Four provisions for pandemic-proof commercial contracts

The pandemic-induced recession is placing commercial contracts under the spotlights. Going forward, provisions and clauses will potentially need to be redrafted to be ‘pandemic-proof’ and align to the ‘new normal’. Ujjawal Dixit, an Associate Director at management consultancy Nexdigm, shares four key provisions of commercial contracts that should be placed under the lens.

Force Majeure and Termination

If Force Majeure events (often defined in contracts) occur for a sustained period, these give the unaffected party the right to terminate the contract. The current thinking assumes that parties to the contract have no way out other than termination. While one party is affected, the party on the receiving end may have no way out. 

In the present situation, it isn’t uncommon for both or all parties to a contract to have their business impacted, and performance of the contract becomes increasingly onerous. The question that then remains is – should an extended period of business disruption be considered and applied for all parties in the contract in addition to just the affected parties? 

Challenges beyond Force Majeure

Force Majeure is not defined in English law. Some civil codes provide an exemption for non-performance due to ‘irresistible forces’ or ‘fortuitous events’ if the event in question is inevitable, extraordinary, or unforeseeable. It is not uncommon to find a situation in which a person finds it extremely difficult, but not impossible, to perform an obligation that would not qualify as Force Majeure.

Parties define Force Majeure events in contracts based on experience, assumptions, and common industry practices. Ideally, Force Majeure should cover unforeseen events beyond a party’s control and outside their knowledge at the time of contracting. Covid-19 could potentially cause situations where it is extremely difficult and challenging, if not impossible, to fulfill a contractual obligation where Force Majeure does not apply. 

For instance, consider low to a limited spread of Covid-19 in a jurisdiction that has regardless been closed as a precautionary measure. This could impact everyday operations such as onboarding new employees, delivery delays, supply chain disruptions, etc. Do the applicable contracts cover such situations for the organisation and third parties? 

Building fail-safe options

Changes in economic or market circumstances that affect contract profitability (commonly known as commercial hardship), or the ease with which obligations can be met, are not by themselves grounds for exclusion of liability. Parties focused on business performance (rather than litigation) need to ideate new ways to handle commercial hardship contractually. 

Frustration of purpose, meaning if the underlying principle or purpose of a contract is so frustrated by an unforeseen event that it renders the contract effectively worthless to a party, such that the party may be able to avoid performance based upon the agreement. This clause should expressly feature in all commercial contracts. 

Financial clauses in contracts should include additional provisions to practically address situations like Covid-19. Some ideas worth exploring include provisions for staggered payments, payment deferrals, the extension of a payment time period, additional discounts on timely payments, and relaxation of performance on certain counts with heightened performance obligations applicable after return to normalcy. 

The right to renegotiate

Parties to a service contract should strive to envision and consider situations where a change in underlying factors could lead to pricing in the contract becoming less profitable. Commercial contracts should include provisions and clauses permitting one or more parties to renegotiate a particular bargain in the event of any change to applicable laws (as a response to a Covid-19 like situation) or market/ macroeconomic factors that make it impracticable or impossible for a party to discharge its contractual obligations. 

By including express provisions, both parties are granted the right to renegotiate pricing under challenging situations. Exercising Force Majeure, leading to termination of the contract, is not a ‘one size fits all’ solution. In a world disrupted by Covid-19, where business losses are mounting, renegotiating the contract to suit both parties should be a preferred solution that is prioritised over the termination of service contracts with vendors.