Managing contract risk in a COVID-19 climate

This article was first published in March 2021 by AMTIL.

With the commercial impacts of COVID-19 still fully to reveal themselves, the uncertainty this creates for manufacturers, suppliers and service providers in the construction, engineering and infrastructure sectors will likely be felt for some time.

Viewing contract risk through a COVID lens

While your options to revisit pre-existing contracts with a view to ‘COVID normal’ may be limited, learnings from the last year can and should be put to use when negotiating future dealings.

Ensuring that contracts are negotiated and drafted to account for the impacts of a global event like a pandemic should be standard practice. Whatever form the contract takes – “standard form”, longstanding in use on successive transactions, bespoke subcontract or supply agreement – it should be vetted to allow for all potential COVID-19 impacts. Indeed, at the time of writing (February 2021), Victorian businesses have just emerged from a snap five-day lockdown. The need to address these types of risks remains ever-present.

Courts and tribunals generally will not interfere with otherwise clear contractual terms, even if the agreement places one party in a far more commercially or legally onerous position than the other.

At its most fundamental, this means the objective remains:

• preserving the continuity of commercial relationships in a workable legal framework;
• minimising or overcoming unexpected interruptions to your ability to deliver on the contract, including interruption to manufacturing at your own premises or an inability to access the supply chains necessary to fulfil your contract;
• remaining alert to changes to the import and exports supply chain for required materials adopted by governments and their agencies;
• avoiding or minimising disputes about what the contract says where there is an adverse impact due to COVID-19 or equivalent pandemic; and
• maximising the chances of successful delivery on active contracts.

What should you be factoring in?

Key considerations that should influence contract negotiations and handling any associated contract disputes include:

• whether your business (or its directors) have provided corporate guarantees and the scope of the other party’s rights to call upon those guarantees, including how the underlying contractual rights are drafted;
• when performance guarantees, including bank guarantees and other security, can be claimed upon;
• what other incidental forms of security are included in your contract;
• whether there are enforceable provisions – either monetary or ‘in kind’ compensation – for any delays;
• how time for performance can be extended or accelerated to make up for any lost time;
• when any suspension provisions can be used, including how they deal with the time and cost impacts of suspension, as well as the appropriateness of the default and termination provisions (as a last resort);
• whether there is a regime for the scope of manufacture or supply to be varied outside the ordinary course of a variations regime i.e. in special circumstances of delay;
• how your programming clauses deal with extensions of time, including additional grounds for claiming extra time to complete your contract. This may help to account for:
  • directions by authorities in relation to COVID-19 that impose more or onerous provisions or restrictions than those in place when your contract was signed, and
  • direct impacts such as access to your own facilities, other suppliers or to another site.

Keeping your contract alive

If your risk allocation and performance mechanics are not set out clearly, your contract will not be as nimble as it should be and it may become more challenging for your business to overcome an event like COVID-19 without adverse consequences.

The scope of any suspension or termination for convenience clauses will be highly relevant, as will any ability of the counterparty to temporarily or permanently seek an alternative manufacturer, service provider or supplier to complete the remainder or part of the contract. Other significant risks potentially impacting upon performance include:

• the relevance of workplace health and safety clauses;
• the potential inclusion of “material adverse change” clauses or equivalent, which may give a right to renegotiate or terminate the contract prior to completion, should an event arise that is serious enough to substantially alter one or both parties’ positions. This may be linked to legislative (change of law) risk, regulatory or economic conditions;
• “force majeure” clauses. There is no automatic right to claim for force majeure – the contract must specifically provide for these grounds. Force majeure clauses drafted post-COVID-19 will need to be specific as to what events in the situation of a pandemic are foreseeable, and which are outside the parties’ reasonable control. In assessing what this type of clause should address, parties should decide on at least the following headline items:
  • is there a regime for prolonged force majeure, after an initial period? At what point can there be termination for a prolonged force majeure event, as opposed to using the force majeure clauses to “keep the contract alive”?
  • can the scope be adjusted?
  • what are the obligations to mitigate?
  • can another party be engaged (and on what basis) and what is the consequence for the original party?

There may still be a point in time at which, despite all best efforts in drafting, risk allocation and performance by the parties that your contract would be deemed to be impossible to perform. That could require parties to deal with “abandoned” imported goods no longer required for projects. Additionally, the cancellation of contracts may trigger the need for both parties to make goods and services tax adjustments.

Legal principles and legislation relating to the “frustration” of your contract ultimately may determine contractual rights and obligations, however the threshold to establish “frustration” can be difficult to satisfy.

Pitfall “sleeper” clauses

Unintended consequences also may arise if insufficient attention is paid during negotiation and drafting to the following:

• what the payment regime says about late completion or late or non-delivery;
• whether your contracts (especially if numerous with the same party or related parties) contain general “set-off” clauses allowing payments to be deducted not only if there is alleged non-performance under the contract in question, but if there are alleged to be other monies owing under other contracts or arrangements;
• whether the indemnity and liability provisions, including general liability caps and exclusions, have been given a wholesale review to account for the ‘new normal’; and
• the need to have workable dispute resolution provisions that try to maintain as much performance as possible while any dispute is being resolved.

You should also consider whether your contract does what it can, and what it should do, in light of security of payment legislation applicable to the construction, engineering and infrastructure sectors in your State or Territory. While familiarity with security of payment regimes is an industry assumption, this does not detract from the need to ensure that contract drafting and ongoing contract administration is consistent with this.

We can help

Rigby Cooke’s Construction & Projects, Customs & Trade and Tax teams include experts in construction and infrastructure, manufacturing, supply and procurement. We can provide strategies that are effective and practical guidance regarding the best way to navigate both existing and proposed contractual arrangements that are relevant to your business imperatives.