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Strengthening contracts for future lockdowns

17 January 2022

#Property, Planning & Development, #COVID-19

Strengthening contracts for future lockdowns

Throughout 2020 and 2021, the COVID-19 pandemic lockdowns caused social, commercial and legal unpredictability. As a governmental response to potentially widespread harm, lockdowns may become more common. This need not only be for health reasons. Imagine the January 2020 NSW bushfires recurring ­– evacuating and locking down large regions of the state may be required to free up emergency services and save lives, and there are many other possible lockdown scenarios.

When preparing new contracts, banking on further lockdowns seems reasonable with attention now – in 2022 – being given to what lockdowns later this year or in future years may throw up. The aim is a contract robust and malleable enough to deal with what a future lockdown event may present, which involves some prediction.

Prediction and good lawyering often work hand in glove – like lawyers advising clients on whether to terminate a contract by assessing how a court might one day view the decision. Other times, lawyers may need to predict if legislation will be introduced or amended, and so on. To be worthwhile, predictions will be based upon a lawyer’s experience ­– in this case, experience with the 2020 and 2021 lockdowns – and then integrated with a lawyer’s legal knowledge. Done properly, clients can make more confident decisions.

Dealing with future lockdowns and other catastrophes

Suggestions follow on improving contracts for future lockdown-type events. But what characterises a lockdown-type event? Features include:

  • governments imposing restrictions on what were previously standard commercial dealings – business as usual becomes suspended, shops and offices close, people remain home, manufacturing and transportation become difficult
  • demand for many goods and services flounders. Businesses lose revenue. Landlords, lenders and suppliers go unpaid. Many people have less work and less income, meaning their residential landlords and financiers and mortgagees go unpaid
  • with unsatisfied liabilities, legal dilemmas sprout. But those owed money cannot say, “I don’t care, I’ll end this contract and sue for damages!” Why not? For starters, these businesses likely have sympathy. Regardless, the legislation creating the lockdown event generally includes moratoriums against common enforcement options under common contracts. Also, those owed money often have their own liabilities and need money themselves to satisfy their creditors. Suing broke people, or tearing up agreements, does not turn into money.

In other words, one lesson from the 2020 and 2021 lockdowns was that simply ending contracts can be self-defeating. More realistically, because lockdowns are temporary, the success of a post-lockdown business requires things to resume, just like we’ve all been hibernating. Manufacturers will need orders from wholesalers. To place orders, wholesalers require demand from retailers and service providers. These retailers and service providers need leases for their shops and offices. Shops and offices require staff and employees. Employees will also be customers for other businesses working out of other shops and offices, etc. It’s all connected, and kind of like, well, a society.

This all suggests the benefit of giving time to reflect on the past two years of lockdowns and re-imagining some contract terms.

Re-negotiations and expert determinations

Lockdown legislation targeted certain contracts. Primarily, many retail and commercial landlords were prevented from enforcing leases without first undertaking a prescribed re-negotiation process. If successful, rent would be reduced for the lockdown, with the reduction being partly waived and partly deferred.

While compliance with the re-negotiation procedure became a pre-condition to enforcement, and re-negotiation guidelines were given (i.e. the ‘National Code’), if no agreement was reached, courts were not able to amend lease terms and judicially impose a re-negotiated position (see Sneakerboy Retail Pty Ltd trading as Sneakerboy v Georges Properties Pty Ltd (No 2) [2020] NSWSC 1141).

While the legislation provided the possibility of one party enforcing if the other did not properly participate in re-negotiation, there was uncertainty and stalemates occurred, and in some cases the stand-offs have continued to date.

Future lockdown legislation is unlikely to empower courts to impose re-negotiated terms. This is not because courts lack competence or expertise, but to avoid jamming courts or tribunals with cases. Not having a judicial circuit breaker also incentivises parties in reaching freely negotiated outcomes.

Given that parties often benefit in achieving contractual certainty via re-negotiation, what can be done? One improvement is including a contractual mechanism for breaking deadlocks with a binding determination on the re-negotiated position. For example, referral to binding expert determination, where an expert would be expressly required to determine the re-negotiated position. When drafting, care is needed so the clause is sufficiently generic to be triggered by future lockdown-type events, including those unrelated to COVID-19. Equally, the clause must be narrow enough to ensure the parties can benefit from any lockdown legislation before appointing an expert, otherwise, the clause may be unenforceable by contracting out of the legislation.

Termination for convenience and rescission

There may be justification for termination rights, such as for convenience during lockdown or giving rescission rights under exchanged but uncompleted contracts. Again, care is needed, most particularly in properly limiting when such rights can be exercised. These clauses may have some benefits, for example, assisting developers unable to progress building work to meet a deadline (where rescission is now notoriously difficult with prohibitive ‘sunset date’ legislation). Equally, a landlord or tenant may feel a lockdown has altered a commercial or retail market that the tenant’s current land use will no longer be viable. For example, an office tenant may need less space as people work from home, or a particular retail enterprise has been overtaken by online suppliers.

But there are risks. Terminating a contract for convenience may cause a party to breach another contract. For instance, a developer’s financier may have set pre-sale levels, or a landlord’s leases affect a building’s value and the landlord’s loan-to-value ratios. Also, terminating upstream – e.g. terminating a sale of land contract – can have downstream consequences, if for example, one party has ongoing liability to a builder.

