Natural Disaster Law and Its Impact on Contracts

Pandemic.  Raging forest fires.  Noah’s Ark level flooding.  What’s next?!

Natural disasters can wreak havoc on all levels of our society, from the devastation to individual property owners to the ripple effect through our global economy.  Most recently, a series of “atmospheric rivers” and “weather bombs” caused catastrophic flooding in the Fraser Valley and other areas of British Columbia. Unfortunately, this resulted not only in the destruction of properties, but also incapacitated our highway system, isolating people from work and their homes and exacerbating the already existing supply chain struggles.

While certainly secondary to the devasting loss of property, livestock and livelihoods, these disasters can also have substantial legal ramifications, including the enforcement of contracts.  Whether the contract deals with the purchase of a property, the provision of goods or even employment, what happens if the underlying purpose of the contract is significantly impacted by something as unforeseen as a natural disaster?

The Contract

Most people are familiar with the concept of the contract and its key elements, such as offer, acceptance and consideration.  The basic idea of the contract is that it sets out with sufficient certainty all of the terms agreed to by the parties with respect to a particular transaction.  Which begs the question – if after you have entered into a contract something completely unforeseen occurs (such as an “atmospheric river”) which impacts either the value of the subject matter of the contract, or one or both parties’ ability to perform their obligations under the contract, what then?

Effect of Disasters and Other Unforeseen Events on the Contract

Contract Terms

The starting point is, of course, the contract itself.  Even in Court proceedings dealing with contracts, the Court will start with reviewing the specific language of the contract itself. This is often referred to as the contract’s “four corners”. While a Court may also look at the circumstances and material facts surrounding the entering into of a contract, the initial analysis begins with what is specifically written in the document.  So while it may seem obvious, in the event of a disaster or other unforeseen event, the first thing you should do is review your contract to see if it actually deals with such circumstances.

Some specific examples include the following:

1. Often in commercial purchase contracts prepared by lawyers, we will specifically deal with what happens if, between the time the contract is entered into and the closing date, there is an unforeseen event that materially impacts the subject matter of the contract. A provision will often provide the buyer with the option of either terminating the contract without liability, or reducing the purchase price by the value of the damage;
2. “Standard” real estate purchase contracts usually provide a simpler provision that effectively states that the property is at the “risk” of the seller until the closing date, and after that is at the “risk” of the buyer. This effectively means that the seller is responsible for insuring the property, and any damage to the property, prior to the closing date, but does not go so far as to provide a right of termination or a specific purchase price reduction mechanism in the event that there is damage prior to the closing date; and
3. A “force majeure” clause. A force majeure clause generally gives the parties a temporary “out” from performing their obligations under the contract in the case of unforeseen circumstances. They are seldom inserted in standard real estate contracts, but are often included in many commercial contracts. Force majeure clauses must be included in the contract itself to apply.

But even if your contract does include a force majeure clause, you do not have an automatic right to back out of the contract. Three requirements need to be met for a force majeure clause to be applicable:

• The force majeure clause must specifically cover the circumstances that warrants its application. For example, in the case of a flood, a force majeure clause must specifically state a flood, or contain a catch-all term such as an “act of God”;
• The circumstances that permit the force majeure clause to be invoked must substantially impact or prevent a party’s ability to complete their contractual obligation; and
• The circumstances that gave rise to invoking the force majeure clause must directly be the cause of the inability for a party to perform their contractual obligations.

Doctrine of Frustration

If your contract does not contain a specific contract term dealing with the unforeseen event, the circumstances may still give rise to frustration. Frustration is not a term of a contract; rather, it is a legal doctrine that may apply when an event occurs and “frustrates” the contract to the point where the contract is unable to be performed, or to where it becomes substantially different. There are three criteria that must be met before the doctrine of frustration can apply:

1. The event must have occurred after the contract was entered into by the parties;
2. The parties must not be responsible for the event; and
3. The event must make the contractual obligations impossible to perform, or substantially change or alter the contract subject matter.

Even if all three criteria are met, the determination of frustration is highly contextual, and the bar is high to make out a claim for frustration and relieve a party of their contractual obligations.

