Concerned about being able to meet your contractual obligations . . . or concerned about whether your suppliers will meet their contractual obligations to you as the impact of Covid-19 unfolds? My colleagues at Gravel & Shea evaluated how typical force majeure clauses may function when performance is interrupted or halted due the impact of a pandemic like the current one. This is not written in the casual (ok, sarcastic) chat-over-tea style I usually use in this blog and it may be a bit dense, but if you have questions or need to ask how this may affect the contracts you are a party to, feel free to call or email me, or contact Catherine, Oliver or Chase, whose contact links are at the end of this post.
by Catherine Burke, Oliver Goodenough, and Chase Whiting
The novel coronavirus and COVID-19 pandemic are causing widespread disruption, not only in our daily lives, but also in our businesses and commercial arrangements. As this disruption spreads, contractual obligations and expectations are being stressed, if not broken. Supply chains face delays. Meeting specified performance dates becomes problematic. In some sectors, such as travel, entertainment, and lodging, outright cancellation is becoming frequent.
All of this puts a spotlight on contracts: how enforceable are they under these circumstances? What happens if it is hard or even impossible for me to deliver? What happens if the government forbids me from or advises me against going forward? And what leverage or recourse do I have if my counterparty threatens non-performance? To a large extent, the answers depend on legal doctrines known as “impossibility,” “impracticability,” “frustration,” or “force majeure.”
The inability to fulfill contractual obligations (or to timely deliver or perform under a contract) due to unforeseen circumstances may be excused under force majeure, either by reference to a specific contract provision or as a matter of general contract law. The governing law applicable to a contract affects the likelihood that such a claim will prevail in litigation. Many contracts specify which state’s law to apply. If not, then a factual analysis must be used to determine which states’ laws could apply, considering factors such as where the parties entered the contract, where contract performance will occur, where the parties operate, and a variety of other factors.
Many states only modify or excuse contractual duties under force majeure if the event that is preventing performance is one of the types of events listed or clearly implied from those stated in the force majeure clause of the contract. (Remember that the pandemic itself is not the only event that may be preventing performance. Consider all of the factors disrupting your business, as government orders or actions, in particular, may also apply.) Virtually all jurisdictions require that the risk was unforeseen by the parties at the time when they entered the contract. Some states, including New York, also require performing the contract to be completely impossible before force majeure applies.
The Concept of Force Majeure and Its Application
A more detailed review of the legal and factual considerations to evaluate when considering the application of force majeure to contracts disrupted by the current pandemic follows.
The basic concept behind force majeure and its related doctrines is that a party to a contract may be excused from its obligations when an event occurs which makes it effectively impossible to fulfill the contract, as long as the event is (i) clearly outside of that party’s control and (ii) outside of the normal performance risks associated with that kind of contract. This principle may apply because of a specific provision in the contract or as a general provision of law. Force majeure clauses in contracts often list wars, rebellions and terrorism, natural disasters (such as earthquakes), actions by government, strikes and labor disputes as excusing events. Sometimes epidemics are included as well. Courts usually enforce these clauses, but they are often read strictly and interpreted to require the event to truly be beyond the party’s control and outside of the normal range of anticipated risks. If the doctrine is invoked for a contract without a force majeure clause, results vary considerably by jurisdiction.
Presence of an Express Provision
Longer contracts often include an express provision providing some level of relief, or excusing partial or late performance, if certain general or specific events occur. A typical clause states what constitutes an excusing event, often using general language followed by a set of non-exclusive examples. While courts sometimes give effect to the general clause, having the event specifically listed greatly increases the odds of enforcement. Looking to see if there is a force majeure clause in the contract and, if so, evaluating its effects in this particular emergency is the first step in any analysis.
A review of sample clauses suggests that even lengthy clauses frequently fail to mention epidemics specifically. Although careful drafting of future contracts will not help mitigate the business harms of the current coronavirus pandemic, the pandemic should at least encourage businesses to take a closer look at force majeure clauses in their contracts going forward.
Looking at existing agreements, if the provision doesn’t mention health emergencies, other specified events might still apply to our current crisis, such as governmental action or a failure of supply. A thoughtful review is necessary.
The degree to which both specific and general language will be enforced varies from jurisdiction to jurisdiction, so the next step is to determine what law governs the contract and then to research how narrowly or broadly that law interprets both explicit and general language force majeure clauses. Later in this memorandum we will survey Vermont and New York law as examples that may be of particular interest.
