COVID-19 has and continues to present significant disruptions to the commercial world. For businesses, commercial relationships have become strained as contractual obligations become weathered by a storm of uncertainty.
As a result of the issues that have arisen from this pandemic between suppliers and customers, it is important for both parties to consider a number of factors when reviewing their current and future contractual obligations and dealing with any disputes that arise. Below is a useful framework which should assist parties to manage disputes and at best avoid a complete breakdown of commercial relationships.
Assessing the situation
- Review your supplier contracts and consider any impacts
For customers, be pro-active in considering which of your suppliers may be impacted by closures or delays and openly engage in discussions with suppliers about their ability to meet delivery commitments, supply forecasts and whether they have activated any business continuity/disaster recovery plans.
In the case of suppliers, realistically consider whether you are able to honour commitments with customers in relation to such matters as timely supply, volumes and service. If not, then the customer should be contacted as soon as possible, and be informed of the issues. Communication can go a long way in preserving commercial relations far beyond COVID-19.
- Consider alternative suppliers
Prior to seeking an alternative supplier, check your contract to determine whether it is on an exclusive basis. If your agreement is on an exclusive basis, consider whether there is an exception on the basis of delay or non-performance or otherwise an option to terminate the contract.
Moving forward, ensure that the drafting of the terms and conditions in your contractual arrangements are flexible enough to ensure you have the option to terminate in situations where supply can no longer be fulfilled, for example, particularly where you already have an existing contract on foot and you are engaging an alternative supplier in the interim.
- Is there a force majeure (or exceptional event) clause?
This clause can be found in some contracts and effectively is a pre-agreed clause that operates to provide relief to a party from liability in performing their contractual obligations as a result of something that occurred beyond their control whether as a result of human intervention or not. Common examples of events include natural disasters, strikes, riots, war. If a force majeure clause is wide enough or has a catch-all phrase it might also cover pandemics, epidemics or contagious diseases (if not already provided for). However, it is usually intended to cover unforeseen events so the timing of seeking to exercise such a clause is relevant.
Where your contract did not cover an event like COVID-19 specifically consider whether the clause might cover ancillary effects of the disease such as government actions or lockouts that might impact on a party’s ability to perform under the contract.
Consider what the ‘Governing Law’ is of your contract and the place of performance to determine whether a force majeure clause can be implied or not. If Australia is the governing law, then there must be an express force majeure clause written in the contract.
If you have identified a force majeure clause and you would like to enforce it, consider the following:
- Causation: Typically, the clause would include a requirement for the party seeking relief to demonstrate that the event caused the delay or non-performance rather than mere ‘hardship’. For example, a decrease in the demand of your product may not be enough to excuse you from your obligations under the contract.
- Timing: If you entered into a contract well-aware of the COVID-19 pandemic and the implications on supply, it would be difficult to rely on a force majeure clause for non-performance and seek relief. Therefore, realistically assess the timing of your contract and the surrounding context.
- Notice: The drafting of the force majeure clause will be key in determining what processes need to be followed. For example, the clause may contain notice requirements or other ongoing obligations which must be complied with for the force majeure clause to be triggered.
- Mitigation: The clause may have been drafted in a way that requires the non-performing party to take reasonable steps to mitigate or overcome non-performance. Taking reasonable steps generally to mitigate your losses should be viewed positively by the other party and facilitate discussions around the provision of relief.
If your contract does not contain a force majeure clause then now is the time to revisit your current and prospective contracts to consider:
- the inclusion of a force majeure clause;
- whether the clause is broad enough to capture relevant events including viral outbreaks; and,
- the drafting of a force majeure and whether it has the intended effect and consequences. For example, does your clause allow the parties to suspend the contract or extend the time for performance or something else?
- Has the contract become impossible to perform?
- In the absence of a pre-agreed force majeure clause, consider whether the pandemic has made the performance of the contract impossible or the bargain agreed to radically altered such that the contract has become ‘frustrated’.
- If so, then the common law principle of “frustration” may apply. Invoking this principle will have the effect of terminating (not suspending) the contract and any future obligations being discharged. However, this argument should be one of last resort as the onus of proving a contract is frustrated is a high one. If a party is taken to have mistakenly alleged frustration and sought to terminate a contract, that party by such action may have repudiated the contract and there could be considerable damages to the other party, not to mention damage of the commercial relationship.
- Examples of frustrated contracts include things like government restrictions on mass gatherings that has meant that hosting a concert would be unlawful, similarly if the goods to be supplied which are the subject of the contract have been destroyed then this could also suggest that the contract is frustrated. With respect to delays, if a delay is unreasonable, then the doctrine of frustration might also apply but it will depend on the context of the delay and specific terms of the contract.
- Is there scope to renegotiate or vary the contract?
Both parties should engage in constructive discussions around offering alternatives to fulfil performance of the contract. You might consider starting this conversation by first identifying key risks in the supply chain. Some options include:
- finding alternative sources of supply (check whether your agreement is on an exclusive basis first);
- reducing volumes in products and/or services based on forecasts (check if there is a minimum volume of purchases requirement);
- extending lead times for customer deliveries;
- exercising step-in rights while a supplier cannot deliver the goods/services (these rights allow the customer to effectively “step in” the shoes of the supplier, take control of their operations in order to meet supply);
- adjusting the price of products;
- suspending or limiting new customer orders (check if the contract provides a right for this);
- renegotiating customer contracts including providing relief or a relaxation of contractual commitments. This might involve amending certain terms in the contract for example grace periods for lead in and delivery times for a specified period; and,
- Ensure that any agreed compromises or solutions are documented in writing and comply with any formalities set out in the contract (for example notice or written requirements) and are temporary in nature only. This is to ensure you do not inadvertently waive your rights and remedies in the event the alternative arrangement is not honoured.
- Executing new or renegotiated contracts
In light of the temporary amendments made to the way documents can be signed and witnessed, it is important to consider including counterpart clauses or clauses facilitating the electronic execution of documents in any new or renegotiated contracts. Be mindful that for the most part these new rules with respect to electronic signing are only temporary.
- Consider insurance position
For suppliers, assess your relevant insurance policies and the wording of the policy terms and conditions (e.g. business insurance, travel insurance, WorkCover, debtor/trade credit insurance) to determine whether you are covered for certain losses as a result of the pandemic. Often policies exclude losses arising from epidemics or pandemics but depending on the wording of the policy, some cover may be available.
Notice periods usually apply in relation to insurable events, so prompt contact with your insurance broker should be made to discuss the next steps with respect to a claim. If you are considering making a claim, you should also be mindful of any excesses and indemnity period.
Communication is key
COVID-19 has been a true test of the strength of many contracts as well as commercial relations. Reviewing your existing supply contracts and other agreements both now and on a regular basis is key in ensuring that you have the relevant provisions to protect you and ensure you have sufficient flexibility to respond to unexpected situations such as the current one. Communicating with your customer or supplier is also an important aspect of navigating through the challenges of this period.
If you are a customer or a supplier requiring assistance, please do not hesitate to contact a member of Coleman Greig’s Commercial Advice team, who would be more than happy to assist you.
Disclaimer; This information is for information purposes only and is not legal advice. You should obtain advice that is specific to your circumstances and not rely on this publication as legal advice. Please contact us if you wish for us to advise you on any issue you may have in your circumstances.