Contracting During a Pandemic: Strategies to Minimise Negative Impact
This article discusses how contracting parties may mitigate the negative impact of infectious disease outbreaks on their pre-existing contractual obligations, through the appropriate use of risk allocation, choice of law, and dispute resolution clauses. It considers the implications of the Singapore Court of Appeal decision in Ricardo Leiman and another v Nobel Resources Ltd and another for provisions for monetary payment in force majeure clauses, as well as the potential use of “springing” choice of law clauses that take effect upon the enactment of legislation which could otherwise affect the relevant contract.
We live in trying times. The novel coronavirus better known as COVID-19 continues its rampage around the globe, crippling economies and reshaping behaviour in fundamental ways. Relevant beyond the present crisis is the question of how to minimise the negative impact of similar crises on future contracts. This article examines three kinds of clauses through which this may be done: force majeure clauses, choice of law clauses, and dispute resolution clauses.
Why Parties Are Best Placed to Save Their Own Contracts
Before examining the abovementioned three types of clauses, it is relevant to consider why parties should not look principally to ad hoc legislative intervention or the common law (principally, the doctrine of frustration) to maximise the chances of generating reliable and predictable solutions during a pandemic.
Several jurisdictions have enacted legislation impacting pre-existing contractual obligations. For instance, Singapore’s COVID-19 (Temporary Measures) Act 2020 (Singapore COVID-19 Act) was passed on 7 April 2020 and remains valid for six months in the first instance. This statute imposes a legal circuit-breaker that holds the strict enforcement of certain legal rights temporarily in abeyance, in respect of several specified categories of contracts where the inability to perform was to a material extent caused by COVID-19. France has similarly intervened via Ordinances No 2020-306 of 25 March 2020, No 2020-427 of 15 April 2020 and No 2020-560 of 13 May 2020 (the French Ordinances). Under the French Ordinances, the operation of cancellation clauses, liquidated damages clauses and acceleration clauses is suspended. If these clauses would otherwise have taken effect anytime between 12 March 2020 and 23 June 2020, they will only bite after a period equal to the duration of contractual performance that has been impacted by the measures resulting from the state of health emergency.1*The article is written in the author’s personal capacity, and the opinions expressed in the paper are entirely the author’s own views.C Cavicchioli, “Covid-19: Impact on commercial contracts – France”, Linklaters, 9 April 2020, <https://www.linklaters.com/en/insights/publications/2020/march/novel-coronavirus-commercial-contracts/novel-coronavirus-impact-on-commercial-contracts/france>.
The principal advantage of legislation is that it can prescribe clear cut-offs, to avoid the conundrums that may arise from relying on common law doctrines to resolve disputes. What counts as a “pre-existing” contractual obligation is dealt with straightforwardly under the Singapore COVID-19 Act, with the statute applying only to prescribed contractual obligations that are to be performed on or after 1 February 2020, for contracts that were entered into before 25 March 2020.2Which date the Minister for Law explained as applying because the Ministry of Health had imposed stricter regulations a day earlier, so parties who entered into contracts despite having knowledge of these facts should not be given recourse under the statute: Singapore Ministry of Law, “Second Reading Speech by Minister for Law, Mr K Shanmugam, on the COVID-19 (Temporary Measures) Bill”, 7 April 2020 at (70). In contrast, the common law doctrine of frustration demands analysis of whether a certain occurrence was “foreseeable”, which is comparatively messier and requires one to consider the parties’ specific circumstances and state of knowledge. Depending on what, precisely, is relied on as the frustrating event, complexities may also arise as to whether it is the occurrence of the disease, its escalation to pandemic or epidemic status, or the imposition of government regulations that must be foreseeable.
However, there are several downsides to relying principally on legislative change to determine the fate of pre-existing contractual obligations. There can be no guarantee that the legislature will enact provisions that deal with one’s case or, indeed, enact any legislation at all in a timely manner. Statutes may also paradoxically generate even more litigation over what consequences should apply to the affected contracts, if they are unclear, conflict with other statutes or doctrines without specifying a hierarchy of application, or are otherwise poorly drafted (a non-negligible risk given the tight timeframe within which such “emergency” ad hoc legislation is typically enacted). Finally, statutes may suspend but not otherwise modify existing obligations. Upon expiry, contractual rights and obligations revive and recourse must eventually be had to whatever regime was in place before the temporary statutory consequences kicked in.
