Part 2 of a series of articles on the COVID-19 pandemic.
In order to curb the spread of COVID-19 pandemic, the government has recently decided to implement a nationwide Restriction of Movement Order (“RMO”) pursuant to the Prevention and Control of Infectious Diseases Act 1988 with effect from 18 March 2020 to 31 March 2020, which was thereafter extended to 14 April 2020. The RMO effectively restricts movement of the people in Malaysia, and requires premises that provide non-essential services to be closed down during the period the RMO is in force. The legislative framework behind the RMO, including the Prevention and Control of Infectious Diseases (Measures within the Infected Local Areas) Regulations 2020, was explored in a previous article entitled “COVID-19: An Unprecedented Crisis”.
The legal and social implications arising from the RMO are significant and manifold. It does not only critically affect the people’s daily routine, but also inevitably disrupt the productivity and economy of Malaysia. The RMO also had the unintended consequence of severely disrupting the legal rights and obligations of private persons. One such instance of severe disruption can be seen in the context of contracts and agreements (commercial or otherwise) between private persons or between business entities.
What happens to the contract between the parties if there is a change in the circumstances beyond the control of the contracting parties, such as COVID-19, which renders the contract legally or physically impossible of performance? What happens if a new government order, such as the RMO, is implemented where it could significantly affect the nature of the outstanding contractual rights and/or obligations beyond what the contracting parties could reasonably have contemplated at the time the contract was entered into? This article aims to address the broad legal issues that arise from the RMO in this context.
As business premises of non-essential services are compelled to shut down during the period of the RMO, one may wonder and have serious concerns as to the legal consequences or implications in the event a person is not able to carry out his contractual obligations under a contract. For instance, are commercial tenants, who are forced to close down and/or vacate their business premises, still required to pay rent under the tenancy agreement? Are borrowers still required to make repayments of their loans in a timely manner in such difficult times ? Should payment obligations still be honoured even if no services are rendered under the relevant service agreement? What happens to a contract where time is of the essence?
As a general rule, contracts are to be performed according to their terms. If the contract does not expressly deal with a situation such as the RMO, it is trite that contractual obligations still have to be performed when they become due. It is unlikely that the courts would imply a term to suspend or extend time for performance, since the interests of each contracting party would be diametrically opposite. For example, the landlord would prefer that rent is paid when its due, whereas the tenant would not want to pay if possible. (There is no testily “oh of course!” from the officious bystander. On the contrary, he would arguably be arrested for breaching the terms of the MCO instead.) Failure to perform would then amount to a breach of contract which would attract financial consequences.
In this regard, a force majeure clause in the contract is of relevance here. In essence, a force majeure clause aims to contractually allocate the risks between the contracting parties with regard to the occurrence of future events in specific circumstances which might affect the performance of the contract. These events are usually of an abnormal, overwhelming or extreme nature: force majeure, a French term, translates as “superior force” in English. In Magenta Resources (S) Pte Ltd v China Resources (S) Pte Ltd [1996] 3 SLR 62, the Singapore High Court explained the essence of a force majeure clause in the following manner:-
“What is referred to as force majeure in our law (as opposed to French law from which that term originates) is really no more than a convenient way of referring to contractual terms that the parties have agreed upon to deal with situations that might arise, over which the parties have little or no control, that might impede or obstruct the performance of the contract. There can therefore be no general rule as to what constitutes a situation of force majeure. Whether such a (force majeure) situation arises, and, where it does arise, the rights and obligations that follow, would all depend on what the parties, in their contract, have provided for.” [Emphasis added]
There is no limit as to what might amount to a force majeure event; everything depends on the agreement between the parties. Examples of force majeure events include acts of God, fire, act of government or state, war, civil commotion, insurrection, embargo, prevention from or hindrance in obtaining any raw materials, energy or other supplies, labour disputes, pandemics etc.
In this regard, the contracting parties may agree on certain relief mechanisms should a force majeure event arises, for instance, an extension of time to be granted, suspension of the contractual rights and obligations, or termination of the contract if the force majeure event does not end after a particular period. It is unlikely that the contract would automatically be brought to an end in the event of a force majeure event. Instead, the rights and obligations of the parties have to be dealt with in accordance with the terms of the force majeure clause.
A force majeure clause is to be distinguished from the doctrine of frustration, as recognised at common law and under section 57 of the Contracts Act 1950. The test for frustration was explained by the Federal Court in Ramli bin Zakaria & Ors v Government of Malaysia [1982] 2 MLJ 257 at page 262 as follows:-
“In short it would appear that where after a contract has been entered into there is a change of circumstances but the changed circumstances do not render a fundamental or radical change in the obligation originally undertaken to make the performance of the contract something radically different from that originally undertaken, the contract does not become impossible and it is not discharged by frustration.” [Emphasis added]
It is immediately apparent from the foregoing that the test for frustration is a strict one, the reason being that commercial bargains should not be lightly avoided merely upon a change of circumstances. When a contract is frustrated, the contract becomes void and would be automatically discharged by operation of law. It does not affect rights and liabilities which have already accrued, but in certain circumstances it may give rise to relief which is restitutionary in nature pursuant to the Contracts Act 1950 and the Civil Law Act 1956.
