Is Covid-19 an opportunity to renegotiate a contract?

30 June 2020

Is Covid-19 an opportunity to renegotiate a contract?

One of the most common questions lawyers have gotten this year is whether the Covid-19 pandemic can be used as a reason to renegotiate a contract or franchise agreement. Excel V. Dyquiangco provides an answer from lawyers in Australia, the Philippines and Malaysia.

Many businesses are struggling these days to keep their companies floating. For many, this means studying their contracts to see how this health crisis can affect long-standing agreements. What happens when suppliers can’t deliver? What about IP agreements? 

One of the more important questions: Is this a good time to terminate or renegotiate contracts during the pandemic?

“In the current economic downturn, whether termination or re-negotiation is more suitable will depend on the terms of the contract and the situation of the parties on a case by case basis,” says Sylvie Tso, principal at Spruson & Ferguson in Sydney. “If your contract provides for an obligation to carry out substitute transactions and it is reasonable for your business to procure supply or production from an alternative source, then this action may be required even before you consider termination or renegotiation.”

She adds, “Generally, if the parties wish to maintain a good long-term relationship, it is preferable to renegotiate. This applies to general agreements and IP agreements.”

Jennifer Kwaan, a solicitor at Spruson & Ferguson in Sydney, adds that the Australian government has also provided a large number of stimulus packages and financial assistance to businesses struggling as a result of Covid-19. “Businesses should investigate to see whether any of these assistants will be able to help minimize any loss suffered as a result of Covid-19,” she says. 

 

A force majeure event?

In Australia, the rights and obligations of a party to a contract are determined by its terms and conditions. According to Tso, if a business wishes to terminate, it should first check the termination provisions in the contract – which may allow a party to terminate without cause, so that a party may at any time terminate the contract by giving notice under the required period. She says that if there is no “without cause” termination provision, however, the party will need to review other grounds of termination, such as breach of contract, non-performance, change in control of a party or a force majeure provision.

“A common question in Australia currently is whether an economic downturn is considered a force majeure event,” Tso says. “Unfortunately, Australian courts generally have confirmed that a change in economic or market circumstances affecting the profitability of a contract or the ease with which parties can perform their obligations are not force majeure events. Traditionally, the courts have taken the view that a force majeure event cannot be merely an economic event, there must be a legal or physical limitation. Therefore, it is unlikely that inability to get financing or difficulties or a delay in obtaining supplies due to financial hardship will constitute a force majeure event.”

 

Kwaan adds: “The Australian courts would respect the provisions in the contract as the agreed terms of the party. So, any renegotiation is a commercial exercise – there is no right to do so, unless the contract provides for it.”

In the Philippines, meanwhile, when parties freely enter into a contract, the provisions agreed upon acquire obligatory force and the contracting parties are not allowed to renege on their obligation under it simply because they change their mind. According to Patricia Bunye, a senior partner at Cruz Marcelo & Tenefrancia in Manila, Philippine contract law dictates that the validity or compliance with contracts cannot be left to the whims and caprices of either party, and consequently, whether termination or re-negotiation will be allowed is a question that ultimately depends on the terms and conditions of the contract as agreed upon by the parties.

“If the parties fail to include provisions in the contract regarding termination or re-negotiation, the law will serve to fill in the gaps,” she says. “In such an instance, the Philippine Civil Code on Obligations and Contracts is deemed written into the contract and will apply suppletorily, particularly its provisions on the extinguishment of obligations, or the grounds for termination of a contract.” 

In the case whether a global pandemic such as Covid-19 may be invoked as a force majeure, she says that this is a matter that can be decided only upon the evaluation of the factual circumstances surrounding each contract. 

“Ultimately, the validity of a claim of force majeure is decided on a case-to-case basis,” she says. “Civil law experts and case law, however, provide for examples of what may constitute force majeure and these are generally divided into two categories – acts of God or natural occurrences, such as earthquakes, storms, floods, fires, and epidemics; and acts of man such as armed invasion, governmental prohibitions, riots, strikes, wars.”

She adds that in any case, the following requisites must be established:

  • The event is either unforeseeable or unavoidable;
  • The cause of the breach of the obligation must be independent of the will of the debtor;
  • The event must be such as to render it impossible for the debtor to fulfill his obligation in a normal manner; and
  • The debtor must be free from any participation in, or aggravation of the injury to the creditor. 

“Based on the foregoing, it is necessary to evaluate the actions of the parties (particularly of the debtor), the nature of the obligations involved as well as the nature and role of the unforeseeable or unavoidable event in affecting compliance with the contractual obligations,” says Bunye. “It is also necessary to review the force majeure clause embodied in the contract because parties may also validly limit or expand the scope of what constitutes force majeure.”

 

Franchisees and IP agreements

Furthermore, the fight to manage Covid-19 has seen businesses and institutions across a range of industries reconsider their IP rights for the sake of public interest. “Our practice is busy with drafting interim IP licences to allow businesses to work together to fulfill demand for medical supplies,” says Kwaan. “Some businesses have amended IP agreements and chosen not to enforce certain IP rights during this time in order to fast track the discovery of vaccines or treatments for the virus (such as Medtronics), others have simply lowered or suspended royalties or licence fees to assist individuals and businesses struggling in the current economic downturn (such as OneMusic Australia). Any changes in licensing or IP arrangements should be considered and documented carefully.”

She adds, “With respect to the enforcement of Covid-19 related patent rights in the current environment, it is important to be aware that Australia, like many other countries, has compulsory licence and Crown use provisions under the Patents Act, which gives the Federal Court authority to order a patentee to grant a licence and the Crown the power to permit government authorities to exploit patented inventions under certain circumstances. However, it is unlikely that these powers will be used in Australia if the government and institutions are able to negotiate and come to an agreement on the use of certain IP on reasonable terms.”

