COVID-19: What you need to know
Termination of contracts
A contract will often expressly outline the circumstances in which one or more parties to the contract may terminate it. Sometimes termination rights are conditional upon particular events or actions (such as notice requirements), so it is imperative the relevant clauses are reviewed in detail and complied with in order to avoid the risk of claims arising out of repudiation/wrongful termination. Parties may also need to prove they have taken reasonable steps to mitigate their losses.
Notwithstanding the risk of repudiation and the consequent damages, it is possible in the current COVID-19 environment that parties may attempt to rely on the doctrine of frustration to terminate a contract and renegotiate more favourable terms.
Under the common law, frustration may be relied upon to discharge the obligations of the parties where unforeseen circumstances arise, through no fault of the parties, which make performance of the contract impossible.
However, this remedy has a very narrow scope, and importantly, will not apply where the change is only temporary, the circumstances were foreseen, or the event is expressly addressed in a force majeure clause.
Before terminating a contract, a party entitled to enforce their strict legal rights should carefully consider the commercial consequences and think strategically about the impact of doing so.
This may include the impact on the ongoing business relationship with the counterparty, the flow-on effects from the counterparty becoming insolvent, or wider reputational damage. It may be that an alternative option can be negotiated.
Force majeure clauses
An effectively enlivened force majeure clause can have the effect of excusing a party from performing its contractual obligations. However, the ability of a party to rely on such a clause depends on how the force majeure event is defined and the specific circumstances it is expressed to cover. The burden of proving its application rests with the party wishing to rely on the clause, and any ambiguity in this respect will be read against that party.
Broad terms such as ‘illness’ or ‘disease’ may well include COVID-19, however, this remains judicially untested at the present time. Similarly, clauses that refer to ‘acts of government’ or ‘impacts from the exercise of governmental powers’ may also qualify as force majeure events.
Interestingly, the Chinese government is said to be liberally issuing ‘Force Majeure’ certificates to certify COVID-19 as a force majeure event for Chinese companies. This is likely to mean that if the governing law and place of performance of a contract is China, COVID-19 will be validly considered a force majeure event. However, it would seem that the efficacy of these ‘certificates’ is doubtful in terms of contracts with jurisdiction clauses elsewhere in the world.
As the COVID-19 pandemic evolves, so do the cash flow and liquidity issues for businesses – resulting in widespread concern about solvency.
It is paramount for directors to remember their duty to prevent a company trading while it is insolvent or where there are reasonable grounds for suspecting that a company is insolvent or will become insolvent if the the company incurs a particular debt.
The applicable test is whether a company is ‘unable to pay its debts as and when they fall due’. A breach of this duty can result in personal liability for debts being imposed on directors.
Safe harbour provisions
Directors should familiarise themselves with the ‘safe harbour’ provisions in the Corporations Act 2001 (Cth). If, upon suspecting that a company may become insolvent, a director starts developing a course of action which is reasonably likely to lead to a better outcome for the company than entering administration or liquidation, a director can use the safe harbour provisions in defence to a claim by a liquidator that they traded the company whilst insolvent.
One of the requirements for relying on the safe harbour provisions is to obtain advice from an appropriately qualified entity. For larger companies, an appropriately qualified adviser would be a turnaround/restructuring professional skilled in the turnaround of large businesses. For a smaller company, the company accountant may suffice as an appropriately qualified adviser. Whoever is chosen, the person should be experienced enough to assist in working out whether the course of action contemplated or adopted would lead to a better outcome for creditors than an immediate appointment of an administrator or liquidator.
However, in order to invoke the protection offered by the safe harbour provisions, a company must continue to pay employee entitlements and lodge all tax related documents when they fall due.
The safe harbour applies to insolvent trading only. A failure to meet other obligations, including a superannuation guarantee or PAYG and GST liabilities, can also result in personal liability for directors and possible disqualification from acting as a director (more information on this can be found here).
Securing your interests
To secure a payment or other obligation that might not occur in light of COVID-19, business owners should consider negotiating security such as a mortgage or a general security agreement (GSA) over the real or personal property of those with whom they are in business. Although this may provide some level of comfort, if a company is placed into administration or liquidation within six months of a security interest being registered on the Personal Property Securities Register, the security interest will vest in the company and not the ‘secured’ party.
Businesses relying on retention of title security arrangements (that is, businesses who supply goods on the understanding that customers will pay for those goods at a later date) should review the arrangements and ensure
their interests are adequately protected. In particular, depending on the agreement terms, businesses which carry out multiple purchase orders may be required to register their security each time an order is executed.
Finally, don’t panic. Liquidation or bankruptcy are not the only options for struggling companies and individuals running businesses to survive the economic disruption of COVID-19.
Struggling companies and individuals should consider negotiating payment plans with suppliers or customers, undertaking a business restructure, entering into a Part IX or X agreement, or appointing a voluntary administrator.
This publication covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. It is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.