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Contracts in the Age of Coronavirus

April 29, 2020 - By: Michael J. Radin
Companies face a rapidly shifting global economy due to the coronavirus pandemic and various government responses. Planning may seem impossible, but we need to look forward for what may come next. While much of the country remains under government orders mandating that non-essential services close, states are looking at what re-opening will look like. As businesses consider and plan the process of re-opening, it is sensible to review important agreements.

Most businesses will face a critical question of how they – or a contract counterparty – can or will be able to perform under contracts entered into prior to this crisis. Some will have to decide whether to assert that it should be excused from performing its part of an agreement due to force majeure. Without a proper force majeure or other applicable excuse, a party will breach its agreement if it does not perform on time. There are three basic defenses to non-performance under a contract: (1) force majeure, (2) impossibility/impracticability, and (3) frustration of purpose. Here is an overview of each.

1. Force Majeure - Force majeure means “superior strength.” It is one of those clauses that typically appears, if at all, in the “boilerplate” part of agreements. Legally, force majeure excuses a party, temporarily or completely, from performing under a contract. It is a contractual concept, something that parties can agree to. But there is no general legal rule creating force majeure: it is a defense to performance only if it is actually written into a contract. If force majeure is not in your agreement, then it does not apply.

Assuming a force majeure clause exists, whether or not it applies in the circumstances depends on the state law that applies to the agreement. States interpret force majeure in varying ways, and similar facts under an identical clause can lead to very different results in different states. If your contract has a force majeure clause, then the first question is what state substantive law applies to the agreement. This may not always be clear unless the parties stated in the agreement which state substantive law applies.

Essentially, a force majeure clause reflects risk allocation between the parties. Parties to commercial agreements generally spent little time negotiating force majeure before the current pandemic. Common force majeure terms (prior to this crisis) include events such as extreme weather events, acts of war, fire, earthquake, explosion, “acts of God” and “governmental actions.” Such events are unpredictable and out of the parties’ control yet affect the ability of one or both parties to perform. Some clauses also include delays in receiving raw materials or disruptions in supply chains, shipping facilities, carriers, or labor difficulties; however, these may be variables the parties intended that one party should bear the risk of. For example, it is often fair that a manufacturing company be asked to manage its labor and raw materials needed to produce its products on time.

Force majeure clauses sometimes have a catch all phrase like “similar events” or “other circumstances beyond the parties’ control.” If pandemic is not specifically included as a force majeure event, then whether the coronavirus qualifies will depend on whether there is a catch-all provision (and whether the other specifically listed events are similar to a pandemic), and whether the state construes force majeure clauses narrowly. The precise wording of the clause is critical. For example, even if the existence of a “pandemic” is not listed as a force majeure event, then perhaps it could become applicable based on a governmental action, such as a shutdown or stay at home order in response to the pandemic.

Some states (e.g., Massachusetts, California and New York) construe force majeure clauses very narrowly. For example, Massachusetts requires that an event be “unforeseeable, unanticipated or uncontrollable” in order to constitute force majeure if the event is not specifically listed. New York requires that the event be specifically listed in the clause or be of a similar type to what is expressly listed if a catch-all clause is being asserted as the trigger. A party seeking to be excused due to a force majeure event will have to show that the party did not have control of the event and the circumstances made performance nearly impossible – not just difficult or impractical or uneconomical. Unless specifically referenced as a trigger, economic grounds (such as not having the funds) are not enough to successfully invoke a force majeure clause: the trigger needs to relate to the difficulty or impossibility of performance apart from economic considerations of performance.

In order to properly use a force majeure clause, a party providing goods or services needs to show that the triggering event occurred and has made performance very difficult or near impossible. For example, a locally issued stay at home order that does not define the providing party as “essential” likely is a force majeure event for the company that could not operate under the law. On the other hand, the party receiving the goods/services may only have to pay for the goods/services. As long as the banking/payments system is operating, the party who has to pay would face a very heavy burden. Therefore, a party obligated to pay due to a difficult cash situation needs another valid basis to trigger force majeure.

A party may anticipate that a force majeure event is likely and be tempted to trigger the clause prior to the actual event. Since the precise terms of a force majeure clause matter most, unless and until the event actually happens, a party does not have the right to anticipate a force majeure event and use that as an attempt to trigger force majeure. The party that declares force majeure before the actual event happens exposes itself to breaching the agreement even if anticipating the event seems rational and even if it turns out to be correct. So, a party that thinks it may be affected needs to consider when to announce it and what the ramifications might be. Keep in mind that any legal dispute about a force majeure event would likely happen after this crisis has passed, and a court may look unfavorably at a party that tried to invoke force majeure before an event happened or if it tried to stretch a clause beyond what the state allows.

If a party believes there has been a force majeure trigger, then it should (absent some specific force majeure notice provision) consider when and how to give notice. Unless the force majeure clause states the specific timing for giving notice of the event, there may be a question of degree: when does performance become so difficult that where previously there was inconvenience, now there has become impossibility. Many courts may consider if the party seeking to use the force majeure clause to excuse performance used “commercially reasonable” efforts to try to perform notwithstanding the circumstances - even if the contract does not specifically require such efforts. Again, the state law governing the contract will control, and this may vary from one state to the next. The agreement may require physical delivery of notice (under a general notice clause requiring written notice x days after being sent by overnight courier) and include a reference as to how many business days are required before notice is deemed complete. An affected party should go through the contract’s mechanical notice process and supplement it with fax and email, even if fax and email are not specifically indicated as being a manner of giving formal notice. Again, a court might be reviewing things and from hindsight, and it is conceivable a judge would want to see use of every available means to give the notice.

