Between the volatile state of today’s financial markets and the unexpected and turbulent weather patterns that have devastated parts of our country, companies cannot help but wonder how such events could affect their contractual obligations should their ability to perform be compromised. What if you entered into a contract to sell a product but your factory was subsequently destroyed in a hurricane? What if the cost of performing your contractual duties has increased three-fold because of the market collapse? While there is no definitive answer to these concerns, both the common law and Section 2 of the Uniform Commercial Code (UCC) provide some guidance.
In general, if a contracting party breaches its obligations, claiming no fault for the breach is not an acceptable defense. In the eyes of the law, the contracting party has promised to perform under the contract and will be in breach by failing to do so. However, if some unforeseeable contingency makes performance physically, legally or commercially impossible, the contracting party might have an excuse for non-performance.
Common Law Guidance
Under the common law, the so-called “defense of impossibility” can terminate a contract where an unforeseen contingency occurs after the contract is executed and makes it impossible to perform. Generally, there are three ways this can occur: (1) a person essential to performing a promise in the contract dies or becomes physically incapacitated; (2) the subject matter of the promise is destroyed; or (3) performance of the promise becomes illegal after the contract is made. The defense of impossibility utilizes an objective standard, which means that performance will only be excused if it would be impossible for any reasonable party to perform its obligations under the contract; a breaching party’s subjective beliefs are not relevant. Common law impossibility applies to all contracts, whereas the UCC deals exclusively with the sale of commercial goods.
The UCC has expanded the defense of impossibility as it applies to the sale of goods. UCC Section 2-615, which applies to sellers, employs a defense called “impracticability,” which requires a determination of foreseeablility. Under this doctrine, a seller’s performance may be excused if the contingency that makes performance impossible or impracticable was unforeseeable at the time the contract was executed and the risk of its occurrence was not contractually allocated to one of the parties.
Under the UCC, there are several occurrences that are considered unforeseeable and may excuse a seller from performing under a contract, including incapacity of key personnel; changes in government rules and regulations; a fire; and a severe shortage of raw materials or supplies because of an event such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or altogether prevents the seller from securing supplies necessary to its performance. While hurricanes and earthquakes are not specifically mentioned in the UCC, it is likely that their occurrence would excuse performance since they are events with low probabilities and their consequences are difficult to predict. That being said, foreseeability might depend on the seller’s location, as an earthquake in Northern California or a hurricane in Southern Florida are arguably foreseeable and their occurrence should have been considered by the parties at the time of contracting.
In general, an unexpected price or cost increase will not excuse performance, nor will a rise or collapse in the financial markets. However, if the cost of performance is significantly higher and the increase can be attributed to an unforeseeable event such as war, fire or crop failure, a seller may be able to discharge its contractual obligations under the doctrine of impracticability.
The Force Majeure Alternative
When drafting a contract, it is important to foresee difficulties of performance wherever possible and place an allocation of risk in a manner that is agreeable to both contracting parties. Rather than depend on the common law defense of impossibility or the UCC defense of impracticability, contracting parties should negotiate a force majeure provision that addresses specific concerns and issues that could affect performance. A force majeure provision will allow the parties to decide who will bear the risk of a particular contingency, although certain contingencies will not always be foreseen. Because a force majeure provision relieves a party from an obligation under an agreement, it is important that all contracts, particularly long-term ones, contain such a provision.© 2010 Much Shelist Denenberg Ament & Rubenstein, P.C.