Month: September 2023

On 11th March 2020, the World Health Organisation (WHO) declared COVID-19 a pandemic, which is defined as “an epidemic occurring worldwide, or over a very wide area, crossing international boundaries and usually affecting a large number of people”.

Since then, the economic threat posed by the novel coronavirus has rapidly turned from a looming threat to a reality. Governments, Central Banks and the private sector are putting in place plans to respond to effects of the virus. However uncertain the times ahead may be, companies nonetheless need to consider how the spread of the virus may affect the conduct of their underlying business and their contractual obligations.

Effect On Contracts

Some of the effects of the COVID-19 outbreak are obvious, such as travel restrictions, quarantines and shortages of medical equipment. However, their immediate impact on contractual obligations, such as the ability to pay, deploy resources on time and meet service levels as agreed, may be less obvious. Most contracts that require ongoing performance are, in principle, absolute: that is, a party affected by the COVID-19 outbreak will be required to perform its obligations and will be potentially liable to its counterparty for a failure to do so. There are, however, two key exceptions to the rule: force majeure; and the common law doctrine of frustration.

A.FORCE MAJEURE

A force majeure event refers to the occurrence of an event which is outside the reasonable control of a party and which prevents that party from performing its obligations under a contract. If successfully invoked, the clause would excuse a party’s performance of its obligation under the contract, thereby avoiding a breach. It could also lead to termination if the event survives for a long period of time. However, this is a factual question and is largely dependent on the wording of the clause in the contract.

Acts Within the Scope

The first thing to check in a contract is whether or not it contains a force majeure clause, as the same will not be implied. Moreover, the applicability of a force majeure clause is largely dependent on the specific drafting. For instance, where the term “pandemic” does not form an express part of the clause, there may be a blanket-clause which covers all events “beyond the reasonable control of the parties”, which may be applicable to consequence emanating from COVID-19.

It appears probable that WHO’s classification of COVID-19 as a “pandemic” means it will be within the scope of clauses that include the words “pandemic” or even “epidemic”. However, certain other aspects of this crisis, such as the increase in government-decreed lock downs aimed at slowing the pandemic’s spread may also fall within the scope of the clause.

Impossible to Perfom

If a force majeure clause provides that the relevant triggering event must ‘prevent’ performance, the relevant party must demonstrate that performance is legally or physically impossible, but not just difficult or unprofitable – See Tennants (Lancashire) Ltd v G.S. Wilson & Co Ltd [1917] AC 495. A change in economic or market circumstances, affecting the profitability of a contract or the ease with which the parties’ obligations can be performed is not regarded as a force majeure event – See Thames Valley Power Limited v Total Gas & Power Limited [2005] EWHC 2208.

In addition, the force majeure event must be the only effective cause of default by a party under a contract relying on a force majeure provision as was held in Seadrill Ghana v Tullow Ghana [2018] EWHC 1640 (Comm). Moreover, the ‘supervening event’ will excuse performance of only those obligations which are affected by the outbreak of COVID-19. Therefore, in contracts with divisible performance obligations, a supervening event like COVID-19 could cause only partial impossibility or impracticability and the party’s unaffected performance obligations will not be excused.

Mitigation

The party claiming relief is usually under a duty to show that it has taken reasonable steps to avoid the effects of the force majeure event, and that there are no alternate means for performing under the contract.

The Court of Appeal in Channel Island Ferries Limited v Sealink UK Limited [1988] 1 Lloyd’s Report 323 held that any clause referring to events “beyond the control of the relevant party” could only provide relief if the affected party had taken all reasonable steps to avoid its operation or mitigate its results.

It is, therefore, important for companies to document the impacts of COVID-19 on their businesses, as well as steps taken to mitigate those impacts, as these could form a viable record for a potential force majeure claim.

Notice Provisions

In addition, if a contract has a force majeure clause, it is likely that it will contain notice provisions, which notice provisions should be carefully followed so as to mitigate the losses that may be occasioned upon the other party. Some contracts, especially construction contracts, include a “time bar” clause that requires notice to be provided within a specific period from when the affected party first became aware of the force majeure event, failure of which will result in a loss of entitlement to claim.

Effect of a Force Majeure Clause

Generally, the effect of a force majeure clause includes some or all of the following:

Suspension: for the most part, affected obligations do not go away and are simply suspended for the duration of time that the force majeure event continues, unless parties agree otherwise.