Turning then to the doctrine of frustration, this is not only difficult to invoke but also comes with potentially unsatisfactory consequences. The prevailing attitude, evinced in The Nema, is still very much that frustration should is “not lightly to be invoked to relieve contracting parties of the normal consequences of imprudent bargains”.3(1982) AC 724 at 752. Thus, parties cannot count reliably on frustration to discharge contracts that have become unfavourable to perform. Moreover, the consequences of frustration, whether at common law or under legislation such as Singapore’s Frustrated Contracts Act,4Cap 115, 2014 Rev Ed. are fairly rigid, compared to the variety of options that parties can contractually provide (eg, suspension of obligations, obligation to renegotiate).
The Contractual Solution
Parties may include at least three kinds of clauses in their contracts to minimise uncertainty: risk allocation clauses, choice of law clauses, and dispute resolution clauses.
Force Majeure and Similar Clauses: Allocating Risk Beforehand
Parties may contractually provide for specific outcomes that should follow in particular situations. Such clauses are commonly referred to as force majeure clauses, which are “no more than a convenient way of referring to contractual terms that the parties have agreed upon to deal with situations that … might impede or obstruct the performance of the contract”.5Magenta Resources (S) Pte Ltd v China Resources (S) Pte Ltd 1996) 2 SLR(R) 316 at (60). The law permits parties a granular degree of control for parties to pre-emptively provide for what should happen, by, amongst other options: (a) specifying what level of disease outbreak (if any) they would like to trigger the clause, whether a pandemic or epidemic or pegging the determination to a decree issued (eg, designation by the World Health Organisation of an event as a pandemic); (b) the level of impact required, such as “hindrance”, “impediment” or “prevention”; (c) the degree of causal connection required, such as being “materially impacted”, or the “dominant cause” or merely “a cause” of non-performance. Parties are also free to specify, with an eye to their particular circumstances and the type of force majeure event at hand, the consequences that follow on the occurrence of a force majeure event.
A question, however, may arise as to whether and if so when liquidated damages will trigger the rule against penalties. The relationship between primary and secondary obligations and the penalty rule was recently recapitulated by the Singapore Court of Appeal in Ricardo Leiman and another v Nobel Resources Ltd and another (Leiman) as follows:6(2020) SGCA 52 at (100).
… the court will give effect to the intention of the parties and hold them to their duty to perform their primary obligations under their contract. The corollary of recognising the parties’ freedom of contract is that the law also allows them the freedom to change their mind and break their contractual undertakings if they so wish, albeit at a price. To address this, the common law imports into contracts a secondary obligation to pay compensatory damages to remedy breaches of contract. … Where a clause imposes a stipulated consequence following a breach of contract by one party, and that consequence, in the opinion of the court, is not reflective of the innocent party’s interest in being compensated but is in fact stipulated in terrorem of the contract-breaker, that clause will be regarded as an unenforceable penalty clause.
While it is uncontroversial that the rule against penalties applies only to secondary obligations, the determination of whether an obligation is a primary or secondary one is not always straightforward, as the facts of Leiman illustrate. This case concerned a dispute between a company’s former executive and the company regarding the terms of his departure. At issue, amongst other things, was a clause 3(c) that entitled the executive to exercise share options “provided that prior to exercise he has not acted … to the detriment of [the company]”. A committee of the company was to “make a final determination in the event of any dispute”. The question was whether the clause should be construed as a primary obligation that the company undertook to grant the executive the right to exercise his share options subject to certain conditions, or a secondary obligation on the executive’s part to forgo his share options if he breached his primary obligations.7Id, at (109).
