The disruption created by the COVID-19 pandemic and the national lockdown imposed under Alert Level 4 will leave many companies concerned about whether they can fulfil – or enforce – their contracts.
We look at some of the ways that businesses can minimise their risk now.
The law of frustration
Under the doctrine of frustration, if performance of a contract is brought to an abrupt stop by some external cause for which no party is responsible, the contract terminates automatically and the parties are discharged from their obligations.
The touchstone of this doctrine is commonly understood as follows:
Frustration of a contract takes place when there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged from further performance.
The threshold for frustration is high. A contract will not be discharged where future performance simply becomes more expensive, onerous or difficult for one or both of the parties. For an agreement to be frustrated as a result of COVID-19, its main purpose has to be rendered unattainable, or a basic assumption the parties had when entering the contracted destroyed.
Force majeure protection
A more certain route to managing contracts during the COVID-19 crisis would be through a force majeure clause. Force majeure is an event beyond the reasonable control of a party.
This may include a pandemic (although the courts have been consistently hostile to labelling market shocks as a force majeure event). Whether a pandemic is force majeure in a particular case will also depend heavily on how the relevant clause has been drafted.
Force majeure clauses operate more broadly than frustration, as they set out what is to happen if certain events occur. The general purpose of a force majeure clause is to keep a contract alive despite a disruptive event: a well-designed provision will specify obligations and rights, and facilitate the resumption of business as usual performance as soon as possible.
Usually the clause suspends performance or extends the time for performance, rather than terminating the contract.
For force majeure to be triggered, a party would have to be unable to perform the contract (or specific obligations). COVID-19, and the requirement for all staff to work from home, may mean this is the case for many force majeure clauses. But if the business is able to perform its obligations in that scenario, then COVID-19 disruption affecting only the profitability of a contract is unlikely to be sufficient to trigger force majeure.
Whether COVID-19 will be treated as a force majeure event will depend on if a specific clause in a contract covers this event. For contracts entered into before early 2020, COVID-19 could be an unforeseeable event or circumstance that will trigger parties’ force majeure obligations. But, be aware that force majeure clauses often include prescriptive regimes for initiating relief, so care needs to be taken to ensure notification requirements met.
Chapman Tripp comments
As New Zealand navigates the COVID-19 pandemic and economic fallout, we expect to see these legal tools increasingly relied on to manage and minimise liability for non-performance in many contracts. Businesses should:
consider what obligations can and cannot be met during the national lockdown, and whether contracts can continue afoot once COVID-19 restrictions are lifted
check relevant contracts to see whether force majeure provisions will apply to COVID-19 and ensure that any notice and timing requirements are complied with
consider mitigation steps, and
where relevant, consider bespoke contractual renegotiations to suspend or ameliorate parties’ obligations for the period of the disruption.
This is one of a series of Brief Counsels Chapman Tripp has produced on COVID-19. See the full list of our COVID-19 releases here.