How do you meet your contractual commitments (e.g. goods and services made/performed properly and to safe, quality standards, delivered on time, paid on time, etc.), in a world where supply chains are suffering, staff have been furloughed or have to travel to work differently and practise social-distancing in environments where that’s seriously challenging, overheads can’t be met and commercial premises have to be shut?
This is the complex and stressful challenge that most small businesses face right now, as we desperately juggle all that we can to preserve trading relationships and keep businesses going.
The government’s announced relaxation of the wrongful trading laws gives at least some comfort that directors should be able to continue the trading struggle without facing the usual sanctions and potential disqualification that would otherwise apply.
However, it’s what’s happening right now on the ground that matters more than anything right now.
The solution, in most cases, is to deal with each contractual relationship candidly, professionally and fast.
“The best chance of keeping your supply chain and your customer base right now is in talking to your counterparts as soon as possible, and doing your best, between you, not to punish each other for a situation that most of us could not have foreseen. Compromise may well be key in getting businesses through this period.
“Even if you now want to get out of what you’ve previously agreed, then in most circumstances the best course of action to achieve this is through proactive conversation and, ideally, without immediately wading in using the typical contract law ‘weapons’ against each other, even if some of these are within your rights.”
That’s the advice of one of our foremost experts on trading and commercial relationships, The Wilkes Partnership’s Helen Smart. We got together with Helen to discuss what we should be doing and how.
Identify the problems as proactively as you can
It’s vital to get on top of the facts, fast, and to understand what your obligations are under the contracts you’re a party to, and what the obligations of your counterparties are.
Once you‘ve assessed which obligations are or may be affected by Covid-19, then you can look at what contractual rights you may have under the relevant contracts..
Rather than review every contract you may have in force right now, prioritise those where the problems are most acute and then consider others that might become more relevant as Covid-19 further impacts our trading environment.
Areas causing the most contractual problems currently are those where your business will already be feeling the pressure including contracts with:
Suppliers: supplies being delayed, stopped, cancelled, not correct or different to what was agreed
Customers: who have delayed or cancelled orders that were contractually agreed, or they can’t pay on time (or possibly at all)
Distributors: not being able to collect/take delivery of orders on their scheduled dates, or have cancelled orders because they’re unable to distribute (home or abroad)
Service Providers: other service providers not being able to provide, or delaying provision of, services that they've committed to providing you
Partners and/or collaborators: who can’t fulfil their obligations to your joint initiatives
Staff: not being able to work because they’re in self-isolation and/or they’ve been furloughed or have been made redundant. Even if staff are able to work, you may have reduced capacity by reducing working hours, or because of the need to address social-distancing requirements while at work and during travel journeys
Landlords: those that you have rent and service charge, etc. obligations to that you're struggling to pay
Tenants: who can’t pay rent on time (or at all)
Funders and lenders: such as banks, who you need to pay loan instalments to, or investors, who you owe trading and performance obligations
We’re going to focus here on the contractual essentials of these first 5 trading areas (a – e). (The other areas are covered in some of our other Covid-19 series blogs.)
For those first 5 areas, the provisions in your contract you should check include:
- Clauses describing the goods/services/content being provided
- Delivery arrangements and time limits/deadlines associated with the delivery of the goods/service/content
- Payment obligations relating to them and time limits/deadlines associated with them, including late payment interest obligations
- Warranties, indemnities, and liabilities relating to these goods/services/content and what happens if contractual duties are not performed as described in the contract
- Are there any specific provisions about what happens if performance can’t be achieved
- Any clauses about changes requested to goods/services/content and how this is to be dealt with
- Force majeure clauses (see discussion below)
- How the contract terms can be varied
- Notices – what form they must take and how they may be served
- Cancellation/termination provisions
- Insurance cover and any obligations relating to it for this particular contract.
Understanding these clauses should give you a good feel for the obligations that you’re being held to yourself and/or you’re holding your counterparty to and what other clauses may form part of your considerations.
Importantly, it should also help you to evaluate how difficult continuing with the contracted obligations may be.
What outcome do you want?
Be clear about what you want to achieve: keeping going, preserving your commercial relationships, or termination and rapid ejection with as little collateral damage as possible.
