Contractual performance in turbulent times: Some recommendations for businesses

At Bird & Bird, it’s our job to understand the commercial framework in which our clients operate and adapt our approach to contracting according. Lawyers from our Commercial, Finance and Dispute Resolution teams recently came together at an internal session to share their views on how contracting is being affected by economic and global factors, the various challenges that our clients are facing in performing their existing contracts in an uncertain world and how we are helping them to manage those changes.

Our panel of lawyers was made up of: Simon Shooter and Ronald Hendrikx, partners in our Commercial team; Jennifer Bird, Legal Director in the Finance & Financial Regulatory team; and Jonathan Speed, partner and Russell Williamson, senior associate, both from our Dispute Resolution group. 

Below we list our panel’s recommendations for businesses (i) at the pre-contract stage when there is much uncertainty about future economic conditions (Recommendations 1 – 4) and (ii) where existing contracts have become difficult (or impossible) to perform as a result of a change in circumstances outside of the parties’ control (Recommendations 5 – 7). 

Pre-Contractual Recommendations

Recommendation 1: Think carefully about force majeure clauses - don’t treat them like a regular boilerplate clause 

During pre-contractual considerations and negotiations, in drafting the force majeure clause a party should always:

1. Review force majeure clauses carefully. In some situations, longer-form force majeure clauses may be required to deal with all the situations within the sphere of influence of the parties. Ronald from our Commercial team says:
   
   ‘In the last two or three years, we’ve had major shocks to the system in the sense that people have been forced to rethink supply chains, costs, pricing profile, and availability of goods. Specifically, in response to the COVID-19 Pandemic, we’ve seen a rise in the use of the term ‘pandemic’ in force majeure clauses’.
   
   
2. Ascertain what the true impact is of any government sanctions or rules that are used as triggers, e.g. a party should be certain about whether the force majeure clause bites when action is ‘advised’ by government or strictly ‘prohibited’.
   
   
3. Consider carefully the use of the terms ‘prevent, hinder or delay’ – the three terms can be construed as a sloping scale of what the impact of the force majeure event is on the contract and the ability to perform the contract. 
   
   
4. If possible, define the degree to which the party attempting to rely on the force majeure clause needs to have mitigated the effects of the force majeure event – there can be an implied duty to mitigate,^[1] but often parties themselves will make it a condition of the clause. 
   
   
5. Consider the wording of any notification requirements. This is important because a party must ensure they follow any duty to notify accurately and speedily to avoid inadvertently giving up rights.

Recommendation 2: Avoid drafting that is too specific

There can be pitfalls to drafting too specifically. Parties should make sure that they draft into contracts measures that are consistent with market practice. Simon says:

‘Trying to be too accurate where you are trying to foresee exactly what may happen in the future is not going to work very well, so we are going to have to come back to some generalities.’

Recommendation 3: Don’t be afraid to suggest amendments to standard clauses 

Jennifer spoke specifically about contractual drafting in finance documents. In these agreements, there isn’t usually the concept of force majeure, primarily because a borrower’s obligation to repay a loan will survive whatever event or circumstance befalls the borrower. Instead, under such contracts a borrower will look to employ a ‘material adverse effect’ (“MAE”) concept, which is used to qualify certain of their representations, undertakings and the events of default under a facility agreement, so as to reduce the likelihood of inadvertent breaches thereunder. A lender may look to include a material adverse change (“MAC”) event of default, which is triggered where the occurrence of an event or circumstance has or is reasonably likely to have a MAE on the borrower . The extent to which a borrower will be able to negotiate the MAE definition and related provisions depends on its bargaining power, the sector and the jurisdiction in which their business operates.

A borrower or lender should seek to negotiate the definition of MAE to make it more favourable to their position. Jennifer emphasised the value of a well drafted MAC event of default, which makes use of the MAE definition: 

“Whilst a MAC event of default is unlikely to be used on its own to accelerate a loan, it is helpful to cover unforeseen events and bring the borrower to the table to negotiate any specific changes to the documentation that are required.”

Recommendation 4: Consider taking out insurance for force majeure-type events 

Another pre-emptive strategy raised by Russell is insurance – parties should check whether there are any ‘first-party’ insurance policies that may cover a crisis or disruption related costs or losses. These types of policies can include Business Interruption policies, which have been of more relevance recently because of the COVID-19 pandemic and the government restrictions that were put in place as a result. But also consider other policies such as (a) supply chain insurance, which is rarer, but can provide cover for losses resulting from disruption to the supply chain, (b) force majeure insurance and (c) event cancellation insurance.

Post-Contractual Interventions

Recommendation 5: Check whether your contract is actually frustrated or whether the event has triggered the force majeure clause

Frustration has a high threshold before it can be used. The contractual obligations must ‘become incapable of being performed’^[2] such that it makes the contract completely different from when the parties initially contracted. There are a number of factors to consider in deciding whether a contract is actually frustrated.

Force majeure occurs within the confines of the contractual clause. It is a clause like all others and is vulnerable to interpretation, so the clarity of drafting is very important. The burden of proof is on the party seeking to rely on the force majeure clause. It can be a very useful contractual tool to navigate uncertainty. As Ronald says:

‘Once you have the FM clause you can displace the frustration doctrine and you can create your own rule book to deal with the unexpected.’

Recommendation 6: Consider both your legal rights and commercial advantages

A party must consider their legal rights as well as any potential commercial arguments - however commercial arguments are especially important and should not be discounted where legal rights are particularly limited.

Any number of commercial arguments can be used in these kinds of situations, however, the key takeaway is that the party with the weaker bargaining power should seek to remind the other party of their shared common interest, the long-term value of the commercial arrangement, and any possible requirements on the other party to negotiate in good faith. As put simply by Jennifer:

‘In situations where you have less bargaining power, be ready to engage in commercial solutions.’

Recommendation 7: As a starting point, parties should avoid being aggressively litigious

When a party reviews the contractual consequences that are drafted to deal with the force majeure situation, they are normally looking at: (a) a relief of liability; (b) a permissioned delay; and, (c) termination. Those three options are not always helpful in a commercial environment – they can’t allow, for example, for a price change or a suspension. There are other options, which cannot necessarily be contracted for, which would be a method of addressing the circumstances more satisfactorily for both sides and it is through mature dialogue that those options can be found, not the words of the contract. Simon explained:

‘In these circumstances - generally, these unforeseeable matters – they affect both sides of the coin, the customer and the supplier. That creates a commercial opportunity for both sides to collaborate. Both parties will be affected, and both should be able to come up with a solution which will be far more satisfactory than what is generally able to be sensibly drafted in a contract entered into in advance of the unforeseeable event. ‘

Our Disputes team agrees with this insight and adds that many of the contracts we deal with at Bird & Bird are relational contracts – there should normally be some recognition on the part of both parties that neither party is really at fault. The situation is outside the parties’ control, and they need to work together to resolve it. Our Disputes team have seen in practice that parties will often work in good faith to try and resolve these issues – so a party should think twice before launching into a very aggressive litigation strategy at the outset. That said it is important that any contractual requirements (such as the timely notification of a Force Majeure event) are carried out in parallel with the commercial discussions, so that legal rights are not waived.

[1] See: Channel Island Ferries Ltd v Sealink United Kingdom Ltd [1988] 1 Lloyd's Rep. 323; and Classic Maritime v Limbungan Makmur Sdn Bhd  [2018] EWHC 2389 (Comm)

[2] Davis Contractors Ltd v Fareham Urban District Council [1956] UKHL 3