Tso adds that with franchising agreements, the current environment will see franchisors and franchisees working together to survive the economic downturn. “This may come in the form of renegotiating minimal obligations, licence fees and other business arrangements (such as finding alternative suppliers),” she says. “Any suspension of fees or payments should be documented clearly. The protection of business assets including any IP (such as trademarks, designs, trade secrets, know-how and business information) will remain important to franchisors. Franchisees will be expected to continue complying their IP obligations under the franchising agreements.”

For Azmi Mohd Ali, senior partner at Azmi & Associates in Kuala Lumpur, like any other general agreements or contracts, IP agreements may be difficult, if not impossible, to meet during this pandemic. He says that the parties’ performance obligations set forth in a license agreement are particularly significant and should be carefully considered, which include.

  • Minimum sales requirements;
  • Minimum production requirements;
  • Minimum royalty requirements; and
  • Timing requirements.

“Clearly, as the economy deteriorates, these performance obligations may not be fulfilled,” he says. “The breaching parties can terminate or renegotiate the contracts. In Malaysia, we have the Contracts Act 1950 that governs our contract law. There are a number of ways in which a contract may be terminated by a party, namely: where one party is in breach of contract entitling the other party to terminate the contract; where the contract provides for termination in the event of force majeure; where the contract provides for termination in the event of material adverse change (MAC); and where an unforeseen event prevents the parties from performing the contract under the doctrine of frustration.”

 

He adds that in renegotiating contracts, the parties may agree to renegotiate the terms of the contract to be more practicable. Parties could, for example, renegotiate the order quantity and payment terms or any other obligations which are affected by the disruptions. Such provision usually requires the variation to be made in writing and signed by all parties. Even if no such requirement is specified in the said contract, it is prudent for parties to ensure that the amendments are put in writing to prevent any future dispute regarding the varied terms. “Even if the contract does not contain the clauses for amendment and variation of the terms of the contract, the parties may also come to an agreement to negotiate a new contract to supersede the prior agreements,” he says.  

In Malaysia, economic forecasters believe that the economic complications related to Covid-19 may cause many bankruptcies among licensees or licensors of IP rights. “In the event of bankruptcy of a licensor, the IP license might be rejected by the licensor, leading the licensee to either force compliance or pursue a breach,” says Ali. “Conversely, if a licensee declares bankruptcy, some IP licenses contain clauses that attempt automatic reversion or termination of IP rights. Whether these clauses are effective may vary by how the clauses are written (for instance whether the triggering event is a bankruptcy filing or failure to perform some other clause), so careful consideration of these rights is warranted before proceeding.”

Bunye adds: “IP agreements in the Philippines are governed by the Intellectual Property Code and the general law on contracts. The IP Code does not provide for the mandatory inclusion of provisions that would apply in the case of a global pandemic such as Covid-19, as they are generally a matter of commercial agreement. The effect of Covid-19 on IP agreements will thus have to be decided on a case-by-case basis.”

Furthermore, for businesses which have entered into a franchising agreement with third parties in the Philippines, they may encounter certain difficulties in regulating their franchises. 

“The burden is particularly heavy on franchisees, which are likely to have difficulty complying with the usual conditions embodied in franchise contracts on minimum sales requirements, production levels, and royalties,” she says. “Franchise agreements also generally contain audit and inspection rights to monitor the use of the IP by the licensee and the goods produced under the license. In this regard, the physical closure of businesses and the logistic difficulties of transport due to the ongoing lockdown may pose challenges in determining compliance with franchise agreements.”

She adds, “In this case, contractual provisions on impossibility of performance or failure of performance of obligations will apply. Pertinent provisions on waiver of performance or force majeure may also be relevant, as are the termination provisions of each contract. As previously discussed, the applicability of Covid-19 as force majeure must be evaluated according to the precise wording of each contract. Some contracts may allow the pandemic as an excuse from performing obligations, while some may provide that it is instead a ground for termination. Again, this must be decided on a case-by-case basis, as it will depend on what a particular contract provides.”

 

Safeguarding contracts

Due to the downturn in the economy, Ali believes that this is indeed a good opportunity to terminate or renegotiate contracts if parties are unable to fulfil their obligations as circumstances have changed. “There are no specific requirements on how to renegotiate a contract,” he says. “You may negotiate and incorporate terms which benefit both parties during this pandemic such as extension of time to be given during the movement control order or deferred payment to be allowed within a stipulated period.”

The “movement control order,” or MCO, was Malaysia’s version of a lock-down during the worst of the Covid-19 pandemic.

Bunye, on the other hand, adds that when a party renegotiates, it should ensure that its relationship with the other contracting parties will be safeguarded or even enhanced, while it tries to mitigate the impact of exposure to risks, being careful in communicating with the other parties, both in terms of the content of the communication and in the approach to the other party.

“A party should thoroughly examine its contracts prior to entering into a renegotiation,” she says. “It should examine the clauses relating to non-performance of obligations, especially the right to suspend performance of its obligations, as well as clauses pertaining to the termination of contracts that have become impossible to perform, and the available remedies. In examining these clauses, a party should take note of its risk or liability exposure.”

She adds that a party must also take into account its effect on other existing contracts. “It should also keep itself updated on government actions and reforms which are relevant for decision-making purposes,” she says. “In the Philippines, for example, there are almost daily issuances from the different government agencies relating to Covid-19 that may impact business operations. And finally, it is important to highlight that negotiating a provisional solution may be appropriate for short-term issues.”


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