Navigating the contractual disruption of the COVID-19 outbreak – Update on force majeure

As the COVID-19 is spreading, its impacts are rippling throughout international trade and supply chains. In this newsletter we provide some of the key points for companies to focus on and consider.

Introduction

Governments and authorities across the globe have imposed restrictions in order to limit the spread of the COVID-19, and many companies have also taken voluntary precautions. These restrictions are causing disruptions in international supply and distribution chains as many companies are facing delay in performance of their contractual obligations or have been unable to fulfil them. Still, many governments, including the Danish government, are exerting continuous efforts to maintain and support some level of business continuity in the private sector and are encouraging ongoing production with certain restrictions, in order to ensure cross-border exchange of goods, rescheduling, and progress in public projects in these challenging times.

Can the outbreak of COVID-19 now be considered a force majeure event?

In a recent update we analyzed the key-parameters applicable when assessing whether COVID-19 could constitute a force majeure event under relevant legal principles.

From a Danish law perspective, this may very well be the case. However, this ultimately comes down to a case specific assessment of (i) the legal framework, contracts etc. of the individual relationship, and (ii) the very specific matters surrounding each case of non-performance, both in terms of geography, business sector and market conditions. Hence, what may constitute force majeure for one company, one project or one business sector, may be subject to a different conclusion for other companies with different activities in other areas.

A significant difficulty is the fact that the COVID-19 pandemic as such and the governmental measures taken are evolving and changing rapidly. In Denmark, as in most countries, the successive measures adopted by governments have progressively increased the restrictions and bans on movement and assembly, thus substantially altering the legal analysis of the consequences of the pandemic day by day.

Important focus points

Based on our daily contacts with clients on concerns and challenges surrounding non-performance and force majeure calls, please find below some of the most important focus points to help navigate your way around the force majeure issues and contractual disruption:

