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Managing and Drafting Contracts in the COVID-19 Era

Managing and Drafting Contracts in the COVID-19 Era
April 30, 2020

As the COVID-19 pandemic continues to intensify, businesses can expect ongoing disruption to key contractual relationships for a variety of reasons, including government-imposed restrictions on their activities, temporary shutdowns, supply chain interruptions, labour shortages, as well as liquidity concerns. The COVID-19 impacts are expected to extend beyond the resumption of business activities and will affect future relationships.

In the following primer, we identify practical steps market participants can take to monitor COVID-related risks under their existing contracts, as well as drafting considerations they can consider when negotiating new contracts in the wake of the pandemic.

ASSESSMENT OF EXISTING CONTRACTS THROUGHOUT COVID-19

The following analysis of existing contracts will need to be carried out at regular intervals as the situation evolves in order to ensure that the analysis remains current and applicable in light of the latest circumstances. With rapidly evolving requirements and recommendations from governmental authorities, any analysis of existing contracts and plans for moving forward will also likely need to be adapted.

  • Inventory Contracts: Carry out an inventory of existing contracts—including any amendments, ancillary documents or verbal agreements—to identify which contracts are likely to be impacted by the ongoing pandemic and categorize these contracts by degree of importance—for example, based on the extent to which these are critical to business operations or meet a threshold of financial importance—so that key contracts can be analyzed on a priority basis.

  • Anticipate COVID-19 Impacts: Anticipate the extent to which a contract may be impacted; for example, identify the parties that will have difficulty fulfilling their obligations and the situations that could give rise to a breach of contract.

  • Supply Chain: Where applicable, identify key subcontractors and suppliers that would be difficult to replace and assess their vulnerabilities.

  • Review Key Provisions: Review the specific provisions of the contract that could be impacted by the current circumstances, or invoked as a result thereof, such as:

    • Force majeure

    • Material adverse effect or change

    • Extraordinary events (other than force majeure)

    • Emergency

    • Payment obligations and terms

    • Events of default and penalties

    • Term and renewal

    • Suspension and termination

    • Exclusivity

    • Warranty, indemnification and limitations on liability

    • Health and safety requirements

    • Cooperation

    • Reporting obligations

    • Business continuity

    • Dispute resolution mechanisms

    • Change in law

    • Insurance requirements

    • Notice provisions and key dates relating to any of the above

  • Consider Remedies: Consider any available remedies in the event of non-performance of obligations and actions required to preserve contractual rights within prescribed delays, as well as any other rights that may exist by law.

  • Mitigate Risk: Identify any avenues available to mitigate risk in the event of non-performance of obligations. Assess whether governmental measures are available as tools to mitigate risk.

  • Reallocate Risk: Determine whether negotiation will be required to reallocate risk between the parties.

  • Identify Next Steps: Set out a strategy for next steps including, identifying short-term action items, interim solutions and longer-term recovery and contingency plans.

  • Document: Document the effect of the COVID-19 pandemic and governmental measures taken as a result thereof on your contract and more generally your business.

  • Communicate and Collaborate: Establish and implement a communication plan and reporting protocol with key stakeholders to facilitate collaboration on strategies for next steps, the preservation of relationships and management of potential differences.

  • Be Practical, But Creative: The strict application of contractual provisions or enforcement of legal remedies may not always be the best policy. Be flexible and creative to preserve long-term relationships and promote collaboration.

NEGOTIATING NEW CONTRACTS IN THE COVID-19 CONTEXT

Although the effects of the pandemic will differ for each industry and for each contractual relationship, the following section of this primer highlights certain contract provisions that parties will want to consider more closely when entering into contracts of continuing performance during these turbulent times; also note that other forms of agreements, including acquisition and investment-related agreements, will raise distinct issues. We expect that some of the following considerations will remain relevant in contract negotiations even after the pandemic, as parties will rely on their experience navigating through this crisis to mitigate the negative consequences of a similar future event.

  • Type of Relationship: The COVID-19 context may force the parties to reconsider the nature or structure of the contractual relationship they had previously contemplated or commonly used. Parties might question whether operating risks might be shared more equally if each side has greater interests at stake, such as through a co-ownership, partnership, joint venture or, especially in the infrastructure and construction sectors, agile contracting. When it comes to supply arrangements, the parties may reconsider traditional exclusivity arrangements, including carving out specific exceptions or adding more flexibility to their supply chains. For example, where supply chain vulnerabilities could jeopardize a party’s ability to perform, the other party will want to maintain alternative sources of supply.

