March 2020

The Frustrating Impact that Coronavirus may have on your Commercial Contracts

This article was published in the Hire and Rental News Magazine May 2020, page 10-11

Background

As COVID-19 (Coronavirus) continues to spread throughout the globe, the effects are being felt on international trade and supply chains. In Australia specifically:

  • The Australian Securities Exchange (ASX) has fallen dramatically in recent times and this week, suffered its biggest drop since October 2008, during the peak of the global financial crisis.

  • The Reserve Bank of Australia (RBA) also cut interest rates on 3 March 2020 as part of the emergency economic response to the Coronavirus.

  • Import/export industries have been hard hit in particular the tourism and education sectors (noting Australia is the largest exporter of tertiary education in the world per capita).

Other ramifications include:

  • negative impact on the demand for certain goods and services (eg tourism)

  • supply shortages linked to uncertainty surrounding production and the ability to import and export from China and other parts of Asia

  • uncertainty for businesses due to the unknown duration and extent of outbreak.

At Bartier Perry, we have already started to see the commercial effects of the outbreak, especially in relation to the impacts on commercial contract performance. With this in mind, businesses and directors (who have their own duties to the company and shareholders) should consider how the following three concepts may assist them during this difficult time.

1. Force Majeure provisions in contracts

The majority of Australian commercial contracts contain a 'force majeure' clause.  These clauses expressly deal with how certain unforeseeable events and circumstances can impact and effect the performance of obligations under a contract.

In some instances, 'force majeure' clauses may also provide a right to terminate the contract, should an event specified in the contract occur.

These types of clauses are often the subject of commercial negotiations. The rights of a contracting party to rely on a 'force majeure' clause will often depend on the breadth of these clauses. 

In light of the Coronavirus and its impact on the global economy, we envisage that many businesses will need to seek advice as to the application of 'force majeure' clauses, if any, on their supply and commercial agreements. 

It is not yet known whether the Courts will consider Coronavirus as a supervening event under the contract, and if that be the case, what steps would need to be taken to ensure that a 'force majeure' clause is properly invoked.  

2. Frustrated Contracts

We predict we will see a significant increase in the number of cases brought between businesses to rescind the contract on the basis that the contract has been frustrated.

A frustrated contract is a contract that is incapable or impossible of being performed by one or more of the parties. This is due to unforeseen circumstances which results in a fundamental change in the contractual obligation initially contemplated by the parties. This inability to perform the contract is through no fault of the parties.

Under common law in Australia, the doctrine of frustration generally operates to terminate the contract at the point of frustration (i.e. when the supervening or unforeseen event occurs). Unlike the application of a 'force majeure' clause, establishing frustration is a more difficult process and often has a much narrower scope.

By way of example, in the matter of Li Ching Wing v Xuan Yi Xiong [2003] HKDC 54 (Hong Kong), arguments were made that a tenancy agreement was frustrated in circumstances where the premises was subject to an isolation order due to the outbreak of Severe Acute Respiratory Syndrome (SARS). As a result, the premises could not be occupied for ten days. On this occasion, the Court held that while it might be arguable, it could not definitively say that the SARS outbreak was an 'unforeseen event'.   

Since SARS, we have witnessed other epidemics including swine flu and ebola. As such, it is arguable that virus outbreaks like Coronavirus may no longer be seen as 'unforeseeable' events. However, the responses that we have seen to Coronavirus, including city lockdowns, may be considered as 'unforeseen'.

What we do know is that the spread of Coronavirus is causing chaos in commerce and amongst communities around the globe. Businesses are having to implement strategies to combat both increased and decreased demand depending on their industry and offering, putting stress on those businesses in different ways. For example, Kleenex has obtained urgent approval in South Australia to operate 24 hours a day given the shortage of toilet paper in Australia, whilst Cathay Pacific has now grounded half of its global fleet and forced 25,000 staff members to take unpaid leave in order to combat a 75% reduction in the number of passengers scheduled to travel this month.

3. Increased chance of insolvency for those reliant on trade with countries effected

It has been widely noted in the media over the past few days that even those companies with a global reach, such as Woolworths and Coles, are reportedly struggling to obtain enough stock to meet the rising demands of customers. With such shortages, smaller retailers will no doubt face significant risks of not having sufficient stock to enable sales and maintain profitability.

Noting the above, it is likely that businesses will see an increase in their trade debtors and accounts receivable. If your business is one which operates on cash flow, this may mean that you potentially suffer from an insolvency event or may need to find short term solutions to inject cash into the business to meet the shortfall.

With popular establishments such as Sky Phoenix Parramatta and Mister Dee’s Kitchen already being placed into voluntary administration and liquidation respectively, citing the downturn in revenue as a direct result of Coronavirus, it is likely to be only a matter of time before other companies in other industries are met with similar circumstances.

These are all serious issues facing business owners on a daily basis, which are being highlighted by Coronavirus, and directors need to be mindful of their obligations to maintain solvency and to take action if they have concerns in this regard.

Conclusion

In light of the uncertainty facing businesses, if you are experiencing either cashflow or supply issues, it is important that you act promptly to:

  1. review your commercial contracts and seek advice on potential options available to you including the application of 'force majeure' provisions or frustration;

  2. contact your suppliers and seek updates on their business continuity plans to ascertain what processes you may need to put into place to combat lack of supply;

  3. contact your insurance broker to see whether you have any policy of insurance that may respond in the current circumstances, and whether notifications are necessary;

  4. in dire circumstances, consider whether the business remains solvent and whether you ought to seek advice from qualified insolvency practitioners or lawyers.

Authors: Gavin Stuart, Adam Cutri and Max Mikha