COVID Business Closures and Contract Implications

The law has a few legal mechanisms available to analyze how a global pandemic may impact contractual obligations between people in our society, and we will address two in this blog post.

The first is found in many commercial contracts. These contracts often contain clauses that address events that are beyond the contracting-parties’ control, which are often referred to as “force majeure” clauses.

The second is a common law doctrine that is often applied to contracts, including employment contract, that fail to have specific clauses. This doctrine is called the law of frustration.

A recent case from the BC Supreme Court addresses both legal principles so it is a useful summary to address these principles and how they may be looked at in the context of COVID-19.

To see a summary of the law of frustration in employment context click HERE.

What is the background of the case?

In Interfor Corporation v Mackenzie Sawmill Ltd, 2020 BCSC 1572, Gomery J. of the BC Supreme Court was evaluating a commercial contract in which the Mackenzie Sawmill Ltd. agreed to supply wood chips to the Interfor Corporation from its sawmill in Surrey, British Columbia. Between 2010 and 2014, a series of fires at the Mackenzie Mill stopped production and ruined the mill and Mackenzie Sawmill Ltd. stopped producing the wood chips to Interfor.

Mackenzie Sawmill Ltd. did not rebuild the same mill but instead other companies related to the owners of Mackenzie Sawmill Ltd. built a new mill on the same site and started production. They were selling wood chips to third parties at prices higher than those provided for under the contract between Mackenzie Sawmill Ltd. and the Interfor Corporation.

Interfor alleged that the contract between it and Mackenzie Sawmill Ltd. continued after the fires and the new mill owners were contractually bound to supply wood chips under the contract. The defendants said that the contract came to an end on account of either the force majeure clause or the common law doctrine of frustration.

Sawmill fire in BC

What is force majeure and frustration?

Gomery J. first defined the legal issues as follows:

[24] The legal doctrine of force majeure gives effect to a force majeure clause – in this case art. 8.5 of the CSA – according to its terms. Art. 8.5 is not a standard form clause and the question is therefore one of mixed fact and law; Sattva Capital Corp. v. Creston Moly Corp., 2014 SCC 53 [Sattva]; Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37 at paras. 36-48. Decisions involving the interpretation of other force majeure clauses entered into in different circumstances are of little assistance. The question is: what is the legal effect of this clause, in the particular circumstances of this case?

[25] The legal doctrine of frustration involves the court’s refusal to enforce a contract according to its terms in circumstances that were unforeseen when the contract was made. The doctrine is tightly circumscribed. The court must ask whether the unforeseen circumstances “totally affect the nature, meaning, purpose, effect and consequences of the contract”; KBK No. 138 Ventures Ltd. v. Canada Safeway Limited, 2000 BCCA 295 [KBK] at para. 14, quoting Folia v. Trelinksi (1997), 14 R.P.R. (3d) 5 (B.C.S.C.) at para. 18. This inquiry is grounded in an interpretation of the contract and its application in the particular circumstances of the case.

[26] Frustration is not a doctrine that negates contractual obligation. Rather, it identifies unexpressed limits to the obligations undertaken by the contracting parties. These limits are consistent with the purpose, express terms, and allocation of risks established by the contract.

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When does a Force Majeure Clause result in a contract coming to an end?

The article in this case uses similar language to many terms found in leases and other commercial agreements, and it is found in the decision:

8.5 If, at any time while this Agreement is in force, MSL shuts down or curtails the operation of the Mill due to fire, strike or other labour disruptions, lockout, sabotage, shipwreck, riot, war, flood, extraordinary breakdown, laws or regulations, Court order, act of any government body or agency, act of God, blockade, civil commotion or disobedience (lawful or unlawful) or as a result of Interfor reducing or discontinuing its purchases of Chips under this Agreement, or for any reason whether similar or dissimilar to the foregoing and which MSL considers sufficient to justify curtailing or shutting down its operations, then MSL, without liability, may discontinue or curtail the production and delivery of Chips to Interfor.

In finding that the shut down of the Mackenzie Mill due to the fires was insufficient to result in a Force Majeure terminating the contract, Gomery J. found the following:

[49] I conclude that MSL’s obligations under the CSA were not permanently discharged under art. 8.5 by the fires that ruined the Mackenzie Mill.