Force majeure

Not long after the 2020 lockdowns commenced, force majeure clauses attracted attention, or more particularly, the absence of such clauses or their effectiveness in leases. Force majeure clauses, when triggered by specified events, suspend a party’s performance obligations. Sometimes if the causative event continues, termination is permitted.

Because force majeure clauses can have consequences normally prohibited by contracts – i.e. suspending payment obligations –triggering events are carefully defined. The utility of a force majeure clause is to preserve a contractual relationship where matters outside the parties’ control have intervened. They are the best of the worst ­– it’s better to suspend performance of a mutually beneficial contract than destroy the agreement either by frustration or a party’s inability to perform.

Construction and off-the-plan sale contracts often provide examples of force majeure. Take off-the-plan sunset date extension clauses, allowing a vendor-developer further time to build apartments because of matters beyond its control. The clause’s rationale is that, in certain circumstances, it will be preferable to wait a bit longer for an apartment’s sale to complete, under than terminate or rescind.

When it comes to leases, the main type of contract affected by lockdowns, force majeure clauses have narrower roles. At best, commercial leases will suspend a tenant’s obligations if the premises are damaged in particular circumstances – for instance, if the landlord’s building, inside of which are the leased premises, catches fire. These clauses will not typically extend to relief where a tenant’s inability to trade is caused by ‘infectious diseases’ or ‘civil commotions’ or ‘government restrictions’. If a tenant wants protection for this, business risk insurance may be an option. Unfortunately (except for insurers), recent case law shows that such policies may exclude cover for lockdown-causing events (e.g. HDI Global Specialty SE v Wonkana No 3 Pty Ltd [2020] NSWCA 296).

Limited force majeure clauses

While there may be some benefit for force majeure clauses covering lockdown-causing events, care is needed, and other approaches may be more beneficial. If a force majeure clause is included, it likely requires limitation. Some considerations include:

  • if legislative relief is available or mandated, such as rent moratoriums or government relief packages, this should exclude the operation of any force majeure clause
  • if legislation requires re-negotiation, a deadlock breaking mechanism, like expert determination, can be included where parties cannot agree on re-negotiated positions. This will avoid any need for force majeure
  • where legislation does not apply to a particular contract – including because of the tenant’s size or because of the contract falling outside of a legislative scheme – a force majeure clause may have a role. But again, limitations are sensible. Consider if the counterparty should instead be mandated to obtain insurance and if the counterparty’s corporate size means the counterparty should bear more of the commercial risk – a reason why lockdown laws excluded tenants earning more than a prescribed amount of revenue.

Sale of business contracts

Lockdown laws focus on leases, given their centrality to business life, and the tenant’s ongoing rent liability. Rent obligations must be satisfied from savings if the revenue-generating premises cannot open or can only trade in a government-imposed, demand-reduced market.

But other contracts are also affected, including business sale agreements. Often these contracts exchange with completion some months later. During this period, vendor obligations include trading in the ‘usual and ordinary course’. What happens if a lockdown-type event occurs during this period? A purchaser may wish to contend the vendor is not trading in the usual and ordinary course, and see lockdown as a means to terminate. Having no choice but to comply with the lockdown laws, the vendor will contend such compliance is trading in the usual and ordinary course. What to do?

Resolution depends on the contract’s terms and scope of what, in the particular contract, the phrase “in the usual and ordinary course” means. There are two broad candidates. First, does the ordinary and usual course reference businesses of a similar type (e.g. a car dealership in Sydney), and not just how the contract’s particular business operated? Secondly, and more narrowly, does the contract make the obligation specific to the actual business being sold, regardless of other similar businesses? If a vendor ran its car dealership this way in the past, then it must do so up to completion regardless of any lockdown. This very issue was recently considered by NSW’s Court of Appeal in Dyco Hotels Pty Ltd & Ors v Laundy Hotels (Quarry) Pty Ltd [2021] NSWCA 332. This decision also explains why frustration should generally be expected not to apply – lockdowns do not prevent the vendor from transferring the sale assets. The issue instead is how the business was to be conducted up to completion. If parties want to make ‘usual and ordinary’ broad enough so the effect of a lockdown will not affect completion, the clause should say so. This passes the business risk to the purchaser between exchange and completion – unlikely to be palatable.

The alternative is for the vendor being obliged to trade up to completion regardless of lockdown restrictions, so the purchaser’s risk is only from completion. If the vendor cannot reasonably trade this way because of a lockdown (or anything else), the sale contract could allow a purchaser to delay completion. This was the practical consequence of the contract in Dyco (but for other reasons, the purchaser was able to terminate). Dyco is illustrative by showing the benefit in parties having their own agreement deal with this, by a clause to delay completion, rather than having a court make this finding.

Future contracting

The above points only sketch issues capable of improvements after the lockdown experiences. There are other areas that warrant attention, from notice provisions to guarantees to assignments. When the time for new contracts arrives, one benefit from 2020 and 2021 is that safeguards can now be added to agreements.

If you have any questions about this article, please contact us or send us your enquiry here.

Author: Bede Haines

The information in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

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