Can a contract impacted by COVID-19 be lawfully terminated?

The impact of restrictions put in place to combat COVID-19 has the potential to cause substantial financial losses from unfulfilled contracts. As such businesses may wish to explore whether they are able to lawfully terminate contracts before they incur these losses.

 

Coronavirus as an unseen force

Some contracts may contain 'force majeure' clauses.

These clauses are intended to deal with events beyond the reasonable control of either party to the contract. We explore further whether a force majeure clause in a contract may be triggered by coronavirus here.

Contracts without a force majeure clause

If a contract does not contain a force majeure clause, and the impact of COVID-19 may mean either or both parties cannot fulfil their obligations under the contract, parties will need to consider termination of the contract.

It may be that the impacts of COVID-19 make a contract incapable of being performed. In this case, the contract may become frustrated. We will examine the doctrine of frustration in further detail in a separate article to be published shortly.

If there is no force majeure clause and the contract has not become frustrated, businesses may wish to exercise their right to terminate it.

Termination of contracts

Each party to a contract has a right to terminate it, if another party breaches the terms of the contract or refuses to perform its obligations.

To validly terminate a contract a party must:

  1. Have a recognised right to terminate the contract. This may include any of the following:

    • The contract contains a clause specifying in what circumstances a party can terminate, and those circumstances have occurred due to COVID-19; OR
    • One party has not performed their main obligation under the contract in time (e.g. not delivered goods or services due to COVID-19 restrictions); OR
    • One party has indicated before their main obligation is due that they will be unable to perform it (e.g. due to newly imposed or foreshadowed restrictions to combat COVID-19).
  2. Effectively exercise the right to terminate the contract. Unless specified in a clause of the contract, there is no automatic termination of contracts, even when parties are in breach of their obligations. Parties must choose if they want to terminate the contract and follow specific processes.
  3. If the contract is terminated based on a clause specifying when parties may terminate, follow the processes specified in this clause (often this will specify that the party intending to terminate give written notice to remedy the relevant breach within a certain period, before it is then able to give written notice of termination).
  4. If the contract is terminated because a party has either not performed their main obligation under the contract or have indicated they will be unable to perform a future obligation which is sufficiently serious, clearly, specifically and unequivocally communicate this termination in writing to that other party.
  5. Not have made any earlier promises that they won't terminate the contract. If such a promise has been made and the other party has relied on that promise in trying to complete performance of its obligations under the contract, it will likely now be deemed unconscionable for you to go back on that promise, in which case you may be precluded from terminating the contract.
If a party wrongfully terminates a contract this may expose it to a claim for damages.

Calculating damages

If a party validly terminates a contract, they may be entitled to claim damages against the counterparty.

Damages in contract law are designed to put parties in the position they would have been in had the contract been performed. This calculation will depend on the contract.

In general terms:


  • if a business was selling goods or services, but couldn't deliver due to trade restrictions, damages will be the difference between what they would have paid under the contract, and the market price of replacements;
  • if a person backs out of buying a property as they can no longer purchase it, damages will be the difference between what a seller would have got under the contract, and the current market price.
In a COVID-19 world of economic doubt, there may be some difficulty in finding current market prices.

It is also important to note that a party generally has a duty to take reasonable steps to mitigate its loss suffered by reason of the counterparty's breach of contract which gave rise to the right to terminate, and its damages may be reduced to any extent which it has failed in that duty.

Key takeaways

A business' right to terminate contracts is not affected by COVID-19, but the circumstances giving rise to a right of termination may be more likely to occur.

If a sufficiently serious breach does occur, and you wish to exercise a right to terminate, it is imperative that you carefully adhere to the specific processes for lawful termination.

Parties to a contract which has been terminated also need to be cognisant of the duty to mitigate damages.

McCabe Curwood has significant knowledge and experience in advising parties to contracts in relation to their rights, including their right to terminate and to claim damages for breach of contract. If we may be of any assistance in this area, please do not hesitate to contact us.

Contributors

Nathan Jones Special Counsel
Talia Mason Law Graduate