Before diving into your options and possible remedies, it’s worth pointing out that many of the common contractual remedies focus on the complete termination of the contract… i.e. extricating the parties as soon as possible from their obligations the deal and helping to pick up the pieces, including by compensating a party for losses that they have suffered due to termination or breach of the contract.
In this blog, we’ve focused on how to salvage the contractual relationship first, if you can and wish to, by reaching compromises and using the available documentation to help you.
If that’s not what you’re looking for, then, of course, we look at some of the options you may be able to use further on in this piece.
The law generally treats parties as capable of striking their own deals
In most cases, the law considers that business-to-business parties know their own minds and are therefore capable of striking their own bargains; meaning they should be held to the terms they agree, whether those terms are fair, reasonable, or not.
Where the parties miss making something clear, then on occasion, the law will imply a particular term into the contract. However, the general default is to hold the parties to what they agreed, even if this creates difficulties and/or hardship later for one or both of them.
For example, if you agreed to pay, even if the amount of that payment was unreasonable, or you suddenly run out of available money, the law does not give you a get out. You’re still liable to pay as per the contract terms and, ultimately, can be sued if you do not.
If you said you would deliver something on time, or in a particular way or to a particular, specified spot, and you fail to do so, then – unless you’ve given yourself an express written ‘get out’ reason/justification in the contract terms – you’ll usually be on the hook for not having done what you promised (something the contract will usually spell out, including in any warranties, indemnities and/or liabilities clause).
We’re going to look at this with a particular Covid-19 view and in relation to business-to-business contracts.
Agreeing a variation to the contract terms
As we’ve mentioned above, if your aim is to preserve the contractual relationship but, due to Covid-19, you need to vary the original contract terms you and your counterparty agreed to, you’ll need to assess whether the existing contract provides any ways of amending the terms.
Change control clauses
For example, some contracts may include a ‘change control’ clause where one party approaches the other to propose possible changes to an order/the contract. If you have one of these clauses in your contract then you should assess whether it may be able to help you.
Negotiating alternative terms (variations)
Even if you don’t have a change control clause, you may well be able to approach your counterparty to discuss the present situation and to negotiate and agree changes to relevant terms of your existing arrangements.
If you do enter into negotiations to vary the terms of the contract you have with a counterparty and you reach an agreement on such changes, then you should check the terms of your existing contract to see what it says about variations.
Often you’ll find this wording in the ‘boilerplate’ section of the contract – in most cases towards the back of the contract. It is usual for such a clause to be included to set out how variations to the contract must be agreed by the parties. Often this will require that the variation be recorded in writing and signed by the relevant parties, but you must check the specific terms of your contract.
Even if your contract allows for verbal variations, it's highly advisable to put the agreement to vary (and precisely what the variation covers) into writing, and to have it signed by the parties, to prevent disagreements about what was intended/agreed further down the line.
You can use our deed of variation to set out in writing the compromise arrangements you have agreed. And if the obligation is in relation to payments, you may be able to reach agreement on alternative, compromise payment arrangements using our agreement to extend payment terms.
The importance of the ‘without prejudice’ label
If you are going to raise the possibility of a compromise position with a counterparty, make sure you label any correspondence, and/or start any conversation, by pointing out that it is made on a ‘without prejudice’ basis.
The importance of this label is to ensure that by having an honest conversation about difficulties that one or both of you are facing, you’re not risking your counterparty holding that correspondence/conversation up as evidence that you admitted breaching your contract, if they attempt to take action against you later.
Ultimately, it won’t stop someone taking action, but the discussions you have on a without prejudice basis cannot be included as evidence of an ‘at fault admission’ within it.
Unforeseen consequences (‘force majeure’)
There’s been a lot of noise about these clauses in the last few weeks. In some, if not many, cases having a force majeure clause in your contract (it cannot be implied) may not be enough to enable you to terminate your obligations, or to use Covid-19 as a reason to substitute existing arrangements for a compromise. But it’s the obvious next consideration for many businesses.
Much will depend on how that clause is drafted and this needs careful scrutiny.
