The Effects of COVID-19 on International Contracts

How to handle the case in which a supplier or customer within an international supply chain defaults on a contract? When can Force Majeure be invoked? What are the consequences on contracts? How to minimize risks to the company’s business?

To answer these questions, it is necessary to analyze the content of the contracts and understand what the law applicable to the individual agreements provides for.

Our experts explain how to manage the effects of the Covid-19 pandemic on industrial and commercial activities and share operational advice for managing international contracts during the emergency.

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USA

How are Force Majeure and Hardship defined in USA laws?

In many civil law jurisdictions, Force Majeure is an implied term defined in local law and read into the contractual relationship.  In the United States (and in common law jurisdictions generally), a Force Majeure clause must be an express clause in the contract.

In most states (including New York and Delaware), a court typically will find a Force Majeure to exist if the clause specifically references the event that transpired.  Force Majeure clauses can vary greatly in their drafting.  They typically refer to events such as war, family, floods, earthquakes, strikes, fire, terrorist attacks, “acts of God”, and government action.  Some clauses refer to epidemics, illness, disease and similar; many do not.  And some clauses include catch-all language, defining a Force Majeure event also to include events like those listed in the clause and which are outside the parties’ control.

Hardship is not generally recognized under US law.  Rather, most states in the U.S. recognize common law doctrines of impossibility (or impracticability) and frustration of purposeImpossibility typically requires the party invoking the defense prove the following elements: (1) an unexpected intervening event occurred; (2) the parties’ agreement assumed the event would not occur; and (3) the event made contractual performance impossible or impracticable.  Nonperformance will not be excused if the risk was foreseeable when the contract was entered into or if nonoccurrence of the event was not a basic assumption on which the contract was made.

Frustration of purpose focuses on whether the event at issue has obviated the purpose of the contract.  The doctrine requires many of the same elements as impossibility or impracticability but does not require a supervening event that impedes performance.  The inquiry is more based on whether the party invoking the defense can show that performance of the contract in light of the unforeseen event would no longer fulfill any aspect of its original purpose.

What are the criteria to consider when evaluating the CV as a Force Majeure or as a Frustration or Hardship?

Regarding Force Majeure, a first question to consider, as stated above, is whether a court under applicable state law would narrowly interpret the Force Majeure clause, and if so, whether the Force Majeure clause in question has language specific to the intervening event.

A second question to consider is the effect of the existence of a Force Majeure event.  Some Force Majeure clauses require that the event render performance impossible or illegal.  Others use a lower standard, satisfied by the event rendering performance impractical or commercially unreasonable.  This analysis is very dependent on the facts and circumstances.  One key inquiry is whether performance has been rendered truly impossible (such as due to government restriction on travel, quarantine or shutdown of commerce) or just impractical or excessively expensive.  As a general principle relevant to this inquiry, a party to a contract assumes the risk of its own subjective incapacity to perform.  Of course, consideration of the foregoing and alternative methods of performance is central to invocation of the impossibility or impracticability doctrines as well.

A third question to consider is whether the Force Majeure clause contains a notice requirement to invoke the clause.  These requirements may be based on a specified number of days from the trigger event, or a temporal standard (e.g., “as soon as practicable” or “promptly”) set out in the contract.  Parties will need to consider how these notice periods are to be measured.

And as a general principle, whether the event in question was expected or was a foreseeable risk at the time of contract execution is a central question to any of these potential defenses to non-performance.

How to prove that the Coronavirus can be considered as an event of Force Majeure?

The non-performing party will have the burden of proof in asserting any of the above defenses.  As Force Majeure is defined by contract and not by local law, the elements that the non-performing party will need to prove will directly be determined by the language of the contract.  Most likely, the non-performing party will need to make a showing in respect of the above concepts – occurrence of an event covered by relevant text in the clause, the standard of non-performance (impossibility, impracticality, or otherwise) has been met, mitigation efforts made, lack of foreseeability of the event.  The non-performing party will similarly have the burden of proof in asserting the doctrines of impossibility and frustration of purpose, and will need to prove the elements listed above.  As to frustration, the doctrine requires rather total frustration of purpose.

What is the best course of actions recommended in case either party issues a notice of Force Majeure?

Companies intending not to perform contractual obligations owing to the Coronavirus outbreak should consider:

  • carefully reviewing with counsel applicable state law and the text of the Force Majeure clause, as well as the availability of other common law doctrines;
  • evaluating alternative methods of performance to mitigate damages;
  • creating a record to support a potential Force Majeure claim (nature of impact and mitigation efforts);
  • considering contingency plan and timely notice and other communications with counterparty; and
  • review whether business interruption insurance coverage may apply.

Companies expecting performance from suppliers concerned about non-performance owing to the Coronavirus outbreak  should also consider steps 1, 2 (in seeking alternative supply), 4 (in communicating with supplier to assess situation) and 5 above.

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