The Court held that the determination of whether a given clause imposed a primary or a secondary obligation should be approached as a matter of substance rather than form. Relevant considerations included the overall context in which the bargain in the clause was struck; any reasons why the parties agreed to include the clause in the contract; and whether the clause was entered into and contemplated as part of the parties’ primary obligations under the contract in order to secure some independent commercial purpose.8Id, at (110). Applying this test, the Court concluded that clause 3(c) imposed a primary obligation. The parties’ e-mail correspondence made clear that clause 3(c) embodied the parties’ bargain for the executive to “exchange one set of entitlements for another”, in return for being a “good leaver”. This view was bolstered by how the assessment by the company’s committee (as required under the clause) of detriment would focus on whether the executive had caused commercial detriment to the company, as opposed to him breaching his contractual obligations.9Id, at (112).
Transposed to the context of monetary payment prescribed by a force majeure clause, the Leiman principles suggest that parties should take care in relation to the following if they wish for the clause to be regarded imposing primary obligations (and hence avoid scrutiny of the proposed payment under the penalty rule).
- In terms of form, the language of damages and breach is best avoided. For example, inherent in the following clause is that deviation from the agreed delivery date is prima facie a breach – the wording of “damages” points to a resultant secondary obligation: “For every day beyond the agreed delivery date for which delivery is delayed, seller shall pay buyer damages of $1,000.”
- In terms of substance, to avoid non-compliance with the contract being construed as a breach, the monetary payment provision could be prefaced by a modification clause, such as: “In the event of delay caused by an infectious disease outbreak, the parties agree that the seller shall be allowed to extend the agreed delivery date in exchange for payment to the buyer of a sum of $x per day”. If so, the clause is more likely to be construed as, in substance, the parties’ agreement to exchange one set of rights and obligations for another.
“Springing” Choice of Law Clauses: Minimising Surprises
Bearing in mind the inter-jurisdictional variations in legislative response and substantive doctrine, it is worth considering the extent to which parties may pre-empt the application of those statutes through an appropriately-worded choice of law clause. At the time of contracting, parties could choose a law for their substantive obligations that they believe and expect to generally be “pro-contract” and more deferential to party autonomy. Beyond this, however, how far can parties agree that the governing law should change after the fact?
The case of Astro Venturoso Compania Naviera v Hellenic Shipyards SA (The “Mariannina”),10(1983) 1 Lloyd’s Rep 12. though unrelated to the pandemic context, is illuminating. It involved an arbitration clause in a bill of lading that had what I will term a “springing” choice of law clause:
Any claim and/or dispute arising under this Bill of Lading shall be referred to arbitration in London pursuant to English Arbitration Law … but if for any reason it is ruled by a competent authority that the … arbitration provision is unenforceable then any claim and/or dispute … shall be governed by Greek Law and solely decided by the competent Greek Courts …
The English Court of Appeal held that although it was unusual for a clause to provide for two proper laws, one to be applied in one event and another if that event did not occur, there was “sound commercial sense” in a fall-back provision of this sort.11Id, at (15).
While the common law has traditionally be reluctant to accept “floating” choice of law clauses of the likes of those in Iran Shipping Lines (The “Iran Vojdan”)12(1985) 2 Lloyd’s Rep 380. on the ground that contracts (being creations of law) cannot exist in a legal vacuum, no such problems should arise in situations where parties agree to change the governing law after formation. As has been convincingly argued, if parties are entitled to choose the governing at the outset, why not when it is made later?13See DG Pierce, “Post-Formation Choice of Law in Contract” (1987) 50 MLR 176 at 194. The “springing” choice of law clause poses no logical difficulty because there is no void – all it does is to provide for a change in applicable law from that initially chosen in the contract, upon the occurrence of a specified event.
In the pandemic context, that event could potentially be the promulgation of legislation that would otherwise affect the contract. Assume for instance that a contract for event photography is initially governed by Singapore law and a deposit has been paid. Under the Singapore COVID-19 Act, such a contract is an event contract for which the deposit may not be forfeited. But given that this statute applies only where the contract is governed by Singapore law, a “springing” choice of law clause could potentially change the governing law and allow for forfeiture, with the mode of operation paralleling that in TheMariannina. The spring is sprung upon suspension or unenforceability of certain obligations under the initial choice of law.