Non–liability: once the force majeure clause is triggered, the non-performing party’s liability for non-performance or delay is removed (usually for the duration of time that the force majeure event continues).

Right to terminate: in some cases, suspension of obligations may be unsatisfactory if it becomes commercially unfeasible for the parties to resume performance of the contract once the force majeure event ceases.

Practical Considerations

Before suspending performance in reliance upon a force majeure clause, parties should review their contractual agreements and consider:

The scope of the applicable force majeure clause and whether a pandemic falls within the scope.

The notice requirements and whether they have been triggered.

Whether mitigation steps should be taken, and if so, the reasonable time for the same.

The potential consequences of a breach under the contract.

How the force majeure clause reads with any indemnity clauses under the contract.

B. FRUSTRATION

In the absence of an express force majeure clause, the common law doctrine of frustration may apply. The doctrine of frustration, as established in Taylor v Caldwell (1863) 3 B&S 826, allows a contract to be automatically discharged when a frustrating event occurs so that parties are no longer bound to perform their obligations.

It was perfectly illustrated in the Kenyan case of Five Forty Aviation Limited v Erwan Lowe [2019] eKLR where the Court stated:

“the doctrine of frustration operates to excuse further performance where it appears from the nature of the contract and the surrounding circumstances that the parties have contracted on the basis that some fundamental thing or state of things will continue to exist, or that some particular person will continue to be available, or that some future event which forms the foundation of the contract will take place, and before breach performance becomes impossible or only possible in a very different way to that contemplated without default of either party and owing to a fundamental change of circumstances beyond the control and original contemplation of the parties.”

The doctrine of frustration (or discharge, as it is sometimes referred to) is generally thought to provide a solution to the problems of loss allocation which arise when performance is prevented by supervening events. Therefore, in the event of a contract being frustrated (and therefore terminated) by the onset of COVID-19 and the resultant inability to perform contractual obligations, the operation of the doctrine automatically allocates risk and loss following from the said termination.

Test For Frustration

Over time, the courts have adapted the test in Taylor v Caldwell and developed a broader test for frustration. Generally speaking, a frustrating event is an event which:

1. Occurs after the contract has been formed.
2. Is so fundamental as to be regarded by the law both as striking at the root of the contract and entirely beyond what was contemplated by the parties when they entered the contract.
3. Is not due to the fault of either party.
4. Renders further performance impossible, illegal or makes it radically different from that contemplated by the parties at the time of the contract.

Effect of Frustration

The doctrine of frustration automatically terminates the contract in question and the parties will no longer be bound by their obligations thereunder. Moreover, the drastic consequences of contractual frustration mean that the threshold for proving frustration is much higher than that for most force majeure provisions since it must be shown that the obligations impacted by the event or circumstance are fundamental to the contract.

Limitations

Where there is an express provision in the contract addressing a particular act or supervening event, such an act or event cannot be relied upon when invoking the doctrine of frustration. A clause in the contract which is intended to deal with the event which has occurred will normally preclude the application of the doctrine of frustration as frustration is concerned with unforeseen, supervening events, and not events which have been anticipated and are provided for within the contract itself.

It is likely that the doctrine of frustration will not be available if the contract contains an express force majeure provision, since the said provision will be deemed to be the agreed allocation of risk between the parties.

This alert is for informational purposes only and should not be taken to be or construed as a legal opinion.

If you have any queries or need clarifications, please do not hesitate to contact Jacob Ochieng, Partner (jacob@oraro.co.ke), Milly Mbedi, Senior Associate (milly@oraro.co.ke) or your usual contact at our firm, for legal advice on how COVID-19 might affect your business.

Start-ups are making great strides and impacting the world economy. It is estimated that there are about nine hundred unicorn start-ups (non-listed start-ups with valuations of US$1billion and above) in the world with an estimated value of more than US$3.5trillion, including companies like Uber, DiDi, SpaceX and Airbnb.

In Ghana, start-ups are also making impact in many sectors of the economy particularly in the transport, entertainment and fintech spaces. However, a significant number of start-ups fail. Globally, it is estimated that the failure rate of start-ups is between 50 to 60%. It is believed that the rate may be significantly higher in Africa where the systems are not in place to support the growth of start-ups. It is, therefore, important for entrepreneurs to avoid pitfalls that lead to the failure of a significant number of start-ups. Whilst obvious mention can be made of access to finance and cost of finance, the crux of the matter is the inability or failure of start-ups to get the right advice.