  • COVID-19 Clauses: Parties should craft clauses addressing the current and future consequences of the pandemic on the performance of their respective obligations, as even a carefully drafted and detailed force majeure clause is unlikely to apply to future consequences of COVID-19 due notably to the issue of foreseeability. The parties would benefit from certainty regarding how COVID-19 and the measures implemented in response to it shall impact the parties’ respective rights and obligations. For example, one party may look to carve out or cap liability that can be tied to the pandemic, such as damages resulting from its inability to perform due to government-imposed restrictions. The other party may resist such exclusions or limitations on liability, arguing that the burden of the pandemic must be shared between the parties.

    As an alternative, certain parties may opt for cooperation clauses whereby each party agrees to work with the other to resolve contract disruptions relating to the pandemic. In such cases, parties will want to carefully consider the standard for cooperation, such as reasonable or best efforts, whether such cooperation should be circumscribed to specific areas—for example, lobbying or communications with regulatory authorities might be excluded—and the consequences of a breach of such obligation. The parties should also consider the extent to which they will be expected to mitigate damages and to assume the associated costs and expenses.
  • Performance Standards: Service providers may be reticent to commit to the same standard of performance or service level that they agreed to in a pre-COVID context. Parties will want to consider how defects can be corrected and what penalty or discount mechanisms can be used to shape performance.

  • Timing: During uncertain times, a shorter initial term may be appropriate with additional focus on the parties’ ability to renew upon certain pre-determined terms and conditions. Depending on the relationship at hand, the parties may also wish to consider whether structured milestones can be introduced to monitor gradual performance. Another alternative would be to provide additional flexibility regarding the timing to perform obligations when certain conditions are met.

  • Price and Payment Terms: Pricing may be particularly difficult during these uncertain times. As operating costs rise, suppliers may look to pass additional costs onto their customers. Fixed price contracts may be less acceptable or may require additional exclusions. Payment terms should also be scrutinized, including the time limits for payments, circumstances triggering a payment suspension and possible penalties for late payment.

  • Termination: The parties will want to revisit all basic terms surrounding termination, including whether a party should have the right to terminate for convenience, which events will give rise to default, as well as the amount of time allotted for giving notice and cure periods.

  • Temporary Suspensions: If disruptions are likely to occur, the parties may wish to delineate the conditions upon which a temporary suspension of performance will be allowed in lieu of termination and the consequences resulting therefrom. For example, the parties may decide that the only remedy in such a case is to relieve the other party from its corresponding obligations.

  • Change Mechanisms: Recognizing that a flexible approach will be needed to address deviations from their initial plans, parties may opt for detailed change order procedures, rather than expecting the parties to work out a solution at a later stage.

  • Audit Rights: The parties will need to consider whether audit mechanisms that require physical access are appropriate in the current working environment and if not, agree on alternatives.

  • Key Employee Commitments: Service providers should reconsider commitments regarding specific individuals in a context where employee absences are more likely. Service recipients will want to ensure that knowledge transfer processes are properly ensured. This will be particularly relevant in the IT contracting sector, where it is common to include covenants regarding key personnel.

  • Dispute Resolution: Parties may want to consider whether alternative dispute mechanisms—such as internal dispute escalation, expert determination, mediation or arbitration—would be preferable to court proceedings in the wake of the pandemic. This is particularly relevant in long-term contracts where disputes need to be resolved quickly without impeding the performance of the contract.

  • Insolvency Risk: Parties may also determine that they require clauses to assess the financial viability of their counterparts, such as routine financial reporting, the maintenance of financial ratios or parental guarantees.

  • Business Continuity and Disaster Recovery: All parties should expect to face greater scrutiny with respect to their continuity and disaster recovery planning, including with respect to disease prevention and workplace safety measures. Parties will need to carefully consider these reporting requirements as the expectation for detailed pandemic roadmaps grows. In some cases, additional insurance coverage will be deemed appropriate.

  • Force Majeure: Force majeure clauses will need to be carefully re-evaluated. In particular, parties should review wording which covers future health emergencies and pandemics and provide the consequences of a force majeure event in greater detail, including with respect to the considerations noted above. Termination rights in the event of an extended force majeure, and the resulting consequences, should also be considered carefully.

  • Hardship Clauses: Parties may also consider the opportunity to incorporate a hardship clause to enable renegotiation of the contract, should its equilibrium be so fundamentally altered that it would result in an excessive burden being placed on one of the parties involved. If such an avenue is chosen, the conditions triggering its application would need to be carefully crafted.

For any questions regarding the issues identified above or assistance with the management of existing or future contracts, please contact any member of our Corporate & Commercial group.

Please visit our COVID-19 Resource Centre to learn more about how COVID-19 may impact your business.