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27 March, 2020
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The outbreak of the novel coronavirus (“COVID-19-Outbreak”) and its potential impact on contractual performance, such as unforeseeable delay in the delivery of goods and services, have generated a lot of discussions on the availability of force majeure clauses and the associated doctrine of frustration. This bulletin highlights some of the key relevant issues, and provides practical tips in invoking as well as resisting the application of force majeure clauses and the doctrine of frustration.
Force majeure
Force majeure – in practice
A force majeure clause typically provides for contractual consequences upon the occurrence of specified supervening events that are beyond the control of either contracting party, such as natural disasters. Such clauses may provide for a range of consequences, for example: temporary suspension of a party’s contractual obligations, extension of target deadlines, or the right to terminate the contract. In practical terms, the availability and effect of force majeure clauses will primarily depend on what the parties have agreed in the contract. It is therefore essential to: (1) consider the specific wording of the clause to determine whether a qualifying event has occurred; and (2) establish causation between the event in question and the actual or potential non- performance of (part or all of) the contract. We elaborate on these points in the step-by-step guide below:
1. Determine the scope of the force majeure clause: the first step is to consider the wording of the force majeure clause. Take the COVID-19-Outbreak as an example, the relevant clause may cover pandemics, but it may also cover e.g. government interference, national crisis, or emergency measures. Whilst the COVID-19-Outbreak may fall under the umbrella term of “pandemic”, the underlying cause of the disruption is likely to be more nuanced e.g. travel bans on employees, mandatory quarantine measures, shut-down of public services, exchanges, and money markets, etc. A comprehensive force majeure clause may list several of these events, affording the impacted party with an arsenal of arguments to explore. On the flipside, if the clause has been drafted in a more generic manner, it may not list any of these events specifically but contain broad catch-all language (e.g. “any other cause beyond [the Party’s] control”). Catch-all language of this nature may still be effective, but it gives rise to significantly more uncertainty and litigation risk for both parties.1
Note that a general rule is that force majeure clauses should be interpreted by reference to the words the parties used.2 If a force majeure clause provides that the triggering event must “prevent” performance, the affected party will be expected to demonstrate that performance is legally or physically impossible, not just difficult or unprofitable.3 By contrast, the words “hinder” and “delay” have a wider scope and might be satisfied where performance is substantially more onerous. A mere increase in the cost of performing the contract, however, would still be unlikely to be enough to trigger a clause with wording of this kind.
2. Establish the facts: force majeure is only available if the prescribed event has taken place, and has caused (or is about to cause) the default in question, which is why it is important to establish the chain of causation at the earliest opportunity. In addition, the relevant event must meet the threshold test for a force majeure event; whilst this will depend on the wording in the contract, generally, an event that makes a contract more expensive or more onerous to perform is insufficient to qualify as a force majeure event.
3. Timely and proper notification is often required: in general, the party seeking to rely on a force majeure clause will be required to give notice of the actual or anticipated non- performance in the manner specified in the contract.
4. Consider exclusion clauses: even if the event satisfies all the above requirements, review the force majeure clause for express exclusion of certain events, such as e.g. economic downturn.
5. The party seeking to invoke force majeure might still bear residual mitigation duties: the party seeking to rely on force majeure might be subject to a duty to show, on the balance of probabilities, that it has used all reasonable endeavours to avoid or circumvent the effects of the force majeure event.4 In this regard, English courts have held that the standard of “reasonable endeavours” is an objective one.5 Even if the contract is silent on mitigation, parties are generally well advised to take appropriate measures to keep losses to a minimum and to put themselves in a position where they can demonstrate that they have done so.
6. The contract may not be fully discharged: note that even if the force majeure clause can be invoked, some contracts might require the parties to continue to perform certain obligations that have not been affected by the force majeure event. This should be clear from the contract.
Force majeure – the law
A matter of contractual intention: force majeure clauses are principally a matter of contract law. Their purpose is to enable parties to allocate risk by making express provisions for what should happen to their bargain upon the occurrence of certain events. Parties are free to specify a wide range of events, and to agree to relief that is tailored to their specific circumstances.8 General principles of contractual interpretation apply when construing force majeure clauses. The burden of proof is on the party wishing to exercise the force majeure clause to bring itself “squarely within the clause” by showing that the relevant event occurred and that it had (or was anticipated to have) the stipulated effect on the affected party’s contractual performance.9 Past cases demonstrate that the court tends to construe force majeure clauses strictly against the party relying on them.
