Contract law: how to navigate risk in an uncertain world

Ingrid Silver and Jonathan Andrews, Reed Smith LLP

2020 will be remembered for many things. The COVID-19 pandemic quickly changed the world as we know it, causing worldwide lockdowns and mass reliance on technology. The Black Lives Matter (BLM) movement shook the world, whilst tectonic shifts in the relationship with China, trade negotiations in the lead up to Brexit, death of Ruth Bader Ginsburg (a particularly great loss to the legal profession), and the US presidential election (and its unprecedented aftermath) all caused much consternation.

2020 was undoubtedly a year of great change – some might even say a year of chaos.  As lawyers, it is sometimes said that our role is to bring order to chaos. Therefore, we should perceive the events of 2020 as an opportunity to re-evaluate how we engage with the rapidly transforming world around us and attempt to make sense of the chaos that we are facing.

What chaos are we currently facing?

Many will be familiar with the “known knowns”, “known unknowns” and “unknown unknowns” concept popularised by then US Secretary of Defense Donald Rumsfeld, in 2002.1  In attempting to understand different levels of certainty, there are some observations we can make:

  • Things are happening faster and bigger. The BLM movement has been around for many years and the issues that it addresses are not new. However, the movement erupted and became a global phenomenon overnight, largely due to social media.
  • Existing trends have been accelerated. For example, high street retail was already in difficulty before the pandemic but that decline has since been accelerated due to lockdowns. On the other hand, tele-working, tele-health and tele-education which have been possible and available for a long time have become embedded in our day-to-day lives. 
  • Unexpected things are happening more. Within a few months, the emergence of a new pneumonia-like virus in Wuhan, a province in central China which was until then little known in the rest of the world, led to mass illness which within a few months brought entire economies to their knees. This may seem like a truism, but as the world becomes more complex and interconnected, and everything is getting faster and bigger, consequences and outcomes become more difficult to predict.

Overall, the changes we are seeing are being amplified by technology and globalisation. Since globalisation and technology are unlikely to slow down, it is highly likely that the associated change, chaos and uncertainty are fundamentally here to stay. The real question is not how do we deal with what’s happened or is currently happening, but rather how do we deal with the fact that we don’t know what’s coming next?

The need to change our approach to contract law

Traditionally, contracts have been founded on clarity and certainty. Without clear and unequivocal drafting, terms and clauses can lend themselves to varying interpretations increasing the risk of disputes. It follows that uncertainty is a thing that lawyers are least comfortable with. Our focus on things that are within the control of contractual parties means that we give minimal attention to changes happening outside of the contract. In an environment where external circumstances are fast-changing and filled with unknown unknowns, it becomes clear that our approach to contracts is no longer fit for purpose.

By identifying our approach to contracts, we intend to start a discussion about how we can address change through using the current legal tools at our disposal, but also with tools that go beyond the strictly legal realm. These tools, together with their shortcomings, are dealt with below.

Common legal tools at our disposal

In the legal profession, we have common contractual tools that we often turn to as mechanisms for dealing with certain types of uncertainty. However, to make the best use of them it is important to recognise the limitations of these tools, one being their sometimes binary and inflexible outcomes. Therefore, they do not necessarily provide the best route for parties that are navigating fast-changing circumstances.

Force majeure (FM)

An FM clause is intended to excuse a party’s performance if an unforeseen event outside of that party’s control prevents performance. Since the COVID-19 pandemic, we have seen a shift towards the inclusion of pandemics in FM clauses. An FM clause can have broad wording in an attempt to include a range of events or it can list specific events (or a bit of both). The difficulty is that judges tend to enforce FM clauses strictly – meaning that, if an event is not listed in the FM clause, a judge is unlikely to uphold the event as FM. Although pandemics are becoming a permanent feature of FM clauses, we are unable to predict and explicitly include other unknown unknowns.

Frustration

Where an FM clause does not feature in a contract, frustration is a common law doctrine that could be relied upon when a frustrating event entirely beyond the parties’ contemplation takes place. Frustration could therefore be a useful tool for unknown unknowns. Parties that contracted prior to COVID-19 are likely to be able to rely on frustration in light of the pandemic. However, a limitation arises for parties contracting in the wake of COVID-19, who would arguably have contemplated a pandemic. This makes frustration an inflexible legal tool when an event, like COVID-19, is continuing.

Warranties and Indemnities

Warranties and indemnities allow parties to allocate risk and liability by providing a mechanism to seek compensation and/or recover losses upon a specific event. The focus of these provisions is often about known knowns, and it is here that their limitations in a fast-changing world become more obvious. They are often drafted tightly at the request of the party giving them, which means that they are rarely of assistance in the face of unknown unknowns.

