COVID-19: the quest for contractual equity

Contractual certainty has long been regarded as a fundamental component of our legal landscape. Businesses plan (and price) on the basis that the contractual terms they sign up to will ultimately be enforceable, if need be through court action. However, the backdrop against which contract terms are enforced is rapidly evolving in response to the widespread disruption caused by COVID-19. Recent practical and legislative developments have had a dramatic impact on the ability to enforce contract terms and are necessitating a new approach to resolving disputes.

The courts – adjournments and backlogs

A major practical hurdle to enforcing contract terms arose as soon as lockdown began. The Scottish courts adjourned all civil business, except the most urgent of cases. The courts are now progressing some cases remotely, but hearings that require witness evidence remain adjourned, and backlogs have inevitably led to significant delays for those cases the courts allow to progress remotely.

Our experience of remote hearings has been very positive and we hope to see many more cases progress by way of videoconferencing and teleconferencing facilities in the coming months, while social distancing measures remain in place. However, we anticipate that the impact of the disruption will lead to delays in civil cases lasting into next year. Unless a case is particularly urgent (for example, where an interim order is sought), the courts are unlikely to provide a route to resolving disputes swiftly any time soon.

Government intervention

The UK Government is taking an interventionist approach in order to help businesses avoid insolvency and continue trading during this difficult time. On 7 May, guidance was issued calling for “responsible and fair” behaviour in the enforcement of contract terms where the performance of a contract is materially impacted by COVID-19. The Cabinet Office’s Guidance on responsible contractual behaviour in the performance and enforcement of contracts impacted by the COVID-19 emergency does not have the force of law; rather parties are being encouraged to follow it “for their collective benefit and for the long-term benefit of the UK economy”. The Cabinet Office guidance does not apply in the devolved administrations, but is of interest across the UK.

The guidance strongly encourages parties towards the amicable resolution of contractual difficulties and disputes. It asks parties to be “reasonable and proportionate in responding to performance issues and enforcing contracts (including dealing with any disputes), acting in a spirit of cooperation and aiming to achieve practical, just and equitable contractual outcomes”. While the guidance states that it does not override specific contract terms, it contains a list of particular examples of circumstances where responsible and fair behaviour is sought, including making payment demands; responding to force majeure or frustration claims; calling up securities; initiating or continuing an insolvency process; claiming breach of contract; and enforcing default/ termination provisions.

Published on 20 May, the UK Government’s Corporate Insolvency and Governance Bill is a further significant intervention because it dramatically affects the remedies available to creditors. The bill is expected to become law by July, with some provisions having retrospective effect. The key provisions extend to Scotland. The explanatory notes describe the overarching objective of the bill as being to “provide businesses with the flexibility and breathing space they need to continue trading during this difficult time”.

The central proposal in the bill is a moratorium process to enable companies to apply for a payment holiday, initially for 20 business days (but extendable) and overseen by a monitor who will be a licensed insolvency practitioner. The purpose of a company applying for a moratorium would be to facilitate its rescue, via a company voluntary arrangement, a restructuring plan of the type also introduced by the bill, or a new injection of funds. The effects of the moratorium on creditors of the company are extensive, and include a prohibition on commencing court action (unless leave of the court is obtained, noting that leave is not to be granted for the enforcement of debts), on enforcing security, and on the exercise by a landlord of a right of irritancy without permission of the court.

Other proposals in the bill restrict the remedies available to creditors of all companies:

• While not prohibiting the serving of statutory demands, the bill deprives them of utility by providing that statutory demands served between 1 March and 30 June 2020 cannot form the basis of a winding-up petition.
• The bill also temporarily prohibits a winding-up order from being made in respect of a company on the grounds that it is unable to pay its debts, where the inability to pay is the result of COVID-19.
• It suspends termination clauses operable on insolvency in contracts for the supply of goods or services, meaning that suppliers can be required to continue to supply, even in the event of significant outstanding payments.

Judicial activism?

Emerging calls for the law to respond to the disruption to contractual performance with equitable solutions suggest that we could perhaps be on the cusp of a period of judicial creativity. The British Institute of Commercial & Comparative Law issued a concept note titled Breathing space – a Concept Note on the effect of the pandemic on commercial contracts, noting the exceptional nature of current circumstances and need for debate on the “necessary contribution of the law to safeguard commercial activity, minimise disruption to supply chains, and ameliorate the adverse effects of a ‘plethora of defaults’”.

The concept note encourages a conciliatory approach to resolving contractual disputes: “In many jurisdictions, procedural rules already encourage conciliation – can these be developed further to give a breathing space? The onus at least in the first instance would be for the continuance of a viable contract rather than bringing it to an immediate end.” So far, uncontroversial.

The concept note goes on to consider how existing legal principles could be applied by the courts to arrive at equitable solutions. The note points out that “as well as the scope of the doctrine of frustration, rules as to the implication of terms and the debate as to long-term relational contracts may be relevant... Another approach would be through the doctrine of unjustified enrichment, the question being whether, without declaring their contract at an end, the relations of the parties can be equitably readjusted by the court so that the one will not be unintentionally enriched at the expense of the other”.

Innovation by the judiciary, relying on development of the law of frustration, the implication of terms, relational contracts (this is a reference to the development of the principle of good faith in the English courts), or unjustified enrichment, in order to arrive at equitable outcomes, is more controversial. Recent Supreme Court decisions have, rightly in the authors’ view, rejected calls to arrive at equitable solutions at the expense of contractual certainty. A theme common to the recent landmark Supreme Court decisions in the field of contract law is the need to respect the terms of the bargain struck between parties: see Arnold v Britton [2015] UKSC 36 (concerning contract interpretation), Marks & Spencer v BNP Paribas Securities Services Trust Company (Jersey) [2015] UKSC 72 (concerning implied terms), and the conjoined decision in the cases of Cavendish Square Holding BV v El Makdessi and ParkingEye v Beavis [2015] UKSC 67 (concerning penalty clauses).

Judicial innovation in cases arising out of exceptional circumstances to arrive at equitable solutions is likely to create unhelpful precedents. Intervention to address unfair outcomes legitimately belongs in Government legislation, as we see with the Corporate Insolvency and Governance Bill.

The way forward

The manner in which businesses and their legal advisers approach contractual disputes is one of the many processes that has to adapt to the current disruption. Enforcement options are limited and, where they are available, are unlikely to result in rapid resolution. Deferring resolution until social distancing measures are at an end and the courts have cleared the backlog of cases will rarely be satisfactory, doing little to resolve underlying issues or the economic or mental stress that has been caused.

Current circumstances have prompted a surge in interest in remote mediation, which can be a quick and low cost method of resolving contractual difficulties. The use of videoconferencing technology allows the physical set-up of a mediation to be recreated, with parties “meeting” their legal advisers in a breakout “room” beforehand, and the flexibility to switch between plenary sessions and the mediator joining parties in their breakout rooms, much in the same way as an in-person mediation.

There is room for creativity in the mediation process. We recently acted on behalf of a client in a “blind bidding” mediation, where parties put forward their settlement proposals in three bidding rounds, with a match resulting in successful settlement. Now, more than ever, the inability to perform contractual obligations is arising from circumstances outside of parties’ control. Remote mediation presents an opportunity to work through those difficulties, preserve relationships and reach a resolution, enabling businesses to move forward and address the other pressing challenges they are currently facing.