In addition, while frustration is a common law concept in BC, the Frustrated Contract Act addresses how contracts of all types are to be dealt with if they are frustrated. This Act generally outlines what the parties are entitled to by severing the contract at the time of the frustrating event. This application renders the parts of the contract which have been fulfilled at the time of the event valid and binding, and relieves the parties of the remainder of the contract that had yet to be performed.  For example, if there was money paid, such as a deposit, this may be recovered if there was nothing performed in exchange for the money. This important piece of legislation is not frequently referred to, however, it may be very relevant to many contracts in the case of a disaster.

Overall, there is no “one-size-fits-all” criteria for frustration to apply.  In the case of a dispute, a Court would perform a full, in-depth analysis of the contract itself, the nature of the frustrating event, and the overall effects that the event had on the contract, and an outcome is not necessarily predictable.

Damages

The general idea is that a Court will not look at fair or extraordinary solutions (such as frustration) if the party to the contract negatively impacted can be compensated by damages (ie. money).  This is likely best demonstrated by way of hypothetical examples.

Scenario 1:  You have entered into a contract to purchase a beautiful house and property on the side of a mountain with the great views you always wanted.  As a result of the latest atmospheric river, the entire house and property slides down the mountainside into a ravine.  In this case, there is really no amount of damages that can be awarded that will put you in the same position you would have been in if not for the intervening event.  Accordingly, the contract is likely frustrated.

Scenario 2:  You purchase a beautiful 10-acre hobby farm property with a house and outbuildings on the valley floor.  That same atmospheric river causes significant flooding, submerging most of the property and causing water damage to the house and some of the buildings.  In this case, once the flood waters have receded you still have the property you contracted to purchase, although the buildings have been damaged and are worth less than they were before the flood (or conversely, additional costs will need to be incurred in order to repair them to the condition they were in when you entered into the contract).  In this case, you are still effectively receiving substantially what you contracted for (the land is still there), so you can be compensated by monetary damages for repair costs/loss of value. As such, frustration of the contract would likely not apply.

One significant issue in a claim for damages is that you must still complete your obligations under the contract to make such a claim.  So in scenario 2 above for example, you would still need to complete the actual purchase of the property (including paying the full contracted purchase price), and then claim/sue for damages.

Case Studies

Let’s take a look at three very real contractual scenarios which have already come up as a result of the pandemic and last summer’s forest fires, and which are also now arising due to the recent flooding and associated consequences.

The Real Estate Contract

You have entered into a contract for the purchase and sale of a property, and we will assume that all subject conditions have been removed (or as is often now the case in the current real estate market, there were no subject conditions to start with!).  Then the unexpected natural disaster hits.  As a result, if you are the buyer you may no longer want (or be able) to complete the purchase, or if you do complete the purchase you will no longer want to pay the full purchase price previously agreed to.  On the other hand, if you are the seller, you are faced with the situation of either having a buyer refusing or unable to complete the purchase, or demanding a significantly reduced purchase price from what you had agreed to and were expecting.

The first issue which we have seen arise (particularly with the fires over the summer) is actually with respect to insurance.  Often the buyer will have a “subject to financing” condition in their contract that is typically removed long before closing.  However, as a term of financing, all lenders require that you have in place insurance over the property. This serves to protect the lender’s interest.

So what happens when a natural disaster occurs between the date the subject condition is removed and the closing date which results in the lender being unable to provide financing as a result of the lack of insurance?  In this circumstance, the buyer will be unable to complete the agreed upon purchase of the property. As the buyer is a party to a firm and binding contract, unless there are specific terms addressing this type of situation (such as a force majeure clause) the failure to purchase the property will constitute a breach of the contract, the transaction will likely collapse, and the seller may be entitled to damages from the buyer for such breach. With this being said, the parties to a real estate contract are always at liberty to negotiate a resolution that better fits their needs and wants, should they so choose.

The second main issue is the more obvious one – you entered into a binding contract for the purchase or sale of a property, and that property is now the subject of some degree of damage due to an unforeseen natural disaster.  In this case, as discussed above, the rights you may have will (i) depend on the specific wording of your contract, and (ii) range from potential termination of the contract due to frustration, through to a monetary damage claim or reduction of the purchase price, depending on the specific circumstances of your situation.

The Contract for Purchase and Delivery of Materials

You have entered into a contract for the purchase of materials within which the seller agrees to provide to you certain items for a fixed price. Unfortunately, due to the natural disaster, major highways are closed preventing the transportation of materials purchased. As a result of the seller not being able to complete its obligations under the contract you do not receive your materials and, further, are unable to complete a specific job. Depending on the specific terms of the contract, such a circumstance can constitute a breach of the contract and damages would likely be payable.

