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How to handle commercial issue legally in time of crisis. Helpful terms in agreement.

Updated: Jun 4, 2020

CORPORATE AND SMEs RECOVERY SERIES - PART 1


Due to the implementation of the Movement Control Order (“MCO”), a lot of SMEs are having difficulties in the performance of their contractual obligations. Is there a way to defer the performance until the cessation of the MCO? What are the clauses in a contract that SMEs should take note of?


(1) Force majeure clause excuses one or more parties to a contract from the performance of their obligations following the occurrence of unexpected events which are beyond the parties’ reasonable control. The extent of coverage and applicability of a force majeure clause is highly dependent on the way it is drafted. Firstly, check if the clause uses the terms such as ‘pandemic’ or ‘epidemic’ or ‘diseases’ or the catch-all phrase of ‘beyond the parties’ reasonable control’ which may arguably cover the current situation. Secondly, check if there is any specific timeline or conditions to be fulfilled (such as requirement of notice) before a force majeure clause can be relied upon.


In the event that force majeure clause is applicable, parties may be allowed to suspend the performance of contract temporarily, or extend deadlines for performance or even to terminate the contract. The duty is upon the party who seeks to rely on the force majeure clause to prove its applicability[1]. It is also important to take note that a change in economic circumstances which makes the contract less profitable or more onerous to perform is generally not sufficient to invoke the force majeure clause.


(2) Hardship clause ensures a balance in the performance of each party’s obligations under the contract. If either party is excessively burdened with the performance of a contract due to unforeseen events, such clause may be invoked. A hardship clause is wider in application and may cover situations in which a force majeure clause is not applicable.



(3) Price adjustment clause allows party to renegotiate on the price of the contract. For example, this clause may be invoked to adjust the contract price for supply of goods in view of the increased costs due to disruption caused by the Covid-19 pandemic.



(4) Material adverse change clause confers the parties with a right to terminate the contract upon occurrence of any event which materially affects the viability of the transaction. Generally, such clause appears in acquisition, financing and other commercial contracts. It is generally used to create parameters whereby a potential buyer may terminate a contract because of the occurrence of an event that negatively impacts the nature of value of the target product, company or business.


Again, the applicability of a material adverse change clause depends on its drafting. However, material adverse change clause is usually carefully drafted and event-specific. Most material adverse change clause may not have been drafted wide enough to cover the present situation. This explains why material adverse change clause is often invoked as a way to renegotiate on the terms of the contract, rather than as a basis for termination.


(5) Assignment or novation clause allows a party who is no longer able to continue with the performance of a contract to transfer their rights and duties to a third party. For clarity, an assignment clause allows the transfer of rights (only) under a contract to a third party. In most cases, assignment requires written notice to be given or for the other party’s consent to be obtained. In the absence of such requirement, common law allows a party to assign their rights without the consent of the other party.


On the other hand, a novation clause allows the transfer of both rights and obligations under a contract to a third party. Novation requires the consent of all the parties to the original contract as well as the third party.


(6) Variation clause allows contracting parties to vary or amend the terms of the contract. Negotiations may be conducted with the other party in good faith and on the basis of the Covid-19 pandemic. Upon a successful re-negotiation, be sure to observe the requirements of the variation clause (such as having such amendment or variation in writing and singed by both parties). This ensure that the original contract is legally and validly varied or amended.


(7) Notice clause provides the notice requirements and procedures under a contract. Certain clause in a contract may have specific method or timeline for notification, failing which, the party may no longer be able to rely on such clause.


If the above clauses are not applicable, you may consider the doctrine of frustration. This doctrine is provided under Section 57(2) of the Contracts Act 1950 which relieves a party from his contractual obligations if an intervening event has disrupted the continued performance of the contract. However, this doctrine is restrictive in its application and the consequence of a frustrated contract is more drastic as compared to force majeure event. When a contract is frustrated, it is terminated immediately at the point of frustration and parties will be entirely discharged from all future obligations.


To rely on this doctrine, a party must be able to show that : (a) MCO must have been one which was not provided for (or predicted) in the drafting of the contract; (b) MCO must not have been caused by either party; and, (c) MCO has rendered the parties’ contractual obligations to be radically different from what was initially undertaken by the contract. On this account, it may be difficult to establish that MCO has rendered any contract to be radically different or impossible to be performed. Doctrine of frustration was tested in the Hong Kong court during the SARS outbreak[2], whereby it was decided that evacuation of premises for a 10-days isolation was insignificant compared to an agreed 2-years duration of a lease. As such, the tenant was not able to use SARS as an excuse to claim that the lease agreement was frustrated.

Reference:

[1] Intan Payong Sdn Bhd v Goh Saw Chan Sdn Bhd [2005] 1 MLJ 311

[2] Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754

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