May 07, 2020

COVID-19–Impact on Commercial Contracts


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Coronavirus (“COVID-19”), which was first reported in Wuhan, China at the end of 2019, and declared by the World Health Organization to be a pandemic on March 11, 2020, continues to have a severe impact on global business and trade, with most economies still to some extent in a government-ordered state of “lockdown.” Whilst the situation is fluid, and the long term impact of COVID-19 on economies and on businesses remains unclear, some shorter term issues in commercial contracts are coming to the fore as many countries approach their third month of “lockdown.” This memorandum seeks to examine some of those issues from an English law perspective.[1]

Uncertainty Over Performance of Commercial Contracts

Termination for Prolonged Force Majeure

As has been widely discussed and analysed, COVID-19 (or events and circumstances flowing from COVID-19) may, depending on the circumstances and the specific wording, provide force majeure relief to a party prevented (or hindered, impaired or adversely affected) from performing its obligations under a commercial contract. While force majeure provisions frequently do not carry any entitlement to additional monetary compensation (even though the contract may subsequently become more expensive to perform), commercial contracts often include a termination right where a force majeure event has subsisted for a prolonged continuous period of time or a series of force majeure events have occurred for an aggregate period of time. As an example, under the FIDIC conditions of contract which are often used as the basis for procuring large industrial projects, these periods are 84 days and 140 days, respectively. Under commodities supply contracts (such as LNG SPAs) these periods tend to be longer.

As the consequences of COVID-19 continue, it is not unreasonable to envisage that some commercial contracts will approach or meet these force majeure termination thresholds. The termination right varies between contracts with some being exercisable by either party, and others by only the unaffected party. However, parties should be wary of a “price majeure” moral hazard which may incentivise a party to exploit a force majeure event by using, or threatening to use, its termination right to bring a commercial contract to a premature end if it has become economically burdensome to perform due to the impact of COVID-19 or to drive better commercial terms if COVID-19 has resulted in a reduced number of competitors.

Any party seeking to terminate a commercial contract for prolonged force majeure should be certain that the requisite elements for force majeure (see our previous note: Commercial contracts, COVID-19 and Force Majeure) have been in place for either the appropriate continuous or aggregate period of time, and all relevant notice formalities have been complied with. The termination provisions for prolonged force majeure may require substantially all of the performance of the contract to have been prevented, and not merely certain elements. Any party seeking to terminate should also naturally be wary that it is in full performance of its own obligations to avoid a potential counter-claim for breach of contract.

Termination for Insolvency

The impact of COVID-19 has placed cash flow strains on many businesses, particularly those which are thinly capitalised. This problem will become more severe if “lockdown” restrictions remain in place during the coming months.

Most commercial contracts will have a termination right for (non-insolvent) parties if another party experiences one of a number of insolvency-related events. The triggers to activate this termination right can be relatively wide ranging, covering both back-end events (such as petitions for the winding-up or liquidation of a company) and more front-end, early-stage events where there is a reasonable prospect of the business in question surviving (such as administration, schemes of arrangement or entering restructuring discussions with creditors).

A party will need to consider carefully whether it wants to exercise such termination rights and particularly where short-term cash flow issues for a counter-party have triggered an early-stage insolvency related termination right because re-awarding contracts to suppliers who are on a substantially healthier financial footing may be challenging in the current climate.

Where project financing is involved, a project company may also have to obtain consent from its lenders prior to exercising its termination rights or conversely convince its lenders that not exercising its termination right is in the best interests of the project because the counterparty is continuing to perform. Equally, where a project company is on the receiving end of a potential insolvency-related termination event from a contractual counterparty, its lenders will need to consider how to support the project company and potentially even exercise their step-in rights under a direct agreement should the termination right be exercised.

Increased Costs of Performing Commercial Contracts Which Are Not Reimburseable

If force majeure relief under a commercial contract does not extend to covering the increased costs of a party impacted by COVID-19 and change in law relief is also not available, adhering to new measures such as social-distancing guidelines as a consequence of COVID-19 may fundamentally change the underlying economics of performing a fixed price contract.

The U.K. has permitted the re-commencement of construction work provided that the Public Health England (PHE) guidelines are followed. Practically, PHE guidance and Site Operating Procedures (published by the Construction Leadership Council to implement the PHE guidance in construction) have impacted on-site construction work through a reduction in available workforce, split shifts, staggered arrive and leave times, additional welfare and canteen space and staggered break times. A reduction in productivity is expected resulting from these social-distancing measures and a reduced headcount, augmenting other productivity problems e.g. regarding the impact travel restrictions on the supply chain.

Where a party to a commercial contract is suffering economic hardship, the other parties may choose to be pragmatic and share the burden, through revisiting some of the commercial terms. Factors impacting a party’s decision to engage in negotiation include the severity to which one party alone is being impacted by COVID-19, the strength of the commercial relationship with the affected party and the availability of alternatives. It may be in the interests of a party to keep the affected counterparty incentivised to persevere with performing the contract. Some flexibility around payment terms, deferring payments, etc., may be considered as a means of assisting a counterparty with short-term cash flow issues.

Inability to Adjust Warranty Periods and Certain Longstop Dates

The broader suite of commercial contracts which underpin the development of industrial or infrastructure projects will contain a series of contractual milestone dates or deadlines for the completion of activities. Whilst many of these will be adjustable where a party is entitled to force majeure relief (and even where they are adjustable, notice should be taken of any termination right for prolonged force majeure), there are circumstances where key milestone dates may be hard-coded.

