Part 1: Force Majeure Clauses in Business Agreements and How to Use Them
I would have never expected that our first blog post for Stanley Park Legal's new website would be one about the impact of a global viral pandemic on business contracts and disputes. But here we are, charting new territory and adapting course constantly in the ever changing landscape. While this post will be on the application of force majeure clauses (i.e. clauses dealing with 'greater force' events) in business contracts in Canada specifically in relation to this pandemic, our next two posts will address the doctrine of frustration in contract law in Canada and the application of the International Sale of Goods Act in British Columbia. In each blog post, we will be also suggesting steps that businesses and individuals may take to safeguard their positions in view of the evolving situation.
Following the rapid spread of the novel coronavirus (“COVID-19”), the World Health Organization declared COVID-19 to be a pandemic on March 11, 2020. At the time of writing at least twenty countries have implemented some sort of lockdown. Companies and individuals may be considering whether the coronavirus outbreak constitutes a force majeure event such that a party is excused from its contractual obligations. Contract parties may consider issuing force majeure notices or may receive such notices to excuse a party’s nonperformance. Any declaration of force majeure must be evaluated under the terms of the agreement and analyzed under the law governing the terms of the contract.
Force Majeure Provisions Explained
A force majeure event refers to the occurrence of an event which is outside the reasonable control of a party and which prevents that party from performing its obligations under a contract. Canadian common law has no general concept of force majeure (save for the limited doctrine of contractual frustration, which will be addressed in our next blog post). A party’s ability to claim relief for a force majeure event therefore depends upon the terms of the contract, and the force majeure provision in particular. Force majeure provisions are express terms and will not ordinarily be implied into contracts governed by Canadian law.
A party affected by such an event of force majeure will typically be relieved from performing the obligation affected for the duration and to the extent affected and may be entitled to compensation. As with all matters dependent upon the terms of the contract, each force majeure provision must necessarily be considered on its precise terms and in its specific context. There are nonetheless some features common to most force majeure provisions, which we consider below.
Events Capable of Constituting Force Majeure
The “test” for force majeure usually requires the satisfaction of three distinct criteria:
the event must be beyond the reasonable control of the affected party;
the affected party’s ability to perform its obligations under the contract must have been prevented, impeded or hindered by the event; and
the affected party must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences.
These criteria will be considered in turn.
One: The Event
It is common to see force majeure events split into two categories which set out a specific list of events which are deemed to be events of force majeure: political force majeure, which deal with risks related to changes in the political or legal environments and non-political force majeure (or natural force majeure), which deal with physical risks that might impact a business or a project. These different categories often provide different remedies—an extension of time and increased costs (for cases of political force majeure) or an extension of the time for completion and relief from termination (for cases of natural force majeure).
Many contractual provisions set out a specific list of force majeure events which are deemed to be events of force majeure beyond the control of the parties, such as “pandemics,” “epidemics” or “diseases.” A specific reference to a “pandemic” will make it easier to bring a force majeure claim but will still require the other criteria for a force majeure test to be satisfied.
However, if the provision does not include language to that effect, then it will be necessary to consider whether COVID-19, or its impact on a business or a project, is captured by a different concept, such as an “Act of God,” “action by government” or a catch-all provision. Most force majeure provisions contain “catch-all” language in respect of events which are “outside the reasonable control of the party affected”. It seems fairly clear that a pandemic such as COVID-19 would qualify as force majeure under such a provision.
It is important to bear in mind however that the relevant force majeure event need not be COVID-19 itself. It is the consequences of COVID-19 and its impact upon the ability of the affected party to fulfil its contractual obligations that will be relevant.
The second criterion will be affected by the degree of impairment of the affected party’s ability to perform its contractual obligations required to trigger the operation of the force majeure provision. A force majeure provision typically relieves a party from what would otherwise be a breach of contract—i.e. its failure to perform an obligation due to the effects of the event of force majeure in question. The party must establish the causal link between the event and its inability to perform. A provision that requires a party to be “prevented” by the force majeure event from performing its obligations will likely be more difficult to rely upon than one which only requires the party to be “impeded” or “hindered” in the performance of its obligations.
A highly likely scenario with COVID-19 would be the inability to perform a contract due to having to self-isolate an office or a team due to the outbreak of COVID-19 at the workplace. Under many force majeure clauses, this would likely have the necessary impact and causal link to qualify as a force majeure event, subject to the party affected having taken all reasonable measures. A disruption that merely impacts the profitability of a contract may not be sufficient for a force majeure claim unless there is express contractual provision for such a situation. Nor would an economic downturn or other general adverse business conditions likely be sufficient, even if it could clearly be shown that a key trigger for the downturn was COVID-19.
