The effect of COVID-19 on commercial and construction contracts
Introduction
COVID-19 (novel coronavirus) was first reported in Wuhan City, Hubei Province, China on 31 December 2019 and has now spread to other provinces and countries. The World Health Organisation has declared that the outbreak is a pandemic.
Circumstances like this give rise to many different legal issues such as insurance, employment and health and safety.
The impact of the outbreak on supply chains, international travel, markets and regulation is making it more difficult or impossible for some businesses to fulfil contractual obligations. This article considers how force majeure, extensions of time and frustration apply to the effects of COVID-19 in the context of commercial and construction contracts (with specific reference to NZS 3910[1]/3916[2] and CCCS[3]).
Force majeure
A force majeure clause typically excuses a party (affected party) from a contractual obligation if:
A specified event occurs (e.g. an act of God, natural disaster, war or act of government). COVID-19 may fall within the category of an ‘act of God’. ‘Acts of government’ may also be relevant if COVID-19 causes a government to impose restrictions (e.g. on imports, travel or gatherings) which prevent fulfilment of a contractual obligation; and
That event:
Prevents the affected party from fulfilling a contractual obligation; and
Is outside of the control of the affected party.
The application of a force majeure clause depends entirely on its wording. The clause needs to be reviewed to determine whether the clause applies and, if so, how. Some force majeure clauses entitle termination of the contract if the event continues for a specified period of time.
Below is an example of a force majeure clause (clause 12.5 of CCCS):
“Should any event occur which:
is beyond the control of either Party; and
is neither directly nor indirectly caused by either Party; and
prevents the performance of the Services (in whole or in part) required under this Agreement,
then those Services will be suspended until such time that it becomes practicable to recommence the Services. This does not include events personal to either Party, such as ill-health or lack of funding or resources.
In the event that there is a reasonable likelihood that the Services are not able to be recommenced, then this Agreement may be terminated by the Client.
In circumstances where the Services or part of the Services have to be suspended or delayed, the Consultant will be allowed extra time to complete the Services and such extra time should be reasonable in the circumstances.
In the event that the suspension continues for greater than 6 months, then this Agreement may be terminated by the Consultant.”
Extensions of time
With similar effect to a force majeure clause, a contract may permit a party to have more time to fulfil its contractual obligations in specified circumstances. This is common in construction contracts.
For example, clause 10.3.1(f) of NZS 3910/3916 states:
“The Engineer shall grant an extension of the time for completion of the Contract Works or for any Separable Portion if the Contractor is fairly entitled to an extension by reason of … Any circumstances not reasonably foreseeable by an experienced contractor at the time of tendering and not due to the fault of the Contractor.”
It seems unlikely that the consequences of COVID-19 were foreseen by the most experienced contractors even in the first few weeks of 2020. However, it will be more difficult for a party to claim an extension of time for contracts entered into since COVID-19 became widely known, given the impact of COVID-19 should have been foreseen (at least to some extent).
Frustration
The doctrine of frustration should also be considered, particularly if there is no force majeure or extension of time clause that applies. A contract is frustrated where, by no fault of either party, an intervening event makes performance impossible or radically different to what the parties had agreed. The effect of a contract being frustrated is that it is automatically terminated.
A contract is not easily frustrated. While we expect COVID-19 to make performance of many contracts more difficult and/or more expensive, due to the very high thresholds of ‘impossible’ or ‘radically different’, we expect that the frustration of contracts will be less common.
NZS 3910/3916 refers to frustration in clause 14.1.1, which states:
“In the event that either the Principal or the Contractor considers that the Contract has become impossible of performance or has been otherwise frustrated, one may notify the other that it considers the Contract to be terminated. If the other party agrees, or in the event of disagreement if it is so determined by the Engineer or by mediation or arbitration under Section 13, then 14.1.2 shall apply.”
Recommended steps
Existing contracts
We recommend that existing contracts which will (or could) be impacted by COVID-19 are reviewed promptly. In some cases, a party must give notice within a specified time period to preserve that party’s right to rely on a force majeure or extension of time clause. For example, under NZS 3910/3916, the engineer is not bound to grant an extension unless notice is given by the contractor within 20 working days after the circumstances arise or as soon as practicable thereafter[4].
New contracts
For new contracts, we recommend that careful thought is given to how COVID-19 will (or could) impact the obligations of the parties, bearing in mind that the extent and duration of the outbreak is unknown. A force majeure and/or extension of time clause may need to be inserted into the contract or amended to deal adequately with the impact that COVID-19 may have on the ability of the parties to fulfil their contractual obligations.
It may also be helpful to incorporate provisions encouraging early communication (similar to the advance notification provisions in clause 5.21 of NZS 3910/3916) and project control groups which meet via electronic means (rather than in person).
Claiming relief - caution
Parties should be cautious about claiming relief on the basis of force majeure, an extension of time or frustration. If a claim is made without grounds, or without following the required procedure, the claim could amount to an anticipatory breach or repudiation of the contract which will entitle the other party to terminate.
More information
If you have any questions or would like our assistance in reviewing and/or preparing commercial or construction contracts, please get in contact with us.
Disclaimer: This publication should not be construed or acted on as legal advice. It is brief and general in nature. Specific advice should be sought.