Legal briefing | 12 May 2020 |

COVID-19: a checklist of ways to dig yourself out of a contractual hole

Two former Supreme Court judges have recently suggested that, given the exceptional nature of the current crisis, a "more creative" approach may be needed in assessing contractual disputes. With that in mind, we've put together a checklist of potential issues to consider if you are looking to dig yourself out of a contractual hole created by COVID-19.

Why might a more creative approach be justified now?

Let's say you can't meet your obligations under a contract because of COVID-19 and there's very little in the express wording of the agreement that seems to help you. For example, we've seen a number of situations recently where, on closer inspection, it transpires that the force majeure clause is rather less helpful than might have been expected. Historically, the English courts have tended to take a strict approach to such situations. In particular, they have not normally been sympathetic to more "creative" arguments aimed at avoiding a harsh outcome for one party. So why should such arguments stand any better chance of success now?

What the judges said

In a recent paper, former Supreme Court judges Lord Phillips and Lord Neuberger, together with a number of academics, suggest that the exceptional nature of the situation created by the COVID-19 pandemic may justify a degree of divergence from the historically strict common law approach. They note that the "present crisis…. does not have an easy analogy in past case law" and that in some situations "an outcome which leaves one party a winner, and the other a loser, will not take full account of the market/social contextualisation of the crisis." They go on to ask whether "there is a case for adopting a more creative, graded, but nevertheless rigorous approach without prejudicing the underlying need for legal certainty." Behind these points lies a concern that an overly strict application of established contract law principles may produce particularly harsh outcomes which do more harm than good, undermining the prospects for economic recovery – which would be in no one's best interest.

What should be in your creative "toolkit" ?

The authors of the paper suggest a number of possible avenues that could be explored if you are looking for potential arguments against a strict application of English contract law principles. We have attempted to turn these into a checklist below:

Is your contract relational? Relational contracts, such as long term joint ventures or distribution arrangements, are not always interpreted as strictly as other types of contract. Greater weight may be accorded to the overall purpose of the contract and in some cases, an obligation to act in good faith may be implied. This difference in approach as compared with other types of contract may help you to avoid what would otherwise be a harsh outcome. For more detail on relational contracts, see our briefing and video explainer on this topic. The recent paper also refers to this lecture by Lord Leggatt (or Mr. Justice Leggatt as he was at the time, since the lecture predates his elevation to the Court of Appeal in 2018 and the Supreme Court in April 2020) setting out his views on the same topic.

Are there other grounds for implying a duty of good faith or other helpful terms? Lord Leggatt's lecture referred to above also highlights the potential for a duty to act in good faith to be implied in certain circumstances, such as where one party is required to exercise a contractual discretion. More widely, if the outcome of a strict application of English contract law is particularly harsh, there may be scope to argue that this would be at odds with the overall purpose of the contract (see text box below).

WHAT IF A STRICT APPROACH UNDERMINES THE PURPOSE OF THE CONTRACT?

In his lecture, Lord Leggatt notes that the purpose of most commercial contracts is not usually "a ‘zero sum game’ in which one party’s profit is automatically the other party’s loss. The essence of trade and commerce is reciprocity which benefits both parties and makes each party better off. To achieve such mutual gain, the parties agree to cooperate with each other in various ways. Contract law facilitates such cooperation by giving it legal backing." He also notes that other judges have observed that "there will generally be an implied term not to do anything to frustrate the purpose of the contract."

Could equitable principles such as unjust enrichment assist? The paper mentions the possibility that in some circumstances, the relations of the parties could "be equitably readjusted by the Court so that the one will not be unintentionally enriched at the expense of the other", based on the doctrine of unjust enrichment. Again, this might assist in situations where a strict application of normal English contract law principles would result in a 'zero sum game' of the type discussed by Lord Leggatt, which is arguably at odds with the parties' original intentions (see text box above).
Do other systems of law offer any useful models? The paper also suggests that it may be relevant to consider the approach of other legal systems to similar questions, such as "the reformed section of the French Civil Code on the law of contract, and other national doctrines such as the German Störung der Geschäftsgrundlage, as well as international dimensions such as the work of Unidroit." If a strong case can be made that other systems of law produce a more just outcome in comparable situations, this may help to encourage a court to take the view that English contract law should seek, where possible, to follow a similar approach.

The creative approach in context

Given the strong attachment of English contract law to precedent, it is important not to underestimate the difficulties of running arguments such as those summarised in the checklist above. Indeed, at first sight, it may appear that the authors of the paper are seeking to overturn well established principles, developed over hundreds of years, giving rise to significant uncertainty. If so, that would be a proposition that an English court would probably be very reluctant to accept. However, it is almost certainly a misreading of the authors' intentions.

JUST HOW RADICAL IS THE CREATIVE APPROACH BEING ADVOCATED HERE?

The paper acknowledges that the strict approach of English contract law to issues such as force majeure, material adverse change, supervening illegality and frustration "has generally worked well so far." Far from seeking to overturn this order, it appears that the authors are merely proposing that in the extreme and unprecedented circumstances of the current crisis, English contract law should be open to greater flexibility; however, a return to more normal conditions would also see a return to the traditional strict approach. It is also worth noting that most of the approaches highlighted in the paper have an existing basis in English contract law; to that extent, the additional flexibility being advocated is more evolutionary than revolutionary.

If presented in this light, it seems to us that the arguments in the above checklist could – given the right circumstances – be helpful to a party looking to dig its way out of a contractual hole created by a strict application of English contract law principles. However, it should also be borne in mind that the authors' primary aim seems to have been to encourage parties to consider options other than litigation, such as contract variations or settlement agreements.

Indeed, it may well be that the real targets of the paper are not businesses which are in a contractual hole but those which, on the face of it, would stand to benefit from the strict application of English contract law principles – and believe that it gives them a very high (80%+) chance of winning their case. In our experience, save for simple debt claims or certain types of "summary judgment" applications, it is rarely possible to put the odds of success that high – and the exceptional circumstances of the COVID-19 pandemic make it all the more difficult to predict outcomes. Even if none of their ideas find their way into case law, the authors of the paper may feel that they have still succeeded if they have managed to persuade some of these businesses to view litigation as a last resort, rather than a "zero sum game".

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