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Writer's pictureVictoria Vieira

The Global Supply Chain Affected by COVID-19 and the Resulting Contractual Challenges


It is uncontested that COVID-19 has presented significant challenges in the supply chain globally. Multiple lockdowns at the national level have slowed or even temporarily stopped the flow of materials and goods. As a result, manufacturing has been disrupted, where outbound and inbound shipments have been cancelled, delayed, or diverted. The continued disruptions in the supply chain have consequently put many businesses in difficult positions, where they have been unable to meet their various contractual obligations. Specifically, situations have arisen where businesses can no longer perform contract terms because of supply chain challenges relating to the inaccessibility of materials and goods. Given these circumstances, then, businesses may seek relief from their agreed-upon contractual obligations.


Modern commercial agreements often have boilerplate clauses that have been given little (if any) attention until the strike of the pandemic. These contractual provisions include clauses such as force majeure. Equally, Canadian contract law has a common law legal principle known as frustration. Both force majeure and frustration deal with the legal effect of unforeseen circumstances on contractual relationships; however, they are based on different rationales – one on impossibility and the other on changed circumstances. When force majeure is provided for in a contract, it becomes unclear whether a party should rely on the force majeure clause or the legal principle of frustration; their relationship and overlap are often understood to operate in the same way. The question then becomes: which of the two (force majeure vs frustration) is the most appropriate to rely on for contracts affected by the current global supply chain challenges?


Given the fact-specific nature of each business’ situation and obligations prescribed in the contract, whether performance of a contract is impossible or whether an extension of time to complete obligations is necessary will determine which relief applies. Moreover, whether a force majeure clause exists in the parties' contractual agreement will also aid that determination.


Force Majeure

A force majeure clause is a contractual provision that operates to excuse (fully or partially) the non-performance of a party's contractual obligations or delay the obligation to perform in the circumstances outlined by the contract. Such circumstances must generally be beyond a party’s control, often considered to be an “Act of God”. The Supreme Court of Canada’s seminal decision on the subject, Atlantic Paper Stock Ltd. v. St. Anne-Nackawic Pulp & Paper Co., highlights that the clause “generally operates to discharge a contracting party when a supervening, sometimes supernatural, event, beyond control of either party, makes performance impossible”.


While circumstances triggering the provision rarely arise, the impact of COVID-19 may qualify as an event of force majeure. The qualification depends on the wording of a party's specific contract and the nature of the obligations prescribed by that contract. The precise contractual language used by the parties must be evaluated when interpreting contractual clauses of force majeure. Clauses that only list such "natural" events may also be understood to cover the COVID-19 scenario. Even if this is not the case, a typical force majeure clause may be applied to the current pandemic if it lists not only specific force majeure events, but also includes a catch-all phrase to cover similar situations (". . . and any event of a similar nature"). The Ontario case of Durham Sports Barn Inc. Bankruptcy Proposal is consistent with the interpretive principle, where courts focus on the specific wording of the clause in question.


Notably, however, the force majeure event is not the pandemic as such, but the factual or legal effects of the global health crisis. Factual effects may involve interruption of supply chains which subsequently renders the performance of a contract impossible, particularly when the supply of materials or goods are necessary for performance. Suppose COVID-19 has made a party's performance less convenient, less profitable, or commercially impracticable. In that case, that party may not be entitled to invoke force majeure. Additionally, the party seeking relief must show that their failure to perform falls under the provision and performance is truly impossible. The parties must also agree on what relief applies when the clause is triggered. This could include relief from liability or an extension of time to complete obligations.


Common Law Principle of Frustration


Within the Canadian jurisdiction, the common law principle of frustration can allow a contractual party to no longer be bound by their contractual obligations due to a notable change in circumstances (through no fault of their own) which makes performance of the contract unreasonably onerous. In contrast to the force majeure clause, frustration is a standalone legal principle, meaning that it can potentially be used in the absence of a contractual force majeure clause.


As confirmed by the Supreme Court of Canada, the threshold for establishing that a contract is frustrated is extremely high. Generally, however, a contract may be frustrated if it is demonstrated that (a) the frustrating event occurs after the contract has been formed, (b) the event is beyond what was contemplated by the parties on entering the contract and is so fundamental that it strikes the root of the contract, (c) neither party is at fault, and (d) the event renders performance of the contract impossible or radically different from that contemplated by the parties at the time they entered into the contract.


It also must be demonstrated that the supervening event, such as a disruption of the supply chain resulting from COVID-19, affects the contract's primary purpose. In the context of COVID-19, affected parties to a contract must take all mitigation measures and try to perform the contract in light of the global supply chain challenges since the threshold for frustration is so high. The courts may find that some contracts can still be performed with some changes.

Like force majeure, whether frustration applies and whether performance of the contract is truly impossible is very fact-specific.


Conclusion


Within the past 19+ months, many businesses have faced contractual issues because their obligations have been disturbed by COVID-19 supply chain challenges. While the courts have released decisions more recently, the situation is still considered relatively new to have clear directions. Parties seeking contractual relief must review their contracts to better understand their rights and obligations. Seeking contractual relief through either force majeure or frustration depends on whether there is a force majeure clause within the agreement and whether performance is genuinely impossible. If either of the two apply, a party may be entitled to relief due to non-performance of the contract.


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