Lessons from COVID-19: Don’t ignore the last page of your contract law textbook

On the very last page of my Law of Contracts textbook is an innocuous section titled: “Supervening Impossibility”. Next to that, is a note in red saying: “DO NOT LEARN”.  As the world has being thrown into a tail spin due to the novel Coronavirus (COVID-19) pandemic, this common law contractual principle, which is often embodied in legal agreements under the auspice of a “Force Majeure” clause, has now become a reality for most businesses.

Force Majeure clauses often function to provide temporary relief to parties to a contract from liability or obligation when an extraordinary event, beyond the control of either party, prevents one or both parties from fulfilling its obligations under that legal agreement. Depending on the drafting, most Force Majeure clauses do not excuse a party's non-performance entirely, but merely suspends it for the duration of the Force Majeure event.

Force Majeure and COVID-19

A party is in breach of contract when it’s not able to perform its obligation(s) under a legal agreement. However, as with every law or legal principle, there are exceptions. In the case of a breach for failure to perform, Force Majeure or Supervening Impossibility is one of the exceptions.

It is expected that businesses will start to receive Force Majeure notices from their suppliers; contractors and service providers. Large numbers of businesses are already reporting huge income losses as a direct result of the COVID-19 pandemic. These losses to business are due to, among other factors, challenges in providing services with limited staff; non-receipt or services and shortages in supplies. Considering the pandemic and the recent unprecedented notice of lockdown by President Cyril Ramaphosa, non-essential businesses must close. Certain businesses like supermarkets, petrol stations, and pharmacies are considered essential and thus are allowed to stay open. It is not difficult to foresee that businesses which are considered non-essential will be disrupted increasing the risk that they may not have enough liquidity to service debt and creditor payments as they fall due. In order to conserve cash, most businesses would look at their supplier legal agreements to see if they are able to avoid paying or extending certain creditor payments for longer.

Would the effect of COVID-19 constitute a Force Majeure event?

In the instance where businesses included a Force Majeure clause with general terms such as “disease or illness” or more specific terms such are “epidemic or pandemic” (taking lessons from the previous outbreak of the Severe Acute Respiratory Syndrome-related Coronavirus (SARS) and Middle East Respiratory Syndrome-related Coronavirus (MERS) viruses (“Specific Terms”), it is possible that COVID-19 has already triggered this clause and as such, businesses would be able to rely on their Force Majeure  clauses in the legal agreement(s).

Where the Specific Terms are not in the agreement, a party may rely on the common principle of Supervening Impossibility if that party can show: (i)performance is objectively impossible;(ii) it’s not caused by any party to the contract, (ii) it’s due to via major or causa fortuitus (events which are irresistible and outside the control of the ordinary person and may be unforeseen/unforeseeable) and lastly, (iv) the impossibility is physical or legal in nature. If the mentioned conditions are met, the obligations under that agreement may be suspended as a result of Supervening Impossibility.

In the case of COVID-19, the party must establish a connection between the Force Majeure event and the failure to perform. If the affected party can demonstrate that, as a result of the COVID-19 pandemic, it is not able to perform its obligation under the legal agreement, it is very likely that a court would find that there is a Supervening Impossibility and the obligation to perform would be suspended. It is important to bear in mind that the party wishing to rely on this bears the onus to prove that the above elements of the test have been met.

While there is no simple tick box exercise to reflect that the Force Majeure event has actually occurred; most current Force Majeure clauses will be wide enough to excuse performance of contractual obligations due to the effects of the COVID-19 and the lockdown.

Effect of a force majeure event?

Though a party may be exempted from its performance under an agreement while the Force Majeure event endures, there is an obligation to use all commercially reasonable endeavours to mitigate the effect of the Force Majeure event and recommence with the performance of its obligations once it is possible to do so.

Where the Force Majeure event endures for an extended period (usually 15 business days, but dependent on the agreement as drafted), there is also a right to immediately terminate the agreement by either party.

In the case where there is no Force Majeure clause, the affected party will, subject to meeting the requirement of the test above, be absolved from its obligation under the legal agreement.

It must be noted that not all obligations or liabilities in terms of the agreement are suspended. The party affected by a Force Majeure event must continue to perform all other obligations that are not prevented by the Force Majeure event.

What does this mean for Ashburton Investments?

In most of our critical agreements with service provider there is an undertaking by our suppliers to have a Business Continuity Plan (BCP) in place in order to ensure continuity of their services. Similarly, the same applies to us and our obligation to our clients. The BCP type provisions and requirements are also now becoming standard provisions that regulators require and expect to see in outsourcing and key legal agreements for financial institutions.

We currently don’t know how long the COVID-19 pandemic will last and how this will affect our smaller suppliers or clients. The lesson we have learned thus far is that we need to possibly reconsider our Force Majeure clause and that of our suppliers considering what we have currently seen. We need to ensure that the requirement for a BCP becomes standard in all legal agreements with critical suppliers and lastly; NOT to ignore the last page of the Contract Law textbook.