COVID-19 and Its Growing Impact on Commercial Contracts: How Should Contracting Parties Respond?
COVID-19 is causing a rapidly evolving public health crisis, and businesses face uncertainty about their commercial relationships. That uncertainty is raising questions about performance under contractual agreements that were entered into before this public health crisis unfolded. Contract-law concepts like force majeure, impracticability, and frustration of purpose — which rarely apply in normal circumstances — are now front and center, and understanding their application is critical to most businesses.
Force Majeure
A force majeure provision is a standard clause found in many commercial contracts. “Force majeure” is a French term meaning an irresistible, super human or superior force and such provisions excuse performance when events that are unforeseeable and beyond the control of the contracting party occur. While force majeure clauses are common, enforcement of such provisions is not. As a result there is little guidance from courts. Also, there are many forms of force majeure provisions and their applicability turns heavily on the language of the provision. Therefore, whether any particular force majeure provision might apply in the context of the COVID-19 outbreak depends on the language of the provision at issue as well as the jurisdiction in which enforcement is sought.
However, there are certain concepts that appear throughout the case law which can be used to provide some guidance. First, the party seeking to avoid performance must be able to show that performance was impracticable. It is not enough to show that there was an event, such as a pandemic, that occurred. Rather, the event must be the reason that performance could not be completed. Second, the contracting party must not be at fault for either the event or the non-performance and the event must have been unforeseeable at the time the contract was executed. An increase in the expense of performance or a change in market conditions alone, is generally not sufficient because those types of economic uncertainties are foreseeable. Third, the event must fall within the scope of the particular force majeure provision which turns on the contract language. A contract provision that identifies pandemics, disease, or outbreaks as force majeure events is going to be more useful when trying to avoid contractual obligations in the context of COVID-19. But, most force majeure provisions do not reference these types of events. One of the most common events referenced in a force majeure provision is an “act of God.” There are few cases that define that term, but those that do agree that an “act of God” must be a natural disaster or other natural phenomenon that is void of human error. The most common natural disaster is a weather condition such as a hurricane. There is some suggestion in cases from the early 20th Century that epidemics such as the influenza outbreak could be an “act of God” as well as some later references to avian flu as possibly being an “act of God”.
A force majeure clause must be express. It cannot be implied. If a contract does not have an express force majeure provision, a party may need to look to other defenses such as impracticability, impossibility, and frustration of purpose.
Finally, in many instances, application of a force majeure provision turns on applicable government action in a particular jurisdiction. For example, a declaration of a state of emergency may trigger a force majeure provision.
Impracticability
As COVID-19’s scope grows, it becomes more likely that the crisis will interrupt contracts governed by the Uniform Commercial Code, which has been adopted by the vast majority of states. The UCC governs contract that apply to “goods” rather than services or real property. The UCC’s impracticability doctrine is codified in UCC § 2-615(a) and provides that “[d]elay in delivery or non-delivery … is not a breach under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.” Increased cost alone does not establish impracticability unless an unforeseen contingency alters the essential nature of what a party is required to perform under a sales contract. Thus, although the doctrine of commercial impracticability is rarely applied, it has been used when extreme weather events or supervening governmental regulations prevent performance. For example, in response to government regulations requiring a mine operator to limit its pollution, the operator asserted that it could cut the usage of its natural gas drastically without liability on a contract requiring it to buy certain minimum quantities of natural gas. The Tenth Circuit agreed, ruling that the intervening government regulations regarding reducing pollution created an impracticability that excused performance. Similar arguments could be successful in the context of the COVID-19 pandemic where a party’s good faith compliance with aspects of emergency declarations or orders make performing a sales contract impractical from a commercial standpoint.
Impossibility
Performing on a contract may also be excused if intervening events make performance impossible.1 Proving impossibility is difficult and courts hold parties seeking to invoke this defense to a high burden. Generally, the party relying on the impossibility doctrine must establish that the subject matter of the contract, or the means of performing the contract have been “destroyed” making performance “objectively impossible.” To excuse performance, the parties must not have contemplated the intervening event when they entered the contract, and performance is not excused if the event merely reduces profits. Application of the impossibility doctrine is usually reserved for very extreme and unusual cases, for example, the September 11 terrorist attacks. In some instances, the COVID-19 pandemic may qualify for impossibility. For example, emergency declarations, bans on travel or large gatherings or quarantines may well make performance of certain contractual obligations “objectively impossible.”
Frustration of Purpose
If the underlying or principal purpose of a contract is so frustrated by an unforeseen event that renders the contract effectively worthless to a party, that party may be able to avoid performance based upon the doctrine of frustration of purpose. However, the frustrated purpose must be so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense. This standard is difficult to meet. For example, a court held that Hurrican Katrina did not so frustrate the purpose of a contract for the sale of a business to excuse indemnity obligations undertaken by the seller. Nevertheless at some point the increasingly serious effects of the COVID-19 pandemic could potentially support a frustration of purpose defense. For example, if an association is planning a conference and most attendees or speakers decline to attend due to COVID-19 concerns or travel difficulties the conference could become a worthless endeavor and the sponsor of the conference may be able to establish a frustration of purpose defense to having to perform contracts related to the event.
Commercial Loan Agreements
Commercial loan agreements rarely include force majeure clauses or other similar provisions, without which courts usually reject borrower defenses based on commercial impossibility, frustration of purpose or otherwise in response to a lender exercising of remedies on default. There, however, infrequent occasions where a financing agreement has a force majeure clause, and in those occasions borrowers may attempt to avoid performance based on the commercial and economic disruption being caused by the COVID-19.
Insurance
As businesses face increasing losses due to COVID-19, insurance coverage for those losses will become more important. Business Interruption coverage will probably be some of the first claims made to insurance companies to cover COVID-19 losses, but parties will likely dispute whether the virus is an “interruption” because there is no physical loss or damage to the insured’s property. Aside from first-party claims, there could be coverage under a business’s CGL Coverage. For example, what if a person visits a mall and contracts COVID-19 there? Can the person sue the mall operators for failing to take reasonable steps to prevent the spread of the virus? Similar claims are already being litigated: on March 9, 2020 cruise line passengers who caught COVID-19 on a cruise sued the cruise line, alleging that it should have done more to keep them safe. More litigation of this nature will surely follow.
1 The impossibility doctrine is closely related to impracticability. In fact, the concepts are interchangeable except in UCC cases.
