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COVID-19: Force Majeure in the Real Estate industry

Posted on 17 April 2020. Source: EG Magazine

This page was last updated 01 June 2020.

Force majeure has become a commonly used phrase during the global pandemic, but what does it mean and how does it apply to property contracts?

The global Covid-19 pandemic has brought the concept of force majeure to the foreground. As the pandemic prolongs, companies will need to be prepared for the outbreak having an adverse impact on their contractual obligations and they will need to consider whether they are entitled to call force majeure under their contracts, and thereby defer performance of their obligations without penalty. But using force majeure clauses is not straightforward and it is helpful to look at their components, alongside the related concept of frustration, in order to assess how they can be applied.

The problems with frustration

English law has long recognised that events can occur that fundamentally change the nature of a contract. A concert hall might be hired, only for the building to burn down (Taylor v Caldwell (1863) 3 B&S 826). A room might be rented to watch a procession, only for the procession to be postponed (Krell v Henry [1903] 2 KB 740). If such circumstances are outside the control of the parties, English law will not enforce the contract but will deem it to be frustrated.

There are a number of problems with frustration in practice, however. The first is that it can be difficult to prove. Contractual obligations are normally regarded under English law as being strict, meaning that when a party assumes them it must perform, or else provide a remedy for breach such as damages. The space for a party to argue that such a burden should be removed is narrow and the party that claims a contract has been frustrated will have to show that, as the House of Lords said, there was “such a change in the significance of the obligation that the thing undertaken would, if performed, be a different thing from that contracted for” (Davis Contractors Ltd v Fareham UDC [1956] AC 696). This would have to be an exceptional circumstance. Last year, for example, the High Court ruled that the European Medicines Agency’s lease at Canary Wharf was not frustrated even though Brexit meant that the EMA could no longer remain in London (Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 Ch; [2019] EGLR 17).

The second problem is that frustration is a blunt instrument. Under the common law, once a contract has been frustrated it has come to an end and the parties must make the best of whatever position they are in. The Law Reform (Frustrated Contracts) Act 1943 at least allows the courts to even up the parties’ positions, for example by ordering the return of any advance payments, but that is the limit of their power and, in particular, they cannot keep the contract alive. The parties will have to negotiate a new agreement if they wish to continue their contractual relationship.

The third problem is that frustration can be derailed by something the parties have said or done. The courts have found, for example, that where a party has agreed to transport an oil rig using one of two vessels, and has committed one of the vessels elsewhere only for the second vessel to sink, frustration cannot be claimed because the situation has resulted in part from the party’s decision to allocate its vessels in a certain way (J Lauritzen AS v Wijsmuller BV (The Super Servant Two) [1990] 1 Lloyd’s Rep 1).

The components of a force majeure clause

To overcome the rigours of frustration, parties themselves legislate in their contracts for supervening events that have a major impact on their obligations. Such clauses are called force majeure clauses (even though the term “force majeure” has no real meaning by itself under English law).

Typically, force majeure clauses contain four principal elements. First, there is the trigger. This is usually defined as an event or circumstance that is outside the parties’ control, and which has the effect of preventing, hindering or delaying the performance of their obligations. Immediately the contrast with frustration can be seen: force majeure clauses address less extreme situations than circumstances where performance has become impossible or radically different.

Secondly, there is the obligation on the party relying on the clause to bring the relevant event to the attention of its counterparty. This can be important because otherwise the other party may not learn about the event until it is too late to do anything about it. Such notification obligation normally continues throughout the force majeure period: the other party will want to know, in particular, when the period has come to an end.

Thirdly, there is the consequence of the force majeure event on the contract. Rather than bringing the contract immediately to an end, as under frustration, force majeure clauses normally provide that obligations are merely suspended for the duration of the relevant period and are then resumed once things are back to normal.

Finally, there is usually an obligation on the party relying on a force majeure event to mitigate its impact if possible. For example, if the contract is for the supply of goods, the party may be required to try to source alternative supplies from elsewhere.

Common difficulties with force majeure clauses

While force majeure clauses address many of the problems with frustration, they can give rise to difficulties themselves.

To begin with, courts and tribunals will normally take a restrictive approach to such clauses. In particular, the party that relies on the clause carries the burden of proof to show that the clause applies in the relevant circumstances. That normally includes showing a direct link between the force majeure event and the disrupted obligation: an indirect link may not be enough. Importantly, in the absence of specific wording the courts have generally not accepted that a force majeure clause covers circumstances which upset the economic balance of a contract, such as an increase in fuel costs that makes a contract uneconomical for one of the parties (Thames Valley Power v Total Gas & Power [2005] EWHC 2208 (Comm)). A force majeure clause will not rescue a party from a bad bargain.

There may also be faults in the drafting of such clauses. Force majeure clauses are usually boilerplate clauses added in at the end of a contract, without much thought as to how they might operate in practice. There may be problems with how the force majeure clause interacts with other clauses in the contract: for example, a force majeure clause may require rescheduling of missed supplies at another time, but that may not be possible when the normal supply obligations resume. There may also be problems with the interaction between a force majeure clause in one contract and similar clauses in other contracts that a party has entered into. These may not all respond to the same event; or they may have different mitigation obligations.

A particular issue arises where a party’s performance of its obligations is only partially restricted, and it then has to work out which contract to perform. Again this is best illustrated in a supply situation: if a party has to supply 100 units under three separate contracts, but because of a force majeure event it only has 80 units available, how is it to divide up the available supplies? Often contracts do not make adequate provision for this.

Force majeure during a pandemic

The COVID-19 pandemic has had an extraordinary impact. Not only have substantial numbers of people become sick, with many fatalities, but governments have taken drastic steps to contain the spread of the virus. While the precise terms of a contract will need to be checked, there is a good chance that a force majeure clause will be triggered in these circumstances: for example, if a development site is ordered to close and dates for completion stages cannot be adhered to as a result.

On the other hand, there needs to be a careful analysis of the impact on the particular obligations, because the force majeure clause in a contract might not be activated even if there is a catastrophic effect on a party overall. Payments under a lease, for example, might not be prevented or hindered, and therefore a force majeure clause might not relieve a tenant of its payment obligations.

Also, the various impacts may need to be analysed separately. In many cases the main impact may not come from the virus itself but from the efforts taken to contain it. A law compelling people to stay in their homes might well trigger a force majeure clause, for example relieving a landlord of its obligation to provide services, but questions might arise about the periods of time immediately before and after the law is in force: are the conditions at those times so bad as to constitute force majeure, even without a law being in place?

It is very unlikely that contract drafters have adequately anticipated these exceptional times and, if parties cannot come to a commercial accommodation, the difficulties of applying force majeure clauses in these circumstances may well give rise to disputes.

This article appeared in EG magazine on 11 April 2020 and can be found here (subscription required). 

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