Covid-19: suggestions for emergency law reform

Promoting fairness, spreading costs and avoiding a long tail of litigation

In my blog post of yesterday I described the existing law as it applies to business contracts during the coronavirus outbreak. I set out below some of the legal steps I think Government/Parliament should consider taking to stabilise the economy and markets and reduce unfair burden-sharing across the economy. It would normally be profoundly un-Conservative to interfere in private contracts, but in this case the circumstances were entirely unforeseen and the losses will be distributed in a way that is close to random, but with the effect falling particularly heavily on small businesses unable to pass costs back to their suppliers. Government attempts to help business with loans and other support are entirely welcome, but unless Government will contribute the entire cost to the economy, which is unlikely, it is important also to share the remaining burden across the economy as evenly and fairly as possible, and to preserve businesses and jobs so that they can resume after the crisis without a burden of debt or the threat of litigation. That needs to be done with very broad-brush temporary legal measures to complement targeted Government assistance.

English law currently makes no provision for short-term suspension of businesses or the temporary laying-off of workers. Businesses that do not perform contracts may be liable for unlimited claims for losses suffered by the other party.

My suggested steps are intended only to apply during the duration of the Covid-19 crisis. Ministers should take power to remove or suspend them when appropriate, with power to restore them if the virus returns. Inevitably they carry risks of further unfairness, fraud and abuse, but their short-term nature should mitigate that. Considerations of moral hazard (relieving those who did not prepare at the expense of those who did) hardly apply when the present situation was so unforeseeable.

All of my suggestions can be implemented by legislation alone, without of themselves requiring additional public expenditure, though for best effect they would be integrated with the financial measures already announced, or to be announced, by the Chancellor.

1.    For the duration of the crisis, businesses should be given power to “mothball” themselves, or individual sites or business activities within a company, without going to court or any other formality other than public notice. I would call this Suspension.

1.1. Suspension would have the same effect as Administration (Insolvency Act 1986 Part II) but the directors would remain in control and the process could be applied to an identifiable part of a business (such as a retail unit or a product line, with the employees, contracts and assets relating to that unit being deemed to be those of the unit in Suspension as if it were a separate company). Suspension would be permitted only if the directors consider the business to be uneconomic during the crisis and for the sole purpose of preserving the business during the crisis.

1.2. During Suspension, no debts or contracts incurred before 16 March 2020 or accruing under existing obligations could be enforced by legal action or appointment of liquidators/administrators. Employment contracts could not be terminated but employees could be laid off at a specified rate – SSP rate, half pay, 75% or full pay, depending on Government subsidies. Government would undertake to pay all or a proportion of these wages costs, and could provide loans pending later claims. This could be extended to zero-hours workers and contractors engaged direct or through service companies. Alternatively, laid-off workers would be entitled to state benefits during lay-off as if unemployed, but without obligations to seek work.

1.3. Rents and interest payments and accruals could be arbitrarily reduced by 25% or 50% during the peak crisis period, sharing burdens with landlords and lenders, depending on how Government subsidies are to be targeted. Services provided to or by the busienss (other than utilities) could be suspended notwithstanding any long-term contracts, and no payments would be due for services not provided.

1.4. At the end of Suspension, the business would have to pay its suspended debts (but not cancelled interest, rent or taxes) no later than equal monthly instalments over six months.

1.5. Public service obligations could be imposed as conditions of Suspension, such as contributing to initiatives to provide essential products or services, or making staff available for volunteering, or a general obligation of directors to do everything possible to support public initiatives to fight the virus and keep the economy going.

2.    Alternatively, or as a separate initiative, employers should be given power to lay off employees on short notice for up to three months or the duration of the crisis, continuing to pay them (at reduced rate as above) with the benefit of state subsidies. Existing redundancy processes are too slow (for large businesses consultation and selection for redundancy plus notice period would exceed the likely duration of the crisis) and result in permanent dismissal. Anyone made redundant on or after 16 March 2020 and for the duration of the crisis should be automatically entitled to reinstated within six months unless the employer goes bust or can show that the job was redundant notwithstanding the crisis. This is what Virgin Atlantic is trying to achieve, but without a change in the law, its initiative would not survive challenge in the Employment Tribunal.

3.    All commercial rents and/or trading company interest rates in force between private parties at 16 March 2020 could be reduced by 25% for three months, purely as burden-sharing, on top of any reduction due to the base rate cut. Financial markets would need to be exempted in view of international implications and there might be a size threshold, though it would be a mistake to assume that only small businesses need relief.

4.    Covid-19 should be deemed a “force majeure” event for all contracts (other countries, eg China, have done this); the law would imply a term into every contract governed by UK law that if performance of the contract is rendered impossible, impractical or uneconomic by the coronavirus crisis (including by labour shortage or unavailability of supplies) the obligation is suspended, if capable of being performed later, or cancelled if time-critical, with any advance payments or expenses being refunded (as per section 2 of the Law Reform (Frustrated Contract) Act 1943), plus consumer deposits or prepayments being refundable in full. This would not apply to financial markets or insurance contracts but could apply to bank lending. This is intended to prevent the economy being overwhelmed by a tide of litigation attempting to shift costs to other parties and breach of contract claims for damages, including for loss of profit. Legislation akin to the Protection of Trading Interests Act 1980 could be used to prevent British companies being victims of such claims abroad or under contracts governed by foreign law.