Alternatively, you have entered into a contract for the purchase of materials and supply chain issues arise between the seller and another party due to the natural disaster. This results in the seller being unable to abide by the strict terms of the contract with you. In this instance, more than one contract is likely in operation and thus a complex issue arises regarding who bears the responsibility should materials not be available.

As we know, the starting point in such situations is reviewing the specific terms of the contract. Typically in commercial contracts (such as for the purchase/delivery of goods), express terms are included addressing each party’s responsibilities and who assumes certain risks regarding the product at issue and its delivery (at a minimum most commercial contracts will, or should, contain some version of a force majeure clause which may apply). These types of clauses will impact whether the seller or the buyer bears the responsibility for unforeseen events.

Also of course with all of these situations, before seeking to have a contract for the purchase of materials held unenforceable, there are practical steps that can be taken such as negotiating the price of goods, seeking credit or considering an agreement to cancel the contract in its entirety.

 

You have hired an employee through an employment contract which sets out that in exchange for payment, the employee will attend your shop or office and complete certain tasks. Again, and unfortunately, the natural disaster wipes out major roadways preventing the employee from attending their place of employment, limiting what they are able to do. While in some contexts if an employee does not attend at work for an extended period of time they can be said to have abandoned their position of employment, if such lack of attendance is a result of being unable to physically travel due to road closures, this likely won’t be considered as abandonment.

Rather, in this circumstance, if an employee is unable to attend their place of employment as a result of a natural disaster, it is likely the case that you, as the employer, have an obligation to accommodate that employee to the point of undue hardship. Accommodations we can expect include allowing the employee to make-up the time lost or providing that employee with the ability to work from home. This latter option is certainly the most attractive, especially as many employees are already set-up to work from home as a result of the COVID19 pandemic. In certain industries however, this may not be possible.

While employment contracts are different from commercial or purchase contracts, the governing principles remain the same. If an employee is unable to meet his or her obligations under the employment contract, options will have to be considered. As is the case with contracts for the purchase of property or materials, should this circumstance arise, accommodation, discussion and negotiations are a practical and welcomed starting point. It is important, however, for you as the employer to keep in mind that should you materially change an employee’s contract as a result of a natural disaster, such a change could constitute constructive dismissal and ought to be approached carefully.

Take-Aways

While for the most part the recent pandemic and natural disasters and the impact they have had on us were unforeseen and unexpected, they clearly do arise and the way things have been going should likely be considered to now be more expected than unexpected!  So if you are impacted by such an event, some practical considerations you may want to take away from this discussion are as follows:

1. First and foremost, try to remain reasonable in your approach. While obviously having a significant impact on you and certainly being very frustrating, natural disasters are usually not the fault of either party to the contract!  So consider such things as amicably negotiating either an extension of the date for performance of the obligations under the contract (your closing date under a purchase contract for example) to allow time for the parties to properly assess the longer term impact of the disaster, or a change in the terms of the contract to accommodate the results of the disaster (a reduction in the purchase price for example).  Most often both parties still want the same end-result they had contracted for before the disaster, it is just that the terms need to be “adjusted” to take into account what has now occurred.  Also keep in mind that while commencing legal proceedings to enforce (or terminate) a contract is always an option (and unfortunately some lawyers will encourage this as being the primary option), such proceedings are usually time consuming, emotionally challenging and extremely expensive, and will not necessarily achieve the result you want anyway.
2. Depending on the nature of the disaster, insurance proceeds may or may not be available. However, this should be looked into, as if insurance proceeds are available they may help resolve the problem!  For example, the proceeds may be used to repair damage before closing, or alternatively assigned to the buyer to be used to repair the damages after closing.
3. The range of possible solutions available to you will clearly be a sliding scale heavily dependent on the particular facts of your specific situation. In addition, the assessment of that situation will usually be based on objective, rather than subjective criteria (ie. what you may see as a material change to the property you are buying may not be viewed the same way by a Court).
4. You should however certainly seek legal advice in assessing your specific circumstances and what your potential options might be. An experienced lawyer can review and interpret your contract as the starting point, and can provide you with practical guidance as to what options might be available to you and the pros and cons of each.