13 March 202016 minute read

The age of growing viral outbreaks: key contract considerations in a world facing the latest outbreak – COVID-19 (Global)

Coronavirus disease (COVID-19) is the latest in a series of viral outbreaks that researchers predict will only increase in the years ahead.  In the last 20 years, the world has experienced SARS (2002-03), swine flu (2009), MERS (2012), Ebola (2014-16), Zika (2015), dengue fever (2016) and now COVID-19.  Each outbreak presents different challenges to the performance of existing contractual relationships, and the latest virus creates the opportunity to consider – or reconsider – some key strategies for mitigating the risks associated with these ever-increasing global outbreaks in pending contract negotiations.

In this article, we provide an overview of some of the contract issues that may be relevant as COVID-19 and other viral outbreaks spread throughout the globe.  While some of the issues may be more relevant to supply chain agreements involving the manufacturer of goods and others might have greater impact on services agreements, including outsourcing agreements, the effect of viruses like COVID-19 on overall business continuity and performance should be a priority in assessing operational, reputational and contract risks and their potential consequences and liabilities. 

Force majeure provisions

If performance of the contract is prevented, hindered or delayed due to events outside the reasonable control of a party, a force majeure provision in the agreement may be relevant to the assessment of a party’s right to suspend or, in the event of prolonged force majeure, terminate the agreement.  In common law jurisdictions, force majeure is not a doctrine applied by the courts absent a provision in the applicable agreement.  Hence, to understand the proper scope of rights and remedies, particular focus should be placed on the contractual language of the force majeure provision and the applicable choice of law.  

Many jurisdictions read force majeure provisions and force majeure events narrowly to avoid undercutting the stability and predictability of commercial transactions.  Hence, when the event giving rise to an inability to perform is specified in an enumerated list of events in the force majeure provision, courts are more likely to enforce the provision as drafted.  Where there is a list of force majeure events and a catch-all covering any other events “outside of a party’s control,” some courts will interpret this narrowly to include only similar events that are of the same general nature as those on the list.  

For example, it is not uncommon to see “diseases,” “epidemics,” or even “pandemics” listed as force majeure events, but these are often not further defined.  Furthermore, the authority for determining the existence of these types of alleged force majeure events – for example, the World Health Organization (WHO) or the Center for Disease Control – is not normally specified.  The WHO has just declared COVID-19 a  pandemic, which is generally defined as “an epidemic occurring worldwide, or over a very wide area, crossing international boundaries and usually affecting a large number of people.”  Such a declaration may increase the likelihood that a court would find the event unavoidable and allow a force majeure provision to excuse performance based on the pervasiveness of the outbreak and the low probability that an alternate means of performance in other unaffected jurisdictions would be available.  

The China Council for the Promotion of International Trade has issued over 1,600 force majeure certificates for businesses in China – a record number – that are purportedly offered as proof of the existence of an unavoidable and unforeseeable event.  It is unclear what the impact of these certificates will be in jurisdictions outside of the People’s Republic of China, but it is perhaps another example of the lack of specificity in many force majeure provisions that may open the door for parties to supply their own standard for establishing the existence of an event outside of their control.  In addition, other events identified in a force majeure provision, such as governmental action or interference, also may give a party an advantage over a counterparty with respect to force majeure relief, particularly when such party is a state-owned entity or when the government has ordered a quarantine or shutdown of operations in a particular jurisdiction such as those we have seen in several cities in China.  

For companies in current contract negotiations, we recommend a careful review of the force majeure clause in light of the COVID-19 outbreak.  The definition of what qualifies as a force majeure event should be carefully reviewed with an eye toward whether that definition should address situations such as COVID-19.  More particularly, it may be a matter of negotiation as to whether an “epidemic” versus a “pandemic” should qualify as a force majeure event.  In light of potentially inconsistent common law decisions, companies also should consider whether to make it clear in express language that the parties do not intend to impose a requirement that the alleged force majeure event be unforeseeable at the time of contracting, particularly when the event is clearly enumerated as part of the provision – and potentially when a similar or dissimilar event is outside the control of a party.

Some force majeure clauses also may include a pre-condition to invoking the clause as to whether the affected party could have prevented the non-performance through reasonable measures, including invoking business continuity plans.  The relationship of a force majeure clause to a party’s contractual business continuity obligations and potential rights of self-help or step-in should be carefully navigated and clearly articulated.  

Force majeure clauses may also include a requirement for an affected party to mitigate the effects of an event, and the extent of such mitigation efforts may be a critical component of a robust force majeure clause.  Finally, the duration of the force majeure event and specified remedies may be a focus of increased negotiation in contrast to the attention given to such provisions before the outbreak.  

