20 May 2020 by and

Regulating the consequences of force majeure in your contract

The emergence of Covid-19 introduced a host of governmental directives that made it impossible for some parties to meet their contractual obligations, often leaving them scrambling for their contracts to see how this has been regulated, if at all.

Governmental directives of this nature are a typical example of what is popularly known as "force majeure" (a French term meaning "superior force"), which in general refers to an unforeseeable event or circumstance which is beyond the control of a party, and renders the performance of that party's obligations under a contract wholly or partially impossible. This term is often used interchangeably with other terms such as "vis major" or "casus fortuitus".

Sometimes parties will regulate the consequences of a force majeure event in their contract by including a "force majeure clause", and sometimes they won't. A force majeure clause would typically contain a non-exhaustive list of events which the parties deem force majeure events, including acts of God, war, riots, earthquakes, hurricanes, imposition of sanctions, lightning, pandemics, strikes, a change in law, governmental intervention etc.

In South Africa, if a force majeure clause has not been provided for in a contract, the common law concept of "supervening impossibility" applies by default.

The primary objective of both a force majeure clause and the common law concept of "supervening impossibility" is to excuse the failure of a party to perform its obligations as a result of the event. This would have the effect of shielding that party from the consequences of a breach of contract which would normally allow the other party to claim damages and/or cancel the contract.  

The concept of "supervening impossibility" does, however, not regulate the consequences any further, and thus it is advisable to include a force majeure clause in your contract so that the consequences can be regulated in more detail and in a more bespoke manner.

Adequate attention is not always given to regulating the consequences of force majeure in a contract, possibly because one does not necessarily appreciate the likelihood of the event occurring (enter Covid-19!), or because it is not always realistic or practical in the circumstances to attempt to regulate in detail a future event which by its very nature can be extremely uncertain and unpredictable.

Excused Performance

A reasonably standard, although abbreviated, version of a force majeure clause may look something like this –

"If either party is prevented from performing any of its obligations in terms of this contract as a result of any event beyond its control including war, riots, earthquakes, hurricanes…, it shall not be liable for any failure to perform its obligations while such event persists and either party shall have the right to terminate the contract if the event persists for a period in excess of 30 days."

The wholesale inclusion of a force majeure clause such as this in a contract can, however, lead to unintended consequences depending on the nature of the contractual obligations that are to be performed by the parties.

Take, for example, a manufacturer who is contracted to manufacture and supply armoured vehicles pursuant to a large purchase order, but who will not be able to meet the scheduled delivery times due to a government-imposed lockdown that occurred earlier in the year.

In this case the performance of its delivery obligations would not have fallen due at the time of the force majeure event, making it unclear whether the manufacturer could then rely effectively on a force majeure clause which seemingly contemplates excused performance only while the event persists.

In this scenario it may be more appropriate to provide that upon invoking force majeure at the time of its occurrence, the contract is suspended for the duration of the force majeure event with a commensurate extension of the delivery schedule.

Often a force majeure clause would provide that if a force majeure event endures for an extended period, the parties shall be required to meet and in good faith attempt to negotiate and agree a mutually acceptable outcome. While this type of provision can often be perceived as a silver bullet to any conceivable contractual problem, it's important to appreciate that the best that can be done to enforce something like this is to get the parties around a negotiating table, and not much more. This is because in our law an "agreement to agree" is not enforceable, and a court will not resort to making a contract for the parties.  

Alternative solutions to contract cancellation in cases where a party's supply or service obligations are prevented by force majeure may include affording the unaffected party the right to procure the goods or services elsewhere for the duration of the force majeure event. Or, the party relying on force majeure, should be required to take reasonable measures to mitigate the effect of the force majeure event, whether at its cost or on a cost sharing basis. 

With service level type contracts involving the provision of many services, it might be worth categorising the services into critical and non-critical services, with a right to terminate the entire contract only if a certain number of critical services are impacted. Alternatively, the parties could provide for certain services to be terminated, while other services are merely suspended for the duration of the force majeure event.

In an instance where the unaffected party does require a right to terminate, consideration could be given as to whether the affected party should be entitled to retain any advance payments, and/or whether a portion of any costs incurred by the affected party to date should be borne by the unaffected party.

Allocation of Risk

In some cases, regulating the consequences of force majeure is less about excusing the need to perform than it is about allocating risk.  

For example, in a lease contract the lessee's obligation to pay rent is not necessarily rendered impossible by force majeure, because the principle underlying the entitlement to relief is based on the requirement that performance of the obligation must be rendered objectively impossible and not relative to the party required to perform. Therefore, a tenant who endures financial hardship due to a force majeure event would not normally be excused of its rental obligations in these circumstances as they are subjective and relative to that tenant.

The applicability of force majeure in this instance is, however, rooted in the common law fundamentals that give rise to a contact of lease, namely that the landlord is required to provide undisturbed use and enjoyment of the property in exchange for a rental to be paid by the tenant. The reciprocal nature of these fundamentals may be disturbed by force majeure insofar as the property is rendered partially or fully untenantable, which then gives rise to the common law grounds upon which the tenant becomes entitled to claim a partial or full remission of rental, as the case may be.

A typical force majeure clause, such as the example given above, will not regulate the risk assumed by the landlord in this case, and therefore landlords will often shift this risk onto the tenant by providing in their contract that the tenant will not have a claim against the landlord for a remission of rent arising out of force majeure. In these circumstances it may be advisable for the tenant to investigate covering this risk through appropriate insurance.  

Other instances where regulating force majeure becomes a question of risk allocation would be in the context of M&A transactions. For example, parties would typically conclude a contract for the purchase and sale of a business with an extended delay between the signing of the contract and the implementation of the sale, whether due to regulatory approval processes that need to be followed or certain other conditions that need to be fulfilled in the interim.

There is then the risk of a force majeure event arising during this extended delay, and just to give you an idea of the sudden and significant value destruction in the business that could occur as a consequence, you can have a look at the year-to-date share price graph of just about any JSE listed company - the abrupt downward squiggle in the graph depicting an ominous looking precipice pinpoints the very moment that South Africa went into hard lockdown.

So while the force majeure event may not in itself render the performance of a party's obligations impossible (in this case the purchaser's obligation to pay, and the seller's obligation to deliver the business), the impact of the event may be so sudden and severe that no reasonable purchaser would want to proceed with the transaction, whether at all or on the terms agreed. The purchaser, however, remains bound by the contract.

A risk such as this is often regulated by the inclusion of a material adverse change clause (a "MAC clause") in the contract. This would allow the purchaser to terminate the contract prior to the sale taking effect if a force majeure event brings about a change in circumstances which would materially adversely affect the business being purchased.

The inclusion of a "MAC" clause will result in shifting the risk to the seller, unless the parties agree to a proportionate allocation of the risk by, for example, including some objective criteria upon which the terms of the contract can be amended to mitigate or take into account the impact of the force majeure event.      

Wrapping Up

The examples given of how force majeure may be regulated serve merely to illustrate, against the backdrop of Covid-19, the scope of consideration that can be given by contracting parties when having to contemplate this potential reality… so much so that it could even elevate the status of the often unacclaimed force majeure clause to a level enjoyed by toilet paper on the eve of a national lockdown.          

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