Finally, a party claiming that a force majeure event has happened needs to consider the effect from it. Some clauses allow the party experiencing the trigger to postpone performance only during the triggering event, while other clauses relieve the party entirely, which would lead to a termination or rescission of the agreement. Once again, the exact terms of the clause need to be looked at carefully under the applicable law. The other party, however, may be obligated to continue its performance under the interrupted agreement, take steps to mitigate its damages, or may be excused only during the delay and have to wait (unless the clause or applicable law lets them terminate the agreement). The party who is not receiving what they contracted for needs to look at its exposure under other agreements that were dependent on the now interrupted agreement, but perhaps did not have appropriate language in them making performance dependent on the now interrupted agreement. A domino effect is often an unpleasant surprise from a force majeure clause under one agreement, particularly in supply chain transactions.

If there is no force majeure clause, then a party interrupted needs to look at two other possible defenses to its performance.

2. Impossibility/Impracticability - The common law of most states recognizes defense of impossibility of performance. This can apply regardless of whether there is a force majeure clause on your agreement. The impossibility defense may be available if there is a government order (such as stay at home orders) that prohibits performance by a party. Here, the type of goods or services to be provided may determine the effect. For example, a live concert performance that is prohibited by a government order against non-essential businesses or group gatherings would likely be excused. A personal service contract requiring performance of a specified person who is in the hospital suffering from Covid-19 would likewise also be excused due to impossibility of performance. However, in the construction industry, stay at home or suspension of work orders will only delay – not excuse entirely - performance. The effects of the event may vary depending on the industry.

The impossibility defense is hard to prove in most states because the party seeking relief needs to show that performance has been made impossible or impracticable because of extreme and unreasonable difficulty, expense, injury or loss that occurred since signing the contract. To meet this test, the party seeking to be excused generally needs to show the intervening event was not foreseeable (but not inconceivable), was not the fault of the party seeking an excuse, is inconsistent with the basic assumptions of the parties at the time of the contract, and something that a reasonable party would not have protected against in the contract. This defense may allow the burdened party to suspend its performance while the event exists or it could excuse performance entirely depending on the applicable law. Both impossibility and impracticability are highly fact intensive and courts generally interpret them very narrowly.

3. Frustration of Purpose - Some states recognize a separate common law defense of frustration of purpose. This is similar to the impossibility defense but instead applies where the intervening event fundamentally changes the nature of the contract and makes performance by one party substantially worthless to the other. This is not a defense based on inability to perform. In the case of the cancelled live concert example, a contract for cleaning after that concert would be frustrated if the concert was cancelled, making that cleaning a wasted effort. Here it may be the party awaiting performance that has a defense to cancelling the contract, not the party that was supposed to be performing.

What to do next. If there is, or is likely to be, a performance issue on either side, or if one party is trying to excuse its performance, then the best course of action is to have a dialogue with the counterparty to see how they are doing. Right now, the effects are widespread and parties are amenable to working together to make it through the current crisis. Keep in mind that there are other clauses in an agreement that may come into play. For example, is there a clause that requires a party to “use best efforts” or to provide forecasts to the other party? Is there any obligation on either party with respect to a “material adverse change?” A party that wants to invoke force majeure or some other defense to performance should confirm that it has and is complying with these obligations.

If performance is looking very uncertain for either party, then a business needs to understand when, and how, to react. Going forward, everyone needs to take the time to read and negotiate appropriate force majeure clauses in their agreements to set the appropriate risk allocation of timely performance and consequences within and outside the agreement if the event is ever triggered. We expect that “pandemic” will start to appear in force majeure clauses that will no longer be viewed as mere boilerplate.

1. There is no consistent list of “essential” businesses affected by government orders as it varies state by state, agency by agency, and authorities do not approach the list consistently. There is no one size fits all even within a state, which can affect the force majeure analysis.
2. Each state has a body of so called “conflicts of laws” rules which determine whether its substantive laws, or the substantive laws of another state, apply to a contract between parties from different states unless a contract states which state’s substantive – meaning internal laws of contract – apply. The governing law clause is another vital clause that is often in the “boilerplate” section of agreements.
3. Harper v. Lancaster, LLC, 95 Mass. App. Ct. 1119 (2019)(no force majeure event where party obligated to pay had not specified that the obligation to make payment was conditioned on a third party vacating property to allow a sale of that property since such circumstance – namely vacating the property for sale “cannot be construed as unforeseeable, unanticipated, or uncontrollable.”).
4. Some force majeure clauses specifically exclude payment of money from force majeure, since the parties’ risk allocation intentionally did not want one party to claim it should be excused from performing because it did not have the funds to pay. There might be an exception however if the bank payment systems themselves were closed, which they are not in the present pandemic.
5. There may be other impacts under a contract from declaring force majeure. For example, does the event also (or not yet) trigger coverage under an insurance policy? If it could, is the party triggering the event being consistent across all of its operations when it makes the announcement by making a claim on its business interruption policy?
6. As a general matter, the standard for a material adverse change is a lower threshold than force majeure.

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