BLAME IT ON COVID-19?A GUIDE ON PERFORMANCE OF CONTRACTS THAT ARE AFFECTED BY THE PANDEMIC

Written by Levi Munyeri.

Beyond deaths and human suffering, no infamy of COVID -19 will match the mayhem that it has descended on the business world. A global pandemic of this kind is an extremely rare event that no business, small or large, can claim to have prepared for or anticipated it.[i]

Human interaction has been adversely limited by the public health emergency which has affected all businesses have been in one way or another. The level of these effects varies from one industry to another. Among the most affected businesses are manufacturing; tourism; exports & imports, entertainment.[ii]

As companies hold crisis meetings to deliberate on massive loss projections, one crucial aspect of business is left in a limbo: the fate of contracts that have been affected by the crisis and the remedies available for the parties.[iii]

1. Purpose of the Article

The purpose of this article is to guide parties to contracts that are affected by the pandemic crisis on the position of contract law on the crisis circumstances, the available legal options to affected parties and the probable consequences if the disputes are escalated to Courts.

To ensure that it is relevant to businessmen and commercial lawyers alike, the article uses basic illustrations to enable easy comprehension and practicalize contractual disputes that shall emerge resultant of the unfolding COVID-19 pandemic.

• Contracts as the foundation of all commercial activities

Almost all businesses are governed by some form of agreement between the parties involved. Most of those agreements qualify as contracts: oral or written. A phone call requesting a person to supply your shop with goods is likely to suffice as a contract.

The applicable law governing contracts in Kenya is the English Common Law by import of Law of Contract Act Kenya.[iv]

Businesses affected by the pandemic, from default by a local shop supplier to a delay in importation of goods, have a contractual aspect that can be interrogated in a Court and orders granted in favour of the successful party.

• Oral contracts

Contracts made by word of mouth create a unique scenario. For a Court to be satisfied that an oral contract exists, a party alleging it is burdened to prove its existence. Prove of oral contract includes part performance of the contract and evidence of payments. Text messages and email correspondence between parties that do not meet the formal requirements of a written contract can also suffice as evidence of an oral contract.[v]

• Consequences of the pandemic crisis to parties to a contract

The pandemic crisis affects a party depending on its role in the contracts. An example is a supply of rice contract where the supplier was importing the rice from China to supply a local supermarket. The supermarket is keen on performance of the contract to satisfy the local demand which has been excited by panic shopping.

Closure of the source port in China because of the pandemic makes it impossible for the supplier to avail the goods within the two weeks agreed period hence interrupting the business of the supermarket. The supermarket is aggrieved by the default of the supplier and experiences loss of profits. More complex is the default, if the supermarket has paid a deposit to the rice supplier. What are the available remedies for the supermarket? What available defences does the supplier have?

• Frustration of contract: definition

Frustration of Contract occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract.[vi]

In a nutshell, it is when an unexpected change of circumstances makes it impossible for a party to perform its contractual obligations.

• Core requirements to prove frustration of contract

The legal parameters for frustration of contract are as follows;

1. Applicable where performance is rendered an illegality by government orders

A change of law to render illegal and activity that was legal at the time of contracting tantamounts to frustration of contract.[vii]

The orders of the government in its frantic efforts to contain the spread of the pandemic have the force of the law. Non-compliance with the orders attracts a penalty in the form of a fine or imprisonment.

• Frustration should not be self -induced

Frustration cannot be a defence where the default is self-induced or attributed to the party alleging frustration. Where a party delays to supply goods until a lockdown is ordered is likely to fail if it pleads frustration.

A party relying on the defense of frustration may have to prove that it took all necessary steps and made all efforts to perform its contractual obligations but proved impossible.[viii] For instance, before declaration of a total lockdown, it is insufficient to plead frustration by alleging an attempt to transport the goods could have risked the health of transporters. It is incumbent upon the party to make all necessary efforts to fulfill its obligations.

• Hardships and losses not enough to prove frustration

Instances where a change of circumstances has created hardships and inconveniences for a party do not automatically qualify as frustration.[ix]

An example is where a party was to deliver goods from China. When the goods arrived at the Port of Mombasa, there was a sharp increase in clearance charges because of the pandemic hence burdening the defaulting party with extra-charges that grossly narrow its profits. The event may not suffice as frustration of contract.

