Do exceptional times call for exceptional measures? Enforcing and avoiding contractual obligations in a time of crisis in British Columbia

| 23 minutes

The social and economic fabric of British Columbia life is facing unprecedented disruption. The COVID-19 pandemic has shuttered storefronts, shocked markets, and closed borders. Public officials have asked businesses and individuals to take extraordinary steps to supress transmission, including by adopting social and physical distancing practices designed to reduce the burden on the health care system and to protect the vulnerable. These measures, and the health crisis that precipitated them, have had varying effects on businesses in British Columbia: some are facing remarkable demand for their goods and services, while others have temporarily suspended operations and closed their facilities.  

How does this time of crisis impact your business’ contractual rights and obligations? While some parties will need to take the exceptional step of activating a force majeure clause, many other contractual mechanisms and remedies are potentially available to businesses. Their pros and cons vary, so each business should consider its circumstances carefully.

Consider your objectives

Identifying your objectives is a useful first step in assessing how to handle your contractual rights and obligations in the current situation. While no business is immune to the social and economic effects of the COVID-19 pandemic, each business in British Columbia will experience those effects in a unique way. Consider the following examples of the ways in which the present situation can create disparate motivations amongst contracting parties:

  • High-demand products and services: some businesses (g., producers of medical supplies and certain consumer goods) are facing unprecedented demand during this crisis. If your business falls in this category, you will likely want to preserve and enforce existing contracts throughout your supply chain allowing access to needed materials and resources and permitting you to get your products and services to market.
  • Reduced-demand products and services: other businesses have seen demand for their products and services evaporate overnight. In the coming days, demand-side problems may be exacerbated by government orders to cease offering all non-essential services. If your business is facing this situation, you may be looking for ways to avoid, delay or modify your contractual obligations while preserving longstanding business relationships to the extent possible.
  • Conditional transactions: parties to conditional transactions that have yet to close (including M&A transactions and financing arrangements) may be anxious about the status of their transactions. Some businesses will look for ways to avoid pending transactions, while others will seek to ensure that the opposing party cannot walk away from a deal at the eleventh hour.
  • Government procurement orders: governments have a wide array of powers to acquire property and to require qualified persons to render assistance during a state of emergency.[1] Businesses ordered to support government responses to the COVID-19 pandemic may be looking for ways temporarily to delay or alter their existing contractual obligations without harming their relationships with business partners.   

Read your contracts

After establishing your business objectives, the next step is to closely review your business’ written agreements. Your contracts may have long-forgotten clauses that are suddenly germane or that you can use to help your business achieve its current objectives. Some examples include the following:

  • Consider whether your contract contains options or unexercised rights. If you are looking to scale up or scale down your operations, for example, does your contract with your supplier provide you with an option to increase or decrease the size of orders? If you are concerned about meeting a payment obligation, does your contract allow you to defer payment or receive goods on credit?
  • If you are a party to a conditional agreement, review any material adverse change (“MAC”) or material adverse effect (“MAE”) clauses in your agreements. In letters of commitment, MAC clauses may allow lenders to refuse to advance funds or (more commonly) to re-negotiate the terms of funding if there has been a “material adverse change” in the borrower’s business. In some M&A agreements, if the criteria in a MAC clause are satisfied, the purchaser may refuse to complete the transaction. MAE clauses are usually broader than MAC clauses, covering not only changes in the underlying business but also other adverse effects that may impact the loan or transaction. MAC and MAE clauses may also appear in loan agreements as an event of default, triggering a lender’s right to pursue default remedies.
  • Consider whether your contract contains a force majeure clause or other provisions that expressly allocate the risk of unforeseen events. The scope and effect of a force majeure clause depends on the language of the clause and your business’ particular circumstances.[2] If your contract contains a force majeure clause, consider the following:
    • Does the clause cover the present circumstances? The scope of a force majeure clause depends on the language of the clause and the principles of contractual interpretation. Most force majeure clauses set out a list of triggering events (sometimes including “pandemics or epidemics” or “acts of a governmental authority”) and also include a broadly-worded basket clause that covers a range of circumstances that are unforeseeable and outside of a party’s control.  
    • Has the specified impact threshold been met? Some force majeure clauses apply only if the triggering event has rendered performance “impossible”, while others contain a lower impact threshold (g., the clause applies where performance is merely “hindered or delayed” by the triggering event). In the absence of express language to the contrary, courts usually impose an impossibility threshold when interpreting force majeure clauses.
    • What is the effect of declaring force majeure? The effect of declaring force majeure will vary according to the clause’s language. In some cases, contractual performance will be paused or delayed for the duration of the force majeure In other cases, force majeure will give rise to termination rights, either immediately or after the passage of a specified period of time. The effect of declaring force majeure should be carefully considered, preferably with the assistance of legal counsel, before delivering a force majeure notice. In some cases, the immediate benefits of declaring force majeure (e.g., suspending a payment obligation) may be outweighed by the long-term costs of doing so (e.g., providing the counterparty a right to terminate the agreement after a period of time).
    • What are the process and notice requirements? Many force majeure clauses contain process or notice requirements that must be satisfied by a party that is relying on the clause—g., a requirement for prompt written notice. Parties relying on a force majeure clause often have a duty to mitigate the impacts of the force majeure event to the extent reasonably possible.
  • Look at your contract’s termination clauses. Termination clauses vary in complexity and comprehensiveness: some will set out a closed list of specific circumstances in which the contract may be terminated, while others will contain broadly-worded basket clauses that can be moulded to fit a variety of circumstances. Further, some agreements will allow only termination for cause, while others will allow termination for convenience (e., without any specific reason, usually on notice).
  • If your contractual counter-party has failed to perform its obligations, or if you are considering the potential cost of breaching an agreement, determine whether your contract has indemnification or liquidated damages clauses. While indemnification clauses are often used to guard against third-party claims, they may also impose liability on one or more parties to the agreement for non-performance or breach. Similarly, some contracts may expressly address the effects of non-performance through liquidated damages clauses that quantify damages for specified breaches.

