Coronavirus – contractual performance amidst a global outbreak

The impacts of COVID-19, also known as the novel coronavirus, are being felt around the world. While the tragic human cost of the epidemic has primarily been confined to China to date, the economic effects of the virus are truly global.

Efforts to contain the spread of the virus such as quarantines, travel restrictions and bans are creating a second – economic – crisis by disrupting global supply chains, which critically depend on the free flow of goods and people. 

Once they have understood their options and obligations as an employer, businesses should also consider their legal position in the event that the effects of coronavirus impede the performance of their contractual obligations.

In the New Zealand context, lawyers advising on these questions should be asking themselves two questions:

1. Is my contract frustrated?
2. Does my force majeure clause apply?

Frustration

The common law doctrine of frustration governs the position of parties to a contract where, as a result of an unforeseen event and through no fault of either party, a contractual obligation is rendered incapable of being performed. In such circumstances, the contract is frustrated and is automatically and immediately terminated, regardless of the subjective intentions of the parties.

In light of the drastic consequences that arise when a contract is frustrated, our courts have confirmed that a high threshold applies. In Planet Kids v Auckland Council [2014] 1 NZLR 149, the New Zealand Supreme Court confirmed that the doctrine of frustration can only be invoked when the main purpose of the contract has become incapable of being performed. The doctrine cannot be relied on to terminate a contract when the main object can still be accomplished.

For example, the doctrine of frustration may be invoked when the subject matter of the contract is destroyed through no fault of either party. In the classic English case of Taylor v Caldwell (1863) 3 B & s 826, the defendant had agreed to rent a music hall to the plaintiffs for a series of concerts. Before the concert series began, the hall was destroyed. The Court held that, as neither party was responsible for the fire or accepted the risk of a fire occurring, the doctrine of frustration was engaged and the contract was terminated.

Whether the effects of coronavirus will be sufficient to engage the doctrine of frustration will ultimately depend on the subject matter of the contract. However, examples from previous global outbreaks indicate that reliance on the doctrine may be difficult in such circumstances.

In the Hong Kong case Li Ching Wing v Xuan Yi Xiong [2004] HKC 353, a tenant to a residential tenancy agreement sought to rely on the doctrine of frustration during the 2003 SARS outbreak. The tenant was unable to access their premises for 10 days because of an isolation order made by the Hong Kong Department of Health. While the Court held that the SARS outbreak and its knock-on effects were arguably an unforeseeable event capable of triggering the doctrine of frustration, the effect of the isolation order did not frustrate the main purpose of the contract as the tenant still had the benefit of the tenancy for the remainder of the lease. Accordingly, the Court was not prepared to find that the tenancy agreement was frustrated by the isolation order or the broader SARS epidemic. 

What this case demonstrates is that parties should consider not only the immediate effects of coronavirus on contractual performance, but also the effect of externally-imposed travel bans, quarantines and restrictions, when considering whether a contract is frustrated. 

Force majeure

Parties to a contract are also free to agree on the consequences that may flow from an event that might otherwise engage the doctrine of frustration. Such an agreement is often documented in force majeure clauses, which are particularly common in construction, supply and transportation contracts.

While the wording of force majeure clauses varies from contract to contract, they are designed to relieve a party from liability arising either from its delay in performing, or failure to perform, its obligations under the contract, upon the occurrence of certain defined events. These clauses will typically list the circumstances in which relief can be invoked such as acts of God, natural disasters, epidemics, war, strikes and acts taken by governments.

It is typically not possible for a party to rely on a force majeure clause in circumstances where performance of contractual obligations has merely become more expensive or is no longer profitable. Rather, standard force majeure clauses require the reliant party to show that: 

1. a triggering event has occurred; 
2. the triggering event was outside the control of the party;
3. the triggering event either delayed or prevented the party from performing their contractual obligations; and
4. there were no reasonable steps that could have been taken to avoid or mitigate the event and the consequences.    

Whether parties will be able to rely on the effects of coronavirus to rely on a force majeure clause will depend on the nature of the contract, the wording of any force majeure clause and the impact the virus has had on the position of the parties. Depending on those circumstances, it is certainly possible that the force majeure clause might provide relief for an otherwise defaulting party where problems in performance of the contract are caused by coronavirus.

What should you do?

For parties who are concerned about how coronavirus may affect their contractual arrangements, we recommend:

• reviewing any relevant contracts to determine whether they contain a force majeure clause;
• determining whether the applicable force majeure clause specifically addresses epidemics, pandemics or other events that are beyond the parties' control;
• making note of any procedural provisions required to invoke the force majeure clause, such as notice or timing requirements. Strict compliance with such requirements is usually required, and a party could lose its rights under the force majeure to excuse or defer compliance if it does not meet them;
• identifying whether there are any alternative means to performing the obligations under the contract, such as identifying other suppliers; and
• considering what steps can be taken to mitigate the potential consequences of a breach of the contract.

If you require contract-specific advice, please get in touch with one of our experts below. 

This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.