Contracting after Covid-19 – How to adapt your contract templates in 2020 and beyond
We’re living in a different environment
And it won’t be back to “business as usual” anytime soon. Therefore, there are important changes we need to make when drafting contracts, especially international ones, in a post-pandemic world.
Hong Kong – Two examples of the new normal:
Since January 2020, the Hong Kong workforce has been alternating between going to the office and working from home in a “stop and go” manner. Whenever the government announces that civil servants will work from home, so do businesses which have the option to do so. The last work-from-home period lasted from 20 July to 23 August 2020.
Since mid-March 2020, people arriving in Hong Kong are subject to a 14-day compulsory quarantine. This legislation has been extended to 31 December 2020 and applies to Hong Kong residents arriving from mainland China, Macau, Taiwan or elsewhere. Non-Hong Kong residents may be refused entry and should check the latest rules before travelling.
Worldwide – A tentative list of what we should expect in the coming months:
The following factors are important to consider when drafting contracts (the list is not exhaustive):
- Administration (i.e. the other parties going into administration)
- Extension of public holidays
- Furlough schemes (working time reduction)
- Manufacturing closures (temporary or permanent)
- Public services closures
- Reduction of national and international freight services
- Reduction of courier services
- Restriction to national and international travel
- School and university closures
- 14-day mandatory quarantine
How to adapt your contract templates to this new environment
Good contract drafting is about clarity and anticipation. More than ever, parties need guidelines to handle whatever is thrown at them. We have identified five important points that general counsels and lawyers should consider including in their contract review checklists.
The list is not exhaustive and considerations should be given to the nature of each contract. For instance, in contracts where time is of the essence, possible exceptions due to Covid-19 related events need to be carefully identified, or simply ruled out.
In a nutshell:
|1) Check your options and conduct enhanced due diligences on the resilience of the parties.||2) Ensure the contract specifies an obligation for both parties to collaborate to work around obstacles. Don’t leave it to professionalism or goodwill.||3) Review termination clauses and consider new triggering events for break clauses, based on turnover or profit reduction.||4) Adapt force majeure and hardship clauses to the jurisdiction of the parties, taking into consideration legal definitions provided by law in civil law jurisdictions.||5) Include effective dispute resolution mechanisms that are available remotely, and consider enforcement challenges.|
- Check your options before entering into a new contract and conduct enhanced due diligences on the resilience of the parties
Choose your suppliers
Do they have the capacity to fulfil their obligations? Are they up-to-date with salary payments? Have they been kept afloat by (or made use of) government support schemes? Do they have access to the raw materials or intermediary supplies needed? What about transport options and logistics – who will bear the additional cost of alternative means of transport? New cost structures mean it may be advisable to choose suppliers located nearer the place of delivery.
One of our clients, for example, a sourcing company, made a down payment to a manufacturer in mainland China which was running out of cash for its salary payments and closed. The products had been manufactured and inspected, but were taken by the manufacturer’s employees and sold. The sourcing company remains liable to its own client, who also made a down payment.
Choose your clients
The same question applies: do they have the capacity to fulfil their obligations? Will they pay their invoices on time, or make excuses if anything (Covid-19 related or not) arises?
- Ensure the contract specifies an obligation for both parties to collaborate to work around obstacles. Don’t leave it to professionalism or goodwill.
More than ever, good contract management is key to the success of the ongoing relationship and overcoming Covid-19 related challenges. It is important to have a key personnel clause to ensure that, quoting Thomson Reuters’ Practical Law notes on key personnel clauses:
- Key roles are identified on both the customer and supplier’s side and that the responsibilities of those individuals are clearly defined.
- Each party identifies a representative who has the delegated authority to act on behalf of each party in relation to its dealings with the other party.
- A mechanism is agreed for the replacement of key personnel.
Add notification and mitigation duties
Covid-19 related disruptions can be expected for all contracting parties with different timing, scope and consequences. It’s advisable to add simple yet effective obligations to your boilerplate clauses, such as:
- an obligation for both parties to notify the other of events likely to disturb its operations – whether such event is local (e.g. a local lockdown or the default of a sub-contractor) or global (e.g. another Public Health Emergency of International Concern declared by the World Health Organization); and,
- a duty to mitigate the resulting breach of contract (if any) and any resulting harm to other parties.
- Review termination clauses and consider new triggering events for break clauses, based on turnover or profit reduction.
Review termination provisions
Consider when you might want to terminate the contract (a tentative list is provided below). To address a question often raised in the context of Covid-19, the termination clause is the right place to insert provisions allowing one or all parties to terminate if the contract is no longer profitable – subject to adequate safeguards.
Tentative list (based on Thomson Reuters’ Practical Law note on contract termination):
- Breach of contract by the other party. For example:
- the other party’s performance is unsatisfactory in critical respects;
- the other party is refusing to perform the contract agreements at all; or
- the other party is performing its main obligations acceptably but has breached another term, such as a confidentiality clause.
