Introduction: Navigating Contractual Non-Performance as a Result of COVID-19
The current global health crisis prompted by the outbreak of COVID-19 represents a significant challenge to multi-national and local supply chains. Some businesses are seeing their revenues halt entirely, and face that shortfall continuing for an unknown period of time. In this environment, many contracting parties will be looking to avoid their contractual obligations, either due to diminished viability of their current arrangements or for reasons of necessity. Contractual non-performance can raise difficult legal issues depending on the context. This article highlights a few key principles businesses should keep in mind when navigating this new reality with contractual counterparts.
Termination: The Danger of Jumping the Gun
When faced with contractual non-performance, innocent parties will have to consider available remedies when making business decisions. Contracts may contain a range of terms with varying degrees of importance. The importance of the term to the contract will dictate the remedy available to the non-breaching party.
Classification of contractual terms occurs at the moment of contract formation. Conditions are terms that go to the heart of the contract, the breach of which entitles the innocent party to an award of damages, the right to terminate the contract, or to engage in reciprocal non-performance. Breach of less significant terms entitles the innocent party to an award of damages, but does not afford the party a right of termination. Where termination is not available, the innocent party must continue to perform its side of the bargain or risk being found liable for breach itself. If both sides are in breach and no one terminates the contract, the parties may each have claims that can be set off against each other.
At times, parties attempt to define the specific defaults that create a right of termination. If a contract defines when a default creates a right to terminate, courts will generally defer to the parties’ agreement. However, the contract might contain conditions that must be satisfied before an innocent party can terminate the agreement. These conditions might include, for example, a requirement that the innocent party demand payment or issue a notice of default prior to invoking a right of termination. Innocent parties who wish to use contractual remedies should ensure they abide by any such conditions or they again risk being found in default of their own contractual obligations.
If the contract is silent on the appropriate remedy for a particular breach, consideration should be given to the severity of the breach in light of the contract as a whole. Do the consequences of the breach deprive the innocent party of substantially the whole benefit of the contract? If so, then the innocent party is entitled to terminate. However, there is always the risk that a court will interpret a contract differently from a party, and place a different level of importance on particular terms. The uncertainty about whether a court will regard the breach as sufficiently serious creates risk for any party electing to terminate a contract in the face of the other side’s non-performance.
The Threat of Future Non-Performance
If a contracting party communicates an intention not to perform the party’s obligations in the future, this might constitute an anticipatory breach. If the threat of contractual breach concerns a serious matter, the innocent party might not have to wait for the breach to occur before acting: it might be able to terminate the agreement based only on the threat of non-performance and then sue for damages.
For that reason, businesses need to be careful about inadvertently committing an anticipatory breach of contract. When communicating with a contractual counterpart about issues a business faces as a result of the current health crisis it will be important to avoid language that suggests the party will be unable to meet future contractual obligations.
On the other hand, if an innocent party receives communications from its contractual counterpart about issues it will have in performing its obligations, the innocent party should be careful not to waive its contractual rights. Many businesses will likely respond to difficulties encountered by their suppliers, customers or other contracting parties with understanding and cooperation. Doing so is good for those relationships, and does not necessarily undermine a party’s position if they end up in a courtroom. Judges are not immune to considerations of fair play and civic responsibility. COVID-19 presents unique challenges for businesses, and those businesses that engage these challenges with a focus on the public good and a spirit of cooperation may find a more sympathetic audience when their day in court arrives.
This said, businesses should specifically reserve their contractual rights and remedies even as they adopt this cooperative tone. Parties should be careful not to acquiesce in ongoing non-performance. They should communicate that cooperative steps taken are without prejudice to the party’s ability to insist on strict compliance with the contract. Taking these steps will permit innocent parties to keep their options open when dealing with the consequences of contractual breach.
Other Reasons a Party May Be Excused From Contractual Non-Performance
Failing to reserve contractual rights or otherwise acquiescing in contractual breaches could result in a court finding that an innocent party was not entitled to terminate an agreement. Additional reasons that a party may be excused from non-performance of a contract are force majeure clauses, the doctrine of frustration, and curative provisions of a contract. A breaching party may also ask the court to exercise its jurisdiction to reinstate contractual rights. There is the further possibility that governments will introduce legislation to address the effects of COVID-19 on parties’ contractual relationships.
(a) Force Majeure Clauses
Force majeure clauses excuse a party from non-compliance with a contract when specified triggering events occur. Triggering events are often extreme circumstances – for example, natural disasters or other “acts of God”, changes in laws, or labour strikes which are outside of any party’s control. Typically, force majeure clauses include a specified list of events and have a broader catch-all phrase to capture those events not listed. Specified events are usually the subject of negotiation between the parties, and are tailored to the particular business in question.
Triggers in a force majeure clause like “epidemics” or “quarantines” would seem to neatly capture the consequences of COVID-19. But absent language along those lines, parties may need to resort to the broader catch-all language, if any. There will likely be significant litigation in the future about the extent to which the impact of COVID-19 fits within the scope of the wording of particular force majeure clauses. Parties may also disagree on whether the consequences of COVID-19 frustrated the commercial purpose underlying the agreement so as to constitute a force majeure event.
