CoronavirusApr 8 2020

Small companies will need an act of God to break contracts

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Small companies will need an act of God to break contracts
ByChris Robinson, Excello Law

The ideal supply chain should be configured with back-to-back contracts and pay-when-paid clauses. In the event of any significant problems arising, the consequential losses are then allocated proportionately and appropriately right across the supply chain, or to the parties who are insured.

But very few supply chains are ideal and such a configuration is the exception rather than the rule. In reality, the loss will most often fall on the chain’s weakest link. Often, that will be a small business that has been unable to negotiate let-outs with its customers or suppliers. You can be liable for breach of contract, including damages for loss of profits or wasted costs, even if the failure was beyond your control.

Consumer-facing businesses are particularly vulnerable, because consumer rights to cancel or get refunds will not be matched in contracts with their suppliers.

That the weakest link should suffer such unfortunate consequences provokes many questions. In particular, what remedies are provided by English law when performance – the act of doing that which is required by a contract – becomes impracticable? Is a party liable for breach of contract if he/she is unable to comply?

In law, if the contract terms do not provide for any form of let-out, then (under English law) the only legitimate escape route is via the legal concept of frustration.

Put simply, a contract becomes frustrated if something occurs after the date of the contract that is not deemed to be the fault of either party, that makes further performance impossible or illegal, or is so fundamental to the contract that it strikes at its very root and beyond what was originally contemplated by any of the parties before they entered into it.

Frustration ends the contract entirely, with basic rights for advance payments to be refunded and parties to be reimbursed for expenses incurred.

The extraordinary circumstances that have arisen from Covid-19 are more than capable of amounting to frustration, but difficulties in performing, extra costs or delays would not be enough. Long-term contracts, or employment contracts, are unlikely to be frustrated.

Force majeure

Thanks to Covid-19, force majeure clauses, which usually remain dormant in most contracts, have now taken centre stage. They excuse non-performance when extraordinary events prevent a party from fulfilling its contractual obligations.

Many contracts contain force majeure clauses, which allow the parties to suspend performance for an agreed period of time and/or to terminate the contract without any liability being incurred on either side.