The impact of COVID-19 on performance of contractual obligations

The COVID-19 (coronavirus) pandemic is having wide ranging and deep effects on the activities of every business. It is expected that the restrictive measures which have been adopted by most countries, will have direct and/or indirect financial and legal consequences on the business activities of every company and that the supply chain will be disrupted significantly.

Any business which will be affected should consider the contractual and other legal implications emanating from the COVID-19 pandemic and it is advisable that legal advice is sought at an early stage. In this briefing we seek to identify the main legal consequences on the performance of contracts by a party whose obligations are affected by the COVID-19 pandemic.

The position under Cypriot law, is that a party is always obligated to perform its obligations under the contract and may be held liable for a failure to do so even if its obligations are affected by this novel pandemic. Exceptionally, a party will be released from its contractual obligations by operating a force majeure clause and/or by invoking the common law doctrine of frustration.

Force majeure clauses

Force majeure clauses set out, in general terms, unexpected circumstances that fall beyond the contracting party’s reasonable control that, having arisen, prevent it from fulfilling its contractual obligations. It is important to note that there is no generic definition of force majeure and therefore it is a matter of contractual interpretation in each case.  However, key factors to consider include:

• Is this situation within the force majeure events covered by the clause? Does it expressly cover a pandemic, quarantine measures, travel restrictions, government action or other circumstance which is preventing performance?
• If not, is it within more general wording?
• Does the event have to be tied to a specific obligation or does it affect the contract generally?
• Does the clause cover events that hinder performance or only events that entirely prevent performance?
• Does the clause say what happens if the clause is engaged? For example, does it just suspend performance for a period of time, permit termination or cater for payments and other performance already made?
• Does the clause require a notice to be given to the other party before it can be relied upon? Care is needed here because some contracts require a notice to be given immediately and a failure to do so may mean that the ability to rely on the clause is lost.
• Is the person receiving the notice in an affected area? Assuming the notice needs to be physically sent, is it actually possible to send the notice?
• If the notice must be received on a business day, is it a business day in the relevant place?
• Are there ongoing information obligations with which you are required to comply once you have claimed force majeure?
• Does the clause require you to mitigate the effects of the force majeure event (e.g. by sourcing alternative goods)?

For a force majeure clause to engage, performance must become “physically or legally impossible, not merely more difficult or unprofitable.”  Similarly, a downturn in economic conditions (even if caused by an event like COVID-19) will generally not constitute force majeure.

Doctrine of Frustration

If the contract does not include a force majeure clause or if the force majeure clause does not cover an event such as the COVID-19 outbreak, the parties will have to ascertain whether the common law doctrine of frustration is applicable to discharge them from their contractual obligations.

This doctrine has been implemented into Cypriot contract law and specifically in section 56 (2) pursuant to which “ a contract to do an act, which, after the contract is made becomes impossible, or, by reason of some event which the promisor could not prevent unlawful, becomes void, when the act becomes impossible or unlawful.  The effect of such a contract,  in accordance with Section 65 of the contract law, is that any person who has received any advantage under such agreement or contract (for example an advance payment) is bound to restore it, or to make compensation for it, to the person from whom he received it.

Thus, frustration can only apply to events that occur after the contract has been agreed and where the events which occurred make the performance of the contract: (1) impossible; (2) illegal; or (3) something radically different from that originally envisioned by the parties.

It should be noted that a party may not be excused from its contractual obligation due to frustration of the contract if, owing to current government and business measures, the contract has become more expensive to perform, even significantly so or if the supply chain has been disrupted, but there is a more expensive alternative available or if the contract was entered into since news of COVID-19 became public.

Material Adverse Change Clause

The COVID-19 outbreak could affect not only the ability of a contracting party to fulfil its obligations under contract, but also its overall financial condition, which could in itself constitute a material adverse change, whether in its financial condition, its business or its prospects. The many unknown parameters related to the outbreak at present, mean that it is difficult to determine the magnitude and timeframe of its consequences, making establishing a material adverse change a very complicated process. The ensuing financial problems that may be suffered by a company, as a result of the outbreak, are likely to generate other related contractual problems, such as breach of a financial covenant or payment default.

In light of the above, companies should consider carefully whether triggering a force majeure clause or claiming frustration in their contracts harms or serves the long-term interests of their business and/or if another less drastic measure or solution may be undertaken, always having regard to either party’s ability to perform their contractual obligations under the present circumstances; in cases of such termination, companies should always first consult their legal advisor to avert the risk of giving the counterparty a right to damages, if the contract is not considered as frustrated.

In addition, in case that a company chooses to trigger a force majeure clause or frustrating circumstances, it should make sure to comply with any notification requirements, any regulatory requirements and official guidelines as at present and prepare a contingency plan in advance. The company should also retain any specific documentary evidence that may prove that this indeed is a force majeure event or frustrating circumstance for your purposes, so that it can use the same in any potential future judicial process, should the need arise.

[This article was prepared by senior associate Charis Christodoulou, from our firm’s Litigation, arbitration and mediation department.]

For further information, please do not hesitate in contacting us.

The above is intended for general information purposes only and does not constitute legal advice.  For legal issues that arise, please consult legal counsel.