January 21, 2021
Contracts are the foundation of business transactions. If one party to a contract refuses to meet their obligations, the other party can seek recourse and relief through the justice system. However, there are mechanisms to alleviate unduly harsh agreements. Such relief can be provided by the courts or can be found in the contract itself.
The rise of the COVID-19 pandemic has added uncertainty to the business world and parties may be unable to perform their contractual obligations due to COVID-19. This post will describe two mechanisms to relieve parties of their contractual obligations due to COVID-19: force majeure clauses and the frustration doctrine.
Force Majeure Clause
A force majeure clause temporarily excuses or relieves a party from their obligations under a contract. These clauses only come into effect when an event beyond the control of either party occurs and could relieve the party of all, or only some of their obligations. The intent is to allocate the risk from events that are well outside of normal business risks. The words used in the force majeure clause will describe the events or acts that trigger relief from obligations. Common terms found in a force majeure clause include: acts of god, acts of war, civil disorder, power failures, labour strikes, or epidemics.
To be a valid force majeure clause, it must describe:
- a supervening event;
- which is beyond the control of either party; and
- which makes performance of the contract is impossible or impractical.
A key question is whether the COVID-19 pandemic qualifies as a supervening event. The words used in the force majeure clause and the nature of the contract may dictate whether COVID-19 constitutes a supervening event. Since COVID-19 is a new disease, it is unlikely that a force majeure clause would specifically mention COVID-19. However, these clauses usually cover events such as epidemics, pandemics or public health emergencies, and COVID-19 likely falls into these broad categories of events.
The next question is whether COVID-19 makes performance of the contract impossible or impractical. Parties cannot avoid their obligations if the supervening event merely renders performance inconvenient or unprofitable. The event must render performance impossible or impractical.
Finally, ensure that you comply with other elements of the force majeure clause before looking to rely on it. Most clauses have strict notice requirements. Failure to comply with the notice requirements may void the declaration of force majeure. It is important to check with third-parties and insurance providers to determine how invoking a force majeure clause will affect business operations.
The key take-away is that force majeure clauses are a negotiated commercial term meant to allocate the risk of events beyond both parties’ control. Courts will look to the words used in the contract to determine whether COVID-19 is a force majeure event.
If COVID-19 is not covered under the force majeure clause, or there is no such clause, a party may seek relief from contractual obligations using the doctrine of frustration. The leading case in Canada is Naylor Group Inc v Ellis-Don Constructions Ltd.
The party seeking relief from their obligations under the contract has the burden of proof to show the contract was frustrated. The doctrine of frustration is as follows:
- “When a situation has arisen for which the parties made no provision in the contract and performance of the contract becomes ‘a thing radically different from that which was undertaken by the contract”;
- When the event has occurred without the fault of either party; and
- When compelling the party to satisfy their obligations under the contract would involve ordering that party to do something radically different from what the parties agreed to do under the contract.
There are some parallels to the force majeure clause. Again, central to the analysis is what constitutes a supervening event? The event must take place after the formation of the contract and must not be the fault of either party, not self-induced, and unforeseeable. Most importantly, the event must significantly change the nature of the contract to the point that:
- the contract is now totally different from what was originally intended;
- a fundamental term of the contract has become incapable of being performed;
- new circumstances in which performance is called for would render performance radically different from what was undertaken by the contract.
There is also element of fairness in the analysis. The Court would likely need to find that it would be unjust to hold the parties to the literal words of the contract in light of the new circumstances.
In short, it is difficult to prove a contract has been frustrated and the circumstances must be quite drastic to cause a contract to be frustrated.
Application in the Context of Commercial Leases
Many businesses have been impacted by COVID-19 and are taking a hard look at their commercial leases. The first place to look is the force majeure clause; does one exist and does it cover pandemic-type situations? In most commercial leases, a force majeure event results in providing specific relief to the landlord and tenant instead of ending the lease. Often a force majeure event will grant the landlord access to the property but will not excuse the tenant from its obligations to pay rent or entitle the tenant to rent abatement.
If the commercial lease does not contain a force majeure clause, or the clause is insufficient, the next place to look for relief is the doctrine of frustration. It is essential to consider the circumstances and consider if COVID-19 truly changes the rental agreement to something radically different or if it merely makes the rental situation inconvenient or unprofitable.Each contract is unique and it is impossible to make a blanket determination that COVID-19 constitutes a force majeure event or causes a contract to be frustrated. However, our commercial litigation team has the experience and expertise to determine whether COVID-19, in your circumstances, constitutes a force majeure or frustrating event.