Note: The word ‘force majeure’ may not be mentioned in the contract, but you should take a look for a clause that deals with events that are unforeseeable or out of the control of the parties, as these a likely to be the same as ‘force majeure’.
What the clause does…
Most good contracts contain this clause as a matter of course, although there is no standardised wording and it will vary.
The term ‘force majeure’ has no specific meaning under English law but usually it describes what happens to the parties’ contractual obligations to each other if particular events occur that were not reasonably foreseeable and over which any business party cannot reasonably be expected to have any influence or control. However, the meaning of force majeure will depend upon how it is described in the contract.
What the clause says…
Some contracts will spell out, specifically, what force majeure covers, others will just include a more general term and aim to scoop up all events that they reasonably can.
It is possible, though not that common, for a clause to expressly include disruption to business caused by pandemics. If you do have a contract that specifically mentions pandemics in the force majeure clause then the force majeure clause can likely be used in the Covid-19 context.
However it is more common for a force majeure clause to be written generally, (e.g. ‘due to events beyond the control of the parties…’).
If you have more general wording like this as part of the force majeure clause in the contract, then whether Covid-19 falls within the scope of the force majeure clause will really come down to an assessment of the specific wording and the timing of the contract.
For example, if the contract was made within the last week, when Covid-19 was very much on everyone’s radar, then it is not likely to fall within the wording of ‘unforeseen’. However, it will all come down to the wording of the clause.
If your contract takes either of the above approaches, the force majeure clause might be helpful to you. It’s a bit more difficult if a list of events is included, but pandemics are not included on this list, unless you have an additional sweeping up statement about other events beyond the reasonable control of the parties, but it would still be subject to the assessment of the wording as discussed above.
If you do not have a force majeure clause or if you do not think that the force majeure clause covers Covid-19 then you may need to rely on alternative measures, (see further below).
The consequences of a force majeure event must be expressly written into the contract and you must comply with any notice requirements
Force majeure clauses typically state that if one of these exceptional, unforeseeable events happens and that event prevents, delays or hinders (not simply makes it more difficult, or inconvenient, or more costly) one or both of the parties to the agreement in performing their obligations, then the clause will usually set out the consequences of this e.g.:
- time extensions apply for the performance of obligations affected by the force majeure event (after which, if the force majeure conditions continue, one of the other outcomes may apply, such as termination)
- the agreement is suspended (in whole or part, for a specified period of time before one of other of the outcomes results/has to be considered)
- a party may terminate the contract, or
- the parties will need to use reasonable endeavours to re-negotiate terms (often in a given time period, failing which, one of the other outcomes results)
and this is usually without liability of either party to the other, in respect of the non-performance or delay in performance of obligations due to the force majeure event.
So, you’ll need to check what the clause says about the consequences of a force majeure event and comply with these.
For example, sometimes the clause may require you to provide notice to the other party if a force majeure event has occurred and you intend to rely on it or to use it to terminate the contract, so you will need to ensure that you comply with any requirements laid out in the clause.
If you are required to provide notice, you’ll need to check any clause in the contract about the giving of notices, to ensure that you provide that notice in accordance with the contract.
The force majeure event must be the only cause
A key point that often gets overlooked is that it must be possible to prove that the force majeure event i.e. Covid-19 in these circumstances, in fact caused it to be impossible for one or both parties to continue to perform the contract.
You’ll need to give this some thought if you want to rely on this clause. If there were other factors at play already, and Covid19 has just exacerbated them, you may not be able successfully to rely on the clause to take the action you desire.
Mitigation of loss/damage is typically required
There is also generally an obligation on the parties to mitigate their losses, lessen the impact of the event and to do their best to do what’s reasonable to preserve the contract, even in really difficult times.
Be prepared to be able to show that you properly considered this and did what you could to limit the effects of Covid-19.
Is it the right action to take?
“Probably the best question to ask!” says Helen.
“Force majeure can be difficult to prove, especially if, in the context of Covid-19, ‘pandemic’ is not specifically listed. It will be up to the party trying to rely on the ‘force majeure’ clause to prove that this is a force majeure event, that their non-performance was solely due to that event and that they can therefore rely on the clause.
