Q&A: Rethinking commercial contracts post COVID-19

December 2020  |  SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION

Financier Worldwide Magazine

December 2020 Issue

FW discusses rethinking commercial contracts post COVID-19 with Rishi Zutshi at Cleary Gottlieb, Tom Dane at CMS, Adrian Cole at King & Spalding and Julie Bédard at Skadden, Arps, Slate, Meagher & Flom LLP.

FW: Reflecting on recent months, in what ways has the coronavirus (COVID-19) pandemic brought commercial agreements into sharper focus? How has it affected the way contract language is being interpreted?

Dane: Coronavirus (COVID-19) and the resulting national restrictions have triggered a significant global economic downturn, which is requiring parties to focus more on their contractual and commercial relationships. This is partly because parties are looking for ways in which to defer their obligations, excuse their delay in performance or to try and extricate themselves from contracts. In order to do so, the focus has been on the parties’ contractual rights and obligations, force majeure clauses, concepts such as frustration and waiver, material adverse change provisions and termination clauses. English law rules on interpretation of contracts are well-suited to the issues arising from the COVID-19 pandemic. This is because English law seeks to give an objective meaning to the contract and includes mechanisms for implying terms into the contract when it is necessary to do so to give the contract business efficacy. English law contractual interpretation rules promote clarity and certainty, which in the midst of a crisis are valuable to help a party assess its position.

Bédard: The COVID-19 pandemic brought unprecedented disruption to global economic activity. Normally, businesses strive to satisfy their contractual obligations. With the COVID-19 crisis, income evaporated for many businesses, which tried to eliminate risks and protect cash for critical needs while navigating an uncertain regulatory environment. Many companies faced various impossibilities to perform or performance became extremely onerous. Commercial agreements were reassessed on the basis of need, and businesses sought to reduce their exposure via strict reading of existing contracts or emergency talks with their contracting partners. The pandemic has brought commercial agreements into sharper focus and certainly has led many parties to have intense discussions about their agreements. The formal judicial or arbitral interpretation of contracts is still to be decided in most cases, as many disputes have been commenced recently and remain under adjudication.

Zutshi: In the early stages of COVID-19, many parties to commercial contracts were understandably reluctant to seek court resolution of contractual disputes. This was not only because of the uncertainties about how courts might interpret contractual questions of first impression related to the effects of this pandemic, but also because of broader uncertainties, including regarding the scope of the pandemic, what responsive measures governments might take, and how the court systems themselves would be affected. In some cases, these uncertainties encouraged companies to reach privately negotiated resolutions. But with the passage of time, and as more and more courts have addressed force majeure and related issues in the COVID-19 context, parties appear now to be rightly focused on the specific contractual language governing their rights.

Cole: Since the start of the pandemic, business managers have been retrieving their copies of contracts from the proverbial bottom drawer of the filing cabinet to see what their rights and remedies are in relation to pandemics and other events often described as force majeure. Parties obliged to perform a contractual obligation will be looking for relief from performance whereas those requiring a party to perform a contractual obligation will be anxious to determine whether that party can be compelled to do so. Attention will also be focused on contractual requirements, such as notice obligations, to ensure strict compliance to guarantee that rights are not lost inadvertently.

FW: To what extent have force majeure clauses become a particular point of focus? What kinds of variations, definitions and exclusions are typically associated with force majeure events?

Bédard: Force majeure clauses were an immediate flashpoint in the pandemic, as businesses sought to delay or excuse performance because of COVID-19 disruptions. Force majeure clauses vary, but most include a series of qualifying ‘events’ that alter a party’s rights and obligations if they occur. Common events include wars, terrorism, strikes, work stoppages, natural catastrophes and ‘acts of god’. The events must usually be beyond a party’s control and must actually cause a party’s non-performance to qualify.

