Can Non-Performance Of The Contractual Obligations Due To The Covid-19 Pandemic Be Excused?

Adnan Trakic

By Assoc Prof Dr Adnan Trakic, School of Business, Monash University Malaysia

Many contracts have been breached due to the Covid-19 pandemic or the lockdowns introduced by the Government to curb the spread of the highly infections virus. Given that the contractual obligations were struck prior to the onset of the pandemic, the question that followed was: could these contract breaches be excused under the law? The short answer to this question is yes. But let me unpack it a bit more as the answer is contingent on a number of factors. 

Two legal concepts have often been cited in this relation, namely (i) the doctrine of frustration and (ii) force majeure – both of which will be discussed below. 

Frustration (excuse external to the contract)

The first legal concept of interest is the common law doctrine of frustration, an excuse external to the contract. Frustration has been codified in section 57(2) of the Malaysian Contracts Act 1950. It states that the contract becomes void when its performance becomes impossible or unlawful. When the contract becomes void, the parties will then be ordered, as per section 66 of the Contracts Act, to restore any advantage they received under the contract or make compensation for it to the person from whom they received it. Could the Covid-19 pandemic or Government imposed lockdowns render the performance of contractual obligations impossible or unlawful? There are few things to consider here.  

The first thing one needs to consider is whether the pandemic or resulting measures (lockdowns) have been provided for in the contract? If they have, then the parties would have been assumed to have undertaken the responsibility to manage the risks of the pandemic by themselves. In that case, the frustration will not apply. 

If the contract does not provide for the event of a pandemic or consequential measures, then one needs to determine if the contract (more specifically the contractual obligations) before and after the pandemic are fundamentally different. Suppose there is a radical change in the parties’ contractual obligations due to the pandemic. In that case, the court may grant frustration as it would be unfair to ask the parties to adhere to contractual obligations that are radically different from those they initially agreed to. But why would that be unfair? Simply because it is neither parties’ fault that the contractual obligations before and after the pandemic are radically different. And, it is worth noting that they are different because the parties could not have foreseen (predicted) the pandemic. Or could they? 

The proving of frustration often comes down to whether or not the accident was foreseeable. That said, the foreseeability test is not really helpful as almost any risk could have or, equally, could not have been foreseen. In other words, it is subjective. Bill Gates famously predicted a pandemic in a TED talk delivered in 2015. “If anything kills over 10 million people in the next few decades, it’s most likely to be a highly infectious virus rather than a war,” Gates said. 

So, could we still argue that the pandemic was unforeseeable? Perhaps yes and perhaps not. The point is, there is a great deal of uncertainty around the foreseeability test. Hence why it is more appropriate to talk about the “magnitude of the risk” – was it beyond reasonable contemplation of the parties? 

While the pandemic might have been foreseeable, the magnitude of the risk and its effects on the contract might not. The natural question that followed was – why not?  One could make a case that this is the first pandemic we have lived through in our lives. Who could have foreseen the magnitude to which the pandemic would affect everyone and everything? But now that we have lived through the pandemic, it would be hard to make that case again in the future should we live (God forbid) through another pandemic. 

It should be noted that there are two other important points that one needs to consider before deciding to plead frustration. First, frustration is intended to provide relief to individuals and not the whole sector of society. Second, the remedy of avoidance that flows from frustration (section 66 of the Contracts Act 1950) may not be suitable for the parties whose contracts have been affected by the pandemic. Rather than avoidance of contract altogether, many parties may wish to have a temporary suspension or compensation as a remedy instead. 

As a general guideline, before applying for frustration, one should consult with a lawyer to see what remedies are desired and then devise an argument that paves the path towards the desired remedy. 

Force Majeure (excuse internal to the contract)

While the court may or may not grant frustration (i.e., there is a considerable risk involved in going for it given the courts will consider it as a last resort), the better way is for the parties to manage the risk associated with the pandemic in their contract through a contractual term known as “force majeure”, the literal meaning of which is “greater force”.  

Force majeure is not a common law concept. In fact, it is not even a legal concept or a doctrine. It is simply a term of the contract by which parties manage the risks and their outcomes. In other words, it is an excuse internal to the contract. This means that everything we know about the basic rules of construction in contracts (contract interpretation) will also apply to force majeure clauses. 

Few things need to be considered here: 

(i) Whether the contract contains a force majeure clause? If it does not, that is the end of the story. The only option then is to rely on the doctrine of frustration discussed earlier. 

(ii) If the contract contains the force majeure clause, the next step is to see whether the clause provides for the pandemic or consequential measures. One should note that the general reference to “act of God”, a phrase commonly found in ‘boilerplate’ force majeure provisions, may not be specific enough to cover the pandemic. It would be interesting to see how this would be litigated before the courts as there are credible ongoing debates among the scientific community as to whether the Covid-19 originated from natural causes or it is man-made. 

Having a pandemic identified in the force majeure clause may still not give you a guarantee that the clause will excuse your breach due to the pandemic. In fact, we have two cases in Singapore – commonly referred to as the Sand Ban cases (Holcim (Singapore) Pte Ltd v Kwan Yong Construction Pte Ltd [2009] 2 SLR 193; Precise Development Pte Ltd v Holcim [2009] SGHC 256; [2010] 1 SLR 1083) involving the same supplier, the same force majeure clause, and the same underlying cause (the Indonesian ban on the export of sand). 

In one case, the court allowed the clause to excuse the breach, while in the other, it did not. Why is that so? Well, it is simpler than one may think. It is all about the interpretation of the contract. In interpreting the contracts (and their clauses) – the court is required to ascertain the parties’ intention by looking at not only the contract (document itself) but also all the factual circumstances. The facts matter. How parties have behaved towards one another will also determine whether the clause will excuse the breach and, if so, to what extent. 

Recommendations:

Parties involved in the drafting of the contractual documents, particularly lawyers and legal counsels, need to be aware of the following:

  • Be cautious about the wording and details of the force majeure clause. 
  • Do not use ‘boilerplate’ provisions. 
  • When drafting a force majeure clause, consider specific transactions and the relationship of the parties. 
  • Include a re-negotiation clause in the event of a substantial change in the circumstances (for example, a drastic increase in the price of raw materials) 
  • Indicate clearly whether the external event excuses performance altogether or only timely performance.

The judges deciding disputes about contractual breaches caused by the pandemic should consider the following: 

  • A careful factual analysis is critical. 
  • Each case must be treated individually, even though there is a common theme. 
  • The force majeure clause is important but also what parties did after the change in circumstances (i.e. reasonable expectations of party behaviour when external events change the environment of the contract).
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