Distinguished from exemption clauses: whilst similar, force majeure clauses are to be distinguished from exemption clauses. Where the event is covered by a force majeure clause, the party whose performance is prevented or delayed by the supervening event is not in breach at all, but relieved from strict performance.10 In this respect, force majeure clauses differ from exemption clauses which presuppose the existence of a breach.
Recent update: “force majeure” certificates
On 31 January 2020, the China Council for the Promotion of International Trade (the “CCPIT”), the national foreign trade and promotion agency of Mainland China, announced that it would offer “force majeure” certificates to companies struggling to cope with the impact of the COVID-19- Outbreak. Such companies could apply online and submit the relevant documents for audit. On 2 February 2020,
the first of such certificates was issued to an auto-parts manufacturer in Huzhou, Zhejiang Province.6
Although it was reported that such force majeure certificates could be used as “factual proof” to potentially absolve the non-performing party of liability,7 it is not yet clear what
legal or evidential value (if any) such certificates might hold in common law courts, especially where the contract is governed by a law other than the law of Mainland China. The CCPIT is not a court or judicial body, and its role is akin to that of a chamber of commerce. Thus, whilst untested, there is considerable doubt that – outside Mainland China – the CCPIT-issued force majeure certificates could displace the requirement to analyse force majeure clauses and the factual circumstances in accordance with existing well-established legal principles.
For completeness, note that there is some uncertainty as to whether force majeure certificates will impact the enforcement of legal awards (whether obtained in arbitration or litigation) in Mainland China, in circumstances where a party obtained a force majeure certificate, but then failed to successfully plead force majeure in proceedings outside Mainland China. Where faced with such a scenario (i.e. a Mainland China counterparty with a force majeure certificate, that is being sued for breach of contract outside Mainland China), specialist legal advice should be obtained before taking action.
Frustration
Frustration – in practice
Assumption of risks: in most cases, frustration will be argued as a defence to a claim for breach of contract. The plaintiff, in the absence of admissions, must prove the contract and the breach, and the defendant must prove facts amounting to frustration.
In practice, the court will want to satisfy itself that the relevant event took place, that it had the alleged frustrating effect on the contract, and whether or not the event was foreseen by the parties (and therefore the risk was assumed under the contract). The party arguing that frustration should not apply will ordinarily contend that the risk was assumed under the contract, and that it was a foreseeable risk. There is no settled test as to the standard of foreseeability that is required to deny the application of the doctrine of frustration, however authorities are relatively consistent that a fairly narrow standard of foreseeability applies.11 Thus, the argument will usually revolve around whether the occurrence of the relevant event was foreseen by the parties as a serious possibility – it will generally not suffice to argue that the event was reasonably foreseeable.
Very high threshold: in practice, frustration generally applies in extreme scenarios.12 The mere fact that an event deprives a party to a contract of benefits which were expected from its performance, or even renders performance physically impossible, might not necessitate that the doctrine of frustration can be used as an excuse for not performing, since a party may be found to have taken the risk of such an eventuality, or undertaken an absolute promise to perform. To illustrate the narrow confines of the operation of frustration, by way of recent example, in Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch), the English court rejected an argument of frustration due to Brexit on the ground that that it only applies where the supervening event renders the performances of the parties’ bargain “radically different”.13
Consequences of frustration: where the doctrine of frustration applies, the contract is terminated automatically without any act/election of the parties. However, since the contract is only discharged prospectively, liability incurred up to the point of frustration might still attract disputes.14 As regards money already paid, subject to the contrary agreement of the parties, Hong Kong statute provides a right to recover money paid in case of frustration or for compensation for partial performance before frustration under a contract governed by Hong Kong law, however note that exceptions apply depending on the type of contract in question.15 In the same vein, UK16 and Singapore17 statutes also offer similar relief.
Frustration – the law
- Distinguished from force majeure: whilst force majeure is primarily an exercise of contractual interpretation, frustration is a common law doctrine where a contract may be discharged upon the occurrence/non- occurrence of some unforeseeable supervening event which destroys the basis upon which that agreement was reached such that the agreement is de facto brought to an end. The object of the doctrine of frustration is to avoid injustice which would otherwise result from a literal enforcement of a contract where there is a significant change in circumstances. The key conceptual difference between force majeure and frustration is that the former reflects the parties’ express intention on how to deal with supervening events and their consequences, whereas the latter is a relief implied by law. Courts would ordinarily refrain from applying frustration when the scenario has already been identified as part of a force majeure clause.18 This is consistent with established principles that where a contract contains express provisions which indicate sufficiently the consequences which are to result, the parties’ rights will be governed by the express terms in the contract.