How likely is such a clause to be upheld? In the Singapore context, Peh Teck Quee v Bayerische Landesbank Girozentrale (Peh Teck Quee) holds that an express choice of contractual proper law will be upheld unless it is not bona fide, not legal, or contrary to forum public policy.14(1999) 3 SLR(R) 842 at (12) and (18).
Considering these in turn, a choice of law is not bona fide if the only purpose is to evade the operation of another law. This would not be the case if there is “good reason” to choose that other law, such as commercial and business connections to that jurisdiction.15Id, at (17); BNP Paribas Wealth Management v Jacob Agam and another (2017) 3 SLR 27 at (41). Hence the “springing” clause will be bona fide if the alternative choice of law is one that has some connection to the parties’ activities, such as the business location of one of the counterparties or the place of performance.
Next, there is some ambiguity about illegality in choice of proper law. If this refers to unenforceability of a clause where the obligation is illegal at the place of performance, a follow-up question is whether such unenforceability applies as a principle of frustration under the proper law of the contract or a manifestation of the forum’s fundamental public policy (ie, a reluctance to enforce a contract where there is intention to commit illegality in a friendly foreign country). If the former view applies, the illegality exception would potentially be engaged if the contract would have been frustrated under the original law of the contract; however, as discussed above, frustration is generally hard to invoke. If the later view prevails, the illegality question would turn on what the ad hoc pandemic legislation of the jurisdiction whose law is the parties’ initial choice of law seeks to do. If it only suspends contractual performance without prescribing mandatory consequences should parties mutually agree to proceed anyway, then likewise the illegality exception is not engaged.
Finally, as for being contrary to forum public policy, there is scant case law on what this means in Singapore vis-à-vis express choice of law. But there is arguably nothing inherently unconscionable or repugnant about the device of a “springing” choice of law clause, that would attract the court’s scrutiny. To every contract there are two sides, and one party being excused from performance often entails the other side having to forbear and suffer the economic consequences. “Springing” choice of law clauses should be upheld if they are mutually agreed, subject to the usual contractual vitiating factors.
How practical would such a clause be? There are two potential issues.
First, it might be that adopting a “springing” choice of law clause would be akin to using a sledgehammer to crack a nut: By changing the governing law of the entire contract if a specific provision were to become caught by pandemic legislation, unintended consequences might arise for the other provisions (such as attracting the unwelcome operation of arcane local regulations). However, a solution would lie where the relevant governing law recognises the concept of dépeçage, under which different systems of law are permitted to govern different parts of a contract. The “springing” choice of law clause could then be made applicable only to provisions affected by the enacted legislation.
Second, “springing” choice of law clauses would be little defence against statutes that operate as forum mandatory rules which apply regardless of parties’ choice. A statute like the Singapore COVID-19 Act does not, as seen from how it is specified to apply only if Singapore law governs the contract and how it contains carve-outs for frustration and force majeure.16Section 5(13) of the Singapore COVID-19 Act “does not affect the taking of any other action in relation to the (obligation that is unable to be performed), including an action pursuant to the Frustrated Contracts Act … or a force majeure clause in the contract where applicable”. But the case for the French Ordinances is more arguable. It is here, perhaps, that the limits of appropriate contractual choice of law provisions are reached. But parties have one more instrument in their contract-drafting toolkit – the inclusion of an appropriate dispute resolution clause.
Dispute Resolution Clauses: Retaining Control and Choosing the Best Battleground
Making provision for alternative dispute resolution may be prudent, to avoid the expense and delay associated with the projected increase in court caseload.
Parties may opt for mediation by inserting a mediation clause. Notably, mediations do not involve any enforcement of legal causes of action and are unlikely to be caught by statutory moratoriums on these. The benefits of mediation are well-known. These include the possibility of compromise and flexible solutions to arrive at mutually-acceptable outcomes, the higher rates of compliance because parties tend to comply with what they had a hand in deciding on, and lower costs. All these are particularly valuable in times of uncertainty. The desirability of mediation is underscored by how the Singapore courts have implemented the “SGUnited Mediation Initiative” to offer free mediation for suitable Supreme Court cases.17“SGUnited Mediation Initiative to help litigants move on from COVID-19”, Supreme Court Media Release (29 May 2020) <https://www.supremecourt.gov.sg/news/media-releases/media-release–sgunited-mediation-initiative-to-help-litigants-move-on-from-covid-19>.
