Torys Business Brief: Managing contract risks and obligations during a pandemic

Torys Business Brief focuses on key issues and actionable knowledge for businesses to emerge from the COVID-19 crisis resilient and well-positioned for the future. Each episode of Torys Business Brief features in-depth, accessible interviews with Torys lawyers, moderated by Munk Debates convener Rudyard Griffiths. These episodes are accredited for CPD purposes.

What does it take to rely on a force majeure clause and walk away from a contract? How should businesses identify key risk areas and triage mission-critical contracts? This episode of Torys Business Brief tackles these and other questions, as Munk Debates convener Rudyard Griffiths and Torys lawyers Jessica Lumière and David Outerbridge cover practical takeaways for companies to manage contract concerns amid COVID‑19.

A full episode transcript follows.

Rudyard Griffiths (00:02): Hello, and welcome to Torys Business Brief, I'm Rudyard Griffiths. You may know me as the convener of the Munk Debates, where we bring together the world's sharpest minds and brightest thinkers to debate the top issues of the day. As the moderator of Torys Business Brief, my role is to provide you, the listener, with compelling conversation about the legal challenges that the COVID-19 pandemic presents for businesses and business leaders.

We're all just now beginning to take stock of the effects the coronavirus pandemic is having on a global scale. As the world continues to respond, businesses have wide-ranging issues to consider.

RG (00:39): This podcast will equip you with actionable knowledge your business can use to emerge from the current crisis, resilient and ready to thrive. To do this, I'll be drawing on the expertise and insights of the lawyers working at the firm named Corporate Law Firm of the Year by Chambers and Partners, Torys LLP.

RG (01:23): On today's Business Brief, we focus on the contractual risks that organizations and business leaders are confronting as the pandemic shakes the economic foundations of our country. What are the key contractual risks businesses should be prioritizing? How can companies manage these risks in the current environment? We'll look for answers to these questions and more by turning to two of Torys' leading practitioners, Jessica Lumière and David Outerbridge who are coauthors of the recent discussion paper, “COVID-19: Managing material contracts in crisis.”

RG (01:59): Jessica Lumière is a senior lawyer who advises clients on technology, acquisitions, licensing, outsourcing, and various transactions dealing with a spectrum of emerging technologies, including blockchain and AI. Jessica also leads a team based in Torys' Halifax Legal Services Centre that provides a suite of service offerings for clients that leverage processes and technological efficiencies.

(02:25): David Outerbridge is a partner in Torys' litigation practice. He acts as both trial and appellate counsel with expertise in complex written and appellate advocacy. His practice is broad with an emphasis on litigation and arbitration in the infrastructure, construction, energy and insurance industries. David, Jessica, welcome to Torys Business Brief.

David Outerbridge (02:47): Thanks Rudyard. Happy to be here.

Jessica Lumière (02:49): Thank you, Rudyard.

RG (02:50): So, Jessica, let me start with you. I know you've been having conversations obviously with many clients over the last couple of weeks. What are you hearing in terms of how organizations are trying to get a handle on their contractual risks? What are some of the things that they can do operationally to again deal with a big known unknown which is this pandemic and its effect on all kinds of legal obligations and agreements that businesses are operating under?

JL (03:18): Right. Rudyard, I think the keyword there is operationally. You want to start with your process. You may know already some of the material contracts you need to look at just by virtue of needing to maintain your operations. But what you're really trying to do is move from sort of the reactive to the proactive by identifying in a part of a thoughtful, systemic application of process, what those material contracts are and then identify any material risks within those contracts and then actioning those learnings. So really what's the first step?

JL (04:04): Well, I think the first question you need to ask yourself as an organization is what is material? Your organization, depending on your size may already have a definition, so fair to start there. You can repurpose those existing processes as needed and reuse the vocabulary and the process that your organizations are already familiar with. Otherwise, Rudyard, what you need to do is define the purpose of the assessment. Are you trying to address strategic planning concerns, your immediate needs such as cashflow, upstream, downstream, contract risk, such as insolvency risk or force majeure clauses, etc., which we'll talk about in a little bit, and identify what material means in the circumstances to your organization.

RG (04:59): Jessica, you're in a kind of interesting position for us. You're on a sentinel post there at the bleeding edge, so to speak, of this pandemic. What are you hearing in terms of where businesses are most concerned right now in terms of wrapping their hands around their contractual risks?