Zutshi: Force majeure clauses are one of the primary mechanisms by which contractual counterparties address how to allocate the risk of loss in the face of potential uncertainties. Given that COVID-19 has forced nearly everyone to confront greater levels of uncertainty about the future, it is not surprising that force majeure is now an area of heightened focus. The specific contractual language is key. For example, there have been a wide variety of measures enacted by various legislative and executive branch authorities in different jurisdictions in response to COVID-19, from travel restrictions to business closures to safety requirements. There are also a wide variety of formulations used in different contracts to identify, or exclude, governmental action as a force majeure event. Whether a specific type of governmental action is covered by a given contract may very much depend on the language used.

Cole: Force majeure clauses are being relied upon by parties seeking to avoid liability for their delayed or non-performance due to the impact of the pandemic. However, many such parties are likely to be unsuccessful; while the fact of the pandemic is universally known, such parties fail to recognise the need to prove or are unable to prove that COVID-19 is causative of their non-performance, thereby denying themselves available relief. Other less scrupulous parties have sought to exploit the commercial disruption caused by the disease and seized upon the pandemic as an excuse for non- or delayed performance which may in fact be due to other reasons. Typically, such parties are delaying the making of payments in order to retain cash reserves to support their own business.

Dane: Force majeure clauses are in sharp focus as a result of the COVID-19 pandemic and resulting national lockdowns and restrictions, which have meant certain parties have been unable to perform their contracts as planned. Under English law force majeure is a creature of contract. Essentially, force majeure needs to be defined in the contract as an event that can be relied on with a defined set of consequences. Typically, force majeure is defined broadly and can be adjusted to reflect the circumstances in which the contract operates, such as a contract for carriage of goods by ship may reference force majeure in the context of the perils of the sea, whereas a contract to provide electricity from the grid may have force majeure definition that is more focused on events that occur on land. In most cases though, force majeure will typically be events that are outside the parties’ control.

FW: In the event that a contract does include a specific force majeure clause, how can parties establish whether COVID-19 constitutes a force majeure event, and thus claim relief?

Zutshi: My initial thought is: how has COVID-19 specifically affected parties’ ability to perform under the contract in question? New York courts generally apply force majeure solely with respect to events of a type that are spelled out in the contract and they have interpreted catch-all provisions in force majeure clauses to capture only events similar in type to those explicitly referenced. It is therefore critical to understand what aspect of the pandemic or resulting events have affected the business operations in question. That analysis will inform both whether the contract can be fairly read to cover the specific circumstances and whether those circumstances in fact render performance impossible, or prohibitively difficult, which are generally the main hurdles to invoking relief under a force majeure clause.

Dane: It will be important to identify the scope of the force majeure clause in the contract and what the requirements are in order to be able to rely on force majeure. In most contracts there will be a defined set of consequences that apply if there is a force majeure event. There may also be a defined set of requirements in order for a party to be able to rely on the force majeure event, such as specific notice within a set time frame. Depending on the definition of force majeure it will be important to isolate the issue that is said to be a ‘force majeure’. For example, in some cases it may be that performance is not possible because of national lockdowns and there may be an argument that this is not a force majeure because national lockdowns are not an act of god. As such, identifying the problem that fits directly within the definition of force majeure will be important.

Cole: Force majeure is an event identified in law or prescribed in a contract that will release parties from their respective obligations where performance is no longer possible, and the event concerned was unforeseen. Force majeure is commonly described as an unforeseeable ‘act of god’. Whether COVID-19 is force majeure or not will depend upon the construction of the law in question or the wording of the contract. In the Middle East and some other civil law jurisdictions, relief may also be available where performance is merely more onerous to perform, rather than impossible. For example, Article 249 of the UAE Civil Code permits a judge or arbitrator to rebalance contractual obligations where exceptional circumstances of a public nature occur that could have not been foreseen cause hardship. Other available relief provides that works contracts may be terminated or cancelled where causes beyond the control of the parties arise.

Bédard: COVID-19’s impact on a business and under a contract is highly fact-specific, and whether it constitutes force majeure will depend on the language of the agreement. Parties should consider whether the underlying contract is in fact breached, whether the COVID-19 outbreak is a force majeure event excusing non-performance under the contract’s clause as written and whether notice to the counterparties is required. Parties should carefully observe any procedure the contract requires to claim force majeure or risk losing the right altogether.

