Managing contract risk in lockdown

Managing contract risk in lockdown

May 15, 2020

Contracts with suppliers, customers and others are the lifeblood of business. The commitments and rights contained in them enable businesses to trade and, hopefully, make money. The Covid-19 lockdown is impacting these commitments and rights in ways most businesses have not experienced before. For some, the impact of contractual default is small but for others, it is potentially existential. Despite everyone’s best hopes, the problems are not going away and there is currently no twinkling light at the end of the tunnel.

The reality is that, for many businesses, fulfilling contractual commitments to suppliers and customers during the lockdown period will be difficult, uneconomic, or even illegal.

With the whiff of costly and commercially disruptive litigation hanging in the air, what approach should you take if you are signatory to a contract you may no longer be able to perform? It may be an obvious statement but, as with most business decisions, a considered, well-informed and strategic approach must be the right one.

So, if you find yourself at risk of defaulting on a business contract due to the Covid-19 pandemic, here are FIVE WAYS TO MANAGE YOUR CONTRACT RISK and play the cards you do have to maximum advantage.

1. CHECK IF THERE IS A FORCE MAJEURE PROVISION IN THE CONTRACT
A party to a contract who is impacted by the Covid-19 pandemic remains liable to perform the contract obligations. However, there are a few exceptions including where performance has been excused by agreement with the counterparty or under the legal principles of force majeure or frustration. Before entering negotiations with the counterparty, it would be wise to check the contract to see if there is a force majeure provision in it – and, if so, whether the wording of it covers the current situation. Not all contracts contain force majeure provisions. If it is a contract with a lot at stake, it would be worth seeking specialist legal advice. Force majeure provisions rarely release parties from obligations completely. More commonly, they allow a party to delay performance of an obligation until it once again becomes possible to perform it. Some may go on to allow termination if the delay extends beyond a certain period. However, if ending the contract is the most attractive option, it would be advisable first to examine all contract clauses giving a potential right to terminate as these may offer a cleaner and more certain outcome than relying on force majeure provisions. For example, there could be a termination for convenience clause with a short period of notice, in which case it will be essential to comply with the letter of any provisions relating to notice.

2. ASSESS IF THE CONTRACT HAS BEEN FRUSTRATED
Frustration is a legal doctrine that can be used to discharge a contract in circumstances where a subsequent event takes place that renders performance of the contract impossible. For example, if you were a betting company and had contracted to advertise before or at half time of Euro 2020 football matches at a named time and date this year, then the postponement of the tournament until next year could arguably lead to the frustration of the contract. A party cannot, of course, rely on frustration if they themselves caused the frustration event – it needs to be an event outside the party’s control. It is also worth noting that, if a contract contains force majeure provisions that apply to the relevant circumstances, frustration is unlikely to be applicable. The courts have set a high bar as to when frustration may be invoked, and so legal arguments need to be carefully crafted in order to claim or resist it.

3. CHECK IF YOU HAVE ANY RELEVANT BUSINESS INTERRUPTION INSURANCE
Businesses should look at their contractual risk and insurance cover in the round. It is uncommon to have standalone business interruption cover for pandemics. Most business interruption policies only cover losses that are a consequence of physical property damage – which contract liabilities resulting from lockdown most likely are not. Nevertheless, it is certainly worth checking the precise wording of any business interruption policy or policy extensions you may have to see if they provide cover for any such losses. It is widely known that insurers are paying extra attention to the detail of insurance policies at the moment, so it is important not to take any action or reach accommodation in relation to existing contracts without the knowledge and acquiescence of relevant insurers or future claims may be prejudiced. It is also important to ensure any losses are mitigated. Liaising closely with insurance brokers and specialist insurance lawyers should avoid you inadvertently compromising your position.

4. DON’T FORGET THE LONG GAME 
Whilst the technical legal position of contract disputes is important, more often than not, the outcome is determined by the relative bargaining strength of the parties. Business leaders need to weigh up the effect of overplaying their hand in situations where maintaining a long-term relationship with the counterparty is important and beneficial. Souring a relationship now for short-term gain may have serious consequences for the future. Finding a win-win outcome in difficult circumstances can very often strengthen a business partnership and help forge strong and lasting relationships for the future.

5. THERE’S NO TIME LIKE NOW TO PREPARE FOR THE FUTURE
Some existing contracts may specifically refer to epidemics and pandemics, but it is likely very few. Now is an opportune moment to be reviewing material customer and supplier contracts to decide if any would benefit from negotiated variations to cater for similar lockdown events. The economic effects of COVID-19 are likely to be hard and long lasting and so we are now operating in a different commercial world. As businesses become attuned to this, they should be reviewing their own contracts in an attempt to future-proof them. The way contractual risk is apportioned going forward may look very different and the most successful businesses will be those that plan ahead.

Michael Ainsworth, Director, O’Connors Legal Services Limited