In the case of a contract affected by RMO, one must first identify if a force majeure clause is provided in the contract to specifically include pandemic and/or government intervention that is beyond control of the contracting parties. If a general description (for instance, an unforeseeable event that is beyond reasonable control of the contracting parties) accompanied by a non-exhaustive list of events is described in the force majeure clause, it is more likely than not that the RMO amounts to a force majeure event as it was unforeseeable and could not have been reasonably contemplated by the contracting parties at the time the contract was made. Once a force majeure clause is successfully invoked, the contracting parties must then adhere to the relief mechanism provided therein.
Unlike other commercial contracts, tenancy and loan agreements do not usually contain a specific force majeure clause. Although a tenancy agreement may provide for a suspension of rent clause (in the event the premises become wholly or partly uninhabitable) whereas a loan agreement may contain a material adverse effect clause as an event of default (in the event the borrower’s ability to make loan repayments is significantly affected), these clauses do not typically cover situations such as a pandemic or the RMO in this instance. In the circumstances, tenants and borrowers are still obligated to pay rent and loan repayments respectively to avoid a breach of contract. It is, however, worth noting that the Prime Minister had, in the recent Economic Stimulus Package, announced a six-month rent exemption for all premises owned by the Federal Government such as school canteens, nurseries, cafeterias, convenience stores and so on. In the private sector, some corporations and well-known shopping mall owners had offered waivers and/or rebates in rental charges for their tenants. Also, Bank Negara Malaysia and banking institutions had earlier announced relief measures for their customers, among others, a six-month deferment for all loan or financing repayments beginning April 2020. Accordingly, in absence of a force majeure clause, one may reasonably contend that the most practical solution to the current predicament faced by many is arguably amicable commercial arrangements and/or negotiations between the contracting parties based on goodwill and made in good faith.
On the other hand, it is by no means clear whether the RMO is capable of causing contracts or agreements to become frustrated. As seen above, the doctrine of frustration is confined to very narrow circumstances. Much depends on the nature of the obligations to be performed under the said contract. For instance, the doctrine of frustration may be applicable to a contract where time is of the essence, a deadline to complete the contract falls within the RMO period (for example a musical concert which is to be held on a specific date), and there are no provisions stipulated in the contract to extend time for performance. On the other hand, however, a tenancy agreement (whether commercial or residential) is unlikely to become frustrated as the landlord’s relevant obligation is usually only to ensure that the tenant has possession and quiet enjoyment of the demised premises. In such circumstances, there is no radical change in the contractual obligations which would render the same to be impossible to perform, and accordingly frustration would not arise.
Therefore, it is advisable that a force majeure clause should as far as possible be included in contractual agreements, and also be drafted clearly to avoid any uncertainties and inconvenience in circumstances such as the current RMO. Such a clause should provide for specific timelines, notification or procedures to suspend contractual rights and/or obligations, and the contracting parties’ rights and remedies should a force majeure event occur and/or persist beyond the specified timelines The Singapore Court of Appeal in RDC Concrete Pte Ltd v Sato Kogya (S) Pte Ltd and another appeal [2007] SGCA 39 aptly observed as follows:-
“[54] The most important principle with respect to force majeure clauses entails, simultaneously, a rather specific factual inquiry: the precise construction of the clause is paramount as it would define the precise scope and ambit of the clause itself. The court is, in accordance with the principle of freedom of contract, to give full effect to the intention of the parties in so far as such a clause is concerned.” [Emphasis added]
The COVID-19 pandemic is a major and unprecedented event that exposes the lack of preparedness and resilience of many. It is clear that the government’s recent move to implement the nationwide RMO has caught the people of Malaysia completely off guard. As discussed above, it appears that inadequate drafting and/or omission to address certain contingencies or eventualities in the contracts could lead to uncertainty and hardship, which may ultimately result in serious implications for the contracting parties. Therefore, it is paramount that contracts should be cautiously drafted to address such situations. Uncertainty and inconvenience can be avoided by incorporating a well-drafted clause that clearly defines the events or circumstances that constitute force majeure, and how the rights and obligations of the parties will be modified or suspended accordingly. Contracting parties will then be able to properly manage the contractual risks between them, and to ensure that their respective rights and remedies are properly guarded under the contract in the event such unforeseen circumstances do occur.