Termination of contract

A termination clause provides the primary mechanism for a party to exit a contract. In changing circumstances, a termination clause is useful because it can be widely drafted to capture, for example, termination for convenience. However, it is important for a party to properly assess its position before making a knee-jerk reaction to terminate; bringing the contract to an end in this way is a binary solution that can damage commercial relationships, and it ultimately ends in an unsuccessful contract for both parties.

Repudiatory breach

A repudiatory breach allows the innocent party to treat the contract as being at an end where the breach is serious and goes to the core of the contract. This common law tool could provide a non-contractual termination route for the innocent party when its counterparty breaches conditions of the contract during changing circumstances. However, much like contractual termination, repudiatory breach results in a potentially damaged commercial relationship and an unfulfilled contract.

Additional legal tools for flexibility and adaptability

There are other legal tools which are not typically used for managing unreliability, but which could usefully be applied to do so. These are provisions that typically focus on the parties’ obligations and 

how they are being carried out under the contract. The key advantage of such tools is that they are extremely versatile; they can be drafted in as much detail as required to capture the nature and degree of information that would be most useful to the particular contractual relationship when facing changing circumstances.

Reporting obligations

Reporting obligations are often included in a contract to ensure that a party reports on financial (or other) performance. To tackle unknown unknowns and to create an early warning system, it is possible to incorporate reporting obligations on other information. Some examples in light of COVID-19 could be reporting on use of the furlough scheme or any change of management. The clause also allows parties to specify the frequency of reporting as necessary. From a holistic perspective, the aim of inclusion of reporting obligations is generally to force a counterparty to focus on the issues they have to report on.

Change management

A change management clause is usually incorporated when a contract has large or complex deliverables that require collaboration between parties. The clause allows either party to notify the other when there needs to be a change in scope of activity under the contract. It also provides a mechanism whereby the parties can reach consent on the change within specified timeframes and agree on any other changes that will flow from it. In changing circumstances, the inclusion of such a clause can provide an effective mechanism that delivers a solution suiting both parties. It can also create better prospects for delivering a mutually satisfactory outcome rather than termination for breach. This is particularly so when faced with “unknown unknowns”, given that a change management clause allows the contract to adapt to changing circumstances, whereas termination merely ends the existing relationship without providing a framework for future dealings.

Dispute escalation

Similarly, a dispute escalation clause can provide a framework clearly identifying who needs to be involved and any specific timeframes when an issue arises between parties. This clause could reduce dependency on formal dispute resolution mechanisms which may be less available in a crisis (as was the case with the court system in the early stages of the pandemic) and reach an agreement that meets both parties’ interests without the high cost.

What to focus on?

The key points to capture when employing these additional tools are:

  • Who needs to be involved?
  • What information would a party benefit from knowing in order to take decisions in a changing circumstance?
  • When would a party need to know the information by?

Looking beyond legal tools

As the world continues to rapidly transform, we should be shifting the paradigm in terms of how we approach contracts. We identified above that we should view legal tools from a different perspective, but we should also re-evaluate how we engage with the businesses we support and the industries we work with. It may become clear that we do not necessarily sufficiently understand the vulnerabilities of businesses within the industry or how business models might be challenged by fast-changing circumstances. Therefore, when we talk about re-engaging, we mean re-visiting our knowledge of that particular industry with a fresh perspective.

We should also consider the data points relevant to businesses that we are not currently capturing. An example is climate change risk and the significant impact it could have on several industries. Importantly, we should ask ourselves: are we equipped to understand relevant data points and what skills, tools or disciplines could we turn to?

Some theories around useful skills are:

  • The importance of hybridity:2 in circumstances of ambiguity, it is more effective to combine at least three areas of expertise rather than simply rely on one. By using a hybrid approach, we can address ambiguous problems with more meaningful and complete solutions. For example, a lawyer could combine legal, technological and psychological expertise. Or it may be better for small teams with diverse skill sets to work together.
  • The O-shaped lawyer: lawyers of the future should develop rounded skills and new approaches to working in the profession. In the face of unknown unknowns, an open, opportunistic mindset could especially help lawyers avoid getting stuck in a risk-averse rut.

What other tools are available to us? Demystifying the jargon

Automation can be useful for scaling a particular approach, for example building in reporting obligations to a set of contracts. It is also useful in evaluating existing agreements and identifying relevant provisions. At the beginning of the pandemic, a company could have benefitted from using automation to review all its FM clauses to see if pandemics were covered.

