05.20
COVID–19 AND THE PERFORMANCE OF CONTRACTUAL OBLIGATIONS
Force Majeure clause or Frustration of Contracts

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Introduction

Unfortunately, the outbreak of the corona virus has created devastating effects on everyday lives, caused significant disruption to businesses and impacted on global markets, trade and commerce. The virus, now classified as a “pandemic”, has led governments issuing emergency measures including, but not limited to the restriction in movement as well as temporary closure and suspension of various businesses, creating thus issues related to the performance of contractual obligations of parties.

From what we have seen so far, it is evident that the main effect of the virus on contractual obligations is related to that of non-performance. The general rule that applies under Cyprus contract law, is that all parties to a contract are obligated to comply with their contractual obligations as stated in the contract or else risk being held liable for breach of contract.

However, in exceptional circumstances, the general rule as stated above may be avoided, provided that the parties have either included a Force Majeure clause in their contract (relevant to the said circumstances) or if the contract is frustrated.

What does “force majeure” mean?

A strict translation of the phrase “force majeure” would be “superior or irresistible force”. However, and given that the concept derives from civil law jurisdictions, even though it is applied within common law systems, it hasn’t been given a recognised universe definition within common law and in effect Cyprus law.

It has been stated that the “term is used with reference to all circumstances independent to the will of man and which are not in his power to control” and thus covers events that cannot be anticipated (i.e. are unforeseen) or controlled by man (i.e. outside the party’s control), for example results of the elements of nature, and which affect a party’s ability to comply with its contractual obligations.

What is a force majeure clause and how does it affect contractual obligations?

It follows that a “force majeure clause” is a contractual provision that will deal with how contractual obligations are to be performed in circumstances in which performance becomes impossible or impracticable due to events that could not have been foreseen, and are not within a party's control.

Such clauses, will usually either excuse the performance of the party’s obligation altogether or delay or suspend, for a specific period of time, the performance of the contractual obligations of the affected party. It is through the use of such clauses in contracts that parties are enabled to better allocate the contractual risk in the event of an unexpected event occurring.

Force majeure clauses may take different forms, for example they may provide for an exhaustive list of events that would fall under the definition of “force majeure”, or may provide for a specific list of events, but also include a term that the list is not exhaustive, thus enabling the parties to cover events not mentioned in the list. There are also broader clauses that refer to events that are “beyond the reasonable control of the party”. It should be borne in mind that we shouldn’t always seek for a label, this meaning that force majeure clauses may be found in the contract even in unexpected places, for example within a termination clause, and thus it is essential to know what you are looking for within the contract. Once you know what you are looking for, you will be surprised to notice that “force majeure clauses” may be included in the contract without even referring to the phrase of “Force majeure’.

But how often do force majeure clauses address the issue of a pandemic? One of the problems many are facing at the moment is that they are unable to perform their contractual obligations and their contracts either do not have a force majeure clause for them to rely on or contain boilerplate force majeure clauses that either do not cover the current situation or are so general that until the matter is resolved, it will be too late for the affected party.

When can a party rely on such a clause?

It is up to the party that will be relying upon the force majeure clause to prove that the facts of his case fall within the ambit of the clause. In addition, even if the party proves the existence of the unforeseen event that falls within the force majeure clause, it will still be necessary for such party to prove that: the unforeseen event has hindered or in some way impacted the performance of his contractual obligations, that the non-performance of his contractual obligations was due to circumstances beyond his control and that he could not, by taking reasonable steps, mitigate the consequences of the event or, in any way, deal with the new circumstances.

Is the corona virus outbreak covered by the force majeure clause in your contract?

What seems to be interesting with the corona virus, is that since it has been declared as a pandemic, it is likely to qualify as falling under the categories of “pandemic” or “epidemic” or even more general ones such as “illness” or “disease" but in addition to those, and due to the measures taken by the government, it is also likely to fall under categories relating to “governmental acts”, for example measures taken in relation to travel restrictions, quarantines and the closing down of businesses.

 

However, it must always be borne in mind that in determining whether or not the corona virus pandemic constitutes a force majeure event, will require a careful examination of the precise wording of the particular agreement as well as the scope, nature and content of the contract in consideration with the applicable law. In addition, and as indicated above, in order to be able to rely on the clause, it will be necessary to establish that Covid-19 has prevented, hindered, delayed or affected (depending on the wording of the clause) performance of the contract and that you have taken all reasonable steps to deal with the new circumstances prior to invoking the force majeure clause. Finally, regard must also be given to any specific requirements or steps to be taken in order to invoke the clause, for example any requirement of prior notice to the other party.      

What happens if your contract doesn’t contain a force majeure clause?

This is where the doctrine of frustration comes into play. The main purpose of having a force majeure clause, is that it enables the parties to pre-agree as to either termination or adaptation of the contract, should an event interrupt or affect the performance of the contract. If there is no force majeure clause, or if the supervening event is outside the scope of the clause, non-performance may be excused through the doctrine of frustration. 

Section 56 (2) of the Cyprus Contracts Law, CAP 149, provides that “a contract to do an act which, after the contract is made, becomes impossible, or by reason of some event, which the promisor could not prevent, becomes unlawful, shall be considered to be void when the act becomes impossible or unlawful”.

