Business Law Blog

On February 11, 2020, the World Health Organization officially assigned the name “Covid-19” to the novel coronavirus that first appeared in Wuhan, China. Its outbreak in China (and increasingly, in other parts of the world) has caused widespread disruption in many people’s personal and professional lives. Some individuals and businesses may run into difficulty in performing their obligations under contracts that they have entered into prior to the outbreak, and many others will be interested in learning how to guard against such a “black swan” event going forward.

In contracts, the most common solution to such an unanticipated event is a force majeure clause, which allocates risks for future extreme events that are beyond the control of any party to the contract (defined as a force majeure event) and, if they occur, will affect the ability of a party to perform its obligations under the contract. The purpose of such a clause is to protect the parties from events outside normal business risk. A party impacted by force majeure may invoke the clause to avoid liability for breach of contract due to failure to perform its obligations, such failure arising from the force majeure.

Given the spreading impact of the Covid-19, we would like to offer a brief overview of the law on force majeure in Canada.

A well-written force majeure clause will address the following three questions:

1. How broad is the definition of triggering events under the force majeure clause?
2. What impact must such triggering events have on the party who invokes the clause?
3. What effect should invocation of the clause have on the parties’ contractual obligations?

We will address each of these questions below and discuss the likelihood of successfully invoking a force majeure clause due to the Covid-19.

Definition of Triggering Events

A force majeure clause typically includes both a list of specified triggering events and a catch-all phrase designed to cover events not specifically listed in the clause. Common triggering events specifically listed in force majeure clauses include:

1. acts of God, including landslides, floods, earthquakes, and storms;
2. non-natural disasters such as fires, explosions, and power failures;
3. actions of military or civil authorities, wars, revolutions, and terrorism;
4. changes in laws, regulations, orders, and embargoes;
5. organized labour activities such as strikes; and
6. epidemics and quarantines.

Parties to a contract generally negotiate the triggering events to be specifically listed in the force majeure clause based on business needs. For instance, if a party’s business operations are vulnerable to extreme weather, such party may specifically list extreme weather as a triggering event. Parties foreseeing the possibility of invoking force majeure clauses may wish to include a list of triggering events which are described in as broad terms as possible. Parties against whom force majeure clauses may be invoked may wish to narrow down the list of triggering events, and to exclude any event that would be reasonably within the other party’s control.

If a force majeure clause contains a catch-all phrase, then the phrase would raise the question of interpretation, because the list of triggering events becomes open-ended. A catch-all phrase one would typically expect to see in force majeure clauses would qualify triggering events as events which are unforeseeable and outside the parties’ control. For instance, the phrase may read as “other similar events beyond the reasonable control of the impacted party”. Due to the broad wording of catch-all phrases, whether a force majeure clause is properly invoked on the basis that an event falling within the catch-all phrase has occurred will be subject to argument on both sides.

A court in British Columbia being asked to determine whether the outbreak of the Covid-19 is within the scope of a force majeure clause will examine the contractual language and factual circumstances carefully to determine what the parties intended when they entered into the contract. If the force majeure clause specifically includes epidemics and quarantines, then the Covid-19 almost certainly is a triggering event. If the force majeure clause does not specifically include epidemics and quarantines, but has a catch-all phrase, then the court will interpret the catch-all phrase based on its plain and ordinary meaning, its relation to the rest of the clause, and the purpose of the contract as a whole to determine whether the Covid-19 would be caught under the catch-all phrase. In doing so, the court will be mindful to put reasonable limits on the application of the force majeure clause so as not to let it become an “escape clause” that easily undoes the bargain entered into by the parties.

Impact Required

If a party invoking force majeure establishes that an event is within the contractual definition of force majeure, the party must also show that the force majeure event has impacted the party’s ability to perform its contractual obligations. This can be divided into two sub-questions:

1. What is the degree of impact on the party?
2. Was the force majeure event and its impact actually the cause of the party’s failure to perform its contractual obligations?

First, when considering the degree of impact of the force majeure event on the party invoking force majeure, the Supreme Court of Canada states that the event must “strike at the root of the contract”. Therefore, a party invoking the Covid-19 outbreak as a force majeure event must establish that the impact of the virus on the party is so great that the commercial purpose of the contract is frustrated.

Second, the force majeure event has to be the event that is preventing a party from performing its obligations. A party cannot seek to be excused from its obligations when its failure to perform is caused by something within the party’s control. The impact of the Covid-19 manifests itself in various forms. The virus may directly affect people’s health and prevent them from performing contractual obligations, or it may indirectly affect people’s freedom of movement as a result of quarantines (and the quarantine itself may be a direct cause recognized in the force majeure clause, merely as a quarantine or as the action of a civil or military authority). Much of the impact of the Covid-19 is economic in nature, relating to disruption of consumer and supplier activities. It will be more difficult for a party to invoke the Covid-19 as force majeure if the impact claimed by such party involves an inconvenience one would encounter in day-to-day business (such as higher operating or financing costs, temporary revenue or cash flow problems, or depressed market sentiments). Since such party will likely have less success in claiming that such inconveniences are outside normal business risks, a court is unlikely to find that such economic inconveniences prevent a party from performing its obligations.

It is uncertain whether a court would find that the Covid-19 is the cause of a party’s failure to perform its obligations when a party chooses to stay home out of precaution, even though it is possible for such party to travel outside the home and perform its contractual obligations. Arguably, such a party can avail itself of precautions when travelling, and is not prevented by a third party from travelling, and as such should not be allowed to rely on its own choice as force majeure.

Given the wide range of situations in which parties may invoke the Covid-19 as a force majeure event, answering whether or not the virus has impacted the party’s ability to perform its contractual obligations will be a fact-dependent analysis.

Effect of Invoking Force Majeure

Prior to entering into a contract, parties are free to negotiate what procedure to follow and which rights and obligations parties have upon the invocation of a force majeure clause. In a typical contract, notice is generally required from the invoking party to the other party. The terms of the notice provision must be strictly followed to give effect to the invocation of such a clause.

Once notice is given of the force majeure event and it is determined that the event falls within the force majeure clause and has impacted the party’s ability to perform its contractual obligations, depending on what is contemplated in the force majeure clause, the obligations of the invoking party may be entirely discharged, partially excused or simply delayed into the future.

We also note that the party invoking a force majeure clause has a duty to mitigate against the effect of the force majeure event. The party must do what is commercially reasonable and feasible to help limit the losses suffered by the other party to the contract.

In situations in which the performance of a party’s contractual obligations is impacted by the Covid-19, depending on the content of the force majeure clause in the contract, the party may find a workable solution either through a temporary suspension or partial performance of its contractual obligations. Such a party should also take advantage of available technologies or resources to mitigate the consequences of invoking a force majeure clause on the other party.

Summary

A party to a contract seeking to invoke the Covid-19 as force majeure must first demonstrate that the Covid-19 qualifies as a force majeure event in that particular situation under the force majeure clause. Second, the party must show that the Covid-19 has impacted the party’s ability to perform its obligations under the contract. Third, the force majeure clause, if well-drafted, should specify the effect of force majeure on the parties’ contractual obligations. Parties seeking to invoke the Covid-19 as force majeure should also keep in mind that parties whose performance of contractual duties is impacted by force majeure still have a duty to do what is commercially reasonable and feasible to help limit the losses suffered by the other party to the contract.