JL (05:18): So I'll start with some examples. For example, what is the value of that contract to your organization? But it might be also something like what is the term remaining on that contract? It might be the value of the strategic relationship or partnership to your organization. It may be something like what that reputational risk is that that contract represents to your organization. So the key here though is to, whatever your criteria are, to make them very clear, as simple as possible so that they're not too complicated for your team to apply and to use consistently across all of the contracts. I think an easy rule of thumb is to say if in doubt, assign it to the material contracts pile and move on.

RG (06:05): Jessica, your answer flows nicely to my next question, which is obviously through your career, you've had a history of dealing with many corporations in crisis, coping with extraordinary situations. But what are you seeing that's kind of materially different with contractual challenges that businesses are facing in the context of the COVID-19 pandemic versus the kind of business as usual scenario?

JL (06:28): Yeah, that's a good question. I mean ordinarily a process like this might include some nifty tech tools. You might use a more sophisticated approach to considering the risk. It might involve applying a risk matrix and assessing the severity of the outcome as compared to its likelihood and so forth. But in this climate. You may not have the luxury of doing all of that. In fact, you may not have the luxury of doing more than simply populating an Excel spreadsheet and storing the relevant documents in a Windows directory if those are the tools and the time that you were given. So, it's perhaps a different emphasis right now than it might be ordinarily.

RG (07:10): Yeah, it sounds a bit more like triage. You've got to understand what the priorities are, move on those first, and move in whatever capacity you have. Great. Jessica, thank you for those answers. David, I want to bring you into the conversation and start getting a little bit more specific here for our listeners and get to this question, a series of questions really, around what organizations should be looking for in contracts. In other words, what are the key contractual terms where you think they can begin to kind of un-package and better understand risk and risk mitigation strategies around those legal obligations?

DO (07:47): Well, you used the word triage earlier, Rudyard, and I think that really is a good image. In a broad sense, what organizations need to be looking at is two categories of provisions. Contract terms or entire contracts that create risk and burden would be the one category and the second category would be contract terms or entire contracts that allow an organization to avoid or mitigate the burdens that are imposed by the pandemic. Now, obviously every organization today would rather, I think, negotiate their way through this crisis rather than having major disputes or finding themselves in financial difficulty. So, the goal of this contract review is not to help parties sort of retrench into their corners and fight. The point is to figure out what are the helpful and unhelpful contractual provisions available to the organization so that they know their negotiating position, their points of leverage, and what types of conversations they need to be having with their contractual counterparties.

DO (09:00): I guess another thing that parties need to be thinking about when they're looking at their contracts is not just “do I have a force majeure clause or a termination clause?” but, just to pick up on one of Jessica's points, what are the real materialities in terms of my business continuity? That might mean looking a little more holistically at things like concentrations of risk. So, for example, if I have as an organization, a large number of contracts with a single customer or a large number of supply contracts with one supplier, making sure that the supply line and the customer relationship are protected and preserved are going to be fundamental to my organization. So, when we're looking at all this, we want to be looking at not only what are my rights, but also where do I want to be focusing my negotiating time and my relationship-building exercises?

RG (09:52): David, let me jump in there because this is really valuable information and have you talk a little bit based on your extensive experience in this area about which contract terms really do create the risk and the potential for burden. In other words, if this is a kind of triage moment, where should they be looking to understand where that risk exposure is? What are the specific types of contract terms that you're advising clients to dig into?

DO (10:18): It depends on the industry and the client. So, to give you an example, if a client has a lending contract, looking at default provisions of the lending contract or provisions that trigger a duty to pay sooner than would otherwise be desirable under the lending contract would certainly be important. The ability of a lender to call on a loan if you're dealing with supply contracts or construction contracts, clauses that allow the other party to terminate the contract would be potentially risky or burdensome for the organization. As I mentioned, there's also the type of risk that's not specific contractual terms, but just the existence of mission critical contracts. So, you want to be looking at contracts that if they failed for one reason or another, the organization would be in difficult straits.

DO (11:14): One of the things we're seeing quite a lot in the news these days is the question of how many commercial tenants are going to be honouring their leases. On the one hand, it seems to be relatively common that there are some parties not being able to make their lease payments. On the other hand, being able to keep your premises is one of the most important things for an organization, and so that would be ... The burden of that contract would be one of the major ones you'd want to be focusing your attention on.

RG (11:41): Absolutely. Well, on the other side of the coin though, which are the contract terms that could potentially help an organization avoid some of these contractual obligations that may really be burdensome to them in this particular moment?

