COVID-19 and Contracts

By Caragh Deery - Law Student @ St Hilda's College, Oxford

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As a result of COVID-19, governments across the world have taken unprecedented measures to reduce the spread of the virus. Measures have included national lockdowns, travel bans, and mandatory social distancing. Whilst we have all felt the impacts of those measures personally, the impacts have been particularly significant for businesses. This piece considers how businesses might rely on the law to overcome some of the difficulties that have arisen.

The Impacts on Businesses

Lockdowns mandate the temporary closure of many non-essential businesses. Once reopened, social distancing requires those businesses to adapt to operate in new, COVID-compliant ways. This creates numerous difficulties for businesses. First, adapting business procedures to ensure that staff and customers are safe is costly. Businesses face significant increases in cleaning fees and incur additional costs such as installing plastic screens. Second, for businesses manufacturing goods, numerous, prolonged closures slow production. This puts the business behind schedule in the fulfilment of orders already made and limits its ability to accept new orders. Moreover, even once the goods have been produced, there are further hurdles to overcome before those goods are delivered. Travel bans and issues with supply chains have significantly slowed down cross-border trade. Cumulatively, these factors have resulted in many businesses being unable to fulfil all of the contractual obligations that were entered into pre-COVID.

How will the law deal with these situations?

Non-performance of a contract, without lawful excuse, amounts to a breach of contract and thus leaves the non-performing party liable to pay damages to the other party. It works against the national interest for a large number of disgruntled parties to seek damages from businesses during an already difficult and financially precarious time. The survival of businesses is crucial for a healthy post-COVID economy. The UK Cabinet Office has thus encouraged parties to act responsibly and fairly in the performance and enforcement of contracts where there has been a material impact from COVID-19. Greater flexibility by parties will reduce the detriment to non-performing parties.

Unfortunately, there is no existing legal doctrine under English law that captures this spirit of co-operation. If the parties did wish to rely on a legal doctrine, frustration would be the most obvious choice. The doctrine of frustration operates to discharge a contract where, after the formation of a contract, something occurs which renders performance of the contract physically impossible, illegal or something radically different from that which was in the contemplation of the parties at the time of entry into the contract. However, this will not capture all agreements and, even where it does, the consequences of the doctrine are draconian. The contract is discharged completely, meaning that the parties have no further contractual obligations. This is problematic as it leaves no discretion to the courts. If discharging the contract will leave one party significantly out of pocket, while leaving the other largely unaffected, the court cannot intervene to distribute the burden more evenly.

How can parties protect themselves?

Most businesses will not want to risk finding themeselves at the mercy of the doctrine of frustration. Legal commentary on COVID-19 has advised businesses to consider instead the impacts of the pandemic at the drafting stage. For example, force majeure clauses can alter parties' obligations and/or liabilities under a contract when an extraordinary event or circumstance beyond their control prevents one or all of them from fulfilling those obligations. When negotiating the terms of the contract, the parties can decide how to allocate liability upon the materialisation of an event captured by the clause. The courts will – with a few exceptions - be bound to apply the term as drafted to respect the sanctity of contract. This puts greater power in the hands of the parties to determine the contractual result and should result in fairer - or at least more economically balanced - outcomes.

Force majeure clauses will be most effective for contracts entered into since the beginning of the pandemic. Drafters in 2019 will unlikely have had in their minds the possibility of an event quite so extraordinary as the pandemic that has since unfolded. This might mean that some parties will still have to rely on the doctrine of frustration in order to be relieved of their contractual duties. Perhaps the time has come to consider whether the law ought to inject a greater degree of remedial flexibility into the doctrine of frustration.

Further reading:

1. An overview of the doctrine of frustration: https://www.lawteacher.net/free-law-essays/contract-law/the-doctrine-of-frustration-contract-law-essay.php

2. A piece by a law firm on the potential role of force majeure clauses in the face of the pandemic: https://www.nortonrosefulbright.com/en/knowledge/publications/844d7cf4/contract-performance-in-a-coronavirus-world-force-majeure-clauses-and-the-doctrine-of-frustration

3. McKinsey report on the implications of COVID-19 for businesses (Note: this is not a legal report, but the law does not operate in a vacuum - it must respond to changes in society and the world!) https://www.mckinsey.com/business-functions/risk/our-insights/covid-19-implications-for-business