Definition of start-ups

Given the informal nature of our economy on the continent, it is important to clarify what constitutes start-ups as different from small businesses. Opening a “provisions” shop within a neighbourhood is not a start-up. Start-ups are generally newly formed businesses by entrepreneurs with a particular drive behind them, based on perceived demand for their products and services with the aim of scaling up quickly to fill a market gap. The main differentiating factor is that start-ups seek to commercialise innovative ideas to fill a market gap. As a result of the need to scale up rapidly, they are major challenges including resource constraints. Many young men and women have brilliant solutions to the myriad of problems facing the nation which can be resolved, or at least minimised, by the provision of products and services. The challenge is transforming such brilliant ideas from just ideas to sustainable profitable businesses and scaling up to fill market gaps.

Avoiding the pitfalls

Existing studies and research have catalogued the numerous problems and challenges faced by start-ups globally. These include:

• Lack of finance
• Neglecting marketing and sales
• Lack of planning
• Finding the right people
• Time management
• The founders
• Scaling up
• Being in a comfort zone

In least-developed and developing economies in Africa, including Ghana, the challenges are more pronounced. In Ghana, access to finance and cost of credit have been topmost problems for businesses generally and for start-ups in particular. Even though this has been a concern for most start-ups on the continent, in advising a number of start-ups or dealing with disputes that have arisen, it has been observed that the most critical of challenges is the inability or failure of start-ups to obtain the right advice and on time at the initial stages of putting their ideas into action.

Observation over the periods shows that the failure to obtain the right advice enabling start-ups to avoid pitfalls has led to the failure of a majority of start-ups. Majority of these pitfalls can be avoided by obtaining the right advice. Start-ups must, therefore, avoid the following pitfalls through the right and timely advice.

• Starting without a proper business plan – Surprisingly, a number of young entrepreneurs with innovative ideas fail to ensure they have a proper business plan to guide moving that innovative idea to products and services that are delivered to targeted clients or customers. A plan cannot be in the head of the founder. Documentation of the plan is important for start-ups. This requires having the right advisor to guide the preparation of the business plan with clear steps and an implementation schedule, as well as fall back positions in the event of setbacks. As is said, failing to plan is planning for failure.

• Not deciding on form of set-ups of start-ups – This covers the business form to use to implement the innovative ideas of start-ups. Choosing the wrong business set-up invariably leads to future challenges and the possible demise of start-ups. In Ghana, the default position has been for start-ups to start the process without incorporating a business entity or registering a business name. Most start-ups operate essentially as a sole proprietorship without the protection offered by registration. Even though, it is not inherently a bad idea to do so, failure to recognise the implication of operating as a sole proprietorship creates problems down the line, particularly when it comes to raising funding. Even in instances where decision is made to have a corporate entity, choices need to be made between a firm (partnership) or the incorporation of a company (and what type of company to incorporate). The right advice or information must be obtained to inform understanding of the decision and its implications.

• Unsuitable shareholding structure and governance system – It has been observed that the default position, in case of creating a corporate entity for most start-ups, after determining how to get the operation going, is to set up a private company limited by shares. In doing so, determining the right shareholding structure must be based on sound advice based on law, the business model and optimisation of funding opportunity as well as the need to protect young founding entrepreneurs. Failure to do that has led to instances where founding entrepreneurs become employees in their own company with no ability to give direction on how the business should operate. Related to the above is the need to have a good corporate governance system. This requires having the right mix of expertise for board composition. Directors for start-up companies, in most cases, are not selected based on the requirements of the business, but on having a board that does what the founder dictates. It is more prudent for the success of the start-up that each member of the board brings on board some expertise required for the success of the business. This must not only be limited to technical expertise but must include having the time, business acumen and commitment to see the growth of the start-up.

Principles of good corporate governance must be adopted based on:

1. leadership, ethics and integrity
2. participatory and inclusive process
3. consensus oriented
4. accountability and transparency
5. responsive, effective and efficient
6. equity or fairness
7. based on rules – both legal and non-legal rules
8. clear roles and responsibilities of the various actors

There is no one size-fits-all governance system. A governance system must be crafted for each start-up taking into account particular circumstances of the founder and persons involved, business and legal requirements. This requires obtaining the right advice.

