Force Majeure Clauses and Risk Management in the Face of COVID-19

March 06, 2020

Written By Richard B. Swan and Preet K. Gill

The novel Coronavirus (which causes COVID-19) was first reported from Wuhan, China, on December 31, 2019, and has been rapidly spreading since, with the outbreak now declared a global health emergency by the World Health Organization (WHO). A consideration that arises in the commercial sphere is whether a party whose performance of contractual or commercial obligations is affected by COVID-19 can utilize a "force majeure" clause within a contract to excuse its non-performance. Such clauses, when engaged, either permanently or temporarily relieve the affected party from the performance of contractual obligations, and from the consequences of a failure to perform those obligations, where performance is rendered effectively impossible by unforeseen, extraordinary events or circumstances beyond that party's control.

Force Majeure Clauses

Force majeure clauses are quite common in commercial agreements, but are rarely triggered. However, such clauses could potentially be triggered as a result of the impact of COVID-19, depending on the local circumstances and the nature of the contractual obligations.

Most force majeure clauses define the circumstances beyond the contracting parties' control that can render the performance of the contract impossible, and then provide for the suspension, deferral and/or release of the obligation to perform the contract based on that event. Some of the typical circumstances identified in a force majeure clause include war, riots, natural or other disasters, and so forth. Some force majeure clauses expressly include "disease" as one of the circumstances in which the clause could apply. Other clauses may have catch-all language such as "any other cause beyond the party's control", which may also be applicable with respect to COVID-19.

The party seeking to rely upon a force majeure clause for relief from contractual obligations would need to demonstrate that there are no reasonable alternative means to perform its obligations under the contract. If the contract is simply more difficult or more expensive to perform, a force majeure clause is unlikely to apply. Canadian courts have typically set a relatively high threshold for the application of a force majeure clause, often requiring a supervening or supernatural event beyond the control of either party, rendering performance impossible.

Whether a force majeure clause will apply in a particular circumstance depends on a number of factors, including the language of the clause, the nature of the contract and the type of services that can no longer be performed, and the local circumstances of the extraordinary event. A key consideration is likely to be the location of performance. For example, if the agreement is a supply contract in respect of which the supplier is in an area that has been declared high risk, with corresponding travel restrictions, quarantined employees, or related higher-risk local circumstances, then excused performance is more likely. However, if the challenged party is located in a low-risk area where relevant economic activity is largely continuing, then force majeure is unlikely to apply. Similarly, if a party is seeking to rely upon COVID-19-related travel restrictions as the basis for non-performance, and travel is not essential to fulfillment of the contract, then force majeure is unlikely to apply. These are largely questions of fact. Additional WHO declarations with respect to specific areas should continue to be monitored as the locations impacted may increase.

As the language of force majeure clauses are different, and under Canadian law must be interpreted in the context of all of the provisions of the contract as well as the contract's surrounding circumstances, the interpretation of each specific force majeure clause may differ. Parties whose contracts incorporate the UNIDROIT Principles of Commercial Contracts should also be aware that article 7.1.7 of those Principles provides for a form of force majeure relief.

Mitigation

The obligation to mitigate the impacts of the virus continue to apply, meaning that the affected party has an obligation to seek alternative methods of performance, supplies of input parts and materiel, and the like. The party who expected to receive the benefit of performance should also take all reasonable steps to mitigate losses, particularly when it is unclear at the time of non-performance whether a force majeure clause will later be found by a court or arbitrator to apply.

Frustration

A related consideration if a contract does not contain a force majeure clause, or the wording of the force majeure clause renders it inapplicable in the situation, is the common law doctrine of frustration. Where an event occurs after entering into the contract that renders the contract impossible to perform, and goes to the very root or heart of the contract, the doctrine of frustration provides that the contract has become frustrated. A classic example is a contract for delivery of a very particular item that has since been destroyed by fire. The doctrine of frustration generally has a higher standard than force majeure, and the consequences of its application may be different, as a force majeure clause may provide for temporary suspension or deferral whereas frustration is generally the end of the contract. However, depending on the specific facts, frustration may potentially be an option if a force majeure clause is unavailable.

Risk Management in the Face of COVID-19

More broadly, businesses and other organizations should evaluate and take proactive steps to mitigate the business risks posed by COVID-19. These actions may include:

• ensuring that a risk management plan is in place;
• addressing workplace health and safety issues;
• assessing alternative production or work locations;
• reviewing the depth of inventory of input parts and materiel;
• reviewing and assessing insurance coverage including business interruption insurance; and
• staying in close contact with local and federal health authorities for guidance and directives.

Commercial parties should also review their relevant contracts for force majeure clauses, paying close attention as well to governing law clauses that will address which jurisdiction's statutory and common laws will apply to the interpretation of the clause, and choice of forum clauses that will specify the dispute resolution forum, whether court or arbitral tribunal.

It is important to seek legal advice whether you are seeking to enforce or excuse performance of the contract. Bennett Jones can provide the advice you require, and help organizations address risk management planning in the face of this serious threat.

*This article has been updated from its originally published version, adjusting a reference to the severity of the situation in North America and a reference to COVID-19.

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