For companies that have executed contracts where performance may now be impacted by the COVID-19 outbreak, any party seeking to avail themselves of a remedy of the force majeure clause should carefully review statutory and case law in the relevant jurisdictions and the express contract language that may dictate the outcome.  For example, causation is required between the force majeure event and non-performance as a party is generally unable to obtain relief for non-performance caused by other events, particularly its own negligence.  However, the degree of direct causation required may differ, and oftentimes mere increased costs or economic burden may not be sufficient.  Courts also often imply a requirement to undertake reasonable efforts to mitigate the effects of a force majeure event.  

In order for a party to avail itself of any force majeure provision, care should be given to complying with the notice provisions in the agreement and to document (i) the commencement of the force majeure event, (ii) the effects and/or “but for” causation of the event on the performance under the agreement, (iii) the efforts undertaken to mitigate the effects of the force majeure event and (iv) the resumption of performance under the agreement.  If a party declares its failure to perform under the agreement and does not take the necessary steps to comply with the requirements of the agreement related to an alleged force majeure event, such party could be exposed to a claim for repudiation of contract or an allegation that the party has admitted it is in breach of the agreement. 

In the absence of an express contractual force majeure provision, there are other avenues of relief to consider that could potentially offer a narrower form of protection.  The doctrine of impracticability could be asserted under US common law, which may provide relief where superseding events occur, the non-occurrence of which was a basic assumption on which the contract was made and it would be unreasonable or commercially senseless to require performance in light of such events.  See also, Uniform Commercial Code 2-615 (Excuse by Failure of Presupposed Conditions).  A much more difficult doctrine to establish, but one that be worth consideration in light of the government actions around the COVID-19 outbreak, is impossibility, which requires a party to establish that performance was rendered objectively impossible for any similarly situated party.  Finally, Article 79(1) of the UN Convention on Contracts for the International Sale of Goods contains similar protections afforded by force majeure provisions and may be applicable to international contracts if the UN Convention is not otherwise expressly excluded by the parties in the agreement.

Other key contractual terms  

While the force majeure provision might be the most obvious contract term that is impacted by COVID-19, several other contractual terms that typically appear in commercial, supply chain, outsourcing and other service agreements also may be worthwhile for the parties to assess or consider in pending negotiations:  

1. Ordering process.  The ordering process specified in an agreement may provide a key to navigating obligations in the event of supply constraints.  For example, if an order is deemed accepted by the supplying party (ie, the supplier) as long as the order conforms to the requirements of the applicable agreement (eg, within the appropriate lead times and forecasted quantities), the party submitting the order (ie, the buyer) will have significantly more leverage than it would under a contract where the order is not binding on the supplier unless accepted in writing by the supplier.  In the former case, the buyer can choose to force performance or, except in the case of a requirements or exclusivity arrangement, can elect to move away from placing orders with the supplier if there is an alternative supply elsewhere.  In the latter case, the supplier may have the right to simply reject orders, including so as not to place the supplier in a potential breach situation due to either (i) capacity constraints (eg, because of unavailability of personnel due to illness or quarantine) or (ii) upstream supply issues (eg, due to interruptions in service or inability to obtain raw materials or component parts).  

2. Timely delivery, notice and mitigation.  Many agreements also provide remedies to buyers in the event of supply chain or other disruptions.  For example, is the supplier required to notify the buyer in the event an anticipated shortage or delay, and does the buyer have any additional rights to require mitigation in such event as expedited shipment?  Is timely delivery of product or services (ie, a “time of the essence” clause) required?  Is the supplier able to make partial shipments, or can the buyer reject incomplete or untimely shipments and seek legal remedies?  What visibility does the buyer have to the bill of materials and vendors lists (eg, is the supplier required to provide up-to-date product allocation reports?) and what process can be put into place to ensure continuity of supply for components and materials, especially for sole source and long lead time components?  The buyer should review the agreement to determine if there are any favored customer provisions that require the supplier to provide priority allocation in the event of capacity constraint over that of any other customer of supplier, or that at least ensures that the buyer receives a fair allocation based on its proportionate share of volume ordered or some other metric.

3. Wind-down and termination assistance services.  If there is a risk the agreement may be terminated, the buyer should review the agreement to determine if it is entitled to termination assistance services or other wind-down protections that allow it to obtain assistance from the supplier in moving to an alternative provider or supplier.  Such services can run the gamut from a period of time during which the supplier is obligated to accept and fulfill product orders even following termination, including last-time buy rights, to knowledge transfer and/or license rights in manufacturing processes and tooling.  In connection with termination, what are buyer’s rights and remedies, and supplier’s liability for, components, materials, work in progress and finished goods?  