FW: In your opinion, should the implications of a force majeure event depend entirely on a contract’s wording and interpretation in the context of the information available to the parties when they agreed it?

Cole: A contract should set out the rights and duties of the parties in such a way as to create legal certainty. It follows that the circumstances in which performance may be avoided should also be described. Thus force majeure events and the consequences of them arising should be addressed expressly if unnecessary disputes about respective rights and obligations are to be avoided. A contract cannot, however, be divorced from reality and the prevailing circumstances are no exception. Whether a claim is framed in force majeure or some other available relief, the necessary ‘ingredients’ for establishing the claim must be proven. For example, in January 2020, the World Health Organisation (WHO) declared that COVID-19 constituted a public health emergency of international concern. Parties contracting after the WHO’s announcement are likely to be fixed with knowledge of the outbreak and therefore unable to argue that any impact from the disease was unforeseeable unless expressly permitted by the contract.

Bédard: The implications of a force majeure event should depend on the agreement and its applicable law. Jurisdictions vary in their approach to the interpretation of agreements and may give different weight to the contract’s wording and the intent of the parties, which ties to the information available to the parties at the time the agreement was formed.

Dane: It is preferable to construe contracts by reference to the information available to the parties at the time of entering the contract. This provides the parties with more certainty as to what they are agreeing to. Defining which events will be force majeure also helps the parties with allocation of risk and pricing at the time of contracting. For example, a contracting party can decide to offset risk by taking out insurance by reference to the scope of the contractual terms agreed to without having the uncertainty that the rights and obligations under a contract could change materially if the contract is later being interpreted by reference to future events.

Zutshi: Wording and interpretation of a contract at the time of agreement is essentially the view that has been adopted by New York courts. The primary rationale for that approach – which I find quite sensible, particularly within the context of commercial contracts between sophisticated counterparties – is that it is the role of the courts to enforce contracts in a manner consistent with the intent of the parties that agreed to be bound.

FW: How do the courts in your jurisdiction tend to approach the concept of force majeure? What issues should parties consider when deciding whether to take a commercial contract claim to litigation?

Bédard: New York courts apply force majeure clauses as written, but they are narrowly construed. An event will generally qualify as force majeure only if the clause expressly includes it. We have seen numerous parties work out their relationship in the context of changed circumstances due to COVID-19. In some circumstances, however, litigation or arbitration is the only way to resolve a dispute if the parties are not able to reach an agreement. Bringing a claim is rarely a decision taken without due consideration to costs and business disruption.

Dane: Essentially, force majeure needs to be defined in the contract as an event that can be relied on with a defined set of consequences. English courts will approach the concept of force majeure in a similar way to other contract terms – it is the job of the court is to decide what the parties agreed to and the scope of the rights and obligations by reference to the wording of the contract terms. In a force majeure context, the court will be focused on whether the events being relied on fall within the scope of the force majeure terms and, if so, what the agreed contractual consequences of that are. In England, parties should always be mindful of the adverse costs risk of losing litigation and parties are encouraged to exchange information at an early stage and explore options for a commercial settlement, whether via direct negotiations or with third-party assistance via alternative dispute resolution. It is also relevant to note that in the context of the current pandemic the UK government has made clear that parties to contracts should act reasonably and should not resort to legal proceedings prematurely.

Zutshi: As a general matter, New York courts interpret force majeure provisions narrowly, and they are also typically reluctant to excuse a party of its obligations under a valid and binding contract based on related common-doctrines, such as impossibility and frustration of purpose. One threshold question to consider is whether events related to COVID-19 have rendered performance under the contract impossible. Parties seeking to be relieved from performance should know that New York courts have drawn a distinction between events that merely cause unforeseen financial hardship on a party and those that actually render performance impossible. In addition, because any evaluation of the likelihood of success on a force majeure or similar theory will necessarily be highly fact-dependent, potential litigants should be clear-eyed about the scope and burdens of discovery.

