Must COVID-19 trigger Force Majeure

A contract is an agreement between two or more entities and is generally divided into two types: verbal and non-verbal.

A verbal contract is usually an implied or oral agreement that is legally enforceable in the same way as other types of contracts. The challenge with verbal contracts is that all parties must be sincere and true to their word. Unfortunately, if for example one party to a contract dies or loses their memory, it can be very difficult to enforce the agreement if the verbal agreement was not recorded, as this is creating room for dispute.
 
A non-verbal contract is an agreement that is documented and signed by the parties affiliated to the contract. In the past, contracts were printed on paper and physically signed with a wet signature. Today, thanks to technology, they can also be documented online and signed by the parties with an electronic signature.
 
Both types of contracts are subject to the same risks.

First, it is crucial to determine whether the contract is for goods, works or services. Next, it must be determined what kind of risks the contract must mitigate, avoid or contain in order to ensure successful implementation.

There are four main types of contract risks - known known, known unknown, unknown known and unknown unknown.
 
Known known risk:
These are the types of risks that all parties are aware of at the contract development stage. A simple example: a company decides to start a ride-hailing service and knows that another company might enter the same business and compete with them. So the risk is known from the beginning.
 
Known unknown risk:
These are the types of risks that are known at the start of a contractual relationship but the impact of the risk should it occur can not be determined unless it actually takes place. One example is the scientific fact that Japan “archipelago is located in an area where several continental and oceanic plates meet, causing frequent earthquakes and the presence of many volcanoes and hot springs across Japan. If earthquakes occur below or close to the ocean, they may trigger tsunami.” This means that any entity that wants to invest in real estate in Japan knows that there is a risk that an earthquake can occur at any time. The unknown part of the risk is which magnitude of the earthquake can occur and what impact it may have on the investment.
 
Unknown known risk:
These types of risks are very rare. They fall into the category where it is known that a risk may occur and yet the contracting parties act with the knowledge that it is an unavoidable element of the contractual relationship. The attempt to colonise Mars is an example for this. It is a known risk that "Mars has no protective magnetosphere, as the Earth does", which increases the radiation exposure for humans and makes colonisation dangerous. According to Marspedia, the average natural radiation exposure on Mars is 240-300 mSv per year. This is about 40-50 times the average on Earth. Scientists have yet to determine the exact effects that radiation exposure on Mars may have on humans (unknown). However, they are certain that the radiation levels definitely pose a risk to humans (known). Nevertheless, this unknown risk does not dampen the enthusiasm of some investors who want to colonise Mars at any cost.
 
Unknown unknown risks:
These are the types of risks that are unimaginable, unforeseeable or unthinkable. They are not just about the risk itself, but also about the geographical scale of the risk, the disruptions caused by the risk, and the aftermath of trying to contain, mitigate or prevent the spread of the risk and further impact on contracts. A recent example of this is COVID-19. The potential for a viral infection to affect parts of the world was imaginable, but a virus that leads to so much devastation, so much death and so much uncertainty worldwide makes COVID-19 a sad prime example of an unknown unknown risk.

Now we are sure that COVID-19 is an example of an unknown unknown risk. But how did it start? Why did it take so long to be discovered? When will there be the next mutation? How many more waves will there be before the virus is contained and how many more people will die? Some of these questions are unlikely to be answered in the foreseeable future. Although COVID-19 is an unknown unknown risk, contracts will continue to be signed in the future.

COVID-19 is caused by infection with the SARS-CoV-2 virus. The documented site of origin is Wuhan, China, in 2019. As of 2021-12-29, over 5.400.000 people have died. To get a better perspective of the death toll: that's more than half the population of Switzerland, or over 140 times the entire population of Liechtenstein.

Unfortunately, according to the World Health Organization (WHO), an end of COVID-19 is not in sight in the foreseeable future.

The occurrence or non-occurrence of an event that makes the performance of a contract impossible for one or all of the contracting parties is specified in a contract as force majeure, or "hardship clause".

These contractual provisions usually serve as protection against known and unknown risks that may have a negative impact during the term of the contract. These may include, for example, coup d'état, terrorism, earthquakes, hurricanes, lightning or explosions. Interestingly, I have yet to come across a contract where a global viral infection has been mentioned as pre-condition to activate force majeure prior to 2019-12-31.

Should COVID-19 be classified as a force majeure or human error? The answer to this question will have far-reaching consequences for dealing with most liquidated damages.

One of the most important factors in all contracts is the supply chain. COVID-19 has created a bullwhip effect within supply chains that most contracts now need to be redesigned to ensure successful execution. In simple terms, millions of contracts have been and are in the process of being cancelled. Humans are the critical actors in the implementation of contracts. During the pandemic, in severely affected areas, such as Lombardy, Italy, it may have been the case that all participants in a supply chain required to implement a particular contract died due to COVID-19 disease.
 

I doubt COVID-19 qualifies as a force majeure. However, I am not sure that the extent of the virus was caused by human error. In any case, the enormous destructive global impact must not be ignored in the decision. In all of this, one thing is certain: the virus has affected contract implementation worldwide on an unimaginable scale.

The challenge that contract administrators, managers and specialists are likely to face for a long time to come will be how to truly determine in this chaos whether the inability to execute a contract is not due to inefficiency but to COVID-19.

Author: Dr. Nana Sackey PhD is a Contract Portfolio Specialist with several years of experience in innovative contracting across shipping, telecoms, managing donor funded projects and academia. He is a Certified Agile Project Manager (IAPM), holds an M.Sc. in Procurement and a PhD in Contract Management. He has facilitated several corporate trainings in the past, focused on contract administration, cost estimation, spend analysis and risk management within contract portfolios. He remains committed to shaping the future of contract design, structure, analysis and management.
He is happily married to Debbie with whom he shares three kids – Iden, Ibby & Ilse – with.

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[1]: cromaconceptovisual / Pixabay