The COVID-19 pandemic has created an unprecedented human and health crisis.
In response, the Federal, state, territory and local governments have reacted with measures to contain the virus, which have triggered an economic downturn. Apart from creating financial challenges for SMEs, the measures may also impact the rights and obligations of parties involved in contracts.
The government has urged entities to work together towards an outcome where all parties in the supply chain and contractual agreement survive the COVID-19 pandemic, but where exactly do you stand when it comes to negotiating contractual terms?
The impact of government measures
The Federal Government has imposed restrictions on international travel, while numerous businesses and schools have been closed. Meanwhile, the Victorian government declared a state of emergency extending from 16 March 2020 until 11 May 2020 to manage COVID-19.
Government actions in isolation won’t impact the rights and obligations of the parties involved in a contractual arrangement. Rather the effect of government measures will hinge on the agreements between the parties and how the contract is expressed.
Reckoning with a force majeure
Force majeure is designed to provide relief to parties affected by an unavoidable or unforeseeable, event such as COVID-19. However, the application, operation and meaning of force majeure will vary from state to state and contract to contract.
The World Health Organisation’s declaration of a pandemic, for example, has sparked force majeure provisions for many businesses from construction companies to the National Rugby League. However, some SMEs might find there are limitations in enacting force majeure obligations. For example, some construction contracts may contain clauses which restrict the meaning of a force majeure to events preventing a party from accessing a building site. However, while COVID-19 may delay the shipment of equipment to the worksite, it won’t trigger force majeure relief because the site is still accessible.
Considerations before contractual changes
The Federal, state and territory governments are urging entities to work together to deliver relatively positive outcomes for all parties impacted financially by the pandemic. For example, the National Cabinet agreed in April to a mandatory Code of Conduct aimed at creating leasing principles based on good faith between commercial property landlords and tenants. As part of the mandate, agreed rent reductions will be linked to a tenant’s decline in turnover. This measure aims to ensure there is a sharing of the financial burden between landlords and tenants. That said, the Code still allows tenants and landlords to agree to a bespoke temporary arrangement.
While an entity such as a landlord or commercial tenant might desire a swift temporary outcome, it is sensible to plan against a backdrop of unique uncertainty. Also, predicting an endpoint for contractual changes taken now may be impossible. Outlined below are some issues to take into consideration before agreeing to temporary contractual changes – please note this is not an exhaustive list and you should seek additional legal advice.
- Repudiation of contracts – Communicating an intention not to complete contractual obligations is enough to provide the other party with an opportunity to terminate the agreement. Before acting, consider the consequences of contract termination on your business.
- Waiver of contractual obligations – Determine the contractual requirements you intend to waive and negotiate a limited amendment for those obligations you wish to preserve. By neglecting to communicate about the other party’s contract obligation, they may argue that you relinquished compliance.
- Breach of bank covenants – Changes to commercial contracts have the potential to breach the terms of a funding arrangement. Talk to your lender before making a contractual move.
- Regulatory compliance – Staying in touch with regulators before making contractual changes is essential to minimising the risk of statutory penalties.
- Government assistance – Consider whether the receipt of government assistance could impact any contractual adjustment.
Clearly, in these unprecedented times, there might seem to be overwhelming pressure to move quickly. However, taking a moment to consider the longer-term implications on your business of making contractual changes might save you from future, unforeseen challenges. Be candid about the changes you are making now and be mindful that it might be possible to make more contractual adjustments as the financial implications of COVID-19 become more apparent down the track.
If you would like assistance to navigate the contractual challenged created by COVID-19, please contact your legal adviser.
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