• The event resulting to frustration must have been unforeseeable

For frustration to be pleaded, the event must have been unforeseeable by the parties at the time of contracting. Contracts entered after the commencement of the pandemic crisis may be excluded from the frustration plea.[x]

Such contracts are expected to have adequately addressed within its clauses the effects of the pandemic to its enforcement.

• Contract with a ‘force majeure’ clause – An alternative to pleading frustration

Force majeure is a French term whose English translation is a superior force. It is defined as an event or effect that can neither be anticipated nor controlled.[xi]

Most formal contracts have the clause to relieve parties from their contractual obligation in an unforeseeable event that makes it impossible for parties to perform their obligations under the contract. The unforeseeable events are often listed as floods, civil commotion, earthquakes, volcanic eruptions and other natural disasters.

It is desirable that the clause clearly specifies the unforeseeable events that shall free parties from all contractual liability. Failure to specifically include a pandemic or public health emergency as part of the events may be narrowly interpreted against placing reliance on an unmentioned event to plead force majeure.[xii]

However if the words ‘and any other natural disasters’ are often included at the end of list, the words can be interpreted expansively to include any other disaster like a pandemic or public health emergency.

The presence of a force majeure clause in a contract is to the advantage of the defaulting party as the clause is an alternative to the defense of frustration. Regardless of the presence of the clause, a party can still rely on frustration of contract which need not be uttered anywhere in the contract document.

• Issuance of Notice of Force Majeure or Frustration of Contract

In cases where a contract has been frustrated, it is advisable that the defaulting party gives the other party a prior notice of frustration of contract. Similarly, a Notice of Force Majeure should be issued where a contract has the clause.[xiii]

This notice enables the aggrieved party to mitigate its losses by making speedy adjustments. The notice may also be a helpful evidential document when the dispute is escalated to Court.

• The importance of clarity in government orders

An argument for non-performance of contract for reason of frustration is robust if the government issues orders with clarity and a legal sanction.

Government advisories and precautions may not be sufficient to prompt a blanket frustration of all affected contracts. To the contrary, a total lockdown may spell a blanket frustration of all contracts that require some form of movement that is outlawed by the lockdown. The frustration may be interpreted to last for only the duration of the lockdown.

What is the legal anchorage of the government orders during the pandemic? The Cabinet Secretary in charge of Health has powers under the Public Health Act to pronounce orders during a public health emergency to achieve containment of the spread.[xiv] The orders of the Cabinet Secretary hence have a legal force.

A party can claim frustration with reference to a specific government order that triggered its non-performance. A general claim of frustration founded on government efforts without pinpointing a specific order that caused the alleged frustration is likely to fall.

1. The option of mutual variation of contract – The silver bullet

The silver bullet for salvaging contracts that have been crippled by the pandemic is for parties to renegotiate and vary the contract as soon as the frustration becomes apparent. The variation of contract path is most achievable in cases where the detriment arising from the frustration is mutual creating the need for a variation to pump new life into the contract and enable it survive the pandemic crisis.

In instances where the pandemic crisis has fundamentally deformed the contract and eroded its very purpose, parties can mutually agree to terminate it on realization that it is incurably doomed by frustration. If there is any part-performance by a party, like payment of deposit, the terms of reimbursement are agreed by the parties and effected.

The most effective way of termination is by way of a termination agreement – essentially a mini-contract between the same parties to termination the mother contract. In the termination agreement, the terms of termination should be included. A properly executed termination agreement forthwith extinguishes the mother contract subject to certain legally-binding terms.

On termination of the contract, parties can wait for the crisis to subdue so that they return to the negotiating table to draw a new contract that reflex the prevailing situation. It is imprudent for parties to rush into another contract without foresight of the longevity of the crisis.

1. Where a party to a contract falls ill or dies 

An extreme consequence of the pandemic could be an instance where a party to a contract suffers from or dies of the disease.  In the ordinary course of business, the death of a party should not affect the business, as another should take it over. In a case of a company or partnership, there is an element of perpetuity as the living directors or partners continue with business as usual.

In death or illness of a person, frustration can only be invoked in a service contract where the affected person was to offer a specific service that can no longer be performed because of the death or illness of the performer. For instance, where a musician who was schedule to perform in a concert falls ill or dies, the contract stands frustrated.[xv]

In principle, the demise of persons does not extinguish their contractual obligation. In cases of satisfaction of a debt, an aggrieved party can still pursue the debt by filing a suit against from the estate of the deceased if the administrators fall short of settling the debts of the estate.