Consider your common law, equitable and statutory options

In addition to the express clauses in your business’ contracts—or perhaps in spite of them—you may need to consider common law, equitable and/or statutory remedies that will allow your business to achieve its objectives. We expect to see the following in the coming months:

  • Parties attempting to avoid agreements by asserting rights that they do not have. For example, a party may try to terminate an agreement or invoke a force majeure clause without a valid basis for doing so. Appropriate remedies may include suing for common law damages, which are designed to place a contracting party in the position that it would have enjoyed but for the breach, and potentially the equitable remedies of injunction and specific performance. Injunctions may be appropriate where the harm caused by a breach would be irreparable; specific performance is reserved for circumstances in which the contractual benefits are unique and the loss of those benefits cannot adequately be compensated in monetary damages.
  • Parties relying on the common law doctrine of frustration. A contract is frustrated when its performance is rendered impossible by a supervening event outside the parties’ reasonable contemplation at the time of contracting.[3] The common law doctrine of frustration typically does not apply to contracts that contain force majeure The historical effect of frustration was to release all obligations after the frustrating event; in British Columbia, the Frustrated Contracts Act[4] imposes restitutionary obligations on parties that have obtained benefits pursuant to a frustrated contract.
  • Situations of anticipatory breach. An anticipatory breach arises where a contracting party, through words or conduct, indicates that it cannot or will not perform a contract. The remedies for anticipatory breach are the same as those for repudiation: the other contractual party may accept the repudiation (and sue for damages immediately) or affirm the contract (and sue for damages if and when the breach actually occurs).[5]
  • Parties agreeing to modify contractual rights, and then disagreeing about the modifications. The British Columbia Court of Appeal has held that parties may vary the terms of an agreement without fresh consideration.[6] While there are many reasons why parties may agree to modify their respective obligations during a time of crisis, businesses should diligently document any such modifications in writing. In particular, parties should turn their mind to whether the modifications are temporary or permanent and, if temporary, for how long they will be in effect. Seek legal advice before accepting or making proposals to modify your existing contractual rights and obligations.
  • Challenges to government orders and action. Businesses may receive orders to support the government’s response to COVID-19, pursuant to emergency measures legislation or otherwise. While many businesses will be able and willing to respond to these orders, in some cases the orders may impose a severe burden on a business’ operations or be difficult or impossible to comply with. In such cases, those subject to government orders may wish to challenge them through an application to court for judicial review or, depending on the nature of the objection, by challenging the constitutionality of the enabling legislation.

Seek legal counsel early

As your business navigates the uncharted waters of the COVID-19 crisis, consider seeking advice from your litigation counsel before you have an active dispute. Doing so will give your counsel an opportunity to advise you on the possible consequences of modifying, terminating, or suspending your contracts, and will give your business the best possible chance of succeeding in any litigation that may ensue.

 

[1] For more on the state of emergency and public health emergency that have been declared in BC, and the effect of those declarations on the rights of individuals and businesses in British Columbia, see www.mccarthy.ca/en/insights/articles/covid-19-can-they-do-part-iii-british-columbias-emergency-program-act-and-public-health-act

[2] For more on the nature and effect of force majeure clauses, see https://www.mccarthy.ca/en/insights/articles/impact-covid-19-contractual-obligations-force-majeure-and-frustration

[3] Interfor v MacKenzie Sawmill Ltd., 2020 BCSC 416 at para. 43, citing KBK No. 138 Ventures Ltd. v. Canada Safeway Limited, 2000 BCCA 295 at paras. 13-17.

[4] R.S.B.C. 1996, c. 166

[5] Ranisavljevic v Sathasivam, 2020 BCSC 413 at para. 96, citing Dosanjh v. Liang, 2015 BCCA 18, at paras. 33-37.

[6] Rosas v. Toca, 2019 BCCA 191 at para. 183. This rule is subject to duress, unconscionability and “other public policy concerns” that may render an otherwise valid term unenforceable.

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