DO (11:55): In terms of specific clauses or provisions of a contract, certainly a force majeure clause that is broad enough to give relief to the organization, it captures the pandemic or it captures emergency orders and does actually allow the party to either avoid performing or delay performing, those can be helpful. Although as I'll talk about a little later, they're not necessarily a get out of jail free card. Limitation of liability clauses that limit the potential scope of liability for failing to perform under the contract are important. The right to terminate, having the right to terminate without cause or with cause in circumstances like these will be important.

DO (12:34): Another type of thing organizations will want to be looking for is, in addition to these particular terms of contract, is just types of contract that as a whole give them some type of relief. Certainly a lot of organizations have been looking to their lines of credit and other vehicles that give them access to funds during this time of liquidity crunch.

RG (12:57): David, let's focus in on retail because we all know that retail is being hit especially hard by the pandemic. You just mentioned some of the debates and challenges that are going on around rent right now. What are you seeing out there in terms of these types of conversations? Are there some ways that these things can be, as you say, resolved without litigation? Also, what are the contractual issues that retailers really should be focusing on? Because that is a discrete industry with its own kind of challenges and opportunities.

DO (13:29): I think you hit on the key point, which is that no one wants to litigate now. I mean everyone is suffering burdens like never before in our lifetime. The globe has never experienced anything like this with so many parties experiencing financial and business stresses all at the same time. So I think as a general matter, litigation is your last resort. Just coming back to the landlord tenant front, I think we're seeing landlords are understanding of tenants who have financial constraints. But the flip side is as a retail tenant, for example, you want to be proactively talking to your landlord, talking through any issues there may be in terms of the ability to make the rent.

DO (14:12): I know a lot of creative solutions are coming to the fore on how to solve short-term liquidity crunches through negotiations to either extend the lease on different terms or landlord are issuing loans, etc. But coming back to your question about the retail space and the types of contract to terms that retailers are focused on, a big one there would be customer rights. A lot of retailers are in situations where they have customers who either can't be served or are looking for refunds. One of the key things retailers need to be thinking about is making sure they don't all at once breach contracts with a large number of their customers because of the class action risks that that can create.

DO (14:56): But also, things to think about there are your duties as a retailer to your employees. Many retailers have to lay employees off temporarily. There's also a duty to provide safe working conditions for retailers who are able to continue operating, like grocery stores and that sort of thing. So there's a heavy emphasis on making sure employees are treated properly and as fairly and generously as possible in the circumstances. So I'll leave it there, but there's a host of things that retailers need to be thinking about, including supply chain obligations and the rest of it.

RG (15:25): Complicated time, but important set of points for retailers to think about. I want to spend our remaining time together really digging into this whole discussion that I think everyone is having around forced majeure. As you've talked about, generally in these types of discussions, there aren't get out of jail free cards that we should be reaching for to think that exists. But nonetheless, with a global pandemic declared by the World Health Organization, this whole question of whether forced majeure clauses can come into effect, where and when, has really become top of mind.

RG (16:03): Maybe Jessica, just to bring you back in briefly, could you define for the kind of layperson what is force majeure and what is its primary purpose? And then David, I'll continue on with you to get some specific thoughts because this really is an area of expertise of yours.

JL (16:17): Force majeure clauses are really a creation of contract. They are risk allocation clauses that parties can negotiate into their contracts in order to identify the risk allocation as between them who will bear the burden of a major unexpected event such as the one that we're all living through right now. I guess I'll leave it to David to walk through the elements of it. But really what that clause covers depends on how that clause is drafted. How that clause applies to you depends on which side of the particular risk allocation you happen to fall on.

RG (16:56): So David, to come back to you, talk about the typical elements of a force majeure clause. You've identified three of them. What are they?

DO (17:06): A party that wants to rely upon a force majeure clause, so they want to either limit or postpone or completely eliminate their duty to perform under a contract, they have to generally prove three things. One, they have to show that the event has arisen. So in this case, the event would be the pandemic or a government order that has been issued that prevents them from operating. They have to, number one, show that that event has occurred and that that event falls within the definition of force majeure in the contract. Number two, and this is critical, is they have to show that the event is what has made it impossible to perform the contractual obligation.

DO (17:50): The third element is that the party that wants to claim force majeure also has to take commercially reasonable efforts to mitigate, to try to perform to the extent they can within the realms of commercial reasonableness. So, it's not enough to just say there's been a pandemic, I can stop performing. They have to, number one, show the pandemic has occurred and falls in the force majeure clause, number two, prove that it's made it impossible to perform and, three, prove that there's nothing they can do to try to perform, even if in part, during the course of the pandemic.