It is evident from section 56 (2) of the Cyprus Contracts Law, CAP 149, that if the doctrine of frustration applies, then its application will render the contract void. By rendering the contract void, both parties will be released from their future obligations. It follows that the doctrine’s effect on the contractual relationship is drastic. It is due to its drastic effect that the courts in Cyprus tend to apply the doctrine strictly.

In a nutshell the main elements of the doctrine of frustration, are the following: a valid contract must be in existence, an event that could not have been foreseen or anticipated by the parties when entering into the contract must have occurred and such event shouldn’t have been caused by either party, the event has arisen following the formation of the contract and the contract must not yet be fully performed, the further performance of the contract is impossible or illegal or completely different from what the parties have agreed to. In addition to the above, the contract should not contain a clause relating to the unforeseen event.

With regards to “foreseeability” what must be borne in mind is that the time of entering into the contract is of essence in that if the event that occurred could at that time have been foreseen, then not including a clause dealing with such event in the contract may lead to the conclusion that the doctrine will not apply. As to “impossibility” it may either take the form of impossibility to perform the contract or of that rendering the performance of the contract as something radically different from what the parties have contemplated. Thus, a contract will not be frustrated merely because the circumstances in which it was made were altered, it will be essential to prove that the change of circumstances are so fundamental as to be regarded as striking the root of the contract. Similarly, disappointed expectations of the parties, as well as increases in expenses or the event that performance of the contract has become more onerous will not be sufficient reasons to justify frustration.   

In order to reach a decision, the courts will examine the contract, the circumstances under which it was made, the belief, knowledge and intention of the parties being evidence of whether the changed circumstances have destroyed altogether the basis upon which the contract was agreed on.

Therefore, it is clear that even though some parties may be able to claim frustration due to the corona virus catastrophe, not all cases whereby performance has been affected may rely on the doctrine and it will depend on the seriousness that the impact of Covid-19 has on the performance of the contract.

Examples that have already proven to be problematic

Tenancy agreements / Lease agreements

One of the main questions raised by clients lately is whether the client can legally stop paying rent or pay a lesser amount due to the corona virus outbreak. The answer will depend on whether or not the tenancy agreement contains a force majeure clause. If it does, then whether or not such clause covers the corona virus will be a matter of interpretation of the clause and the party relying on such clause will still need to prove the elements referred to above.

Unfortunately, from what we have seen so far, most tenancy agreements governed by Cyprus law do not contain force majeure clauses. In such circumstances, what remains to be considered is whether the doctrine of frustration applies. Due to its drastic effect, i.e. rendering the contract void, it will be very difficult to invoke the doctrine of frustration in rental agreements as the party relying on it will probably need to prove that the pandemic has affected the operation of the property or its rental. It is highly unlikely that the courts will rule that the pandemic has affected in any way the operation of the property especially in circumstances where the tenant is still in possession of the property. Any impact on the tenant’s financial position or ability to pay rent due to the virus will not be a sufficient reason to justify frustration of the tenancy agreement, as the tenancy agreement will not be rendered impossible to perform.   

However, what happens in the case of business rentals or licensees that have been affected by the governmental decrees? One may argue that due the governmental decrees issued, by which mandatory suspension of certain business activities, for example the mandatory shutdown of the malls, cafes and restaurants, could be an important consideration to be taken into account for the purposes of “frustration”. So, the question that will arise in such circumstances is whether the governmental decrees referred to above, which suspend the business activities of a business, frustrate the agreement. An important consideration to be taken into account will be the duration of the measures issued by the government as well as the duration of the lease. So, for example, if the lease is said to continue after the measures have been withdrawn, then it will be highly unlikely that the court will rule that the lease has been frustrated. The result may perhaps differ in the situation where the lease is to expire either at the same time when the measures are lifted or prior to that time.

 

Another consideration that must be borne in mind, is that the parties may not wish to terminate their contractual relationship. In such a case, the parties to the contract will not be willing to invoke the doctrine of frustration.  

Next steps for your organisation

It is essential that businesses have to consider which of their contracts have been impacted by the corona virus situation. Those contracts should be very carefully reviewed in order to check whether a force majeure clause has been inserted in the contract and whether the corona virus situation is covered by the clause. Remember, force majeure clauses are not always found where they are expected to be found. If you are in any doubt as to whether or not the force majeure in your contract is applicable and what relief could be available to you under the clause, or in the event that you are not sure whether or not your contract contains a force majeure clause and what implications this may have on your business, seek legal advice.

Conclusion

It is evident that the corona virus situation is proving to be catastrophic and many lessons should be learned from the current situation we are facing. One of the most important ones is being prudent enough to shield ourselves from potential inability to comply with our contractual obligations, should a similar event occur. This will require careful consideration of the terms of a contract in that a force majeure clause is included in the contract that would cover such a situation. Immaterial boilerplate clauses should be avoided; the more precisely a triggering event is drafted in the force majeure clause and the more triggering events are included in such clause, the more protection will be enjoyed by the parties of the contract, avoiding thus scenarios of either termination of the contract through the concept of frustration or breach of the contract.   

 

DISCLAIMER 
 

This publication has been prepared as a general guide and for information purposes only. It is not a substitution for professional advice. One must not rely on it without receiving independent advice based on the particular facts of his/her own case.  No responsibility can be accepted by the authors or the publishers for any loss occasioned by acting or refraining from acting on the basis of this publication.

 

April 2020

 

Contact Persons:


ANDRIANNA SOLOMONIDES
Counsel – Litigation Division
Andrianna.Solomonides@kinanis.com

 

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