1. Where a debtor is financially incapable of paying debts

It is without doubt that the pandemic will spell financial death to some companies and persons. When the pandemic dust settles, the worst hit of companies will scamper for refugee in Courts under the law of insolvency.[xvi]

For the companies that are likely to collapse to ravages of the pandemic, an effective reaction for the aggrieved parties is to ascertain the feasibility of filing insolvency proceedings against the defaulting companies as soon as normalcy resumes. Preparations include an investigation into the assets and liabilities of the defaulting company.

1. Importance of Arbitration Clauses in Contracts

All public institutions shall be adversely affected by the pandemic crisis and its restrictions. The Judiciary is no exemption. The crippling effects of the pandemic shall be felt in the corridors of commercial justice long after the pandemic has passed.  The judiciary which is currently on a partial shutdown will resume to find an avalanche of commercial disputes awaiting it.

To avoid being caught up in some judicial crisis after the market reopen, arbitration clauses should be included in contracts entered henceforth. Whereas many formal commercial contracts include arbitration clauses, parties are at liberty to vary contacts to include arbitration clauses where it is lacking or poorly drafted.

A great advantage of contracts that have arbitration clauses; it is easier to commence arbitration processes even during the crisis period as the rules of the process can be relaxed with ease to allow smooth proceedings with minimal human interactions.

1. A guide test of determining whether to sue in Court – Checklist

Several factors should be considered before arriving at the decision to sue a party for breach of contract that COVID-19 pandemic related;

1. Whether the agreement that has been allegedly dishonored meets the qualification of a contract. Not all business agreements suffice as legally enforceable contracts.

• Whether the violation of contractual terms by the defaulting party has a direct connection with the pandemic. In essence, the orders issued by the government should have made it impossible for the defaulting party to perform its part of the bargain. If so, it is imprudent to sue as the defaulting party has a defense of frustration.

• Whether at the time of contracting, the adverse effect of the pandemic were foreseeable. This specifically touches on contracts that are entered into during the pandemic period.

• Whether the contract can be rescued by the renegotiations between parties and the willingness of the parties to engage and vary the contract accordingly to befit the prevailing situation. If there is willingness by parties, variation is a best option out of a contractual crisis.

• Whether the contract has a meritorious force majeure clause that can be invoked as an alternative to pleading frustration to cease obligations.

• Whether the defaulting company is still in a financial position to pay the aggrieved company damages if it is successful in court. If the pandemic pronounces financial death to the company, then the aggrieved party should look beyond a suit to how it can commence insolvency proceedings.

• Whether the contract has an Arbitration Clause that can be invoked to avoid going to Court where the case is likely to delay and take a much longer time to be decided.

• Whether the monetary value of the claim is substantial enough to make financial sense to approach Court and spend on legal fees. Take note that a party that is successful in Court is ordinarily awarded the costs it has incurred to litigate.

1. Available remedies when the court declares a contract frustrated

A declaration by the Court that a contract is frustrated means that the contract ceases and parties are forthwith discharged from their respective future obligations.

What happens where a party has already performed an obligation? Where payments have been made in anticipation of deliveries, should the Court order for reimbursement of the aggrieved party.[xvii]

Where there has been part-performance of obligations, the Court should order that the aggrieved party is adequately compensated for the work already done.[xviii]

1. Applicability of the doctrine of frustration in employment contracts

There are contracts that are governed by specific law legislations beyond contract law because of their legal uniqueness. Although the general principles of contract still apply to these contracts, the respective statutes governing them substantially modify contract law to customize its application. Among them are employment contracts which are governed by the Employment Act that has specific provisions dictating employer – employee relations and its termination.

The general counsel in this article is not fully applicable in the interpretation and enforcement of such specified contracts during this pandemic crisis.

1. Conveyancing transaction

Land agreements are a common formal contract.[xix] Completion of land transfers has been fundamentally affected by the pandemic crisis with the closure of the land registries and other government offices that issue the various completion documents.

Purchasers and their advocates will have extreme hardships in achieving the ordinarily ninety (90) days completion period.[xx] To rescue the land transactions from collapse for breach of contract, parties should invoke the silver bullet of variation of the contract to extend the completion date period.

Due to the prevailing uncertainty on when the crisis will end, parties should be cautious not to extent the completion date to a specific date but rather peg it on an occurrence to roughly read as follows;

The completion date shall be within two weeks after a formal pronouncement of the Government of Kenya to mark the end of the COVID-19 crisis or the time of normal resumption of services at the Land Registry and other government offices that are essential to the conveyancing process.