Three: Duty to Mitigate
Finally, a party seeking to rely upon a force majeure provision will usually have to show that it has taken reasonable steps to avoid or mitigate the event and its consequence, and that there are no alternate means for performing under the contract. What constitutes a reasonable mitigation measure is fact-specific and depends upon the nature and subject matter of the contract in question.
For example, a supplier could consider using alternative manufacturing lines in a different location, or a project owner could seek alternative suppliers. However, the reasonableness of a mitigation measure will be considered in light of any additional burdens and costs that the party incurs, as well as availability of alternative manufacturing lines and suppliers at that time and the overall impact of any delays that a mitigation measure could have upon the project schedule.
Given the continued impact that the spread of COVID-19 is having upon global businesses, it is possible that there may be fewer mitigation measures available to parties than in other potential events of force majeure. However, it will be important for employers to follow all relevant official guidelines and to consider all reasonable measures to contain or limit the spread of the virus in the work place so as to allow contractual performance to continue. Short-term measures such as home-working may be necessary.
Example of a Force Majeure Clause
Below is an example of a force majeure clause common in a variety of Canadian business agreements:
A. Performance will be excused, and the parties shall not be liable for any failure to perform under this Agreement, when (1) such performance is prevented or delayed by any cause or condition of force majeure, or (2) Supplier... is unable, despite diligent efforts to do so, to obtain raw materials or energy on terms Supplier deems commercially acceptable. The term “force majeure” means any contingency beyond the reasonable control of Supplier or Customer (for example, war or hostilities, Acts of God, accident, fire, explosion, public protest, breakage of equipment, governmental actions or legislation, or labour difficulties) which interferes with Supplier’s or Customer’s production, supply, transportation or consumption practice. During times when performance is excused, all quantities of affected Product(s) will be eliminated from this Agreement without liability and Supplier will allocate its supplies of raw materials and Product(s) among their various uses in any manner that is fair and reasonable. However, Supplier will not be obligated to obtain raw materials or Product(s) from other sources if there are shortfalls, despite commercially reasonable efforts to do so, or to allocate raw materials or Product(s) from Supplier’s internal use. ...
B. The party affected by force majeure shall notify the other party within two (2) days, excluding weekends and holidays, following the commencement of the force majeure condition and shall also notify the other party within two (2) days, excluding weekends and holidays, following the end of the force majeure condition. During force majeure condition, the party affected shall use commercially reasonable efforts to continue to perform notwithstanding the force majeure condition.
Lack of Profitability Not An Excuse
Canadian Courts have held that force majeure clauses may not be resorted to where circumstances affect the profitability of a contract or the ease with which a party’s obligations can be performed. An example is found in Domtar Inc. v Univar Canada Ltd., 2011 BCSC 1776. The force majeure clause in that case set out:
The term “force majeure” means any contingency beyond the reasonable control of Supplier or Customer (for example, war or hostilities, Acts of God, accident, fire, explosion, public protest, breakage of equipment, governmental actions or legislation, or labour difficulties) which interferes with Supplier’s or Customer’s production, supply, transportation or consumption practices.
The Defendant sought to rely on this clause when market changes made it more expensive to supply caustic soda at the contract price. The Court held that the clause did not apply. Performance was not impossible and the fact that the contract became more expensive to perform was not a ground for relief under the force majeure clause.
Typically, the affected party’s right to relief for force majeure under the contract will be conditional upon the issuance of a notice by it to the other party, supported by the required evidence. The contract may additionally require the notice to state the anticipated consequences and duration of the force majeure event. Some contracts, especially construction contracts, include a “time-bar” clause that requires notice to be provided within a specified period from when the affected party first became aware of the force majeure event, failure of which will result in a loss of entitlement to claim.
Unlike a one-off event such as natural disaster, which is usually limited in time and confined to a particular geographical locale, the COVID-19 outbreak has been dynamic and has been characterized by its ability to proliferate rapidly and unexpectedly across multiple countries and geographical regions. Parties have therefore adopted the approach of issuing “protective” or “rolling” force majeure notices that take into account the developing impact that the COVID-19 outbreak has upon the performance of their obligations under the contract.
Consequences of Force Majeure Claims
The consequences for the parties where a valid force majeure event has occurred will depend on the nature of the affected party’s obligations under the contract, as well as the consequences and remedies expressly contemplated by the force majeure provision.
Contractual remedies for force majeure typically include an extension of time to perform those obligations or suspension of contractual performance for the duration of the force majeure event. If the force majeure event extends over a longer period, some provisions may entitle the parties to terminate the contract.
