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COVID-19: Managing material contracts in crisis

contracts

It is vital to have a clear understanding of contractual rights and obligations when addressing the business impact of the COVID-19 crisis. In meeting this challenge, some of the key questions business leaders will want to ask are:

  • What contracts are likely to be impacted by COVID-19?
  • What are the parties’ rights and remedies in the event of non-performance caused by COVID-19?
  • What is the best business solution to address any potential non-performance?
  • How should businesses reserve legal rights and remedies while managing relationships with third parties and mitigating impacts?
  • Which counterparties are most likely to be impacted by COVID-19?

Whether engaging external help or undertaking the process in-house, the checklist below can help organizations prioritize their contractual relationships and identify practical steps to manage material contracts through this current crisis.

Task 1: find the agreements

The first step is finding and collecting all material contracts. If the contracts are not organized and retrievable, those responsible for contract review should contact project managers, business leaders, vendor managers and others to locate contracts and related documents (purchase orders, statements of work, addenda, etc.). This might mean reaching out to the counterparty for a copy of the executed agreement.

Tip: To determine whether to devote additional resources to review and discussion, start sorting documents based on counterparty, type of agreement and contract value early in the process.

Task 2: prioritize

Some contracts can be identified as material based on dollar value alone, but that is not the end of the analysis. Other relevant considerations include:

  • Which services, products, or other obligations provided or fulfilled by your counterparties are mission critical to the organization’s ability to satisfy obligations to other parties?
  • Which services, products, or other obligations provided or fulfilled by you are mission critical to the organization’s counterparties and their ability to fulfill their obligations to third parties?
  • Are there counterparties that pose a “concentration risk”?
    • Which service providers does your business, multiple business lines or competitors rely on most in the aggregate?
    • Would any clients say the same about your organization?
  • Examine both long-term and short-term considerations:
    • Which contracts are key to maintaining operations during the crisis?
    • Which contracts are key to long-term viability after the crisis?
  • Consider the current priorities of the business:
    • Does the business need to minimize costs and preserve cashflow?
    • Does the business need to ensure the continuity of its supply chain?
    • Does the business need to develop alternative structures for the performance of its obligations, or delivery of its goods or services?
  • Stay on top of developments in the media and other channels and consider prioritizing contracts with counterparties that are at higher risk for non-performance.

When assigning priority, remember that the goal is not perfection: settle quickly on simple criteria that will offer the clearest and quickest picture of materiality, and try to apply them consistently.

Tip: Once a materiality assessment has been created, keep material contracts organized—store them in one place, each contract associated with its related documents, notices, notes, and correspondence. Consider identifying a single overall project owner tasked with coordinating management of these contracts through the crisis and providing documentation and updates to relevant stakeholders.

Task 3: identify key contractual rights/obligations

The vast majority of COVID-19-related non-performance issues are going to be dealt with through a business discussion and not a legal proceeding. The contractual framework will dictate the parties’ relative leverage in those discussions, as well as their overall approach to mitigating their risks.

Beginning with the most material contracts, conduct a legal review of contractual terms to understand both parties’ legal rights. This will inform the process of assessing leverage and formulating the strategy for any business discussions.

Some contract provisions will be clearly relevant to understanding your organization’s rights and remedies:

  • Force majeure provisions (read our COVID-19 force majeure analysis here)
  • Notice requirements in the event of service interruptions or material adverse events
  • Indemnities and limitations of liability
  • Events of default
  • Cross-default clauses
  • Termination provisions
  • Insurance requirements

There may be other clauses that are relevant as well, which may include:

  • Change management
  • Rights to set-off or withhold payments
  • Definition of insolvency events
  • Dispute resolution provisions
  • Business continuity/disaster recovery requirements
  • Governing law

Also, be aware of other relevant legal rights and how they may apply:

  • Do contractual doctrines like “frustration” or “impossibility” apply to current circumstances?
  • Have there been government directives or legislation passed dealing with the COVID-19 outbreak that would affect either party’s ability to perform or enforce its rights, such as the obligation for all non-essential businesses in Québec and Ontario to close their physical places of business (read our full summary and analysis on Québec and Ontario business closures here)?
  • Would equitable remedies, like rescission of the contract (whereby the agreement is voided and the pre-contractual conditions are restored), be available were a court to consider damages inadequate?
  • Are there statutory considerations, such as the application of the Uniform Commercial Code or the United Nations Convention on Contracts, which can imply a force majeure in certain circumstances, the Civil Code of Québec, which includes provisions on force majeure and the right to terminate unilaterally certain types of agreements or the application of a statute like the Frustrated Contracts Act[1] in Ontario, which provides a framework for judges to adjust the rights and liabilities of parties where non-performance of contractual obligations is excused?

Tip: There are many contract management and document review technology solutions, but if you do not already have one, now may not be an opportune time to try to implement one. As a provisional step, Excel spreadsheets can be helpful to sort and store information. Once the immediate threat has passed, consider longer-term solutions.

Task 4: put a strategy in action

Once material contracts posing a significant risk to the organization have been identified, it’s time to make a plan and execute. While every business and third-party relationship is unique, here are some ideas to consider:

  • Focus first on the most critical risks and relationships.
  • When dealing with long-term relationships, don’t lose sight of the big picture. Making the relationship as the focal point of discussions will encourage the tabling of reasonable compromises and workarounds, and leave open a path back to normalcy for the relationship once the crisis recedes.
  • Coordinate an internal communication strategy to avoid inconsistencies and bad publicity. Ensure that the right people are assigned to managing key relationships.
  • Direct communications to the right people at the counterparty organization. Where there is no specific notice requirement, consider whether an informal conversation with a business partner would be preferable to a formal letter to the legal department.
  • Keep records of correspondence and conversations. The parties’ efforts to mitigate may be relevant to later determinations of contractual remedies.
  • Open and timely communication can be beneficial to both parties on several fronts, including that the parties are able to make better decisions and mitigate damages. However, try not to prejudice your organization’s legal position in arriving at a business solution. For instance, be mindful of maintaining privilege and think carefully about whether admissions of an inability to perform or pay fees may have the effect of triggering contractual remedies.
  • Where the agreement contains specific processes for negotiating changes, be mindful of those processes and the time it will take to complete them when having discussions with the counterparty. Ideally, try to hold business discussions within the agreed framework (but don’t let the framework get in the way of those discussions).

Tip: This is a crisis environment where government intervention and new developments have the potential to change the situation quickly: organizations should be prepared to make adjustments to strategy as needed.

Further thought

If you have limited capacity to take on contract management in these times, we can help you do this through our Halifax Legal Services Centre, which offers a low cost option to extend the reach of your people and undertake large scale contract review and triage.

By Jessica R. Lumière, Steven Slavens, Don Bell, Guillaume Lavoie and David Outerbridge, Torys LLP


[1] R.S.O. 1990, c. F.34

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In addition to our regular guest bloggers, Inside Internal Controls blog published by First Reference, provides occasional guest post opportunities from various subject matter experts on the topics of risk management and best practices in finance and accounting, information technology, environmental issues, corporate governance, sales/marketing and operations, not-for-profits and business related issues in Canada. If you are a subject matter expert and would like to become an occasional blogger, please contact Yosie Saint-Cyr at editor@firstreference.com. If you liked this post and would like to subscribe to Inside Internal Controls blog click here.

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