30 Mar 2020 | Constantinos Michael
We answer 10 important questions on how Coronavirus-Covid 19 can affect contractual performance. Are existing contracts at risk?
It is undeniable that the worldwide spread of the new coronavirus Covid-19 has caused serious concerns to the global community not only with reference to the extended numbers of reported cases or deaths from the new coronavirus, but also due to the adverse economic impact of this new pandemic. While many raise issues relating primarily to the severe impact on tourism and consequently the effects on local markets and related businesses such as hotels, restaurants etc, uncertainty and nervousness are evident across all sectors of the economy, whether this involves real-estate, retail, heavy industry, transportation and others. From a contractual point of view, many legal issues arise, especially in relation to existing contracts which may, or may not, include a force majeure clause. Its interpretation and wording is a very wide topic often to be decided by courts of appropriate jurisdiction.
1. What is the Contractual Clause of Force Majeure?
In Cyprus, the term force majeure describes a discretionary clause sometimes used in contractual agreements. In general terms, Force Majeure clauses are used to describe many factual circumstances or events that occur and go beyond the control of the parties involved and may justify the non-execution of a contractual obligation or a considerable delay in execution of a contractual term, depending on the wording used in a particular contract.
There are contracts that list a wide array of such Force Majeure ‘events’ i.e. circumstances that have been agreed by the parties as force majeure situations. These may include acts of war, inundations, epidemics, strikes etc. Often, some contracts provide a more generic reference to these occurrences, effectively using a clause which indicates that a force majeure event includes any circumstances that go beyond the control of the contractual parties. Therefore, interpretation will depend on the actual intention of the parties at the time of signing.
A Force Majeure clause may be enforced by any of or both parties in a contract depending of course on the precise language of the clause, but the aggrieved party that invokes the clause must prove that such party made every logical effort and took all reasonable steps to avoid or deal adequately with the situation or event, but without success.
2. Can Coronavirus-Covid19 be deemed as a force Majeure Event?
The COVID-19 outbreak has been recently characterized by the World Health Organization as a pandemic. Nevertheless, there should be a careful assessment before Covid-19 is deemed as qualifying as a force majeure event. There is no straightforward answer. It would mostly depend on the precise language used in the clause. It will also depend on the very nature and subject-matter of the contractual relationship. Not all cases will justify non-performance based on the Covid-19 outbreak, especially in cases where there could exist alternative solutions for continuing to perform the obligations stipulated in the contract. In other circumstances, the virus could justify either a delay in performance and/or a delay in meeting a milestone.
As mentioned above, even if a contract specifically makes reference to e.g. a pandemic or epidemic as a force majeure event, the party aiming to benefit from the Force Majeure clause must prove that such an event has indeed caused or led to performance inability or delay in performance, despite all reasonable steps taken in an attempt to mitigate the situation. To reach such a conclusion, a three-phase test can be applied.
3. What is the three-phase test that must be followed by a contractual party to decide if it should invoke the force majeure clause in an existing contract?
Note: Seeking legal advice would be a wise decision at this stage as a legal advisor may assist you in interpreting the relevant clause and may provide guidance and advice on the actions which need to be taken based on the specific of each contract.
4. What are the possible consequences of enforcing a force majeure clause on existing contractual relationships?
The application/ qualification of the Covid-19 as a force majeure event, could possibly justify the non-performance of the obligations referred to in a contract or early termination of such a contract. It may however also function as an excuse for non-compliance, delay or suspension of compliance, minimizing or excluding liability and preventing the other party from claiming compensation for losses or damages. Usually, the clause will also refer to a notification procedure towards the other party on the occurrence of the force majeure event, and such notifications should strictly be adhered to.
5. Can the other party bring the case to Court?
The answer is yes. The other party can apply to Court for a final decision on the matter. A Court will decide on the circumstances relating to a force majeure event based on the specifics of each case, the governing law and its own interpretation on the force majeure term as well as the parties’ intentions within the contract under consideration. In addition, the Court will examine whether the party invoking the clause had taken all reasonable steps to mitigate the situation. However, a fraudulent or unreasonable invocation of the force majeure clause can result in the relevant party being considered as being in breach of its contractual obligations, with any consequences this may carry over depending on the contract at hand.
As a result, we highly recommend you seek legal advice not only prior to the declaration of coronavirus-Covid 19 as a force majeure event that could excuse invoking the relevant clause in an existing contract but even at the early stage of drafting a contract for purposes of legal certainty and clarity.
However, there are existing commercial or other contracts that do not include a force majeure clause. What happens if a contractual party becomes unable to perform its contractual obligations due to Covid-19?
Then the Doctrine of Frustration may come into play.
6. What is the Doctrine of Frustration?
Based on the Cypriot Law on Contracts (CAP 149/Art 56(2)), a contract may be considered as having been ‘frustrated’ when an unexpected event occurs that the parties could not prevent or have foreseen the possibility of it occurring, and which renders the performance of the contract impossible or unlawful. In such a case, the contract is considered invalid.
7. What requirements must be met for a contract to be frustrated?
Firstly, there must be an existing valid contract. Secondly, the contract should not include a force majeure clause or any other clause regulating any such new situation as the event should be unforeseen at the date of the creation of the contract. Thirdly, the unexpected event should have had such an effect that the continuance of the contract would be impossible or unlawful. Fourth, the party that invokes the doctrine should have not contemplated the event or have been reasonably able to know the impossibility or unlawfulness of the contract at the date of the creation of the contract.
8. What are the consequences?
According to Cypriot Law on Contracts, the contract becomes invalid from the point in time when the unexpected event has taken place. In such a case, the parties will not be held liable for non-performance of their contractual obligations and no claim for compensation for damages or losses will be available.
9. Can the Coronavirus Covid-19 be deemed as event leading to frustration of a contract?
The answer is still not clear. While many may rush to say that the outbreak of the coronavirus indeed constitutes an unexpected event as well as the recent measures imposed by the government on matters relating to financial, regulatory and employment, at the same time it is important to assess the real effect of the virus outbreak or the subsequent governmental measures to the performance of the specific contractual obligations under consideration. For instance, it would be more difficult to rely on the Doctrine of Frustration when a contract was created after the virus had already reached most countries around the globe and/or a contract that was entered into after the measures from foreign governments (travel restrictions, economic or other regulatory restrictions) were announced publicly. This could constitute such ‘event’ as probable rather than as unforeseeable.
10. Can the other party bring the case to Court?
Again, the answer is yes, and this is indeed a frequent scenario due to the fact that contracting parties have difficulties in accepting that a contract may have indeed been frustrated. However, the parties must bear in mind that the threshold is high in the doctrine of frustration and the Courts are quite strict and apply a narrow interpretation to this - only in exceptional circumstances would a court accept the application of this particular doctrine. As mentioned, a Court will duly assess the actual circumstances/facts of the case in line with the terms and clauses of the particular contract.
Constantinos Michael - Advocate/Senior Manager