Warranty Periods

Manufacturers of plant and equipment used in large projects frequently supply on the condition that warranty periods will run from the date on which the plant or equipment is delivered to the site or is first used (subject to longstop dates). If the plant or equipment cannot be put into operation (e.g. due to a force majeure event) and the warranty period has commenced, the warranty period may be eroded during this time. Similarly, the “defects liability period” provided by the main contractor for a project will run from the time it is taken over by the owner, regardless of any force majeure preventing its use during the period. In both cases, there may be implications if defects are subsequently discovered when it is finally put into operation but contractual warranty periods have expired. Certain contracts may contain express “latent defects” remedies where defects are discovered following the initial warranty period or a party may be entitled to avail itself of common law remedies for breach of contract due to the existence of latent defects but subject to applicable statute of limitations periods and the contract not containing any “sole and exclusive remedies” limitation clauses in relation to the warranty provisions.

‘Drop-Dead’ Dates

Some commercial contracts may include an unmoveable “drop-dead” date by when, if performance has not commenced in whole or in part, either the whole contract or a specific opportunity will be lost (e.g. a power purchase agreement may incentivise the generator to have at least one unit operational earlier than the others to take advantage of a period of peak power demand).

Inability to Carry Out Routine or Emergency Maintenance of Equipment

Large items of plant and equipment used in engineering processes (e.g. gas or steam turbines) often require the owner to perform regular, routine maintenance as a condition of the manufacturer’s warranty. If the maintenance is not carried out (e.g. because of restrictions in the movement of labour and equipment), then the contractor’s warranty may potentially be vitiated together with any related insurance policy which may well include conditions around the performance of regular maintenance.

Implications Under Financing Documents

Borrowers may find the COVID-19 restrictions and resulting cash flow problems cause them to breach financial covenants (such as cover ratio tests) contained in financing documents. Where amortising loans with fixed repayment schedules are involved, borrowers may even struggle to meet their next debt repayments as these dates are not adjustable due to the occurrence of force majeure. The issue will be most acute for merchant projects or demand-risk projects, where revenue may be heavily impacted by, for instance, social-distancing restrictions impacting demand and operation and maintenance, compulsory business closures or supply-chain issues in respect of feedstock or parts ahead of maintenance. However, there may be certain mitigants available to projects to help weather the impact of COVID-19 on their financing.

Lenders may in the first instance look to ensure that whatever cash is trapped in the company is not distributed (in project financed transactions shareholder distributions are typically permitted only every six months and are contractually subordinated to debt service obligations) and then to the debt service reserve account (usually sized to cover up to six months of debt service) or any letters of credit posted in lieu as a means of avoiding a payment default arising from a short term impact on revenue.

Some financing documents contain “equity cure” provisions enabling the project sponsors to inject additional equity into the project to ensure financial covenants are not breached. Whilst this may be detrimental to the equity returns for the sponsors, it may also be the least-worst option to prevent a default and subsequent enforcement.

If the foregoing are still insufficient to alleviate the cash-flow strain on a project, borrowers may seek to enter discussions with lenders around restructuring the debt repayment profile for the project. Much will hinge on the circumstances and willingness of sponsors to “share the pain;” however, the current climate is not optimal for lenders seeking to enforce against a distressed project. Some projects, especially those subject to market or price risk (for instance most petrochemical projects), have debt service holidays built into the financing terms so that principal payments can be deferred in certain cases. However, even if not contemplated in the financing documents, borrowers may want to have discussions with their lenders about deferring principal and/or interest payments.

Unavailability of Revenue Replacement Insurance

Whilst COVID-19 has prevented many businesses from operating fully or indeed at all, it may not have caused physical damage, which is the customary pre-condition to obtaining business interruption insurance cover, and so affected businesses are unlikely to have been able to make insurance claims for lost revenue whilst the effects of COVID-19 persist. As a result, many governments have intervened to act effectively as an insurer of last resort by providing financial support packages to struggling businesses to avoid total economic meltdown.

As an example, through the Covid Corporate Financing Facility (CCFF), the Bank of England aims to aid the liquidity of large U.K. firms by buying short-term debt (maturity up to 12 months) in the form of commercial paper. The facility is available to non-financial companies that make a material contribution to the U.K. economy and were in sound financial health prior to the COVID-19 pandemic. In practice this means companies that have a significant number of U.K. employees, customers or operating sites, with a short or long-term investment grade credit rating as at 1 March 2020 are eligible.

However, governments have warned they do not have unlimited capacity for providing financial support and such packages may be withdrawn as effects of COVID-19 become more prolonged.

Commodity Price Drop

There may be some good news for project developers and contractors amid the challenging circumstances. As global commodity prices drop due to the fall in demand, this could decrease capital expenditure for projects being tendered in the coming months or which have already been procured but on a cost-reimbursable basis. However, conversely the fall in commodity prices may also make new projects in certain sectors commercially unviable.


COVID-19 will inevitably lead to an uptick in disputes arising from many of the issues described above impacting on business relationships. The most immediately obvious area for disputes will be around claims for force majeure relief and termination.

Disputes surrounding a force majeure provision will include: whether a force majeure claim is properly substantiated, whether proper mitigation measures have been taken, which obligations have been impacted by the alleged force majeure event, whether the party claiming force majeure has continued to perform unaffected obligations and whether the events instead properly qualify as economic hardship or similar legal concepts instead.

Force majeure claims that are actually predicated on relieving economic hardship are unlikely to succeed–under English law, economic hardship and payment obligations are not typically relieved by a force majeure event. Whether the COVID-19 pandemic is a force majeure event, and practical suggestions for clients receiving notices or making claims of force majeure is considered in our previous note: Commercial contracts, COVID-19 and Force Majeure


[1] Civil law jurisdictions address force majeure, economic hardship (imprevision) and other related concepts covered in this memorandum differently.