What happens to contractual obligations during COVID-19?

by Clinton Tan Kian Seng ~ 17 March 2020

What happens to contractual obligations during COVID-19?

Outline

The Restricted Movement Order (“RMO”) announced by the Prime Minister on 16 March 2020 states, among others, that all business premises must be closed except for supermarkets, public markets, and convenience stores selling everyday necessities. Only essential services (such as defence finance, electricity, gas, water, etc) are to remain operational. This was also later clarified to include restaurants that do food delivery services. Aside from the above, all businesses must close. 

What are the legal implications to businesses who have contractual obligations to perform during the RMO period from 18 March to 31 March 2020?

For example, what if your business contracted to supply 100kg of steel to a factory every month, or if you contracted to provide cleaning services every two weeks? What happens to contracts that you have already performed halfway, or have already paid deposits or part-payments? 

Broadly, there are two ways to consider the impact of the RMO on contracts: 

  1. Whether contractual obligations of parties are suspended; and 
  2. Whether the contract is frustrated and therefore rendered void.  

To determine which of the two categories apply, it must first be asked whether the effect of the RMO results in the purpose of the contract being taken away entirely or to a significant extent

For example, if the contract was for an artiste to perform a concert on a date during this RMO period, it is clear that the RMO entirely takes away the purpose of the contract. In this event, the contract is said to be “frustrated” and becomes void in law (this is explained further in the section below). 

However, if the contract is, for example, to provide cleaning services once every two weeks for a period of one year, the RMO only affects one instance of performance out of the entire year. The RMO does not entirely or significantly take away the purpose of the contract. 

Contractual obligations are suspended

Using the example of a contract to provide cleaning services once every two weeks, the law is likely to consider that contractual obligations of parties are suspended during the RMO period. It is common for contracts to have what is known as a ‘force majeure clause’. 

Force majeure clauses are usually drafted to state that if an unexpected event (for example acts of God and declaration of wars) occurs beyond a party’s control, that party’s obligations under the contract will be suspended as he is unable to perform due to the said unexpected event. Depending on how the clause is drafted, it could also be that the entire contract is terminated and not suspended. Here is a sample force majeure clause:

“In the event either party is unable to perform its obligations under the terms of this Agreement because of acts of God, strikes, declarations of war, equipment or transmission failure or damage reasonably beyond its control, or other causes reasonably beyond its control, such party shall not be obligated to continue performing this Agreement and shall not be liable for damages to the other for any damages resulting from such failure to perform or otherwise from such causes.”

Even if there is no force majeure clause in the contract, a party is not precluded from arguing that it was not possible to perform the contract due to the prevailing circumstances. It is likely that the Courts will look into the conduct of parties and the surrounding circumstances to determine whether the contractual obligations in question were suspended. 

In The State Government of Sabah v Sipadan Dive Centre Sdn Bhd & Ors [2013] 2 MLJ 793, the Court of Appeal contemplated that in the case of emergency situations or force majeure, common sense would dictate that even the strict operation of the Sabah Land Ordinance may be suspended. If the Court of Appeal was prepared to recognise that strict operation of the legislature could be suspended, it is in my view reasonable to suggest that private contracts could similarly be suspended. 

Further, in Yong Toi Mee & Anor v Malpac Capital Sdn Bhd & Anor [2013] 6 MLJ 453, the Federal Court answered a question of law to the effect that where a contract has been suspended by mutual agreement of the parties, time for performance is also thereby suspended. Obligations were suspended until the contract is revived by either party subsequently affirming the suspended contract (see Yong Toi Mee & Anor (supra)).

Therefore, if any party tries to bring an action for non-performance of the contract, the other party will be able to successfully defend itself in justifying that no breach had occurred because the RMO rendered the contract impossible to perform during this period.

Contract is frustrated and rendered void

As mentioned earlier, if the whole purpose of the contract is taken away due to the RMO, the contract will be deemed to be “frustrated”. This applies even if the contract does not have a force majeure clause. 

The Federal Court’s decision in Pacific Forest Industries Sdn Bhd & Anor v Lin Wen-Chih & Anor [2009] 6 MLJ 293 provides a helpful discussion on “frustration”. In essence, Justice Zaki Azmi (the then Chief Justice) explained that a contract is frustrated when after the contract was executed, a change of circumstances renders the contract legally or physically impossible to be performed. The doctrine of frustration is also captured in section 57(2) of the Contracts Act 1950 which states:

“A contract to do an act which, after the contract is made, becomes impossible, or by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful”.

In Guan Aik Moh (KL) Sdn Bhd & Anor v Selangor Properties Bhd [2007] 4 MLJ 201, Justice Copal Sri Ram (as he then was) explained that there are three elements woven into the fabric of the doctrine of frustration: First, the event must have been one which was not provided for (in other words predicted by) the contract; Second, the event that occurred must not have been caused by either party. Self-induced frustration is not allowed; and Third, the event which is said to discharge the contractual obligation must be such that renders it radically different from that which was undertaken by the contract. The court must find it practically unjust to enforce the original promise. If either of these three elements is missing, section 57 of the Contracts Act 1950 will not apply. 

Using the example earlier of the artist who contracted to perform a concert: the RMO issued due to COVID-19 was not something contemplated by parties in the contract; the RMO was not caused by either party; the effect of the RMO in preventing mass gatherings radically changed what the contract envisaged i.e. a concert. Therefore, neither the artist nor the company who engaged the artist can insist that the contract be carried out as it is in the circumstances impossible to be performed. So, the contract is frustrated and rendered void. What happens next? What happens to monies or deposits already paid?

This is covered by Sections 15 and 16 of the Civil Law Act 1956 which provides for adjustments to rights and liabilities of parties once a contract is frustrated, including allowing parties to recover monies that were paid before the contract was discharged. The Court can assess the situation and order that refunds or payments be made so that neither party unfairly gains a windfall. The Court can look into what monies were already paid and whether any party had already obtained valuable benefit due to the contract being performed in part before it was frustrated.

For example, if a company entered into a one-time contract to supply 100kg of rice to a restaurant by delivering 50kg of rice at the end of the second and fourth week of March, the restaurant is liable to pay the value of the first 50kg it received even if the company cannot perform the second delivery. 

Payment obligations still need to be complied with, employers must still pay employees

Bank loans and any other sort of repayment agreement will still carry on. Unless a person is hospitalised and physically unable to make the payment transaction, it is unlikely that payment obligations can be suspended or loan agreements terminated due to the RMO. In Pacific Forest Industries (supra), Justice Zaki Azmi (the then Chief Justice) said:

“A contract does not become frustrated merely because it becomes difficult to perform. If a party has no money to pay his debt, it cannot be considered impossible to perform as it is not frustration.”

Flowing from this, it also stands to reason that the employers’ obligations to pay employees their salaries are also not suspended or terminated by the RMO. 

Conclusion

It is prudent to check if your affected contracts have force majeure clauses. Even if they do not, consider whether the effect of the RMO has completely taken away the purpose of your contract. That will assist you in understanding if the contractual obligations are merely suspended or the entire contact is frustrated and terminated. 

Lastly, although this article focused on the effects of the RMO, the above principles still apply even after the RMO period (i.e. after 31 March 2020) if the COVID-19 situation is such that it still affects your contract.