When events take an unexpected turn, parties may be left unable to perform their contractual obligations, or may find that their counterparty is unable or unwilling to perform.
In such circumstances, a party may be able to rely on contractual provisions, such as a force majeure or material adverse change clause, to suspend or avoid its contractual obligations. Alternatively, a party may argue that the contract has been brought to an end automatically as a result of frustration or supervening illegality.
Below are some practical tips to consider when deciding how to deal with unexpected events.
- Force majeure clause
Start by checking whether the contract contains a force majeure clause.
The clause does not have to be labelled “force majeure”. In substance, you are looking for a clause which suspends (and may end) performance of obligations where a party is prevented from performing by events outside its control. Such clauses may be specific to the events listed (for example flood, war or pandemic) but may also be general (for example making reference to anything preventing performance that is beyond the party’s control).
The requirements of a force majeure clause will depend on the particular wording of the clause. However, the following considerations are helpful to have in mind:
- First, whether a particular event may qualify as force majeure will depend on whether it falls within the scope of events listed in the clause. Many phrases in force majeure clauses are boilerplate and have been well-litigated (such as the language “act of god” or “force majeure” itself). You should bear previous cases in mind, although these are not necessarily determinative.
- Second, the non-performance must be due to circumstances both beyond the control of the party and for which the party had not assumed responsibility. It follows that there must generally have been no reasonable steps which could have been taken to avoid or mitigate the supervening event or its consequences.
- Third, although it will in each case depend upon the particular wording of the force majeure clause, many clauses exclude foreseeable and/or foreseen events.
- Fourth, it is important to comply with any formalities given in the contract. For example, many force majeure clauses contain notice provisions that require notice of the force majeure event to be given in a particular way.
The consequences of a force majeure clause will depend on the express terms of the clause. However, normally parties agree to suspend performance, rather than provide for an automatic termination of the contract. Sometimes long stop wording is included which provides that the contract will terminate if the force majeure event has continued beyond the date specified. Other times there is no longstop. In this scenario, parties facing indefinite suspension will want to consider their ability to terminate the contract. See “A Practical Guide to Contract Termination” for guidance on this.
- Material adverse change (or “MAC”) clause
This is a term found in some agreements which allows a party to refuse to proceed with the transaction (or aspects of it) if certain events occur after the contract date.
They are most commonly found in the context of a lending transaction (for example a clause allowing the lender to call a default if there is a MAC affecting the borrower) or the sale of a company (for example a clause allowing the buyer to walk away if there is a MAC before the deal closes).
There is a large amount of variation in the drafting of MAC clauses between contracts. As with any contract term, the interpretation of a MAC clause will depend on the language used in the context of the contract as a whole, the background facts and the commercial context.
After considering the contractual terms, the next port of call is the common law doctrine of frustration.
Frustration applies where an event occurs after the contract has been entered into, which is not due to the fault of either party, and which makes further performance impossible or renders the obligations radically different from what was contracted for.
There is a high threshold to meet and each case will turn on its particular facts. However, the circumstances in which frustration has been successfully argued in previous cases broadly fall into the following categories:
- impossibility of agreed performance;
- the mutually agreed purpose of the contract becoming impossible (impossibility of the “commercial adventure”); and
- a significant change to a mutually agreed state of affairs (for example, destruction of the subject matter of the contract or cancellation of an event).
The effect of frustration is to automatically bring the contract to an end. It does not require an act by the parties to the contract.
The next question is what claims, if any, can be made against the non-performing party after frustration takes place?
- a. First, there are statutory claims. In most cases, the parties will then have a claim under the Law Reform (Frustrated Contracts) Act 1943. Section 1(2) allows claims for money paid before discharge and section 1(3) allows for recovery of non-money benefits.
- b. Second, there are common law claims. Section 2 of the 1943 Act excludes contracts for carriage of goods by sea, the sale of specific goods, insurance contracts, and certain charterparties. And even where the 1943 Act does apply, the common law is available in the alternative. In these cases, any claim would be in unjust enrichment, likely for total failure of consideration.
4. Supervening illegality
It is also worth considering the impact of changes in the law, such as legislative actions, which make performance of a contract illegal.
In an English law-governed contract, a contract is discharged if its performance becomes illegal by English law.
This doctrine requires the illegality to clearly prohibit performance. Hindering performance, or making it more inconvenient, is not sufficient.
- Other options
Finally, if force majeure, MAC, frustration and illegality do not apply then consideration will need to be paid to other options. It may be helpful to consider whether the contract contains any provisions governing the occurrence of insolvency events and whether these may have been triggered. It may also be worth considering whether there has been any material or repudiatory breach triggering termination.
Recent events, including the COVID-19 pandemic and the sanctions imposed as a result of the Russo-Ukrainian war, will lead to a wave of disputes as to which party bears the risks of non-performance. As this guide seeks to show, there are a number of legal principles which can assist commercial parties in such circumstances. However, application of those principles is not always straightforward and is likely to be fact-sensitive.
If you would like more information on how to deal with unexpected events, please contact one of our Commercial Litigation Team.