[50] MSL is not obliged to operate the Mill and generate chips, but if it does, until the CSA is terminated, it must sell the chips to Interfor. To recapitulate my findings to this point:

a) The CSA is an agreement of indefinite duration to secure for Interfor a supply of chips generated by the Mackenzie Mill’s operations, so that Interfor may fulfill its own obligation to supply chips to Catalyst under the CPSA;

b) Art. 8.5 is concerned with the operations of the Mackenzie Mill, not MSL’s business as a whole;

c) Art. 8.5 contemplates temporary suspensions of operations and the delivery of chips by MSL to Interfor; and

d) The CSA distinguishes between the suspension of the obligation to supply or purchase chips under arts. 8.5 and 8.1, and the termination of the agreement under art. 9.

[51] The defendants submit that the CSA does not impose on MSL an obligation to rebuild the Mackenzie Mill and start producing chips again, following the fires. I agree. That is not the question at hand. The question is whether the contractual obligation persists if there is or could be a new “Mackenzie Mill” to which the CSA would apply.

[52] The question of whether a new mill at the same address as that of the former Mackenzie Mill is one to which the CSA applies is not before me on this application. Nor am I tasked with deciding whether there has been a termination of the CSA pursuant to art. 9.

[53] The defendants’ argument presupposes that some fires triggering the operation of art. 8.5 are so serious as to give rise to permanent consequences and a termination of the contract, while the effects of other fires might be merely temporary. They would distinguish a fire in a broom closet that shut down operations for a month from the fires that ruined the Mackenzie Mill in this case. There is nothing in the text of art. 8.5 to support the proposition that the legal effect of the clause is different in the case of more and less serious fires, and no guidance to be drawn from the CSA as a whole as to where the line would be drawn.

[54] The difference between the parties’ positions only matters if the Mackenzie Mill can be rebuilt (or a new mill that would constitute the “Mill” under the CSA can be built in its place). On any view of the matter, MSL is only obliged to deliver Available Chips it has produced from the Mackenzie Mill. If the Mill cannot be rebuilt, MSL’s obligation to perform under the CSA is permanently suspended, and there is no practical difference between a permanent suspension and a termination of the contractual obligation. In the case where the Mill can be rebuilt and it does make a difference, it is difficult to see how the suspension of the obligation under art. 8.5 becomes a termination of the contract pursuant to art. 9.

[55] In sum, taking a practical and common sense approach, in my opinion, art. 8.5 provides only for the suspension, and not for the termination, of MSL’s contractual obligations under the CSA.
In short, the defendants could not rely upon the force majeure clause to say that the fires at the mill were sufficient to terminate the contract. Given the mill could be replaced and wood chips could be produced, these facts were sufficient to deny applying this clause. The court was focused on the possibility of following the contract and refused to apply the clause to excuse the defendants from their contractual obligations. So, we can look at force majeure clause defences being rejected if the contract context does not excuse the parties from their obligations.

The context did really matter in this case, so it becomes very important to have sound legal advice in evaluating your contractual obligations. If you need legal advice on this issue, then please feel free to contact us. We offer free initial consultations and can help you consider the contractual terms in your lease, employment agreement, or other type of contract.

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When does the doctrine of frustration impact a contract?

After looking at the contractual terms and finding them not determinative, Gomery J. turned to the doctrine of frustration of a contract and summarized the law, as follows:

[62] Ellis-Don is a leading modern decision. Speaking for the Court at para. 54, Justice Binnie rejected Blackburn J.’s reasoning in Taylor v. Caldwell that frustration results from an implied condition in the contract. Rather, he held that frustration occurs when a situation has arisen for which the parties have made no provision in the contract and performance has become “a thing radically different form that which was undertaken by the contract” (at para. 53, quoting Peter Kiewit Sons’ Co. v. Eakins Construction Ltd., [1960] S.C.R. 361 at 368, itself quoting Davis Contractors Ltd. v. Fareham Urban District Council, [1956] A.C. 696 (H.L.) at 729. At para. 55, Binnie J. added that the doctrine requires a supervening event that:
… would have had to alter the nature of the appellant’s obligation … to such an extent that to compel performance despite the new and changed circumstances would be to order the appellant to do something radically different from what the parties agreed to under the … contract.

[63] While KBK preceded Ellis-Don, it applied the “radical change in obligation” test from Davis Contractors that was later approved in Ellis-Don (at paras. 13-15). Speaking for the Court at para. 14, Justice Braidwood also adopted a more detailed statement of the test for frustration developed by Sigurdson J. in Folia at para. 18:
In order to find that the contract at issue has been frustrated the following criteria would have to be satisfied. The event in question must have occurred after the formation of the contract and cannot be self-induced. The contract must, as a result, be totally different from what the parties had intended. This difference must take into account the distinction between complete fruitlessness and mere inconvenience. The disruption must be permanent, not temporary or transient. The change must totally affect the nature, meaning, purpose, effect and consequences of the contract so far as concerns either or both parties. Finally, the act or event that brought about such radical change must not have been foreseeable.

