respond in accordance with the relevant contract.  At the same time, parties’ responses should be consistent with how their insurance policies interact with these rights.  It may be that organisations which work with their counterparties to understand how these rights sit within the broader commercial framework of their contract and business, and use this to best develop their optimal response to the pandemic, will have the greatest success in minimising the long term effects of this global challenge.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).