• Be proactive and do your homework. It has to start with an identification and assessment of any key contracts and the risk of your company not being able to meet the contractual obligations therein. When reviewing, pay specific attention to the presence or lack of force majeure clauses.
• Check the scope of the force majeure clause. Many force majeure clauses will include a list of examples of those events, which may constitute force majeure. Generally, and in particular in jurisdictions relying solely on the contractual concept of force majeure, it will be easier to claim force majeure if the event is listed as an example in the specific contract clause. While epidemics and/or pandemics may sometimes^[1], but certainly not always, be included as such an event, the impact of a pandemic similar to COVID-19 may be subsumed within more general terms such as “disease” or “illness”, or emergency measures to address or contain an outbreak may be listed or covered under general terms such as “government action” or “national or regional emergency”.
• Consider other remedies available to you. Some contracts may have provisions – other than force majeure – providing relief or entitlements in the event of governmental actions which impact contract performance. Governments worldwide have instated measures, orders and policies to be followed, and these might amount to such a change in law as to give effect to e.g. change-in-law provisions in contracts, or so called hardship provisions, which may help justify non-performance without incurring legal liability under the present circumstances.
• Performance is more difficult or expensive now – is that enough?  Depending on the exact wording of your force majeure clause (if you have one) and the choice of law covering your contract, generally speaking, force majeure defense claims will come neither easy nor cheap. Very often the party calling on force majeure will be required to prove that the non-fulfillment is due to the impossibility to perform his obligations. In most jurisdictions, this is a very high threshold to meet. As a starting point, it will not in itself be sufficient that performance of some or all contractual obligations have become much more burdensome, less profitable or even entirely unprofitable. As a result, companies need to give careful consideration to whether a contract can be fulfilled in a timely fashion in any alternative way despite disruptions. You might include the following considerations:
  • Is it technically, logistically and practically possible to source components from other suppliers?
  • Is it possible to take in temporary workers as intermediary replacements of absent employees?
  • Do you have the rights to pass on any excess costs either to suppliers or to customers?
  • Consider whether there are suppliers in the market that hold greater stocks of any relevant supplies in demand.
  • Consider whether parts of the supply chain can be delivered or assisted virtually using technology or spec up via process or other improvements.
• Focus on your defense file. The question of force majeure remains to be finally settled retrospectively in court or arbitration. Remember that the burden of proof rests with the party seeking to rely on a force majeure event. Make sure to collect any relevant documentation of all relevant facts rendering performance disrupted. This is often crucial for subsequent disputes potentially settled not only in Danish courts but also if a dispute is to be considered and battled in courts in most other jurisdictions and foreign legal systems. The documentation should include any relevant details related to the timing, the scope of impact on workforce/sourcing of parts/alternative facilities or the lack thereof, as well as evidence of all mitigating efforts or means taken to prevent non-compliance or limit the impacts of non-compliance.
• Consider the impact of governmental relief and bail-out measures. Alongside the implementation of restrictive measures and lock-down, governments are rushing through bail-out legislation, all of which would presumably serve as mitigating relief, not least financial, at least to some businesses. In addition, by way of political decision, the Danish government has decided that public contract parties should refrain from pursuing claims for breach of contract including liquidated damages, against supplier’s to support the suppliers and relieve them of the uncertainty related to force majeure^[2]. The impact of those measures have yet to be seen, but they may serve to paint the color of the landscape surrounding any non-performance of a contract. Consequently, any positive effects on a company of such measures might limit the need for and applicability of force majeure.
• Consider your global supply chain. Almost inevitably, any chain of contracts upstream and downstream will fail to provide full back-to-back relief. Whereas you might be fortunate that you have been able to agree on Danish law and Danish dispute resolution with your non-Danish supplier as well as your non-Danish customer, more of often than not, this is not the case. National legal concepts and interpretations of force majeure will vary from country to country, and only time will tell to what extent legal interpretations will spread globally. Local courts in any country will apply their own legal framework. However, considering the global scale of the COVID-19 pandemic itself, and the massive and rather similar issues facing businesses everywhere, including when the global legal community these days at great lengths discusses the concepts of force majeure, interpretations might end up with a more global answer, but there is no certainty, or even precedence for this at the moment.
• If you have Chinese suppliers or sub-suppliers, you should be particularly aware that the China Council for the Promotion of International Trade (a state organ) has issued “force majeure certificates” since early February 2020 in order to help Chinese companies build their case in disputes with foreign trading partners, arising from Chinese government control measures related to the COVID-19 pandemic. Whereas the certificates do not per se infer force majeure, they do certify facts relating to the virus outbreak. Presumably, these certificates will gain rather strong recognition by and sympathy from Chinese courts (hearing disputes subject to Chinese law), whereas the value outside of Chinese courts and choice of law remains more uncertain. For any non-Chinese company affected by Chinese events in their downstream supply chain, we do however recommend asking their Chinese contract parties to provide the certificate to serve as evidence in any upstream chain force majeure disputes. Other countries may follow China’s approach on issuing force majeure certificates, it which event similar caution as stated above should be taken.
• Communicate clearly and stringently. Communicate clearly and loyally to your contract parties, explaining the nature and scope of the problems you are facing and what you are doing to address them. Try to balance the commercial need of the company and its management to raise the voice and ease concerns on the one hand, and the legal requirements of force majeure obligation to serve formal notice of force majeure on the other hand. Moreover, you will be in a much stronger legal position if you update your counterparty on an ongoing basis, both before and after you have given formal notice, telling them what the problems are and what you are doing to address them. Again, this may prove important in the context of mitigating losses and giving your customer/counterparty ample opportunity to comment on or otherwise confirm the proposed mitigation measures, as this will make it harder for them to object later down the line.
• Make sure you comply with formal requirements of notification. Most contracts will only accept force majeure if formal notice is given without undue delay or within a certain period of time after you have become aware, or should have been aware, of the event constituting force majeure. If the contract does not provide time limits for issuing notices or other notifications, they must be issued within a reasonable time. It is also worth reviewing your business insurance policies in order to make sure that any damage events are notified within the time required by the insurance terms.
• Be alert to new contracts. As the COVID-19 pandemic has become the new reality for business worldwide, traditional and generic force majeure clauses are likely to be insufficient in mitigating any of the future risks associated with the development of the outbreak in future contracts. In particular, a party seeking to rely on COVID-19 as a force majeure event in contracts entered into subsequent to the international spread of the outbreak, is unlikely to fulfill the condition of unforeseeability. Consequently, companies should consider incorporating a specific “COVID-19 clause” specifically granting contractual relief from and defining the contours and consequences of any non-performance due to the outbreak. When drafting such clauses, a number of issues should be carefully considered, including, inter alia, the specific delimitation of the relevant circumstances granting relief, and the extent of such relief.
• And, if you are the party receiving the force majeure notice from a supplier or subcontractor, make sure that it is passed up the chain in accordance with any contractual notification requirements, even if you consider if you consider the notice to be questionable or inadequate in some way. Make sure to react and reserve your position towards that contract party claiming force majeure, even if this involves engaging in good-faith negotiations to help bridge the difficulties. Request further information and details from the notifying party to help build your own defense file.

In Gorrissen Federspiel we will be keeping a close watch on developments and will provide further briefings as the situation changes.