Alternatively, parties may opt for arbitration – in particular, international arbitration. Several jurisdictions distinguish between domestic and international arbitration, with fewer mandatory rules or proscriptions in relation to the latter. Saliently, the Singapore COVID-19 Act prohibits domestic but not international arbitrations, meaning that arbitrations may still proceed under its International Arbitration Act (whether an arbitration is domestic or international can be determined by party agreement18International Arbitration Act (Cap 143A, 2002 Rev Ed), s 5. ).
Therefore, parties can maintain greater control over their desired forum and potentially the outcome by choosing an appropriate dispute resolution clause. The law does not demand that they have perfect foresight in coming up with watertight contractual obligations; parties may also contract for dispute-resolution mechanisms suited to their case.
In sum, the best way to increase certainty of outcome is for parties to contractually provide for the outcomes they prefer, rather than rely on common law doctrines or hope for statutory intervention. Such contractual provisions include express contractual risk-allocation provisions such as force majeure clauses, choice of law clauses including “springing” choice of law clauses, and dispute resolution clauses. Parties may indeed be “masters of their contractual fate”.19Pagnan SpA v Feed Products Ltd 1987) 2 Lloyd’s Rep 601 at 611.
|↑1||*The article is written in the author’s personal capacity, and the opinions expressed in the paper are entirely the author’s own views.C Cavicchioli, “Covid-19: Impact on commercial contracts – France”, Linklaters, 9 April 2020, <https://www.linklaters.com/en/insights/publications/2020/march/novel-coronavirus-commercial-contracts/novel-coronavirus-impact-on-commercial-contracts/france>.|
|↑2||Which date the Minister for Law explained as applying because the Ministry of Health had imposed stricter regulations a day earlier, so parties who entered into contracts despite having knowledge of these facts should not be given recourse under the statute: Singapore Ministry of Law, “Second Reading Speech by Minister for Law, Mr K Shanmugam, on the COVID-19 (Temporary Measures) Bill”, 7 April 2020 at (70).|
|↑3||(1982) AC 724 at 752.|
|↑4||Cap 115, 2014 Rev Ed.|
|↑5||Magenta Resources (S) Pte Ltd v China Resources (S) Pte Ltd 1996) 2 SLR(R) 316 at (60).|
|↑6||(2020) SGCA 52 at (100).|
|↑7||Id, at (109).|
|↑8||Id, at (110).|
|↑9||Id, at (112).|
|↑10||(1983) 1 Lloyd’s Rep 12.|
|↑11||Id, at (15).|
|↑12||(1985) 2 Lloyd’s Rep 380.|
|↑13||See DG Pierce, “Post-Formation Choice of Law in Contract” (1987) 50 MLR 176 at 194.|
|↑14||(1999) 3 SLR(R) 842 at (12) and (18).|
|↑15||Id, at (17); BNP Paribas Wealth Management v Jacob Agam and another (2017) 3 SLR 27 at (41).|
|↑16||Section 5(13) of the Singapore COVID-19 Act “does not affect the taking of any other action in relation to the (obligation that is unable to be performed), including an action pursuant to the Frustrated Contracts Act … or a force majeure clause in the contract where applicable”.|
|↑17||“SGUnited Mediation Initiative to help litigants move on from COVID-19”, Supreme Court Media Release (29 May 2020) <https://www.supremecourt.gov.sg/news/media-releases/media-release–sgunited-mediation-initiative-to-help-litigants-move-on-from-covid-19>.|
|↑18||International Arbitration Act (Cap 143A, 2002 Rev Ed), s 5.|
|↑19||Pagnan SpA v Feed Products Ltd 1987) 2 Lloyd’s Rep 601 at 611.|