5.    Compliance with Government recommendations on public health should be deemed compliance with a legal obligation for the purposes of all contracts and the law of torts, so that no-one can be sued for doing so and compliance, by the business or third parties, provides a lawful excuse for non-performance of obligations and enables insurance and benefits claims. No-one should be penalised for acting in accordance with Government advice, or because it is advice rather than the law.

6.    Legislation should say that exposure to coronavirus in the course of normal working should not in any circumstances be deemed a breach of health and safety laws by employers or negligence by the operators of business or premises. Otherwise businesses which should be staying open, perhaps in essential sectors such a heath supplies or food distribution, will close down because of the duties they have towards their own staff and the public, and will be reluctant to re-open as the danger reduces. We need to be explicit that businesses and individuals are allowed to take some risk in order to combat the virus and keep the economy going. Employers are reacting as if the call to work from home means that all workplaces must be closed, whether or not home working is possible. We do not want courts examining decisions with the benefit of hindsight, or businesses being burdened with litigation as they try to recover.

7.    Loans made under Government crisis initiatives should be exempted from prohibitions in other contracts and from calculation of financial covenants in bank lending documents. Otherwise acceptance of such emergency loans is likely to amount to a default under existing loans and result in lenders enforcing security, appointing administrators or increasing interest rates and fees to penal levels. There is a danger of lenders seeing receipt of crisis subsidies as an opportunity to recover pre-existing debt. It would be possible to suspend all financial covenants in loan agreements for a period to prevent defaults.

8.    Ministers should take powers to disapply intellectual property rights during the crisis if they restrict business responses to the crisis, eg by inhibiting UK copying and production of ventilators or other essential supplies normally sourced from overseas.

9.    The EU should suspend all State Aid restrictions during the crisis (at least outside the Eurozone) and disapply competition law to the extent that it inhibits businesses co-operating for the efficiency of the economy and the sourcing and distribution of goods during the crisis.

In the absence of steps such as these, businesses will take their own steps to protect themselves and (as they are required by law to do) their creditors and employees by making staff permanently redundant, disposing of assets (eg by not renewing leases) and/or going into insolvency, doing permanent damage to the economy and having knock-on effects for creditors and the wider economy. An overhang of litigation could stifle the economy for years to come. 

Stay safe.

Covid-19: who bears the loss? Contracts and Coronavirus

All the news is about Coronavirus and its dangers to people, society and, in third place, the economy. As well as human tragedies, we are facing unprecedented disruption to work and economic activity. We could be facing an unprecedented wave of bankruptcies. But where will the losses fall?

Supply chains and back-to-back contracts

Supply chains and labour markets are complex and often unstructured, and in many cases the effects of Covid-19 losses will be close to random. Businesses may be fighting for survival, and anxious to pass on costs and losses to other parties. Consumers will want their money back for goods and services they can’t use. Demand has fallen, in many cases to levels at which it is uneconomic to continue. Wages and business costs continue to accrue. Suppliers still want to deliver and be paid.

It can come as a huge shock to a business to find itself bearing the loss of the entire supply chain because it is a man-in-the middle, due to mismatches in contract terms. Purchase orders can’t be cancelled unless the contract terms allow that, even if customers cancel their orders or refuse delivery. Consumers may have rights to cancel, return goods or just fail to pay, but a retailer may not be able to pass the cost back up the chain. The loss will often fall at the retail level, because consumers have legal rights (cancellation, returns, refunds) that retailers must respect; trade contracts up the chain will not usually give the buyer the same rights. International contracts may be worse still, with different laws and legal systems applying to each link in the chain.

Imagine a small travel agent, putting together its own packages for holidaymakers on a modest margin: it may have committed to hotels and airlines, or even paid them in advance, but when the FCO advises against travel, or the destination closes borders, the customers will be entitled to their money back. The agency’s contract with the suppliers may not entitle it to a refund, leaving the agency with the full liability. In an ideal world, supply chains are built with back-to-back contracts and pay-when-paid clauses that allocate the loss appropriately across the supply chain, or to parties who are insured, but that is the exception rather than the rule. Often the loss will fall on the weakest link in the chain, the person who has not been able to negotiate let-outs with either its customers or its suppliers.

Frustration

What remedies does the law allow when a performance of a contract becomes impracticable? Is a party liable for breach of contract if he simply cannot comply?

If the contract terms provide no let-out (such as an express cancellation right, or an implied right to terminate and indefinite contract on reasonable notice), the only legal escape is the legal concept of frustration. A contract is frustrated if something happens after the date of the contract has been formed that is not the fault of either party and is so fundamental that it strikes at the root of the contract and is beyond what was contemplated by the parties when they entered into the contract. It must render further performance impossible or illegal, or make the obligations radically different from those contemplated by the parties at the time of the contract. Frustration brings the contract to an end immediately, and relieves both parties of any unperformed obligations. Under the Law Reform (Frustrated Contracts) Act 1943, money already paid is normally recoverable, less any expenses incurred by the other party. A party who has gained a valuable benefit under the contract must pay a just sum for that, and a party who has incurred expenses may charge them to the other party. 