Even if the clause does cover you for Covid-19, if the consequence of enforcing the clause is termination, then you might not want the agreement to end (especially if the termination of this contract would badly affect your other supply chain and customer commitments).
In spite of the circumstances, you’re not prevented from both agreeing a variation to the original contract compromise in writing that keeps the contractual relationship going albeit under slightly different arrangements, whether temporary, or permanently for the remainder of the contract.”
While many businesses are finding that their existing clauses don’t go far enough to help them extricate themselves from commitments that leave them legally liable to their counterparty, many more businesses would not want to rely on force majeure even if it was an option, because the last thing they want is for their valued trading relationships to fall apart.
If you don’t have a force majeure clause in your contract, or it doesn’t enable you to terminate your contract, and that’s what you want to do, then unfortunately the law will not imply a force majeure clause into the contract.
This means if you cannot rely on a force majeure clause and you’re the party who cannot perform your obligations under the contract any longer, then you will potentially be in breach of contract and your counterparty may have a claim for damages against you and/or may terminate the contract.
However, there is a legal concept called ‘frustration’, basically where a significant, unforeseen change of circumstances makes performance of a contract either impossible or radically different from what was originally envisaged and very hard to be performed.
It doesn’t need to be written in a clause in your contract, but it’s (rightly) a difficult test to satisfy, since the event must have made performing your obligations impossible or a radically different scenario, not that it’s simply more difficult or expensive to perform, or because a supplier has let you down.
Having said that, in current circumstances, where almost all businesses have been told by the government to close premises, staff are not permitted to leave their houses, gatherings cannot take place, etc. ‘frustration’ may well be applicable to their circumstances, especially for those who cannot simply delay their contracted activities or counter their difficulties with a reasonably feasible alternative, e.g. ramping up their online services.
However, it shouldn’t be concluded that Covid-19 makes it easy to rely on a frustration argument to release them from their obligations.
And again, like force majeure, the rule is not much help if you really want your contracts to carry on or to alter them in a way that enables both contracting parties to reach some form of compromise. But unlike force majeure, there’s no need to serve notice on the other party to bring it to an immediate end.
The effect of a successful frustration argument is to release both parties from the contract and from their future obligations under it. Depending on the applicability of certain laws, if some part of the contract has already been performed, then there will need to be some reconciliation, usually in the form of money being paid to cover the value of what’s already been transferred.
Other things to consider
Identify the problems as proactively as you can
If you don’t have a force majeure clause in your contract, or you don’t want to rely on it or if you think it unlikely that frustration will apply, or again you don’t want to rely on it then consider whether any of the following clauses appear in your contract that may assist:
- change control clauses (as discussed above)
- termination provisions (what termination provisions does the contract include, for example terminating on a certain amount of notice)
- cancellation of specific orders (if you have some overarching agreement, then there may be certain terms in the contract dealing with cancellation of specific orders without compromising the entire relationship)
- material adverse changes clauses (some contracts may include clauses dealing with material adverse changes. As with force majeure, you would need to check carefully the wording of the clause as to when these apply and what the consequences of using such clauses are)
If you want to enforce a force majeure clause or to rely on frustration, it’s sensible to take legal advice. These can be tough areas to prove and enforce and you do not want to take a route that is ultimately unsuccessful.
In addition, you should consider whether invoking a force majeure clause or relying on frustration may affect any business insurance you have in place, including business interruption insurance.
Talking proactively (on a without prejudice basis) works best
“Most businesses want to come through this and get back to normal as soon as they are able. Most are applying for the reliefs and support offered by government and will hopefully increasingly be in a position to still keep supply chains and relationships going, even if they’re not the slick and seamless arrangements that they were before.” says Helen.
“Most business partners, whether customers, suppliers or others, will expect their counterparties to be responsibly applying for whatever reliefs and support they can get, and to be managing their staffing and overheads as best they can, given the challenges, so that they can keep going and they can keep these all-important trading relationships afloat.
“And where there is dialogue and they can see that you are doing all that you can to keep going, responsibly, this will help to give confidence in agreeing compromises and temporary measures, to help everyone get through this.”
“We all know there are lumps and bumps – big ones – in the road ahead,” she concludes, “but handling trading obligations fairly, honestly and proactively, will really help.”