The extensive social and economic disruptions brought about by the COVID-19 pandemic have severely hindered individuals and businesses from performing their contractual obligations. Given the unforeseen nature of the COVID-19 situation, parties at risk of defaulting are understandably aggrieved and at a loss at the prospect of having to pay damages or forfeit deposits. Recognising these difficulties, the Singapore government passed the COVID-19 (Temporary Measures) Act (the “Act”) on 7 April 2020.
In summary, the Act seeks to offer temporary relief to businesses and individuals who are likely to have been hit hardest by COVID-19, by alleviating the risks of them being unable to fulfil their contractual obligations.
The Act will prohibit a contracting party from taking certain legal actions against a defaulting party, including the commencement of court and insolvency proceedings. However, the Act only covers certain types of contracts prescribed by the Act, and only applies to contracts entered into, or renewed, before and inclusive of 24 March 2020.
Commercial contracts not covered by the Act
One notable omission from the scope of the Act is commercial contracts (at least, those not covered by the Act in other ways, such as being in connection with construction work, events, or tourism etc.). As the pandemic situation evolves, these companies have had mixed fates.
On one hand, certain companies have been adversely affected. For example, companies that produce IT hardware such as chips and processors have been hit hard due to supply chain disruptions. These companies may find themselves at risk of defaulting on their contractual obligations.
On the other hand, given the sudden surge in demand for telecommuting capabilities, med-tech, and online services such as food delivery, certain tech providers are experiencing a boom in business. These companies may find themselves entering several new contracts for the provision of such goods and services.
We set out below some of the more pertinent issues which companies could consider to better manage the risk they may face under their existing contractual obligations.
Existing contractual arrangements
Negotiating an interim arrangement / varying the contract
Before at-risk businesses start considering the termination or suspension of contractual obligations via force majeure clauses, it may be helpful for parties to first consider negotiating an interim arrangement until the situation improves. This is especially relevant where both contracting parties have been adversely affected by COVID-19.
For greater certainty, the interim arrangement could be formalised by entering into a supplemental agreement or an addendum to the existing contract.
Force majeure
Most commercial contracts are likely to contain force majeure clauses. These clauses typically allow parties to suspend or terminate contractual obligations when their performance of these obligations is affected by an extraordinary event or circumstance beyond their control.
There are three aspects to consider: (1)whether the clause covers the present situation; (2)how the clause should be invoked; and (3)how the respective obligations of the parties will be affected moving forward.
All three aspects are dependent on how the clause is worded.
- Is COVID-19 considered a force majeure event?
Whether a party can rely on force majeure clauses depends on how the clause has been drafted. Force majeure clauses are typically drafted by providing a general definition of a force majeure event, and by listing specific examples.
The simplest scenario is where the clause lists specific force majeure events that include reference to an epidemic or a pandemic. The clause may also refer to laws or regulations introduced by governments. This may be relevant where governments have introduced travel restrictions or trade embargoes, and these measures have affected performance of the contract.
If none of the events specified are relevant, parties will have to rely on the general definition of the force majeure event and an interpretation of the clause. One of the more common definitions would refer to the inability of a party to perform its contractual obligations due to an event or circumstances beyond that party’s reasonable control. It will then be up to the affected party to prove that it is indeed unable to perform its obligations, and that this was caused by circumstances that were beyond its control.
- Invoking the force majeure clause
Affected parties cannot assume that the force majeure clause would be automatically invoked, and should act in accordance with the requirements for invoking the force majeure clause as specified. Most clauses typically require the affected party to give the other party written notice.
- Effect on parties’ obligations
This is again dependent on how the clause has been drafted. Typically, the affected party will be excused from its obligations or liability under the contract for a certain period. This may continue until the situation is alleviated. In other cases, if the situation continues for a specified time period, either party may be allowed to terminate the contract.
Frustration
Under the common law, a party may seek to terminate a contract that, without the fault of either party, has become impossible of performance or been otherwise frustrated (i.e. incapable of being performed due to an unforeseen event). Thus, where the contract does not provide for force majeure, the affected party may have to consider relying on the doctrine of frustration. This involves proving that an external event beyond the control of parties has caused the contract to be impossible to perform, or it has transformed the performance of the contract into something fundamentally different from parties’ initial expectations.
However, resorting to the doctrine of frustration should be left as a last resort. This is because the bar for establishing frustration is a very high one.
New contractual arrangements
Fortune may be smiling on businesses currently benefitting from the COVID-19 situation. However, business owners must be conscious of the volatility and uncertainty that come with it. They cannot assume that this boom will continue indefinitely, and must take into account possible future changes for the better or worse in negotiating new contracts.
Adjusting obligations according to different scenarios
Most force majeure clauses can only be called upon when performance of the contract would be impossible or near-impossible. The reality is that there are many degrees of severity in between full performance and near-impossible performance of the contract. It would be ideal for parties to tailor the degree of their obligations according to developments in the COVID-19 situation.
Thus, parties can stipulate certain obligations to be varied in the event something occurs, taking into account how various governments have reacted to the COVID-19 situation.
For example, in Singapore, the government has implemented a set of “circuit breaker” measures, but has stopped short of imposing a full lockdown, as several countries have. Parties may consider providing for how their obligations may be varied in the event the government imposes a curfew, or if the list of essential services currently allowed to operate gets cut down even further. This can also be considered from the other perspective of a future relaxation of restrictions.
In either case, it would be prudent to keep these provisions fluid, given the possibility that things may worsen again even after the situation improves, and vice versa.
Service levels and service level reliefs
Contracts for the provision of services typically stipulate for varying service levels in defining key performance indicators for the performance of the contract.
Providers may wish to temper service level metrics while the situation remains uncertain, for example, by reducing minimum service thresholds. Alternatively, providers can consider negotiating for service level credits to be waived when certain events occur.
Consider exposure of third-party risks
This issue is pertinent where a service provider’s contractual obligations are reliant on the performance of contractual obligations by third party suppliers of products or services.
With the ever-changing landscape of social and economic measures, providers should be cautious and anticipate potential supply disruptions. For example, having to change suppliers in the middle of a contract may cause an increase in costs. Service providers can consider an apportionment of these costs between parties where the increase is too significant.
Commercial contracts also typically provide that service providers are to indemnify customers against losses caused by its third-party suppliers. Given the uncertainty and the possibility of default by its third-party contractors, service providers may also wish to negotiate for these indemnities to be removed or watered down.
Conclusion
Whichever way a business looks to navigate their contractual arrangements with the measures in place, they must remember that the Act is only a temporary measure to allow parties the space to negotiate a variation of contractual obligations affected by COVID-19. It does not completely absolve the affected party from fulfilling its contractual obligations. Once the temporary measures are lifted, the existing contractual obligations will resume unless the parties have successfully negotiated and agreed to a variation of their contractual obligations.