Circumstances arising from Coronavirus are certainly capable of amounting to frustration. If it became illegal to ship goods across a border, or particular workforce could not travel or was incapacitated, or an asset (such as hotel or ship) was requisitioned or closed down, that could frustrate a contract specifically relating to that, and applying in the short term. Because frustration ends the contract completely, it cannot help if all that is needed is a temporary suspension or delay. The performance of the whole contract must be completely impossible or radically different to what was expected. The contract is not frustrated just because it becomes more expensive or inconvenient to perform, or if there is another way of performing it, or if it cannot be performed due to a risk that should have been contemplated by the parties, such as supplier failure. There is no frustration if the purpose, rather than the performance, of the contract, is impossible: for instance, the European Medicines Agency’s 25-year lease of its London headquarters was not frustrated by Brexit (Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch)).

A particular issue arises (at the time of writing) from the UK government’s approach to the social distancing measures required to fight Covid-19. The Government is acting by making strong recommendations, rather than imposing legal banks on events or activities. That means compliance is voluntary, so the advice is unlikely to frustrate contracts. A party complying with the advice, or who cannot perform because his employees or suppliers are complying, risks being sued for breach of contract, or forfeiting his advance payments. Not only will that cause losses to consumers (who may not be able to get refunds for holidays, event tickets etc, and may be sued by desperate businesses unable to fill vacancies), but this could be detrimental to the essential public health objectives. Venues will be tempted to stay open and events to go ahead so as to avoid paying refunds or being sued for failing to deliver promised goods or services, and the public will be tempted to go ahead with activities they have already paid for.

Employment contracts are unlikely to be frustrated, except in the sad event of the death of the employee. Employers will still have to pay salaried staff who are ready and willing to work and will continue to have an obligation to provide paid work for other staff. It seems that employees self-isolating will be deemed to be sick, at least for the purposes of statutory sick pay, though it is not clear whether that relieves employers of paying more generous contractual sick pay, or full pay for salaried workers, who are not in fact sick. Emergency legislation has made statutory sick pay payable from day 1.  There is no automatic right to suspend or stop paying staff if workplaces are closed or customers stop buying. Not all contracts provide for short-time and lay-offs. Cuts to the workforce will have to follow usual redundancy procedures, including consultation, selection and payment of notice pay and redundancy compensation.  Employers will be looking for other cost saving measures that can be implemented swiftly. On the day of writing, Virgin Atlantic has invited its staff to take eight weeks of unpaid leave or face mass redundancies; many workforces would not agree to that, but some may feel that they have little option to keep their jobs when others are unlikely to be recruiting. They are unlikely to qualify for most state benefits if still employed but on unpaid leave. The cost of redundancies could well be as great as paying wages through the crisis, depending on how long it lasts. Further emergency legislation is likely in this area.

Force majeure

Many contracts (including standard terms of business) contain “force majeure” clauses. They usually relieve the parties from performing obligations if they cannot be performed for specified reasons beyond the parties’ reasonable control. They may suspend performance for a period, and/or allow the parties to terminate the contract without liability on either side. Labour shortages, transport disruption or supplier default may (or may not) be listed as a force majeure event, though it would still have to be the main cause of the disruption and outside the party’s control. Whether a public health emergency amounts to force majeure depends on the wording of the clause. 

The situation must still be beyond the control of the affected party. Again, the fact that compliance with Government advice is voluntary might not help to bring the situation within the force majeure clause. Inability to pay money due to loss of income will not be force majeure; nor will obligations that are just more expensive or difficult to carry out, but are not impossible.

Often there are formalities needed to invoke the force majeure clause, such as giving notice to the other party, or taking steps to mitigate the effect of the event. Unlike frustration, force majeure may apply to the obligations of one party only, and can grant a temporary suspension or delay. On the other hand, the presence of a force majeure clause may mean that the contract is not frustrated: if the agreed terms deal with a situation, that situation will not frustrate the contract.

The cost

The main impact of Coronavirus is the large number of human tragedies. Economic considerations are less important, but the economy also has real effects on keeping people alive and safe. The damage will be spread throughout the economy, but the losses will not be even and will not fall fairly, especially if governments do not intervene. Some individuals and some businesses will suffer disproportionate pain. The English law of frustration and force majeure is not going to help significantly in restoring order or fairness in this crisis. Ultimately, much of the economic cost may be felt through business failures and job losses. Insolvencies result in real and permanent damage, even if new businesses, or phoenix businesses, eventually arise from the ashes to provide the same goods and services. Innocent employees, business owners, shareholders and pension fund members will bear the cost.

Things are changing fast – this article is written on 17 March 2020. Further emergency legislation is very likely – it may include new ways for businesses to suspend or reduce activities.

Stay safe.