Play nicely - contractual performance in the time of COVID-19

United Kingdom

Businesses in almost every sector are facing challenges brought about by an unprecedented operational climate. In those circumstances, parties are having to consider whether and how to meet their contractual obligations and respond to any short-comings in the performance of others. English law has long been cited as a preferred choice for parties because of its predictability and certainty. On that basis, a party’s rights and obligations ought to be reasonably certain, principally by reference to the contractual terms, but with a set of fairly well-established additional rules mainly developed by English common law. Against this backdrop the UK Government has published guidance seeking to persuade parties to act reasonably, fairly and proportionately, in order to adopt a new approach to litigation that avoids, where possible, commencing legal proceedings. Whilst it is certainly well-intentioned, does such guidance actually help parties avoid disputes?

According to some media reports, the pandemic appears to have had an immediate impact on the number of new claims filed. For example, it has been reported that the number of new claims filed in the Chancery Division and the Commercial Court fell by 50% in a four-week period to 5 April 2020, compared with the same period last year. That statistic might, in part, be explained by businesses having more pressing immediate issues to contend with, and the practical limitations of a lockdown. Further, an increase in litigation is usually seen after a crisis rather than in the depths of it. It is, therefore, too early to tell what appetite there will be for COVID-19 contractual issues to be ‘worked-out’ through the courts. 

However, contract law exists to provide certainty, protect parties, and hold others to their contractual bargains. Often, the terms of a contract reflect a carefully negotiated allocation of risk. An unfortunate consequence of the pandemic is that a risk to which little regard was likely to be had at the point the contract was negotiated, may now be having a profound effect on either or both parties. The law, and the right to recourse to courts, however, exists to allow access to justice and to “keep the wheels of commerce running smoothly”. In some cases early recourse may be necessary to secure ongoing performance, stave off insolvency and, potentially, avoid redundancies. If a contractual right exists, it will usually be responsible for a party to enforce it, often for wider reasons than the performance of the contract itself. 

Thus, whilst it is generally a good thing to avoid litigation where possible, that is not always possible. In the light of the new guidance, parties seeking to avoid contractual obligations may now reach for additional arguments to position themselves pre-litigation.

The Government Guidance

On 7 May 2020, the Cabinet Office published guidance on ‘responsible contractual behaviour in the performance and enforcement of contracts impacted by the Covid-19 emergency’ (“Guidance”). The stated purpose of the Guidance is to ensure that businesses that are parties to contracts engage in “responsible and fair behaviour”. The Guidance lays emphasis on such behaviour particularly in “dealing with potential disputes”. In that regard it includes a list of 15 points in relation to which responsible and fair behaviour is “strongly encouraged”. Those points cover almost every issue that can be foreseen to arise in the operation of a contract, including:

  • relief for impaired performance and exercising remedies in that regard;
  • extensions of time;
  • payment;
  • damages (including liquidated damages clauses);
  • events of default and termination rights;
  • giving notices and contractual variations;
  • dispute resolution procedures (including court proceedings), mediation or other ADR or fast-track dispute resolution; and
  • enforcing judgments.

It is apparent from the wording and tenor of the Guidance that the Government expects parties to take a measured and proportionate response to potential contractual disputes during this time. That approach is in many respects well-founded. In practical terms, most businesses are likely to adopt such an approach without Government guidance since maintaining contractual relations is likely to be in a party’s long-term interest before rushing to act on a short-term default. It will now be prudent for businesses to consider the Guidance as part of their decision making. However, parties should also bear in mind that the status of the Guidance is made clear at various points as being “guidance and recommendations”, “guidance only” or “non-statutory guidance”. The Guidance also makes clear that such responsible and fair behaviour applies to contracts “where there has been a material impact from Covid-19”.

While the Guidance has no legal effect, parties should also bear in mind that counterparties themselves may have very good reasons to require performance under a contract, and it should not be assumed that they will take a more generous approach to failings in the performance of contractual obligations in their interest.

Procurement Policy Note

The nature of the contracting party in question is also a relevant factor. The Guidance includes public authorities. Part of the Government’s response to the pandemic included the publication of a Procurement Policy Note aimed at supplier relief (“PPN”). The PPN requires public authorities to accelerate their payment practice from the usual 30-day period, and pay suppliers “as quickly as possible” so that cash flow is maintained and jobs are protected. Other measures of supporting suppliers include “payment against revised/extended milestones or timescales, interim payments, forward ordering, payment on order or payment in advance/prepayment”. A business that is involved in supplying a public authority and is facing uncertainty may look to take advantage of those provisions. However, such businesses should be aware that the PPN does allow public authorities some leeway. For instance, in the case of disputed invoices, authorities are urged to “consider paying immediately and reconciling at a later date in critical situations”. Those requirements also do not apply to contracts that do not contain a volume commitment.

Corporate Insolvency and Governance Bill

In a clearer step, legislation was introduced in Parliament on 20 May 2020, in an attempt to prevent struggling companies being forced to enter into an insolvency process because of problems caused by COVID-19. That legislation is currently in the form of the Corporate Insolvency and Governance Bill (“Bill”), to be debated by MPs on 3 June 2020. 

