COVID-19 and commercial agreements: force majeure and frustration

With the World Health Organization declaring COVID-19 a pandemic, and the resulting economic uncertainty including the recent temporary closure of non-essential businesses in Ontario, many businesses are wondering what the impact will be on commercial contracts, pending business transactions, commercial leases and other similar agreements. Could COVID-19 allow a party to cancel a contract, or could it render a contract otherwise unenforceable?

The short answer is maybe. It depends on whether the contract includes a force majeure clause (and the nature of the clause), or alternatively, whether a party can prove that the contract is “frustrated.”

This blog is intended to provide a brief overview of force majeure clauses and the equitable principle of frustration of contract, and to discuss the potential applicability of these concepts to the COVID-19 pandemic.

What is a force majeure clause?

A force majeure clause generally operates to discharge a contracting party when a supervening, sometimes supernatural event, beyond the control of either party, makes performance under the contract impossible. Depending on the specific wording of the provision, the COVID-19 pandemic could trigger the rights and responsibilities set out in a force majeure clause.

Force majeure clauses are contractual agreements between parties and included in a contract. As such, the contract must be reviewed to determine whether the contract includes a force majeure clause, and to understand the scope and extent of the clause. Most commercial agreements contain force majeure clauses.

What triggers force majeure clauses?

It is important to recognize that force majeure clauses vary and the specific language of the force majeure clause in your contract matters.

The triggering of the rights and responsibilities contained in the force majeure clause will depend on the wording of the provision.

In some clauses, the trigger is based on the impact to performance of the contract. For instance, one force majeure clause may state that it can only be invoked where performance of contractual obligations becomes impossible, while another may trigger if carrying out one’s contractual obligations becomes more difficult or will delay performance.

In other clauses, the trigger may relate to a specific type of event. A few examples of specific force majeure events commonly incorporated into contracts include:

• Acts of God including natural disasters (i.e. floods, earthquakes, tornados etc.)
• War, terrorist attacks and civil disobedience
• Shortages of power, supplies, infrastructure or transportation
• Government action such as lockdowns, forced closures, changes in law, orders and embargoes
• Public health emergencies such as pandemics and epidemics
• Labor strikes and work slow-downs

Whether a force majeure clause includes a trigger based on impact to performance or based on the nature of the event, or both, the specific wording of the provision needs to be considered to understand whether the rights and obligations under the clause have been triggered.

Does COVID-19 trigger force majeure clauses?

As noted above, whether or not a court would consider a force majeure clause triggered by COVID-19 or its related impacts will depend on the specific language of the clause. Language like “Government action,” “Act of God,” or “epidemic” might capture COVID-19 and its impact. Language such as “natural disaster” or “shortage of supply” may be less likely to trigger a force majeure clause and depend on the specific circumstances.

There may be other factors to be considered, such as timing in relation to foreseeability. If the parties contracted in November 2019, it would seem likely that a court would find the pandemic to be unforeseen. In contrast, if the parties contracted in mid-March 2020, the court may find instead find that the impact of COVID-19 was already in the contemplation of the parties.

Can a COVID-19-related economic downturn trigger a force majeure clause?

What if a force majeure clause does not contain specific language that would be triggered by the pandemic itself? Could the economic downturn that has followed in the wake of COVID-19 be sufficient to trigger a force majeure clause? It appears unlikely that it would.

Generally speaking, 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.

For example, in Domtar Inc. v. Univar Canada Ltd., a party sought to rely on a force majeure clause when sudden market changes made it more expensive to supply caustic soda at the contract price. The clause in question read as follows:

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 court held that the force majeure clause would not apply simply because it became more expensive due to market changes.

Similarly, in Tandrin Aviation Holdings Ltd. v. Aero Toy Store LLC, (2010) EWHC 40 (Cmm), the defendant claimed it was unable to accept delivery of an executive jet aircraft because of the “unanticipated, unforeseeable and cataclysmic downward spiral of the world’s financial markets”. The court disagreed, observing that “it is well established [ … ] that a change in economic/market circumstances, affecting the profitability of a contract or the ease with which the parties’ obligations can be performed, is not regarded as being a force majeure event”.

In the past, courts have been skeptical of allowing a change in market or economic circumstances to trigger a force majeure clause. Whether the economic impact of COVID-19 will be treated differently by the courts remains to be seen and may depend on the nature and extent of the impact.

There is no force majeure clause in my contract – what now?

If a contract does not include a force majeure clause or any other clause addressing similar events, a party to the contract might be able to rely on the common law doctrine of frustration of contract.

Frustration occurs when an event, through no fault of either party occurs that so significantly alters the nature of the parties’ rights or obligations from what they could reasonably have contemplated when executing the contract, that it makes the contract impossible to fulfill or that it would be unjust to hold the contracting parties to the literal stipulations of the contract given the new set of circumstances.

Frustration can only occur where neither party caused the event, and where the contract fails to adequately address the occurrence of such an event. If a contract contains a provision meant to address the event, the doctrine of frustration will not operate. Where frustration does occur, both parties are discharged from further performance of their obligations under the contract.

COVID-19 and frustration

The threshold required for frustration is very high. In order to rely on frustration, a party must show that the original reason for entering into the transaction was completely destroyed by a supervening event.

Generally, as in the case of force majeure clauses, courts have not accepted economic disruption or falling markets to constitute an event that would frustrate a contract.

In Forest Hill Homes v. Ou, a home was to be purchased from the plaintiff. The parties agreed to the purchase in November of 2016, but the closing date was not until 2019 as the plaintiff was building the house. At the date of closing the plaintiff was ready to close, but the defendant took the position that the contract had been frustrated due to a “drastic and unforeseeable drop in the real estate market,” which made it impossible for them to close.

The judge concluded that there is nothing about changes in the market that amounts to an unforeseen event which would trigger frustration and that, even if there were, it was incumbent upon the buyer to adduce real estate market evidence in support thereof.

There may be instances where COVID-19 or its impacts would be sufficient to frustrate a contract. Take for example a circumstance where a facility was booked for an event prior to the government mandated closure of non-essential business and the ban on social gathering. In such a circumstance, it is likely that a court would find the contract frustrated.

What does this all mean for me?

The starting point is to review your contract carefully, or better yet, to have your contract reviewed by a legal professional. Importantly, the party who intends to rely on a force majeure clause or who asserts frustration has the burden of proving that they are entitled to do so. If a party gets it wrong, they face exposure for breaching the contract.

Many contracts will have force majeure clauses, but not all force majeure clauses are identical. The precise wording of the force majeure clause matters. Whether or not a pandemic or forced business closure are contemplated by the contract, and what it means for both parties may even depend on a single word or even the placement of a comma in the clause. If you are thinking of invoking a force majeure clause you need to be very careful, the contract may include specific timelines for giving notice to the other party and may trigger other requirements under the contract.

In the event a party is unable to perform a contract that does not contain a force majeure clause, legal advice should be sought to assess whether it is possible to assert that the contract has been frustrated.

This blog post was co-authored by Alexander Bissonnette, a member of the Commercial Litigation team and Mark Fortier-Brynaert, a member of the Business Law team. Alexander can be reached at 613-369-0358 or at alexander.bissonnette@mannlawyers.com and Mark can be reached at 613-369-0380 or at mark.fortier-brynaert@mannlawyers.com.