Cole: In the UAE, we have both onshore civil law courts where proceedings are conducted in Arabic and offshore common law courts where English is the prevailing language. Civil law tends to be more accommodating than common law when it comes to relief from performance. Having said that, both onshore and offshore courts will have regard to what the parties have agreed in their contract and seek to give effect to that agreement. During the global financial crisis of 2007/08, many parties that had sought relief from performance due to the consequences of the crisis were disappointed when the courts refused to treat the crisis as an event of force majeure or an unforeseen circumstance. Litigants seeking to rely on the pandemic should not assume that the courts will be sympathetic. It is of the utmost importance that parties seeking relief, either as claimant or defendant, present a robust case fully supported by evidence proving a causative link between the pandemic and the alleged impact on performance.

FW: What essential advice would you offer to parties on drafting their commercial contracts going forward? What specific lessons can we draw from this pandemic, taking into account the nature of foreseen and unforeseen events?

Cole: Forewarned is forearmed. If parties thought that economies could not be closed down by a pandemic, they need to think again and ensure that their contracts reflect new realities. Parties should take a realistic look at their contracts and ensure they provide sensible provisions for dealing with pandemics and global crises. We live in an ever-expanding global economy. Effective mechanisms must be available to both the performer and the beneficiary under a contract to deal with regional and global issues if contracting structures are to remain effective.

Zutshi: The unique questions posed by COVID-19 may or may not tell us much about what the next unexpected global crisis will be. But recent events have certainly sensitised us to the rules of interpretation that courts are likely to draw upon in evaluating claims and defences based on unforeseen events in the future. The strict construction that courts in New York, as well as many other jurisdictions, give to force majeure clauses counsels in favour of revisiting the use of ‘boilerplate’ language from existing templates. One key lesson going forward is for parties to be as explicit as possible in identifying and describing qualifying events, exclusions to those events, and any desired prerequisites to seeking relief, such as notice or diligence requirements. Legal departments engaged in this exercise may also benefit from consulting the comprehensive risk assessments that many businesses have recently conducted in light of recent events.

Dane: The pandemic brings into focus contractual risk allocation. In some sectors it may be that parties had become accustomed to operating in low-risk environments and did not always factor in the risk of unforeseen events. Going forward, parties could consider contractual provisions that set out consequences not only of a future pandemic but also knock-on consequences such as national restrictions. These may include express force majeure clauses that respond to both a pandemic and governmental restrictions that may come with it, contractual mechanisms for automatic deferral of performance and extensions of time in a defined set of scenarios, mechanisms to require parties to maintain financial reserves for critical suppliers in order to ensure ongoing performance of key contracts, and exclusions and liability limits.

Bédard: Parties drafting commercial contracts going forward should get the benefit of the tremendous learning we will derive in the coming years from cases that remain under adjudication today. Corporate drafters should involve litigators, and litigators should seek the input of corporate lawyers for their disputes.

FW: What long-term impact do you expect COVID-19 to have on commercial contracts generally? In what ways might it trigger a rethink?

Zutshi: It is certainly possible that the recent first-hand experience of unforeseen obstacles to performing even routine commercial contracts in many sectors may cause parties to focus greater attention at the outset of their negotiations on how to address issues that could impede future performance. At a minimum, it is safe to assume that parties will be far more sensitive to force majeure clauses in the near future. But only time will tell how long this attention persists and whether it results in greater focus and clarity with respect to the drafting of other contractual provisions, such as those relating to termination and breach.

