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The pandemic has put many contractual relationships under immense pressure. We explored in our last Business as (un)usual article here some of the problems which contracting parties may have inadvertently created for themselves when attempting to resolve urgent contractual performance problems or offer a counterparty some breathing space in the pandemic.
In this article, we examine some of the key themes we are currently seeing in fresh contractual negotiations. Having been tested under pandemic pressure, parties are keen to ensure that new commercial arrangements can be changed with ease and speed, or that they can relieve themselves of contractual obligations when performance becomes impossible or commercially unviable.
Rethinking variation of contractual terms and exit routes after Covid-19
Force majeure provisions were firmly in the spotlight last year, as parties scrambled to find a means to manage and allocate costs for delays to performance or total non-performance of contractual obligations. Many (suppliers in particular) found themselves in challenging positions, often facing situations where performance was not impossible, just more expensive and complicated. In many instances, force majeure provisions were not drafted to cover the consequences of Covid-19, often leaving parties no legal right to stop performing.
Key points that should be considered when drafting or reviewing force majeure provisions going forward include:
- Covid-19: do you want to exclude Covid-19 as a Force Majeure Event (“FME”) on the basis that parties should now know the impact that any Covid-19 related restrictions will have and should have adequate (and tested) contingency plans in place? Or, is it preferable to include a separate Covid-19 provision that specifically addresses the steps that should be taken in the event Covid-19 impacts a party’s obligations? A trend we are starting to see, is for contracts to include details of the measures taken by the supplier at the height of the pandemic in 2020 to handle the disruption and continue performance (to the extent possible). Whilst this is usually framed as a non-binding provision and does not oblige the supplier to replicate these measures, it does provides customers with some comfort that the supplier has implemented appropriate work-around procedures.
- Material adverse change (“MAC”): increasingly we are seeing parties include a separate MAC clause to provide a simpler way for the commercial deal to be changed, without having to trigger force majeure provisions. For example, a MAC clause could enable a customer to vary the type or volume of goods/services required and a supplier to seek a price adjustment to reflect rising costs or changes to service levels. Of course, this increased flexibility should be weighed against the increased uncertainty as to how the contract will be performed (e.g. the overall cost of the contract to the customer – although a cap on the increase of costs could be negotiated).
- Defining a FME: as well as ensuring ‘pandemic’ and ‘epidemic’ are included within the definition, consider whether other risks such as cyber security incidents or wider government intervention should also be included.
- Impact of the FME: it is worth reassessing the sort of rights you might you want in the event of an FME (e.g. termination, suspension or an ability to appoint an alternative supplier whilst the contracting supplier is affected).
- What should trigger these rights? – does performance need to be prevented entirely or (if acting as a supplier) is it sufficient that performance is just made more difficult or unprofitable?
Termination rights are always a hotly contested area of contractual negotiations. The impact of Covid-19 on businesses has shown the importance of clearly drafted termination provisions, to ensure that parties are certain when they have a right to terminate agreements and the process that must be followed. The key themes we are currently seeing in negotiations of termination provisions are:
- Shorter terms – generally, parties are requesting shorter fixed initial terms to preserve greater flexibility. We expect this trend is likely to continue, especially as the UK furlough scheme comes to an end on 30th September 2021 and the economic landscape remains uncertain.
- Termination for convenience – we are seeing (even more!) pressure from customers to agree rights to terminate for convenience, again to ensure greater flexibility in financial commitments.
- Early termination fees – in exchange for agreeing rights to terminate for convenience, more businesses are requiring early termination fees be paid if termination rights are triggered.
Looking past negotiations and forward to the end of a contractual arrangement, it is vital to ensure that your agreement includes a clear process for how a party serves notice to terminate. The termination process must be carefully followed, to avoid the counterparty claiming repudiatory breach if they can show the agreement was wrongly terminated (see the recent case of CIS General Insurance v IBM where this happened). Often losses for repudiatory breach fall outside any contractual caps on liability, so not following the correct notice procedure could be a very costly mistake.
Insolvency – impact of the Corporate Insolvency and Governance Act 2020 (“CIGA”)
CIGA came into force on 26 June 2020 and is targeted at managing the huge fall-out from the UK-wide lockdown in addition to implementing some measures that had been under legislative consideration for a number of years. As a recap, the key developments of CIGA were:
- the introduction of two new protective procedures for companies - the moratorium and the pre-insolvency restructuring plan. These can be used by companies in financial difficulties to achieve a breathing space in which to continue to trade prior to insolvency; and
- the suspension of a supplier’s contractual right to terminate a supply contract or “do any other thing” if a customer becomes subject to a relevant insolvency procedure. So far, we have seen the prohibition on doing “any other thing” discussed in the context of price variation.
Since CIGA’s implementation, many clients have reviewed existing contracts to check the scope of termination rights for insolvency and whether the provisions could extend to the two new insolvency procedures brought in by CIGA. Key strategies we are seeing clients consider in light of CIGA:
- Inclusion of additional termination triggers to widen the ambit of the insolvency termination rights and provide a right to terminate earlier e.g. on breach of a financial covenant, or by permitting termination by the supplier upon a threat of customer insolvency or inability to pay bills.
- Requiring a right to terminate for convenience, again to ensure that there is a means to terminate the agreement earlier if necessary.
- Additional audit provisions to enable more frequent monitoring of the counterparty’s financial health. For suppliers this is particularly important to ensure that they have advanced warning if the customer may be in financial distress.
- Restructuring of payment models to require upfront payments and/or shorter periods of payment.
While many businesses have continued to function throughout Covid-19 and generally taken heed of the government guidance around not strictly enforcing contractual rights, we have seen litigation arise as a result of increased costs and a dramatically different performance landscape.
Where contracting parties have sufficient commercial leverage, they should carefully consider the above key factors when negotiating new contracts in order to try and avoid litigation. In addition, they should ensure that they are adequately entitled to enforce the terms of the contract through court or arbitral proceedings in a timely manner. For example, we would generally advise on a right to fast-track any contractual dispute resolution negotiation procedure and apply for emergency injunctive relief if necessary.
- P&O Princess Cruises International Ltd v Demise Charterers of the Columbus.
P&O Princess Cruises International Ltd v Owners and/or Demise Charterers of the Vasco de Gama.
Also known as: Port of Tilbury London Ltd's Claim for Port Dues, Re  EWHC 113 (Admlty)
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