Smart contracts are a piece of code that is performed automatically without human intervention, for example an automatic transfer of ownership or funds. These contracts are not flexible by nature, but they could have a valuable place in delivering certainty and accountability during unknown unknowns by ensuring that external circumstances do not affect the performance of a contract.

AI and machine learning are a computer’s ability to perform certain tasks based on data that has been inputted. AI is completely dependent on the data that is inputted so it is difficult to input around unknown unknowns. However, upon learning the data, AI can help us to process and employ it in an efficient way.

Agile development is a technique employed in software development processes, which involves a lot of iterative processes and in-flight testing to minimise flaws in the end-product. There are learnings that lawyers can take from agile development to improve the output of our work during changing circumstances.3

The human element

Organisations across sectors are increasingly considering how diversity of background, identity and thought, especially in leadership positions, can make a difference in dealing with unknown unknowns. There is substantial evidence that diverse teams and diverse leadership are generally more successful and make better decisions. Harvard Business Review found that diverse (including cognitively diverse) teams are able to solve problems faster than less diverse teams4, and a white paper from online decision-making platform Cloverpop found that when diverse teams made a business decision, they outperformed individual decision-makers up to 87% of the time.5

In terms of practical examples, it is worth considering how countries with female leaders have responded to COVID-19. Data from a report called Leading the Fight Against the Pandemic: Does Gender ‘Really’ Matter?,6 confirms that COVID-19 outcomes have been better in female-led countries, and among the best responses were New Zealand and Iceland, the only countries to date to have had more than two women elected as head of state or government. There is also evidence to indicate that the same trend has been replicated across business sectors.7

Looking beyond gender to other forms of diversity, such as intersectionality, another noteworthy example is the strong performance of Norway’s COVID response. Norwegian prime minister, Erna Solberg, is openly dyslexic, and her leadership during the pandemic has been strongly praised as playing a key role in this national achievement. The key takeaway is that diversity is a key asset when it comes to approaching how we deal with unknown unknowns.

Living in a changing world

2020 – and probably also 2021 – will be remembered for their chaos. Organisations across all sectors have been, and in all likelihood will continue to be, affected. Businesses across the Entertainment and Media sector, for example, have had to adapt to severe restrictions on in-person gatherings, but have also benefited from an increased focus on live streaming, and, in some cases, from greater take-up of remote and flexible working reducing the amount of office space required. Organisations would be wise to recognise this chaos, examine how it affects their work, and ultimately embrace the increased rate of change we are currently seeing – because it is probably here to stay.


1 https://digitalcommons.wcl.american.edu/cgi/viewcontent.cgi?article=1898&context=auilr

2 See work by Dev Patnaik, e.g. https://consciousleadershipweekly.com/016-dev-patnaik-empathy-business-culture-conscious-capitalism/, for more information.

3 See the Business Agility Movement for more information.

4 https://hbr.org/2017/03/teams-solve-problems-faster-when-theyre-more-cognitively-diverse

5 https://www.cloverpop.com/hacking-diversity-with-inclusive-decision-making-white-paper

6 https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3617953

7 https://www.bbc.co.uk/news/business-54974132


Ingrid Silver is a partner in the Reed Smith global Entertainment and Media Industry Group operating in the space where media, communications and technology converge. Her understanding of often conflicting cultures and expectations of all sides and engagement with a wider variety of stakeholders has enabled her to broker complex and innovative deals and provide strategic, solutions-focused advice on key industry developments throughout her distinguished career. She joined Reed Smith in 2017 having been drawn to the firm’s international base and largest entertainment and media group of lawyers in the world. Ingrid’s clients include blue-chip corporates as well as early-stage innovators and disruptors. Much of her work is international. In addition, Ingrid is European President of the Global Telecoms Women’s Network, a member of the IBC Council, Special Advisor to the Mobile Ecosystem Forum, an investor, Board Member Mobile Market Association MMA and a qualified French/English translator.

Jonathan Andrews is an associate solicitor in Reed Smith’s Entertainment and Media team. He has experience in a range of work, including transactional management for key clients and advisory matters regarding developments in copyright law and international jurisdictions. He has undertaken secondments to leading international clients Bauer Media and GVC, where he dealt with Commercial Agreements, Terms & Conditions, Licensing, Intellectual Property, Data Protection and Defamation. An advocate of inclusion in the workplace, he is a member of Bauer Media’s Diversity and Inclusion Forum (Belonging at Bauer) and the Law Society’s Equality, Diversity and Inclusion Committee, and in 2020/21 was named the UK’s 4th most influential disabled person in the Disability Power 100 List and ranked #13 on the global OUTstanding LGBT+ Future Leaders List.