In the wake of the global COVID-19 (coronavirus) outbreak, we consider the general legal principles that apply to commercial contracts and the implications for our clients (particularly those of commercial landlords and tenants).
Most English law commercial contracts will include a force majeure clause, which acts to defer, suspend or release a party’s contractual obligations in the event of certain rare and extreme circumstances, which make it impossible or significantly more onerous (but not simply more costly) for that party to perform its contractual obligations. Such a provision varies by contract, but usually covers a specific list of events (e.g. pandemics, outbreaks, war, famine, riots, strikes, fire etc.) followed by broader wording to cover any other “force majeure event” which could excuse, delay or cancel performance under the contract. Whether the coronavirus outbreak is deemed a “force majeure event” will depend entirely on each individual contract and the specific wording used within that contract. However, given that the outbreak is an evolving state of affairs rather than a specific event, it would be possible that a government-sanctioned quarantine would constitute a “force majeure event” rather than the outbreak itself. In the context of commercial leases, force majeure clauses are rare now, but parties should review leases carefully to identify the implications of any such provision and whether this could entitle a tenant to suspend payment of rental sums or conversely provide a landlord with the right to suspend the provision of services to a tenant, under a lease.
So where does frustration occur?
Where a force majeure provision is neither included nor applicable in a contract, the contract may be deemed frustrated i.e. it may be automatically discharged if it is rendered physically and commercially impossible to fulfil that contract (or the contractual obligations are transformed radically). As no one party is at fault, neither party can claim damages for the other’s non-performance and the ability to recover money under the contract is usually limited to the money paid before the frustrating event. However, the threshold for a frustrating event is typically much higher than that of a force majeure clause and is not invoked lightly by the Courts because it acts to discharge the contract entirely rather than suspend performance. Given that there have been previous disease outbreaks such as SARS, Ebola, Foot & Mouth disease, the COVID-19 outbreak is not necessarily something that is completely outside of either parties’ expectations about risk when entering a contract (pandemics are often included as standard wording in force majeure clauses).
Furthermore, frustration will not be determined for example if the frustrating event should have been foreseen by the parties (i.e. any contract entered into since the COVID-19 outbreak became public knowledge) and many other reasons. That is not to say that frustration is unavailable as a remedy, but will likely be invoked only in the most limited circumstances, with many contracts failing to reach the required threshold.
It is also vital that any party to a contract seeking to assert its rights under a force majeure provision or by way of frustration must do so validly – any assertion that is deemed to be incorrect can amount to a breach or anticipatory breach of a contract. It therefore fundamental to seek legal advice before considering these provisions as a form of recourse for the impact of COVID-19 under any commercial contract.
Considerations for landlords
Many of our clients are starting to report serious effects on their businesses as offices, shops and communities close down. In the case of commercial leases, there is usually nothing in the lease that enables a tenant to expect lowered rental rates due to the extreme circumstances of the outbreak, particularly in the absence of any valid force majeure clause. However, given the extent of the problem and its effect on the entire country, we may see landlords become forced to react accordingly. We have to hope that landlords who have deep pockets will realise that rent suspensions will serve them better in the long run rather than being left with multiple empty units as their tenants go bankrupt. We can expect private Landlords to be more commercial from the outset. The government can also help by reducing or suspending VAT and business rates for the duration of the outbreak to alleviate the commercial and economic impact. Whether it does or not, we have to wait and see.
As the COVID-19 situation unfolds, it remains to be seen the full extent of its implications on businesses and the UK economy. In a commercial context, is somewhat hopeful to note that the government has now bowed to pressure and changed its stance to declare coronavirus as a “notifiable disease”, a formal classification required by many professional insurance policies, to cover businesses for coronavirus losses in England.
By Danny Schwarz, Partner, Real Estate, Secured Lending & Banking and Priya Patel, Trainee Solicitor, Litigation