[Emphasis of Braidwood J.A.]

[64] In Veritas Geophysical (Nigeria) Limited v. Energulf Resources Inc., 2010 BCSC 1253 at paras. 43-48, Justice Harris (as he then was) reviewed Ellis-Don and KBK. He explained the decision in Krell through the application of the modern test of a radical or fundamental change in obligation.

Looking at the summary of the modern law of frustration, it is clear that it may have implications for the effect of COVID-19 on many different types of contracts because in some cases:

  1. the effects were not self-induced or foreseeable and are a result of government controls;
  2. the contracts can result in totally different setting than contemplated before COVID-19;
  3. it is fruitless to continue forward;
  4. the disruption may be permanent; and,
  5. the change must totally affect the nature, meaning, purpose, effect, and consequences of the contract.

These are very context specific circumstances and accordingly it requires a detailed understanding of the circumstances. If you need legal advice on this issue, then please feel free to contact us. We offer free initial consultations and can help you sort out the contractual obligations.

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How did the case workout for Mackenzie Sawmill Ltd.?

After looking at the law of frustration, Gomery J. concluded that in this case the fires were insufficient to conclude that the contract was frustrated. Gomery J. concluded that:

[65] In my opinion, MSL’s obligations under the CSA were not frustrated by the fires that ruined the Mackenzie Mill, for the following reasons.

[66] The destruction of the Mackenzie Mill by fire did not totally affect the nature, meaning, purpose, effect, and consequences of the CSA for the parties. The contract was to secure for Interfor a supply of chips generated by the Mackenzie Mill’s operations, to the extent that chips were generated. MSL’s obligations were suspended but not terminated while the Mackenzie Mill was shut down. There remained the possibility that the Mill might be rebuilt.

[67] The possibility of fires damaging the Mackenzie Mill was foreseeable in this case, and was expressly contemplated in art. 8.5. The possibility that fires might not only damage the Mill but completely ruin or destroy it was obviously foreseeable. What happened in this case is not a different kind of event from that expressly contemplated by art. 8.5.

[68] MSL was not obliged to rebuild the Mill, but if it did, the revival of the obligation to supply to Interfor chips from the restored operation would not work hardship on MSL. Far from imposing on MSL an obligation that was radically different from that undertaken under the CSA, the revived obligation would be the same as before. The circumstance of having rebuilt the Mill would not render the obligation to supply chips to Interfor fundamentally more onerous.

[69] Much of the defendants’ argument is grounded in the mistaken premise that the Mill was synonymous with the Business. They also focus attention to the asset purchase under the APA rather than chip supply under the CSA. Referring to the APA, they contend as follows:

49. The fundamental purpose of the parties’ contract was to transfer that Mill from Interfor to Mackenzie in return for $10 million. Within that, under the CSA, Mackenzie was to provide defined amounts of chips from the Mill to Interfor.

50. The supervening event is clear. In fact, while catastrophic and devastating, it is simple. The three fires destroyed the Mill. The fires destroyed “the Business”.

51. The fires thus destroyed the root and foundation of the parties’ 2006 contractual relations, including the ability of Mackenzie to produce and provide chips to Interfor.

52. Fire is an archetypal frustration event. It is the supervening, frustrating event in the founding decision on frustration, Taylor v. Caldwell.

[70] I disagree with this analysis. In determining when MSL’s obligation under the CSA was frustrated, one must focus on the nature, purpose, meaning, and effect of the CSA, not the APA. The inquiry mandated by the modern law of frustration is not a search for the root or foundation of the parties’ contractual relations. The modern law asks whether the result of the fire is a radical change in the obligation imposed on MSL under the CSA. The answer to that question is no.

[71] Accordingly, I find that the CSA was not frustrated by the fires that ruined the Mackenzie Mill. The fires did not bring MSL’s obligations under the contract to an end.

With the severe economic disruption of COVID-19, we can only anticipate the number of businesses that will be claiming force majeure or frustration of contracts with suppliers, employees, landlords, and other contracting parties.

It is important that you have clear legal advice on this issue from people who know how to address these concerns. Please do not hesitate to contact us. We offer free consultations and have lots of experience helping businesses identify strategies to survive trying economic times.

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