RG (18:24): David, I'm puzzled. I mean just as a layperson I would have thought that the global declaration of a pandemic would just automatically make it a force majeure event. But that's not necessarily the case.

DO (18:36): No. That's right. Force majeure clauses, as Jessica mentioned, are creatures of contract and so the parties decide what's in and what's out of a force majeure clause. They decide what risks qualify for force majeure relief. It may be that the force majeure clause doesn't even capture pandemics in the first place. Even if it does, the important nuance of having to show that the party can't actually perform the contract because of the pandemic. To give you an example of what I mean there, there's a host of organizations right now who are experiencing liquidity issues either because their customer base is drying up or because of supply chain problems.

DO (19:19): Typically, just the shortage of cash, just the inability to pay will not qualify as a force majeure. For example, under a lending agreement where the debtor's primary obligation is the payment obligation, the fact that their business is performing poorly doesn't give them force majeure relief typically under a lending contract. I say typically, I mean you have to look at the terms of your contract. But that would normally be the case. You have to show that the reason you can't perform is specifically because you directly have been affected by the pandemic or by the government order in question. And then as I mentioned, show that you can't solve the problem by mitigating it.

DO (20:01): Many of the essential services orders that forced businesses to shut down in various jurisdictions in Canada continue to allow for remote working, for example. If you can continue to operate through remote working, that would be a reasonable mitigation measure you would need to demonstrate you'd taken before you could claim the benefit of a force majeure clause in that example.

RG (20:21): These really are not blanket protections. These are carefully crafted clauses that have all kinds of parameters embedded in them. What I'm hearing from you, David, is that businesses really need to look at these carefully. I assume there's a lot of interpretation that goes into how you read that clause.

DO (20:40): No, that's exactly that right, Rudyard. I think there's two main themes I'd stress about force majeure clauses. One is by all means check whether you have the force majeure clause that you can take advantage of or that your contractual counterparty might be taking advantage of so that you can either anticipate your own ability to press the pause button on your contract or anticipate your counterparty's likely approach to you to try and do the same thing. The second point I'd make is that they, as you say, they're not complete solutions to every problem.

DO (21:16): As a practical matter, telling your contractual counterparty you can't perform because of force majeure is all very well until it doesn't solve your problem in the sense that your contractual counterparties in this pandemic mix as well. They need to ensure that they're not impaired in their ability to conduct their own business. I think the emphasis needs to be on cooperation, communication, negotiation and solution finding, using dispute resolution as a last resort. But in the first place, focus on once you know what your rights are, go solve the problem.

RG (22:24): Well, Jessica, as we begin to think about how to distill this conversation down into some specific insights for our listeners, let's also just pause for a moment and acknowledge that with the analysis, the detailed analysis of contract terms, you can go down a proverbial rabbit hole. There are other contractual factors that are relevant to an organization's risk analysis. What do you see in broad strokes as some of those other areas where corporations need to be looking to understand contractual risk?

JL (22:57): Right. What we're really, I think, talking about here, Rudyard, are what are some of the factors actually outside of the contract itself? In a common law jurisdiction that might be a doctrine like the doctrine of frustration, which may provide relief where the performance of a contract is impossible or at least radically different from the original deal. Just very quickly, it's typically a high standard. It's a little bit higher than force majeure. Its application can result in a complete end to the contract as opposed to force majeure, which relates to that particular specific obligation.

JL (23:43): Legal doctrines like that outside of the contract need to be considered. Government directives, that's an easy one that we've been hearing a lot about in the news. An obvious one is the closures of non-essential businesses. But as we go, keeping an eye on what's going on and what new government directives might be that applied to you or to the opposite party are going to be important. Statutory considerations and governing laws, so what applies to the contract. UNCC, the United Nations Convention on Contracts, for example, or Quebec Civil Code, those can imply a force majeure concept, various provincial statutes that might provide a framework for adjusting the party's rights and liabilities in the context of one or both of them non-performing.

JL (24:37): Further to what David was speaking about earlier, you may also have to consider some of the consumer protection legislation as well. And then I guess I would say thinking about what the mitigation measures might be. David mentioned earlier remote working. Some of these things you can generally rely on your common sense. Might not be a situation where you simply have to throw up your hands and not do anything. There may be some mitigation measures that you can employ to reduce the risk to your organization and to reduce the negative impacts on your upstream and downstream relationships.

JL (25:14): I think it's important also to make sure that you're documenting the measures that you are taking and also documenting the counterparty's compliance or noncompliance. Also, as a mitigation measure, just ensuring that you have thought about your communication strategy as an organization. So those are some of the other considerations that I think are important outside of the specific wording of the contract.

