The spread of COVID-19 and government measures in response are affecting supply chains and the ability of businesses to perform their contracts.
What if your business or your supplier (or other counterparty) is prevented from carrying out its obligations?
Your contract may contain an applicable clause or clauses under headings such as force majeure, change of law, or change of circumstances. Such a clause may relieve you or your counterparty from liability and specify other options or consequences.
In the absence of any applicable clause in the contract, the law of frustration of contract may apply when performance of the contract becomes impossible.
A force majeure clause relieves a party from liability in certain circumstances that prevent the performance of its obligations.
Such a clause typically applies in the event of war, natural disasters, government acts or other serious circumstances. Many standard clauses refer to epidemics or similar. Whether the clause applies in your particular circumstances will depend on the wording of the clause.
In the case of COVID-19 and the government measures in response, a force majeure clause may apply if it:
- refers specifically to epidemics or pandemics (or similar);
- refers specifically to government acts (or similar); or
- the general wording of the clause applies to the relevant circumstances.
Generally, the wording of the clause may apply to events or circumstances that:
- are unforeseeable;
- are outside of a party’s control;
- cannot be avoided; and
- prevent the performance of a party’s contractual obligations.
Typically, the relevant event or circumstance must prevent the performance of contractual obligations and not merely make performance more difficult or expensive.
The clause may specify certain other requirements such as a duty to:
- give notice to the other party within a certain period of time; or
- take steps to mitigate the situation (for example, find a work-around or lessen the impact if possible).
If the clause applies, then the consequences may be specified in the clause. Typically, the party prevented from performing its obligations will not be liable for breach of contract.
The clause may also specify what happens if the relevant event or circumstance lasts for a period of time and may specify whether any rights to terminate the contract are affected.
Change of law or circumstances
A change of law or change of circumstances clause may apply depending on its wording. The key issues will be whether the specific change of law or circumstances that has occurred:
- is covered by the particular wording of the clause; and
- is genuinely the cause which prevents the performance of the contractual obligation.
In the case of government measures in response to COVID-19, it will be relevant whether:
Frustration of contract
- the clause applies to changes in New Zealand law or regulations and/or foreign laws or regulations; and
- the particular government measure is a change in a law or regulation, or is simply the exercise of pre-existing legal powers.
If there are no applicable clauses in the contract, the law of frustration of contract may apply.
A contract may be frustrated if performance of the contractual obligations becomes impossible or radically different from what was contemplated, provided neither party is at fault.
Frustration will only apply where the main purpose of the contract can no longer be achieved. It will not apply where only a secondary or minor purpose cannot be achieved.
This is a high threshold. It will not apply if performance of the contractual obligations merely becomes more difficult or expensive.
If a contract is frustrated, it will terminate immediately. The Contract and Commercial Law Act 2017 sets out certain consequences if a contract has become impossible to perform or has been otherwise frustrated, including matters relating to payment.