Dane: The legal issues arising from the COVID-19 pandemic are not entirely novel, as in many cases it involves the consideration of well-established legal concepts such as force majeure or frustration or material adverse change, albeit to a new fact situation of a global pandemic. It is likely that in some sectors parties will be seeking to reallocate contractual risk for unforeseen events. Parties may want to include a wide definition of force majeure events, to include any event which is outside their reasonable control. They will also want any examples that are listed to be on a non-exhaustive basis, although the list should ideally include express reference to matters such as epidemics and pandemics – ‘natural event’ may not be enough in the absence of the general catch-all wording – as well as government guidance and legislation. Other concepts that might receive more focus include express obligations to act in good faith, automatic termination rights, deferral of performance and extensions of time and flexibility, for parties to adapt supply chain to changing requirements during the ‘crisis phase’.

Bédard: Risk awareness will be heightened, and risk management will be increased. We can expect parties to give more thought to circumstances in which their business may be severely impacted and how they want to manage that risk. Parties may give renewed consideration to boilerplate language.

Cole: Contracts reflect the competing interests of the parties and those most affected by the pandemic are likely to require that their future interests are protected to the maximum extent possible. COVID-19 will inevitably lead to an increase in litigation and arbitration, much like other previous crises, such as the global financial crisis. Well-informed parties will be motivated to consider how they wish their disputes to be resolved rather than slavishly adopt state court processes by default. Alternative dispute resolution (ADR) mechanisms are increasingly being recognised as offering cost and time-effective means of resolving disputes. In an international context, the ability to enforce court judgments across borders remains challenging outside of common trading areas such as the EU. Accordingly, arbitration as a confidential and flexible means of finally deciding disputes will continue to prosper due to, among other things, the ability to enforce arbitral awards in any of the 165 countries that have acceded to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards.

Rishi Zutshi’s practice focuses on complex commercial litigation, as well as securities and M&A litigation, with extensive experience in disputes relating to financial products and markets. He also has experience handling internal investigations and enforcement matters, including representing clients in matters involving the US Securities and Exchange Commission (SEC), US Department of Justice (DOJ), US Commodity Futures Trading Commission (FTC), state attorneys general, and overseas government regulators and agencies. He can be contacted on +1 (212) 225 2085 or by email: rzutshi@cgsh.com.

Tom Dane leads the finance disputes team in London. He has over 15 years’ experience of litigating high value and complex disputes with a particular focus on banking and finance disputes. In 2017, he was seconded to a large UK bank where he worked on a range of high-profile matters including a substantial remediation scheme, follow-on litigation against the bank and parallel regulatory investigations, together with more ‘business as usual’ claims. He can be contacted on +44 (0)20 7524 6829 or by email: tom.dane@cms-cmno.com.

Adrian Cole’s practice focuses on disputes relating to energy and infrastructure development. A partner in King & Spalding’s projects and construction, and international arbitration practices, he leads the firm’s Middle East dispute resolution area. He represents parties in a variety of construction and engineering matters. He can be contacted on +971 (2) 596 7013 or by email: acole@kslaw.com.

Trained in both civil and common law, Julie Bédard is experienced in conflict of laws and represents clients in connection with litigation and arbitration proceedings throughout the world, raising disputes on governing law, jurisdiction, the enforcement of arbitration agreements, extraterritorial discovery and international judgment enforcement. Ms Bédard regularly advises clients on protecting their global investments under international treaties and provides strategic advice on drafting dispute resolution clauses in international commercial contracts. She can be contacted on +1 (212) 735 3236 or by email: julie.bedard@skadden.com.

© Financier Worldwide

THE PANELLISTS

Rishi Zutshi

Cleary Gottlieb Steen & Hamilton LLP

Tom Dane

CMS

Adrian Cole

King & Spalding

Julie Bédard

Skadden, Arps, Slate, Meagher & Flom LLP

International dispute resolution

Q&A: Technology and the future of dispute resolution

COVID-19 and the types of disputes arising

Remote arbitration hearings: advantages, challenges and participant considerations

No longer a remote possibility: best practices for remote depositions in 2020 and beyond

Arbitrating post-M&A disputes: a look forward

Sidestepping ‘Morrison’ through foreign law claims and litigation

Getting ahead of the game: advocating for a proactive approach to dispute resolution

Q&A: Rethinking commercial contracts post COVID-19