Contracts and Covid–19: what to do if you or your counterparty cannot perform
Andrew Rhys Davies
Frankfurt am Main
Arnold Croiset van Uchelen
11 May 2020
1. Check the terms of your contract to see if they deal with the scenario
This is a question of contractual interpretation under the law that governs your contract. Consider whether:
- what has happened is expressly addressed in the agreement, for example in a force majeure or material adverse change clause, an illegality clause, or some other provision (such as a general termination clause);
- the right to rely on the clause has arisen – i.e. whether the event is within the scope of the clause and whether performance has been impacted in the way the clause requires (to rely on a force majeure clause, you may have to show that performance is impossible – a high threshold to meet);
- other clauses or market practice (or, in a civil law context, the preceding negotiations) should inform the way you interpret the clause.
2. In addition to your contractual rights, ascertain whether you have any other rights/obligations as a matter of law
Parties may have rights and/or obligations as a matter of law that apply in addition to (or, potentially, in place of) express contractual rights. Consider whether:
- specific statutory or common law rules or remedies may be available, for instance: (a) rules that would allow a party to imply terms; (b) special protective rules (e.g. for consumers); (c) rights to deviate from the contract pursuant to principles of reasonableness and fairness and comparable quasi-equitable remedies (more prevalent in civil law jurisdictions); (d) statutory rules on force majeure or, in common law systems, the doctrine of frustration; (e) civil law rules that may allow contractual obligations to be altered in the event of unforeseen circumstances;
- more opportunistic statutory or common law grounds might allow for the termination or suspension of obligations, for example on a party's breach (if one can be identified);
- the prospect of a party's insolvency (or the invocation of other bankruptcy-related statutory measures entitling suspension of performance or cancellation of obligations) will alter your analysis (e.g. creditor's ability to claim specific performance or exercise termination rights may be switched off);
- emergency laws put in place to deal with Covid-19 might apply, for example temporary laws that suspend or enhance private contractual rights.
3. Confirm whether there is a regulatory overlay to take into account
Consider whether you need to take into account regulatory rules or guidance. Regulators around the globe have published a raft of statements on how regulated entities should respond to this crisis, both in terms of their own operational resilience and how they deal with clients and customers, which may impact any decision on whether to enforce strict contractual rights.
4. Confirm whether other mandatory or public policy rules affect your analysis
In a similar vein, consider whether laws, other than the governing law of your contract, may need to be taken into account. While, typically, the circumstances in which this happens are very limited, here, with some national emergency legislation and export controls being mandatory in nature, this might become an issue. Accordingly, take into account mandatory laws or public policy rules of the jurisdiction in which any dispute may be heard and (usually at the discretion of courts seized) mandatory laws of the place of performance and/or of the party's domicile. For arbitral tribunals, also look to mandatory laws at the seat of the potential arbitration.
5. Make sure you comply with the mechanism for relying on any rights
Once you have worked out what rights might be available, you then have to look at how (and when) those rights can be exercised. Ask yourself whether these rights must be exercised within a particular time frame, whether there is an obligation to notify the counterparty (and if so, how) and whether their exercise requires an application to court. It may be difficult, if not impossible, to give notice or apply to court if the relevant jurisdiction is locked down.
6. Identify the consequences of relying on particular rights
Consider the consequences of exercising contractual or other legal rights. Will the exercise of a particular right discharge the parties from their obligations? If so, will it be on a suspensory or permanent basis? Alternatively, is the remedy an amendment to the contract (and what might that amendment look like)? Is there a mechanism for unwinding aspects of the contract or compensating a party that may have lost out?
7. Map out the pros and cons of the different approaches
If there is more than one viable legal route available, consider the advantages and disadvantages (both legally and commercially) of each option. Think about what you want to achieve: do you want to extract yourself fully from the relationship or would you prefer another approach? How strong are your arguments? What might happen if it turns out that you got it wrong – for example, if you terminate when you had no right to do so. Might you be in breach and potentially liable? A proper assessment of litigation risk will help you assess which route to follow.
8. Consider whether there is another way through
Having carried out the formal legal analysis it is critical to step back and think about whether there is another way to resolve performance issues. For example, consider whether you might instead wish to agree to amend the agreement, waive certain rights and/or expressly reserve particular rights. Be clear about what you are trying to achieve, act consistently with that aim and document the steps you take.
9. Identify any other factors you might want to consider
There are many other things that you may wish to consider, including: whether you need to be telling third parties (e.g. insurers) about what you are doing; how you manage any reputational risks; whether you should be recording decisions (and, if so, how to do so whilst minimising the risk of disclosure to third parties); and whether you should commence proceedings pre-emptively to reduce the chances of being forced to litigate in an unhelpful forum.
10. Think about the lessons you have learned when negotiating new deals
For new deals, careful thought will need to be given to how to allocate future risks of non-performance (force majeure clauses are no longer likely to be seen as boilerplate and negotiations on risk allocation may well be highly contentious) and what to do about some of the mechanics (e.g. whether to include mechanisms for serving notices electronically). You may also wish to consider much more fundamental questions, such as whether your preferred choice of law or disputes forum has proved to be the right one or whether a change of approach would make sense. Questions such as whether the courts have remained open (whether physically or virtually), whether rights available under your preferred law have been beneficial and whether you are happy with the level of state interference (if any) in private contractual rights will help inform the decisions you take on future transactions.
While there has been lots of commentary about the merits of exercising forbearance or looking for an agreed resolution, in practice it is important to consider how to respond to contractual performance issues in the context of a clear understanding of your strict legal rights and best commercial interests. If you consider all of these points in the round you should be well placed to make sensible decisions about how to proceed.