In order to be prepared for different scenarios as the situation continues to unfold, consider taking the following proactive steps:
Review your contract to determine whether the contract includes a force majeure provision and, if so:
Carefully review the definition of force majeure in that contract to determine whether there is any express event incorporating events such as COVID-19 and, if not, whether the general language is sufficient to include COVID-19 and its consequences. If in doubt, it may be helpful to seek legal advice early in the process.
Consider those aspects of the relevant contract that you are not able to perform and satisfy yourself that the inability to perform is due to the consequences (direct or indirect) of COVID-19 and not a different reason.
Consider and review what steps you are taking as a business to avoid or at least reduce so far as possible the effects of COVID-19 upon your work force and your ability to continue to perform contracts. It will be important to be able to show that you have taken all reasonable measures and followed all official guidance. Remote working and other steps such as adopting a “clean” team structure may be helpful in this regard.
Consider whether there are any notice requirements to trigger entitlement to relief, including what type of supporting documents must be provided and whether there is any time limit for that notice to be issued.
Consider what the consequences of a successful claim for force majeure are.
Review the financing or other related documents to determine whether there are any notice provisions that must be complied with in relation to anticipated or actual force majeure claims.
Determine whether insurances, such as business interruption insurance or force majeure insurance, may cover any of the expected losses.
We highly recommend hiring a lawyer well versed in force majeure claims to assist you in these deliberations.
Parties Receiving Notices of Force Majeure
A party receiving a notice of force majeure should carefully examine the claim to determine:
if it is consistent with the scope of protection conferred by the force majeure provision;
if the process for giving notice has been complied with; and
whether the relevant supporting documentation or information has been provided.
A party involved in back-to-back contracts or a network of interrelated contracts will need to take a strategic approach, taking into account the overall impact of the claim for force majeure on its obligations under the related contracts. A party embedded within a chain of contracts is involved must also consider whether to issue protective notices of force majeure under the linked contracts as a protective measure. Where different laws govern back-to-back contracts, the differing interpretations of force majeure under those laws requires careful consideration.
Parties Making Claims of Force Majeure
A party affected by the COVID-19 outbreak should take steps to record and document the steps it is taking to prevent or mitigate the impact of the COVID-19 outbreak on its ability to perform its obligations under the contract.
A party looking to make a force majeure claim should consider carefully how the force majeure event is framed, and the consequences that are said to flow from that event. For example, a party could claim that the COVID-19 outbreak constitutes the force majeure event, or it could rely upon a supervening government regulation or a disruption in its supply chain or the supply of labor.
A party should only make a force majeure claim with care, because a wrongful claim could have serious consequences, including amounting to a breach of contract or a repudiation of the contract. In such circumstances, the other party may be entitled to claim damages or to terminate the contract.
While fact-specific to any particular contract, the current coronavirus pandemic is likely to have a profound impact on commercial agreements. Companies or their counterparties may find they are unable to perform under an existing commercial agreement.
Parties to existing contracts that are or may be disrupted by the outbreak should promptly assess their legal rights and obligations, including: (i) assessing contractual provisions that have been or may be affected, (ii) identifying and abiding by any relevant notice requirements; (iii) analyzing the risks and consequences of a default or breach under the agreement, and (iv) determining or negotiating alternative means of performance under the contract, where possible.
Parties currently negotiating contractual agreements should proactively consider the impact of the current coronavirus pandemic and appropriately allocate potential risk in the agreement.
Parties should not cease their performance on the basis of a force majeure event without consulting counsel because a mistaken assertion of force majeure or frustration could have serious consequences. Specifically, an incorrect assertion of force majeure or frustration may amount to a breach (or anticipatory breach) of the contract. Business should also be aware that force majeure will generally not excuse nonpayment. Lastly please keep in mind this blog post is provided for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind.
If you have any questions the author may be reached at (604) 628-1835 or firstname.lastname@example.org. Due to the current conditions, he is also available for videoconferencing on Skype, FaceTime, and Zoom instead of in-person meetings.
About the Author
Marco is an experienced Canadian commercial lawyer and arbitration counsel with over nine years of running complex legal negotiations and trials in the British Columbia Supreme Court as well as institutional and ad hoc arbitrations. He holds a Juris Doctor in law from the University of British Columbia as well as a Post Graduate Diploma in Commercial Arbitration from Oxford University (Queen’s College). He also sits on the Advisory Board of the Institute of Transnational Arbitration and is listed on the prestigious Institute of Energy Law (IEL) Energy Arbitrators List. Prior to private practice, Marco worked at the Federal Department of Justice for Canada in Vancouver.