• Inability to raise funding – Whilst this may be seen as the number one challenge on the continent (seen as the topmost in Ghana), there are many financial institutions and investors prepared to invest in start-ups. From observation, the underlying problem has been the preparedness of the start-ups to access such funds. Generally, initial investments are sourced from family and friends. This is mostly done on a very informal basis with no clear agreement on repayment for debts or exit of friend/family “equity” investors. This has led to many disputes when friends and family start to see potential growth of the business. Even where the initial investment is secured and products or services are launched, the next stage of raising funding to scale up encounters challenges due to the fact that the start-up fails to have a proper contractual framework for its activities. These may cover simple issues like the right employment contract for staff, terms of initial investment, not having the right shareholding and governance structure, improper or inadequate business plan, contractual arrangement for clients (especially where these are major clients) to secure receivables, proper documentation on title to assets including intellectual properties of the start-ups, etc. Without the right foundation, one is not able to build and scale up operations of the start-ups leading to their inevitable demise. Advice on each of these is vital for the survival and growth of start-ups.

• Not dealing with founder’s dilemma – Whilst the cultural setting in Ghana seems to require involvement of owners for a venture to succeed, advice on two factors is crucial. The first relates to how the founder’s ideas are capitalized to become assets of the start-up with commensurate compensation – usually future consideration – to the founder. This also involves issues of knowledge transfer which must be factored into terms under which the founder works for the start-up. Secondly, how the founder is protected to maintain some level of control through the various stages of growth of the start-up with a good transition process is key. This requires having good advice on shareholding structure, consideration for founder’s shares, in-built succession plan in governance structure, among others. Also, the recognition by the founder that he or she cannot do it alone is critical. This requires engaging the right mix of people to constitute a team that is able to deliver at the various stages of the growth of the business.

• Lack of title to assets and terms of acquisition – failing to document the assets of start-ups, hampers the ability of the start-ups to access credit. Proper documentation of assets requires right advice on acquisition of title acquisition and having an asset register. Documentation is especially required in acquisition of immovable property – land and buildings. It is also required for securing occupation of office space. For example, a start-up may rent an office without any proper tenancy agreement and once the landlord gets an insight into the operations of the start-up, he demands exorbitant rents which the start-up is unable to pay, leading to eviction and disruption of the business operations. As part of the documentation for start-ups, creation of asset register may also be very useful.

• Failure of legal and tax compliance – the law affects every aspect of business operations. Operating without complying with the law only leads to adverse consequence. All the above pitfalls and challenges also have legal implications. It is, therefore, important to ensure that, right from the conception stages, one obtains the right and full legal advice on all aspects of the business operations. The tax implication should not only be understood as a requirement to pay taxes. There are tax benefits and tax breaks available to start-ups. However, these are based on compliance with legal requirements. Obtaining the right legal advice will ensure start-ups take advantage of such benefits. The compliance requirements should not only be limited to specific jurisdictions. With the introduction of Africa Continental Free Trade Agreement (AfCFTA), seeking the right advice enables start-ups understand how they can take advantage of and be able to reach wider markets created under the AfCFTA to start-ups the scale-up or collaborate with others that may be seen as competitors.

Knowledge, they say, is power. Having the right information enables one avoid pitfalls. Start-ups, in particular, requires the right information to avoid failing. Experts are able to advise and guide start-ups to overcome the numerous pitfalls they face. Whilst the issue of cost may be raised as a stumbling block for obtaining the right advice, firms have adapted and are willing to engage with entrepreneurs to provide advice and guide such start-ups at very low rates or on a pro bono basis as part of their own business development initiative to grow with the start-ups. Start-ups should, therefore, seek out such firms. The government has launched the YouStart Ghana Initiative. It is recommended that not only should the government be making funds available to youth entrepreneurs, it should create the ecosystem to provide full advice on the above issues.   

Conclusion

In conclusion, great opportunities exist for start-ups on the continent to become unicorns. Even if they do not achieve the status of unicorns, they may grow to the likes of Chippers Case, Andela, Opay, Wave, Flutterwave, Interswitch, Esusu, Jumia and Fawry, which are leading the way to be unicorns. The key is seeking and obtaining the right advice to move brilliant ideas from the incubation stages to viable successful businesses providing products and services to fill the numerous market gaps on the continent and in Ghana in particular.