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Contract Performance in a COVID-19 Economy April 9, 2020

The novel Coronavirus (COVID-19) has become an economic threat in which organisations are facing great challenges and preparing to respond quickly not only nationally, but globally.  The Australian Government has provided temporary regulatory relief for financially distressed businesses including the statutory demand threshold of $2,000 being raised to $20,000 under the Corporations Act 2001 – see related article Temporary relief for financially distressed businesses issued by the Australian Government.   In addition, regulatory barriers and directors’ risks to companies trading while insolvent have been lifted for the next 6 months in helpful regulatory measures designed to keep businesses operating and business owners ‘on the tools’.  Other changes and assistance are expected – see our related articles.

Due to the impact COVID-19 has had on numerous businesses, there may be disruptions to fulfilling contracts and leases resulting in delays, suspensions or even terminations.  Generally irrelevant and unused by most legal practitioners since law school, principles such as force majeure, frustration of contract and other contractual rights are being relied on to seek relief from fulfilling contractual obligations.

Force Majeure

 Force majeure, or literally ‘irresistible force or strength’, is the term used to apply to the termination of contracts due to unforeseeable situations or events that restricts and prevents a person from fulfilling a contract.  Think ‘Acts of God’, war strikes and pandemics.

To be utilised:

  1. this contractual right must be incorporated within the contract itself. There is no common law rights for force majeure within Australia.
  2. the clause will need to provide for the actual circumstances which could hinder someone from their contractual obligations. As an unprecedented modern event, it is unlikely (though not impossible – we have seen some instances) that the COVID-19 pandemic will trigger the rights of termination.

Frustration of contract

A further contractual principle that is similar to force majeure is that of frustration of contract.  In our experience, the application of these principles are much more likely to provide relief in the current circumstances.

Where:

1. a contract has been formed;

2. but the contract is not capable of being fulfilled as a result of an unforeseen event;

3. resulting in the obligation within the contract being entirely different from what was contemplated by the parties to the contract; and

4. without either party being at fault.

The surrounding circumstances of the contract should be taken into account when interpreting the scope of the contract as indicated by the Codelfa Construction case, considered the leading decision on frustration in Australia.

In that instance, Codelfa were engaged by NSW State Railways to excavate a tunnel.  Residents successfully obtained an injunction to limit the work times for the excavating workers.

The majority of the High Court found that the contract had been frustrated and was terminated on that basis given –

‘the performance of the contract in the events which have occurred is radically different from performance of the contract in the circumstances which it, construed in the light of surrounding circumstances, contemplated.’ (Paragraph 55 per Mason J)

It is not difficult to apply these principles to the current pandemic which has drastically altered the circumstances in which contracts are being performed.

It is important to note that frustration only applies to future obligations from the point of frustration – it does not ‘void’ the contract from its beginning.  Parties should consider the point of frustration and prior obligations very carefully.

A commercial approach

It is important to note that all contractual obligations will be different for each agreement.  Even provisions in similar documents, such as leases, can contain vastly different provisions.  There is no substitute for reading the document itself.

Due to the complexity and the esoteric nature of legal principles such as force majeure and frustration and the global impact and application of issues in the current situation, we are observing that simple mutual solutions are coming to the fore.

Knowing your legal position can and should inform your negotiations and approach.  Ultimately, communicating and negotiating with other parties to find common ground and solutions are an important and commercial tool which, once documented appropriately, is assisting many businesses to negotiate these troubled times.

James Stokes is an Accredited Specialist in Business Law and Director at Stokes Lawyers.  Ayesha Charan is a lawyer working for Men’s Legal Service.

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