Without prejudice to the above clause, parties may mutually agree to proceed with the conveyancing process if the necessary completion documents are acquired before the formal cessation of the crisis as contemplated herein above.

1. Need for careful draftsmanship in contracts made during the pandemic

Contracts drafted henceforth during the pendency of the pandemic should include a specific clause to capture the intention of the parties in the event of further escalation of the pandemic.

This can be done through elaboration of force majeure clause to specifically address the fate of the contract if clogged by the pandemic.

The termination clause of the contract can also be expanded to expressly provide for automatic termination if the pandemic deepens to a level that conduct of business is rendered impossible.

1. Conclusion

Businesses are walking on a tight rope when it comes to fulfillment of contractual obligations that have been fundamentally affected by the raging pandemic crisis. The need for such businesses to be nourished with competent legal advice on how to navigate the prevailing murky legal waters during and after the pandemic cannot be underscored. A single misstep can be the fatal bullet that will ultimately kill the business. This elaborate article offers the urgently needed general guide on the matter for business owners and commercial lawyers.

*Levi Munyeri is an Advocate of the High Court of Kenya and a practitioner at Kimani, Kiarie & Associates.

NOTE that the article is for purposes of general advice and SHOULD NOT be relied upon without seeking specific legal advice. For queries and legal advice, contact the author via levimunyeri890@gmail.com

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[i] Jones. L, Brown. D & Palumbo. D (2020, March 20) BBC Coronavirus: A visual guide to the economic impact. Available at https://www.bbc.com/news/business-51706225

[ii] Cyton (2020 March 15) Impact of Corona Virus to the Kenyan Economy. https://cytonn.com/topicals/impact-of-coronavirus-1

[iii] Bracewell LLP, Contractual Performance In The Age of Coronavirus: Force Majeure, Impossibility And Other Considerations (2020, March 16) https://www.jdsupra.com/profile/bracewelldocs/

[iv] Revised Edition 2012 [2002] Sec.2

[v] Mclnnes  Wilson Lawyers ( 2016, August 31) The Enforceability of Oral Contracts. Available at https://www.lexology.com/library/detail.aspx?g=a7608568-e4a6-47ae-b123-d9cb9805ea24

[vi]Davis Contractors Ltd v Fareham Urban District Council: HL 19 Apr 1956. Available at https://www.trans-lex.org/311200/_/davis-contractos-ltd-v%C2%A0fareham-urban-district-council%C2%A0%5B1956%5D-ac-696/

[vii] Ertel Bieber & Co v Rio Tinto Co Ltd[1918] AC 260,

[viii] Karachi Gas Co Ltd v H Issaq [1965] EA 42

[ix]Tsakiroglou & Co Ltd v Noblee Thorl GmbH [1962] AC 93. Available athttp://www.e-lawresources.co.uk/Tsakiroglou-v-Noblee-Thorl-GmbH.php

[x] Edwinton Commercial Corporation and another v Tsavliris Russ (Worldwide Salvage & Towage) Ltd (The “Sea Angel”)  [2006] EWHC 1713 (Comm): 26 July 2006. Available at  https://archive.onlinedmc.co.uk/edwinton_v__tsavliris.htm

[xi] Black’s Law Dictionary.

[xii]  Tadros, Rania (3 October 2014). “Force majeure: Update in light of recent developments”. Ince & Co.

[xiii] Shearman & Sterling, COVID -19: Force Majeure Event? https://www.shearman.com/perspectives/2020/03/covid-19–force-majeure-event

[xiv] Section 13 Public Health Act, Chapter 242, Laws of Kenya, Rev. 2012 (1986]

[xv] Robinson v Davison (1871) LR 6 Ex 269

[xvi] Bankruptcy, Coronavirus (COVID-19), and How Retailers Can Brace for the Impact, (2020, March 24). Available at https://www.jdsupra.com/legalnews/bankruptcy-coronavirus-covid-19-and-how-52679/

[xvii] See the Law on Unjust Enrichment and the Law Reforms (Frustrated Contracts) Act 1943. Available http://www.legislation.gov.uk/ukpga/Geo6/6-7/40/section/1

[xviii] Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd [1942] UKHL

[xix] Land agreements must be written to be enforceable as provided under Section 3 of the Law of Contract Act.

[xx] Law Society of Kenya, Conditions for Sale [2015] Condition 8.1