In the Absence of a Direct Provision
In the absence of a direct contractual provision, consider applying general principles of contract law. Here, too, the result varies between legal systems. In the United States, many states apply some version of the force majeure/impossibility standard as part of the common law of contracts. The requirement for strict, limited application appears widespread. The discussion of New York and Vermont, set out below is illustrative.
For particular kinds of contracts, there may be statutory authority that could also excuse contract performance. For instance, in the context of sales of goods governed by Article 2 of the Uniform Commercial Code, Section 2-615(a), “Excuse by Failure of Presupposed Conditions”, reads:
(a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty 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.
In international law, the idea has been codified in Article 7.1.7 of the UNIDROIT Principles of International Commercial Contracts. It provides relief from performance if a “party proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.”
Here, too, the result is likely to turn on the degree to which the event was beyond the control of the party and whether it was beyond the issues the parties likely contemplated as a possibility when entering into the deal.
Analysis of the Doctrine in New York and Vermont Law
Different states apply different legal standards to evaluate claims of force majeure. New York applies a strict (or narrow) standard. To be excused from contractual duties under force majeure under New York law, a contracting party must satisfy a three-part test. First, the event that prevents performance either must be one of the specific types of events listed in the force majeure clause or clearly intended by its language. Second, the contractual duties must be objectively impossible to perform for that reason, not just much more difficult or much more expensive than expected. Third, the event that makes it impossible to perform must not have been one that was reasonably foreseeable when the parties entered the contract; otherwise, they will be assumed to have allocated the risk of its occurrence under the contract terms.
The label of force majeure is not often applied by Vermont judges, who instead use the related doctrine of impossibility or impracticability of contractual performance. Under Vermont law, a party may breach a contract when her own performance has become impracticable or impossible due to an unforeseeable change in circumstances. Courts narrowly apply this doctrine by verifying that performance has become unreasonably difficult due to an extreme hardship that was unforeseeable to the parties when they formed the contract. Courts also consider such things as extreme or unreasonable difficulty, expense, injury, or loss.
Thus, under New York law, performance is likely required if COVID-19 makes contractual performance more difficult but not truly impossible, whereas under Vermont law, performance is likely required unless it has become either impracticable or impossible. Moreover, performance is likely required under either Vermont or New York law if the effects of COVID-19 or a similar pandemic were foreseeable to the parties when the contract was formed, regardless of whether performance is now impossible.
Practical Considerations for Dealing with Problems Arising from the Pandemic
A plunge in the stock market is generally not an excusing event; a government shutdown of a business sector may well be. A facts and circumstances analysis will be necessary for any given example. However, when evaluating a particular force majeure clause, if it does not mention epidemics or health crises, it is worth considering whether other specified events, such as government action or supply chain interruption, are present in the effects of the crisis on the particular transaction.
How do we deal practically with these doctrines, either asserting them as a defense or dealing with them when a counterparty asserts them? In either event, the starting point is the contract itself: does it have a force majeure clause, and, if so, what does it say? Does it specifically mention epidemics or other health crises? Do other mentioned events apply instead (e.g. government order)? Is relying on general language or on general doctrines of impossibility necessary?
Next, what law applies? Does the contract elect a specific jurisdiction or is that a matter of implication and interpretation? What does the applicable law say about the application of force majeure principles?
Once the strength or weakness of the position has been determined, a choice can be made on whether to invoke the doctrine or on how to evaluate it if used by the counterparty.
The next step will often be negotiation. In a time of commercial distress, getting to a reasonable and feasible outcome may be in everyone’s best interest. Preserving good relations with suppliers and customers may outweigh short-term enforcement or excuse. During negotiation, it is prudent to make it clear that unless and until the parties agree to a modification, willingness to bargain does not constitute a surrender of existing rights.
It will also be useful to look into insurance coverage. Business interruption insurance may apply, as may other kinds of coverage. Check your insurance policies, and speak to your insurance agents for more information. Meeting the requirements of any applicable insurance coverage should be a background consideration for all actions, including negotiations and, if necessary, litigation.
Litigation may be a final resort in attempting to enforce a contract. Here, too, assessing the strength of the defense and the necessary factors for asserting force majeure is critical.
In the present crisis, many contractual obligations will become hard to fulfil. As parties on both sides of this problem consider their options, the related doctrines of impossibility, impracticability, frustration, and force majeure should be kept in mind.