- The contract is no longer profitable (for example, the cost of performance has become prohibitive, or the customer can get the same goods or services cheaper elsewhere).
- The customer no longer needs the goods or services (time of the essence contracts).
- The other party has gone into insolvency or is about to do so.
- One party has been bought by a competitor of the other.
- One party is carrying on its business in a way that the other fears will damage its own reputation.
- Adapt force majeure and hardship clauses to the jurisdiction of the parties, taking into consideration legal definitions provided by law in civil law jurisdictions.
The force majeure clause
Covid-19 has highlighted a dividing line between common law and civil law jurisdictions. Force majeure is defined by law in civil law jurisdictions (e.g. French Civil Code article 1218; People’s Republic of China, article 180 of the General Principles of the Civil Law and article 117 of the Contract Law) and authorities have issued certificates or official declarations confirming that certain circumstances amount to force majeure events. In other words, civil law came to the rescue of parties unable to fulfil their contractual obligations due to the unforeseeable circumstances.
In common law jurisdictions such as Hong Kong, the definition of a force majeure event and its consequences are created by the contract only. No certificate or official declaration should be expected from the authorities. In the absence of a force majeure clause, parties may consider the Doctrine of Frustration, but it has been decided already that it does apply to temporary frustration (Li Ching Wing v Xuan Yi Xiong  1 HKLRD 754).
Bearing this dividing line in mind, consider (a) including a legal definition of the force majeure relevant to any party of the contract and (b) having the terms “diseases”, “epidemic”, “pandemic”, “quarantine” and “acts of governments” included as force majeure events. Regarding the consequences of a force majeure event, the words “hinder” and “delay” have a wider scope than “prevent”.
The hardship clause
Hardship is defined by law in civil law jurisdictions (e.g. French Civil Code article 1195; Brazilian Civil Code articles 317, 478 to 480). Contracts made with parties in civil law jurisdictions should take into consideration the relevant provisions of such laws, and whether to reinforce them or exclude them (if that is allowed). The clauses mentioned provide for the judge’s intervention in case parties cannot agree on the consequences of hardship, as defined by law. It is quite different from the judge’s intervention in case of breach of contract and claim for damages.
In common law jurisdictions such as Hong Kong, the definition of hardship and its consequences are created by the contract only. Consider this hardship clause from ICC 2003 as an example:
- A party to a contract is bound to perform its contractual duties even if events have rendered performance more onerous than could reasonably have been anticipated at the time of the conclusion of the contract.
- Notwithstanding paragraph 1 of this Clause, where a party to a contract proves that:
- the continued performance of its contractual duties has become excessively onerous due to an event beyond its reasonable control which it could not reasonably have been expected to have taken into account at the time of the conclusion of the contract; and that
- it could not reasonably have avoided or overcome the event or its consequences,
the parties are bound, within a reasonable time of the invocation of this Clause, to negotiate alternative contractual terms which reasonably allow for the consequences of the event.
- Where paragraph 2 of this Clause applies, but where alternative contractual terms which reasonably allow for the consequences of the event are not agreed by the other party to the contract as provided in that paragraph, the party invoking this Clause is entitled to termination of the contract.
- Include effective dispute resolution mechanisms that are available remotely, and consider enforcement challenges.
Governing law and jurisdiction clauses
Make sure the options chosen are effective: avoid the stalling caused by courts closures and unavailability of remote communication with the courts or videoconference hearings. Hong Kong, for instance, has an abundance of mediation and arbitration centres that have quickly adapted to offer remote options. For small contracts, eBRAM, the International Online Dispute Resolution Centre, established in 2018 with the support of the Law Society of Hong Kong, Hong Kong Bar Association and Asian Academy of International Law Ltd, is designed for online interactions.
Interim measures in support of arbitration now available in mainland China
Interim measures needed to preserve evidence or assets were previously not available in mainland China in support of arbitration.
Now, for contracts with a Chinese party, subject to the availability of arbitration off-shore, administered arbitration in Hong Kong is likely to be your best option. The reason being the coming into force of the “Arrangement” on 1 October 2019. The full name is sufficiently explicit: “the Arrangement Concerning Mutual Assistance in Court-ordered Interim Measures in Aid of Arbitral Proceedings by the Courts of the Mainland and the Hong Kong Special Administrative Region”. This means parties to administered arbitral proceedings in Hong Kong can now seek interim measures in aid of arbitration from the mainland courts to protect the enforcement of arbitral award.
Interim measures and enforcement challenges
Interim measures and enforcement challenges need to be considered early on as the choice of jurisdiction is reduced to the place where the other party has assets and only the State Courts have jurisdiction.
This article is the result of on-going learnings in adapting to the new environment and assisting our clients effectively. We welcome your comments and questions.