- The test for frustration: there is no single definitive test for when frustration will apply, and recent authorities support a broad approach taking into account all facts and circumstances of the case. However, generally speaking, a frustrating event will satisfy the following characteristics:
First, it is an event that occurs after the contract has been formed.
Second, the event is beyond what was contemplated by the parties when they entered into the contract, and is so fundamental as to be going to the very essence of the contract.
Third, the event is not due to the fault of either party and not self-induced.
Fourth, as a result of the event, performance of the contract has become impossible, illegal, or radically different from what was contemplated at the time the contract was entered into.
Checklist
Apart from the legal principles noted above, we set out below a summary highlighting the legal and commercial issues that one should consider before invoking a force majeure clause or relying on the doctrine of frustration.
Step 1
Is there a force majeure clause in the contract? If the 1 answer is yes, see step (2). If not, go directly to step (4) and consider the application of frustration.
Step 2
Carefully scrutinise the wording of the force majeure clause, particularly:
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the definition of the specified events;
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causation requirement;
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qualifying effect;
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notification requirements;
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exclusion/caveats; and
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mitigation duty.
Note: even if a mitigation duty is not expressly provided for, it is likely to be implied by law.
Step 3
If the event falls within the scope of the force majeure clause, consider the possible relief(s) sought and any relevant provisions regarding costs and indemnity. Prepare the relevant notices and mindful of the notice provisions in the contract which will generally stipulate the form of the notice required and the method of service.
Step 4
If the event falls outside the force majeure clause, consider the application of frustration, but bearing in mind that any costs/liability incurred prior to the point of frustration might still be subject to dispute.
In practice, at this stage a careful legal analysis should be undertaken of the facts; consider obtaining an assessment from your legal advisors.
Step 5
After the assessment of the facts is completed, a 5 carefully drafted letter to the counterparty would be required setting out why frustration has occurred.
Note: with force majeure and frustration alike, when communicating with the contractual counterparty one should prepare all correspondence bearing in mind that a dispute may arise; consider obtaining specialist legal advice to ensure that your position is not compromised.
For further information, please contac
Melvin Sng, Partner, Head of Dispute Resolution, Asia, Linklaters
melvin.sng@linklaters.com
1 There have been instances where force majeure clauses were found to be void for uncertainty because of how broadly the clause was drafted e.g., see: British Electrical and Associated Industries (Cardiff) Ltd v Patley Pressings Ltd [1953] 1 WLR. 280)
2 Coastal (Bermuda) Petroleum Ltd v VTT Vulcan Petroleum SA (No 2) (The Marine Star) [1996] 2 Lloyd’s Rep 383.
3 Tennants (Lancashire) Ltd v G.S. Wilson & Co. Ltd [1917] AC 495).
4 For more, see footnote (2) and Goldlion Properties Limited v Regent National Enterprises Limited (unrep., FACV 10/2008, [2009] HKEC 1517).
5 See footnote (2).
6 See CCPIT press release at http://en.ccpit.org/info/info_40288117668b3d9b017 019772b5706b0.html.
7 Ibid.
8 See Treitel: Frustration and Force Majeure 3rd Edition, 12-020.
9 Channel Island Ferries Ltd v Sealink [1988] 1 Lloyd’s Rep 323.
10 See footnote (1), 12-022.
11 See footnote (1), at 13-012.
12 The Hannah Blumenthal [1983] 1 A.C. 584.
13 For more, please see our previous client bulletin on key contract law cases of 2019: https://knowledgeportal.linklaters.com/llpublisher/knowledge_1/uk-top-ten-english-contract-law-cases-of-2019.
14 On the same note, an arbitration clause may remain in force to govern matters up to the date of frustration or the issues arising from frustration itself.
15 See section 16 of the Law Amendment and Reform (Consolidation) Ordinance (Cap 23).
16 See section 1(2) of the Law Reform (Frustrated Contracts) Act 1943.
17 See section 2(2) of the Frustrated Contracts Act (Chapter 115).
18 There are limited exceptions to this, such as in Empresa Exportadora De Azucor v Industria Azucarera Nacional SA (The Playa Larga) [1983] 2 Lloyd’s Re. 171, where the force majeure clause merely stated that the shipping period shall be extended by 30 days where certain uncontrollable events take place. The English court held that the force majeure clause was only intended to cover events of the type that would result in temporary interruptions, but not an event that practically renders performance illegal, such as the coup de ’tat and change in national law in question. In these circumstances, frustration remained available to be argued.