These clauses are really about risk allocation. The question of whether the parties should have reasonably foreseen the challenges presented by COVID-19 will be a key consideration if claims arise. Parties seeking to benefit from a force majeure clause should ensure that they document efforts taken to comply with their contractual obligations.
(b) Contractual Frustration
The effects of COVID-19 may also be sufficient to justify a finding that the contract has been frustrated. Frustration occurs where an event occurs subsequent to contract formation that makes performance problematic. It must be an event that was not present at the time of formation and impose such unfair hardship on one party that it would be unjust to hold the party to the literal stipulations of the contract. For frustration to apply, the parties must also have failed to allocate between themselves the risks now coming to fruition as a result of COVID-19. The doctrine of frustration forgives parties from having to comply with their obligations in the future, but does not address the consequences of past contractual breaches.
In British Columbia, the Frustrated Contract Act, R.S.B.C. 1996, c. 166 may give contracting parties restitution for losses incurred in trying to perform frustrated or avoided contracts. The Act applies to a contract from which the parties to it are discharged by reason of the doctrine of frustration, or to a commercial transaction that is avoided as a result of s. 11 of the Sale of Goods Act, R.S.B.C. 1996, c. 410 (where specific goods perish before risk is transferred to the buyer through no fault of either party). The availability of restitution for lost value is in part dependent on whether the event in question is the type of loss against which the party usually insures itself. The extent to which insurance companies will be on the hook for COVID-19-related business disruptions will be the subject of significant future litigation (and could be the subject of an entirely separate article).
(c) Curative Contractual Provisions
As discussed above, contracts often contain certain procedural requirements that an innocent party must follow before it can invoke contractual remedies. At times, those procedures include curative provisions that give the breaching party an opportunity to cure its default. Some curative provisions require that curing the default be to the satisfaction of the innocent party. The innocent party may also have the discretion to extend time periods in which to permit the other party to cure its default.
In those circumstances, innocent parties would be well advised to evaluate steps taken by the breaching party in good faith, and with a view to genuinely considering whether the breach has been cured. When imposing deadlines by which the party must cure its default, the innocent party should consider the current status of the market in light of COVID-19.
(d) Relief from Forfeiture
For the party in breach, there may be an opportunity to reinstate contractual rights by seeking relief from forfeiture. Relief from forfeiture is a means by which a party can ask the court to forgive it from having to pay certain contractual penalties or forfeit contractual rights due to the party’s default. The British Columbia Supreme Court has a discretionary jurisdiction to grant this remedy and will generally consider the defaulting party’s conduct, the seriousness of the breach, and the damage caused by the breach.
This jurisdiction may be curtailed for contractual arrangements that are impacted by a statutory administrative scheme – for example, residential lease agreements (see Seignoret v. Bakonyi Holdings Ltd., 2019 BCCA 105). Generally speaking, however, a party that acts in good faith and comes to court with “clean hands” may be able to ask the court to forgive it from paying certain penalties or forgoing certain contractual rights. Parties who might later seek relief from forfeiture should make all commercially feasible efforts to comply with the contract and minimize the damages suffered by the innocent party.
(e) The Possibility of Future Legislative Intervention
In addition to the common law and statutory mechanisms outlined above, there is certainly the possibility that governments could introduce specific legislation to address defaults due to COVID-19. This remains to be seen.
At All Times, Contracting Parties Should Perform Their Contractual Duties Honestly
It can be difficult to translate doing many of the above steps into day-to-day communications with suppliers, customers and clients. At minimum, however, businesses should ensure that they are being honest when performing their contracts.
Canadian law recognizes a duty of honest performance in contractual relations, and an organizing principle of good faith more broadly. Courts are still exploring the contours of this organizing principle and how it manifests in particular doctrines. One can quickly imagine scenarios where litigants may invoke good faith considerations in future litigation centered on the effects of COVID-19.
What we do know right now is that parties must perform their contractual duties honestly. A party that seeks concessions or justifies prejudicial contractual performance by making false statements about the impact of COVID-19 on its business may be in breach of these principles. The party may also be liable for negligent or fraudulent misrepresentation where the innocent party has relied on those representations to their detriment.
In a time like the present, parties understandably may wish to cooperate with one another, but still take steps to preserve the financial health of their own business. Those goals are not incompatible.
Speak to each other honestly but not in a way that indicates an intent to breach the contract. Be cooperative but reserve rights under the contract. Document steps taken to comply with the contract. Pay close attention to the terms and conditions of the contract, and think carefully about the significance of the consequences of breaches.
There may be measures available to parties to relieve of the consequences of breach. However, benefiting from those measures may take too long for businesses faced with immediate financial difficulties, and interrupted supply chains. As with the rest of Canadian society, our courts are facing closures and delays in having matters heard as a result of the health crisis. This will create a backlog that needs to be addressed by our already over-burdened courts. In the meantime, parties that keep in mind these principles may be able to preserve their rights while moving forward with their contractual relationships.