RG (25:42): Thanks, Jessica. David, similar question to you, I mean what are the different litigation risks that organizations should be thinking about? I mean there's a host out there, but what are kind of top of mind for you right now as you're advising clients?

DO (25:56): There's really two categories I think that are new. One is class action risk and the second one is new and different business risks that could give rise to litigation in the COVID-19 environment. On the class action side, any step that an organization takes that affects a large body of similarly situated people, whether we're talking about employees or customers or buyers or what have you, can generate a class action risk. We're seeing a fair amount of early class action activity so far primarily coming out of the U.S., as is common. But it will just be a matter of time before we see it in Canada.

DO (26:41): Cruise lines, airlines, sport clubs, governments are being targeted by class action plaintiffs for the way that their approach to a particular legal problem has affected a large group of people. Whether the class actions will be substantiated is a different matter. But it's the type of risk that is materializing in a more concentrated way during the pandemic simply because there's so many decisions that organizations have to make in real time that are affecting a large number of people. So it's important to be alive to these risks when you're thinking about, first of all, what are the material contracts? It may be that there's a relatively small contractual duty in a retail contract. But if you multiply that by a million customers, it becomes a material class action risk.

RG (27:30): Jessica, I'm giving you the challenge of summing up this rich discussion that we've had and really, if you can, help us pull out what are some of the key pieces of advice that you would take away from a conversation like this when you're talking to business executives about developing an action plan to mitigate and understand their contractual risks as an organization.

JL (27:53): So some of the things that I would say have come out of the conversations that I've had are things like for sure coming up with a strategy that incorporates all of the things, all of the elements that we've been talking about in this discussion so far, but being open to having that strategy changed depending on, for example, what your contract review might uncover. I think flexibility, particularly when things are changing so quickly, is going to be key. But it's helpful to have a baseline so that you know where you're coming from and where you're going to, and so does the team.

JL (28:29): Just going back to my point about the communication, it's going to be really important right now to make sure that where you can, you've identified a point team that has the right sort of expertise on it to manage some of these questions. So having a plan for managing the story, so making sure your HR department, your PR department, marketing, etc, are the right people who are in the loop so that you are telling the story that you want to make sure is told. I would say focus your efforts and don't spread yourself too thin. I would say now's not the time for grandstanding or wielding leverage like a broad sword, if that's the right expression.

RG (29:18): Let's go with that.

JL (29:18): I think now's the time to identify and offer compromise early where you can and move on. So I think getting that agreement, whether it's an amendment or a settlement agreement, getting that done and documented and resetting for the next relationship or deal is important. But I would say take a moment if you have the time to sort of debrief from that experience and use that first pass as a template for other discussions and documents. That will really help you to save time and maintain consistency.

JL (29:57): I would end with know when to get help. Some of the decisions executives will need to make will involve or may involve tax considerations, cybersecurity issues, not just the legal analysis that we've been speaking about, but intimate knowledge of the relationship with the counterparty that may lie with different SMEs in your organization. So I would say rely on those experts in those areas just as you would if it was business as usual, know where to find the help and lean on the people who have that experience.

RG (30:32): Jessica, thank you, to both of you. This has been a really insightful, thoughtful, rich conversation and bringing your years of experience and careful consideration to, I think, just some of the frenzy of these last few weeks certainly leaves me with a sense that there are practical paths forward here. There are sequential decisions that organizations and business leaders can make to really manage through the risks of this period and hopefully position their businesses to come out the other side of this crisis ready, resilient, and positioned to grow. So thank you for coming on the show and sharing your analysis and insights. Greatly appreciate it.

DO (31:20): It's a pleasure. Thank you, Rudyard.

JL (31:21): Thank you, Rudyard. It was good to be here.

RG (31:25): Well, that wraps up this episode of Torys Business Brief. For more of David and Jessica's analysis and insights into contractual risks that organizations and business leaders are confronting during the pandemic, visit torys.com/covid19. Again, that website, torys.com/covid19.

RG (31:47): Our next podcast will be with partners, Mike Amm and Krista Hill, who will cover the gamut of continuity issues business leaders must consider in the context of the COVID-19 crisis.

RG (26:54): Thank you for listening to Torys Business Brief. I'm your host, Rudyard Griffiths.
 
 

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Written Materials:

• COVID‑19: managing material contracts in crisis
• COVID‑19 and force majeure clauses: key considerations, implications, and practice tips

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