In summary, the Bill as drafted provides that:

  • a 20-day moratorium, similar to that currently available to companies being placed in administration, will be available to almost all companies that are insolvent or likely to become insolvent;
  • current wrongful trading provisions, which impose personal liability on directors, will be suspended;
  • restrictions are to be placed on the use of winding up petitions (discussed below); and
  • restrictions are to be placed on exercising termination clauses in supply contracts (discussed below).

Statutory demands are sometimes used as a means of exerting pressure on a debtor to make payment, as a winding up petition may be presented to the court if the statutory demand remains unsatisfied for a period of 21 days. On 23 April 2020, the Government announced that legislation would be brought in to temporarily ban the use of statutory demands and winding up petitions issued to commercial tenants by their landlords. Based on the wording and context of the press release, the court suggested in Shorts Gardens LLP v London Borough of Camden Council [2020] EWHC 1001 (Ch) that it was “overwhelmingly likely” that any legislation would: (i) be limited to certain sectors of economic activity (e.g. retail and hospitality), (ii) apply only to demands or petitions based upon arrears of rent, and (iii) only apply where the tenant is unable to pay its debts due to the pandemic.

However, the Bill is in fact far more wide-reaching in scope. It prohibits the presenting of a winding up petition on the basis of a statutory demand served on or after 1 March 2020. This is drafted as a blanket restriction. For statutory demands served before 1 March 2020 that still remain outstanding, a winding up petition may not be presented now unless the creditor has reasonable grounds to believe that the pandemic has had no financial effect on the company, or that the facts underlying the statutory demand would have occurred even if not for any financial effect caused by the pandemic. 

Separately, the Bill also introduces provisions restricting a supplier from exercising a termination clause in a contract if the customer is in an insolvency process, where the supplier became entitled to terminate the contract before the customer entered into the insolvency process. The supplier may also not impose the payment of any outstanding debts as a condition of continued supply during this period. These provisions do not apply if the supplier in question is a small supplier, or if a supplier is able to prove to the courts that continuing supply would cause it genuine hardship.

Senior Managers and Certification Regime

For businesses facing financial distress and default under their finance documents, it is also worth keeping in mind the requirements of the Senior Managers and Certification Regime (“SMCR”) which has applied to banks since March 2016 and is of wider application across FCA and PRA regulated entities. The legislation and new regime followed the 2008 financial crisis and the work of the Parliamentary Commission for Banking Standards and its recommendation for a new accountability framework focused on senior management. The current pandemic is one of the first major tests of the regime which, at its heart, targets firms taking more responsibility for employees being fit and proper and ensuring that there are better standards of conduct at all levels in banking firms. More information on the SMCR can be found here and details of the relaxation of certain provisions that has been applied to the regime as a consequence of COVID-19 can be found here. Parties may benefit from greater co-operation and support from lenders in sectors hardest hit by the pandemic (such as hospitality and leisure) suggesting that some of the mistakes, conduct issues and ensuing high profile investigations, reviews and litigation arising from the last financial crisis may not be repeated in this environment.

Comment

Given that the Guidance is non-statutory and the Bill is yet to be enacted, it appears from the above that any immediate impact is likely to be felt by public authorities.  That will change, in particular once the Bill receives Royal Assent, and as parties adjust their behaviour in light of the developing effects of the pandemic. In the meantime, the British Institute of International and Comparative Law (BIICL) has published a Concept Note calling for an urgent debate on the “necessary contribution of the law to safeguard commercial activity… and ameliorate the adverse effects of a plethora of defaults”, noting that some jurisdictions have taken steps on a statutory footing. For instance, Singapore has enacted legislation providing companies with breathing space where they are unable to fulfil their contractual obligations owing to the pandemic.

Whilst the measures referred to above are not currently binding, they do merit consideration. Regardless of the Guidance, prudent parties may wish to consider the following factors before embarking on litigation.

  • Does the contract give you discretion in relation to one or more matters? If so, is there a risk that the exercise of discretion is arbitrary, capricious or irrational?
  • Does your contract contain a requirement to act in good faith? Although the requirement of good faith does not generally apply to the majority of contracts governed by English law, parties may expressly agree that it does. Where applicable, parties should be prepared to justify why they have taken a particular course of action and demonstrate that it was pursued in good faith.
  • Consider the provisions of the PPN if your contractual counterparty is a public authority. However, take into account that this may impact the future of your relationship with such authorities.
  • Does the short-term requirement outweigh the potential long-term effect of the litigation on the contractual relationship and the party’s standing and reputation in its market sector(s)?
  • Before taking any step, consider its potential reputational impact in light of the increased scrutiny being applied on the conduct of businesses at this time. The Guidance also emphasises this, requiring responsible and fair behaviour particularly in relation to contracts that are required to support the response to the pandemic.
  • More generally, consider whether alternative steps can be used in the first instance in order to de-escalate a potential contractual dispute. For example, have the parties considered ADR options rather than litigation?

The Guidance can be found here. The Bill can be found here. The PPN can be found here.