4. Disaster recovery and business continuity.  Some agreements may – and likely should – require a supplier to implement and comply with business continuity and/or disaster recovery plans (BC/DR plans) that are acceptable to the buyer.  The BC/DR plans should address how goods and services may be provided to the buyer in the case of a force majeure event.  For example:

  • If facilities are impacted, determine whether backup or alternate facilities are required for manufacturing, procurement, assembly, test, storage and warehousing activities.
  • Can workload be shifted from an impacted facility to a facility in another geography?  For example, the shutdown of a call center in China might be alleviated by shifting calls to Singapore.
  • Is the supplier required to provide alternate transportation methods; offsite storage of records and data, including design and manufacturing documentation; emergency component and raw materials acquisition; and/or replacement of tooling and equipment required for the manufacture of product?  
  • Does the inability of a software development facility in an impacted jurisdiction cause a release event to occur under a software escrow agreement?
    Is there is a detailed recovery process outlined in the BC/DR plans?
  • Do the BC/DR plans include specific recovery time objectives for when services must resume or it is considered a default or termination right under the agreement?

The agreement should clearly state the relationship between the obligations to implement BC/DR plans and the relief that may be provided under the force majeure provisions.  Relief may not be provided in circumstances where the implementation of BC/DR plans can avoid the consequences of a force majeure event and the supplier failed to implement the BC/DR plan.

For parties that are in the midst of negotiating agreements that incorporate a BC/DR plan, similar to the review, we recommend that, in the context of the force majeure clause, there should be a review of the triggering events under the BC/DR plans and ensure that listed force majeure events are, in fact, covered under the BC/DR plans.  If a viral outbreak, epidemic or pandemic is not listed, consider expanding the definition of the triggering events to include such events.  However, each situation should be carefully considered to evaluate whether a mere outbreak or epidemic, as opposed to pandemic, should be a triggering event, especially if alternative means of delivery are available for more limited outbreaks and epidemics.

5. Rescheduling and cancellation flexibility, termination.  It is also conceivable that the COVID-19 outbreak could affect the buyer’s customers or upstream OEMs and/or systems integrators, thereby requiring the buyer to adjust its demand for products.  In such event, it would be important to understand the cancellation and rescheduling rights of the buyer if it wants to cancel or delay delivery from the supplier for accepted orders.  Also, examine the termination provisions of the agreement to determine (i) whether there is any right for either party to terminate for convenience, (ii) whether a party may claim relief under termination for cause provisions and understanding the potential cure periods and notifications, including as they may relate to notice and termination rights under the force majeure provisions and (iii) the options for non-renewal, especially if there are automatic renewal provisions or you are otherwise closing in on a renewal period or notice requirements associated with a renewal.  

6. Exclusivity and other restrictive covenants.   If you are a party to – or currently negotiating – an exclusive arrangement or an arrangement that includes restrictive covenants that restrain your ability to compete or obtain alternative sources for goods or services, consider the impact that a viral outbreak or any other force majeure event may have on your operations and your ability to obtain temporary or permanent relief from any exclusivity or other restrictions.

7. Self-help and step-in rights.  Continuity of supply, whether goods, services or otherwise, is paramount to the success of any business operation.   Termination of an arrangement often is a last-resort method of relief, but one that is not without some consequences in terms of time and costs due to notice requirements, cure periods and transition costs.  Intermediate remedies such as self-help and step-in rights should be factored into your negotiations to allow a party to continue business until the non-performing party can resume performance.  Parties should not rely upon the law to necessarily provide a self-help remedy and, instead, the contract should clearly define the basis for self-help and step-in, the permitted timeline, which party bears the costs and how the parties may resume performance or ultimately terminate the arrangement if performance cannot be resumed.   Self-help and step-in rights may afford both parties some relief during any waiting period that may be required before a termination right can be invoked due to a force majeure event and, therefore, the interplay between such rights and the force majeure provisions of the contract should be carefully considered.

Understanding the potential impact of COVID-19 on your rights and obligations under your commercial, supply, outsourcing and other services arrangements that exist today, as well as those in the course of being negotiated, is critical during this time of potential disruption.  Of course, the business realities will control whether – and if so, how – those rights are asserted, including (i) the benefits of any long-term business relationship, (ii) determining when operations might resume and (iii) whether an expansion or clarification of terms to include more explicit references to either COVID-19 or its anticipated impacts should be considered to mitigate the results and impact of the outbreak, and assessing reasonable alternatives to ensure business continuity. 

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An earlier version of this appeared on Law360 on March 13, 2020.