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Would COVID-19 provide an excuse not to perform a contract?

2020-03-31


Introduction

On 11 March 2020 the World Health Organization (“WHO”) declared that the outbreak of COVID-19 is a pandemic, meaning the “worldwide spread of a new disease”. Many countries have taken emergency measures such as quarantine, travel restrictions and special work arrangement, which have led to disruption to business, trading and travel, as well as closure of factories and schools. Facing the unprecedented challenges, some contractual parties are looking for ways to relieve themselves from performing their obligations under the contracts. This article will explore whether a force majeure clause in a contract or the common law doctrine of frustration may be of assistance to them.


Force majeure clause

A force majeure clause is a common clause in contracts which may allow the contractual parties to lawfully rescind the contract and be discharged from their respective obligations under the contracts upon the occurrence of specified events, which are beyond their control. The events included in force majeure clauses vary from contract to contract and it is up to the parties to set out the precise scope.

Whether the outbreak of COVID-19 constitutes a force majeure event is a matter of interpretation. The effect of each force majeure clause must be construed based on the actual wording of the clause with due regard to the parties’ intentions, the nature of the contract and its other terms. Since contracts were made to be performed, clauses invoked to remove or modify obligations of performance like force majeure clauses generally receive a strict construction.

In Goldlion Properties Ltd v Regent National Enterprises Ltd (2009) 12 HKCFAR 512, a company in liquidation, acting through the liquidator, agreed to sell a hotel. On the eve of completion, a third party made some moves to set aside the winding-up order and the liquidator’s capacity was revoked. In the circumstances, the vendor could not complete the sale and sought to invoke the force majeure clause. The issue was whether the vendor was reasonably of the opinion that the move by the third party constituted a hindrance to completion. The subject contract provides that the force majeure clause could be invoked “should the vendor become unable or fail to complete the sale and purchase of the property on the completion date due to any matter (including and without limitation to third party action) beyond the reasonable control of the vendor and which in the reasonable opinion of the vendor materially hinders, prevents or obstructs the completion of the sale and purchase of the Property”. The Court of Final Appeal held that:

(1)   the vendor must show that its failure to complete was “due to” a matter that must be beyond its reasonable control and which in the reasonable opinion of the vendor materially hindered, prevented or obstructed the completion of the sale and purchase of the building;

 

(2)   the vendor must genuinely have formed an opinion that the matter constituted a material hindrance to completion and that such opinion must be reasonable; and

 

(3)   the word “hinders” set a substantially lower threshold than the word “prevents”. It permitted the vendor to adopt a risk-averse approach especially where third party action placed difficulties in the way of completion, even though completion was not thereby prevented or rendered impossible.

 

In finding that the clause was validly invoked, the Court of Final Appeal held that a material hindrance could be constituted by the uncertainty flowing from a reasonable perception that the vendor might lack legal power to convey property which it had purported to sell, an uncertainty that was likely in itself to pose significant commercial problems.

The above case illustrates that whether an event triggers the force majeure clause depends on the exact wordings of the clause. Since the WHO has categorized the COVID-19 outbreak as a pandemic, the contractual parties are more likely to invoke the force majeure clause if it specifies “pandemics” or “epidemics” as a force majeure event.

For the clauses adopting vague terms such as “act of God”, in Lebeaupin v Richard Crispin & Co [1920] 2 K.B. 714, the English court held that force majeure “is used with reference to all circumstances independent of the will of man, and which it is not in his power to control, and such force majeure is sufficient to justify the non-execution of a contract” thus “war, inundations, and epidemics, are cases of force majeure”. Although it has not been addressed in the Hong Kong courts, depending on the nature of the contract, the COVID-19 outbreak may also be covered as a force majeure event.

Further, when trying to invoke the force majeure clause, the contracting parties should be mindful of the followings:

(1)   the parties have to comply with the requirements on notice of the force majeure event, which is a condition precedent to reliance on the clause, to ensure that the notice given is effective to invoke the force majeure clause;

 

(2)   the parties have to show that the COVID-19 outbreak has affected the performance of the contractual obligations according to the requirements set out in the clause, such as hindrance, prevention or obstruction; and

 

(3)   the parties should consider the possible consequences of invoking the force majeure clause, such as termination of contract or merely suspension or time extension for performance.


Doctrine of frustration

Alternatively, if the contract does not include a force majeure clause, the parties may seek to rely on the common law doctrine of frustration. The doctrine of frustration applies when, after a contract has been entered into, some supervening event occurs that makes performance of the contract radically different from what the parties had contemplated when they entered into the contract.

The doctrine of frustration operates narrowly and the courts are reluctant to invoke the doctrine to allow the parties to be discharged from their contractual obligations easily. In general, a contract will only be frustrated in circumstances where the performance of the contract under its existing terms and conditions becomes impossible. If it is merely more difficult or less profitable for a party to perform the contract, the contract will not be frustrated.

In Li Ching Wing v Xuan Yu Xiong [2004] 1 HKC 353, the plaintiff let a flat in Block E of Amoy Garden to the defendant for a fixed term of 2 years commencing from 1 August 2002. Upon the outbreak of SARS in March 2003, many residents living in Block E were infected with the disease and the defendant moved out of the flat on 29 March 2003. The Department of Health issued a ten-day Isolation Order to the residents living in Block E. Subsequently, The Defendant purported to terminate the tenancy agreement and the Plaintiff later claimed against the Defendant for the accrued rent and damages for wrongful repudiation of the tenancy agreement.

The Defendant argued that the tenancy agreement had been frustrated due to circumstances relating to the SARS outbreak. The Court of First Instance held that the ten-day period was insignificant in the context of a two year lease and the SARS outbreak did not significantly change the nature of a tenancy agreement, therefore the circumstances relating to the outbreak of SARS were not sufficient to invoke the doctrine of frustration.

As such, whether the outbreak of COVID-19 would be considered as frustrating a contract may depend on the nature and extent of its actual impacts on the performance of the contract under its original terms and conditions, whether the performance is impossible or merely more difficult and costly.


Takeaway

Parties should draft the force majeure clause with due care and review the clause from time to time to ensure that the actual wordings used in the clause are precise and wide enough to provide sufficient coverage and protection to the parties. Particular attention should be given to the events constituting force majeure events, the requirements on notice of the force majeure event to invoke the clause, the standards of effects on the performance of contract, and the possible consequences upon relying on the clause. Further, legal advice should be sought before invoking the force majeure clause or doctrine of frustration as there could be severe consequences if the Court later finds out that such force majeure clause or doctrine of frustration could not be relied upon to relieve a party’s contractual obligations.


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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

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