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Jun 05, 2020 | Risk Management

Worth the paper they’re written on? How COVID-19 has changed the way we see contractual obligations.

Written by Justin Simon-Shore, Western Union Business Solutions Counsel, UK and Europe

Contracts – how the certain became the unknown
Business is based to a large extent on trust. We enter into a contract and we expect it to be fulfilled or at least adhered to, whether we are buying goods, organising events or receiving a loan from the bank. The sudden and huge impact of COVID-19 on all our lives has certainly dented this trust. For some time, goods were no longer being shipped, events were cancelled, and supply chains appeared to be broken down. Aside from the uncertainty that this caused to businesses of all kinds, large amounts of money have also been lost (and made) – but by whom? For those relationships that have broken down during the crisis, there can be real financial pain felt along the entirety of the supply chain.   

In normal circumstances, when a contract cannot be fulfilled (i.e. the delivery of goods or services), there are many reasons for the supplier or service provider to work things out with the customer. Certain events happen, like fires in factories or IT outages, which should be far and few between, and the contract between the parties hopefully has the mechanism to deal with such occurrences. In service provider contracts, there are sometimes service level agreements (SLAs) and penalties set out for breaching them. Equally if a shipment is delayed for a one-off reason, the buyer may suffer but they may mitigate that loss by purchasing from another supplier.  

What we’re witnessing today are anything but normal circumstances. Early on, before the pandemic hit Europe, we started to see supply chains struggle and goods fail to reach Europe (therefore having a knock-on effect for global consumers). With the global lockdown, many contracts and obligations could not be fulfilled.  The consequence has meant that a wider range of goods and services weren’t delivered and most probably exacerbated the economic fallout. As we know, hotels and airlines weren’t able to receive customers and had to deal with refunds. Shops and restaurants were furloughing staff en masse because customers were unable to come through the door (and staff costs were quickly outweighing any sales).

Contracts which should be black and white have quickly gone grey. Even when the contract clearly states that a refund would be paid in the event of cancellation or similar, some hotels, travel companies, venues, airlines, etc. have found that when fighting for their survival, contractual terms can be interpreted in a myriad of different ways or, dare I say it, ignored.

In the UK, the legal system has a long history of giving support to the deal reached by the parties. Of course, this is nuanced when you have a David and Goliath situation, but generally English courts prefer not to introduce new terms or concepts into contracts happily entered by the parties. In this crisis , many consumers are seeking compensation and having to read the small print (perhaps for the first time) in airline contracts, hotel agreements, with travel operators and ticket sellers to confirm who assumes liability for failure to perform. 

While financial loss can be lawfully placed on the consumer in many of these contracts today, the reality is that businesses will value the custom and support after the crisis and won’t want to upset customers who may not come back after the crisis.      

COVID-19 – Force Majeure?  
Many contracts have a “get out of jail” clause to allow for the supplier of goods or services to not perform but also not assume liability. This is called “force majeure” and sits in contracts ranging from loan agreements to package holiday contracts. This term, meaning act of god, can include things like floods, famine, war, volcanic eruptions or pandemics.  Generally, it’s an event which isn’t foreseeable and can frustrate the contract.

To no surprise, businesses during the COVID-19 crisis and lockdown have had to consider whether they have a way to avoid performing contractual obligations. The truth is that the pandemic may trigger a force majeure and therefore suppliers wouldn’t be liable for non-   performance – but it’s not always so clear cut.

I am confident that triggering a force majeure will be entirely justified for a lot of businesses, but it should not be abused.  If a supplier does receive a trigger notice, the buyer should ask the supplier to explain how/why the force majeure applies and what actions the supplier has taken to mitigate the situation. Buyers shouldn’t just accept non-performance but rather suppliers should try to minimize the impact of the crisis on their customers

The way forward
We’re all looking forward to the time when the crisis will end and the world will return to business as usual - the new normal. Businesses from across sectors are hoping that supply chains will return to full capacity and that hotels and flights will eventually take customers again.

I am sure that the courts will test businesses and the underlying contracts where they have refused compensation or triggered force majeure events. What is fair and reasonable? Did the supplier seek to reduce the impact on the buyer or just do nothing?

Trust will also return. The only way our society works is through adherence to the rules, so the rules (although tested severely) should survive. While businesses have had to sometimes make up rules in times of crisis, that approach won’t always work after the dust has settled again. Commercial parties and consumers need certainty -as do the financial markets.

That certainty can be achieved once the pent-up demand is released and the contagion recedes. We will expect to see business boom again. We can hope to witness unprecedented demand for goods, services, entertainment and all the things we have been denied during the crisis.  We can expect that our business relationships will need to have some additional flexibility but maintain and respect the old contractual norms.