Contracts and COVID-19: What are the options for a business unable to perform its obligations?
By Eric Duhon
The measures our state, the nation and many countries have implemented amid the coronavirus crisis are necessary to protect ourselves, our loved ones and our community at large from the deadly virus. But COVID-19 will have lasting impacts on our businesses and the economy well after it has finished its attack on our communities.
Recent laws, such as the CARES Act, are designed to help businesses and their employees deal with the economic fallout, but what about contracts? What happens if a business can’t fulfill its obligations under a legal agreement because of state-mandated measures or other effects of the coronavirus? Will it be liable, even if there is nothing it can do? Contracts are often unforgiving and can lead to substantial liability if a party fails to satisfy its obligations. But, there is hope. The law contains a number of excuses for a business’s failure to perform under a contract. These options include the doctrines of force majeure, frustration of purpose, impossibility and impracticability, among others.
I. Force Majeure
Force majeure is a Latin phrase that commonly refers to contract provisions that permit a party to avoid performing their obligations under a contract when an “act of God” — or a similarly extreme event — prevents performance. Force majeure provisions are often located in the “boiler plate” language of a contract and typically include a list of scenarios followed by a general “catch-all.” Some contracts don’t have a force majeure provision, and language will vary from contract to contract, but provisions will typically look something like: “If either party’s performance of any obligation under this Agreement is prevented as a result of strikes, restrictive governmental laws or regulations, war, act of God, or other reason whether of a like nature or not that is beyond the control of the party affected, then such performance shall be excused.”
Historically, courts will only apply a force majeure provision to excuse a party’s breach of the contract if the reason they couldn’t perform is specifically listed in the provision. Rarely is an obligation to pay money excused, but, where applicable, courts may excuse other types of performance, such as providing a service. Unfortunately, many force majeure provisions do not include “pandemic,” “self-isolation,” “shelter-in-place” or other consequences of the coronavirus. And because many force majeure provisions don’t include this language, the question becomes — assuming there is “beyond the control” language — whether the party failed to perform because of a reason beyond the control of the party affected. The coronavirus may seem to be a reason beyond the control of the party affected in almost every circumstance, but it is important to keep in mind that the force majeure event must directly cause the nonperformance.
Let’s say a food supplier agrees to provide 1,000 steaks per day to a large restaurant, and the agreement includes the same force majeure language provided above. After the contract is signed, the state, in an effort to minimize the spread of a deadly disease, implements a shelter-in-place regulation requiring the public to stay at home unless they are leaving for necessary purposes. The regulations have severely diminished or even eliminated demand, and the restaurant cannot sell the steaks. As a result, the restaurant’s revenues have plummeted, and it no longer wants the 1,000 steaks a day. Under a strict interpretation of the force majeure doctrine, the restaurant may be required to continue to pay the food supplier and accept the steaks, or may be liable in damages to the supplier, because the government regulation did not directly prevent the restaurant from purchasing the steaks and market conditions are not a force majeure event. The restaurant may be able to argue that the global pandemic falls under the catch-all language, but there is no guarantee that this will succeed in court. The restaurant could be found to have breached the contract unless some other doctrine excused performance.
On the other hand, if the government regulation also prohibited the shipment of the steaks, then the food supplier probably would not be required to deliver the steaks (assuming for the moment, that, for some reason, the restaurant wanted them) because the government has prohibited delivery and the force majeure provision specifically states that restrictive government regulations will excuse performance.
II. Frustration of Purpose
The doctrine of frustration of purpose was developed by the courts to excuse a party from performing its obligations under a contract, where an unforeseeable and uncontrollable event frustrates that party’s principal purpose in making the contract. The contract must have been made on the presumption that the event would not occur and the event must be outside of the control of the parties. Importantly, the frustrated purpose must be so essential to the excused party that without it the contract wouldn’t make sense. However, the frustrating event must substantially frustrate the purpose — it is not enough that the contract is no longer profitable or that the party will suffer a loss if they perform.
Using the steak example above, the restaurant may be excused from performance under the doctrine of frustration of purpose. Here is why:
First, neither the restaurant nor the food supplier could foresee the outbreak of a deadly disease or the state’s regulations to slow the spread. Second, the restaurant’s principal purpose in entering into the contract was to allow it to serve steaks to a reasonably predictable number of customers. Unlike a typical reduction in demand for the restaurant, say after a bad review or a slow time of year, making the contract unprofitable, the state’s shelter-in-place regulation has all but eliminated the restaurant’s ability to sell the steaks. Even if the restaurant was able to sell a few steaks to take-out customers, the restaurant’s purpose has been substantially frustrated because its ability to sell the steaks to its customers has been nearly completely eliminated. Under the doctrine of frustration of purpose, a court may well excuse the restaurant from purchasing the steaks from the food supplier until the shelter-in-place regulation is lifted.
III. Impossibility and Impracticability
The doctrines of impossibility and impracticability of performance are almost indistinguishable, and like frustration of purpose, were created by the courts to excuse a party’s failure to perform its contractual obligations, but with a slight twist. Unless the contract states otherwise, these doctrines apply where an unforeseeable circumstance makes performing contractual obligations unexpectedly impractical and performance becomes nearly impossible as a result. The unforeseeable circumstances are traditionally (i) death or incapacity of the person necessary for performance, (ii) destruction of a specific thing necessary for performance, or (iii) supervening prohibition or prevention by law. However, other circumstances such as acts of God or acts of third persons have also been viewed as circumstances excusing non-performance under the doctrine. Shifts in market conditions or financial ability are not circumstances that will justify non-performance. Similarly, like frustration of purpose, non-performance is not excused where performance merely becomes expensive or unprofitable. Instead, performance must become so burdensome that it is unjust to require the party to perform.
Imagine a manufacturer contracted with a buyer to produce 1,000 widgets a day. The state implements a shelter-in-place regulation that prohibits the manufacturer’s employees from going to work. The manufacturer cannot produce widgets without its employees. A court will likely find that the manufacturer is excused from producing the widgets because the government regulations made it impossible to produce the widgets. On the other hand, if the shelter-in-place rule only prevented half of the employees from going to work and the manufacturer could still produce 1,000 widgets a day (for example, by paying overtime to that half), even if it costs significantly more, the court would probably not excuse the manufacturer from producing the widgets.
The following additional examples relate to a contract the owner of a ship to deliver goods to a buyer in a port 10,000 miles away for a flat fee. After the contract is signed:
(i) A civil war breaks out and rebels threaten to sink all vessels bound for the port. The ship’s owner will likely be excused from performance because the risk of injury to both the ship and the crew is sufficient to make the performance impracticable (although perhaps not impossible).
(ii) The typical route through the Suez Canal is closed and the only other route is 13,000 miles long. The ship’s owner is likely not excused from its performance because although expensive, the other route is not impracticable nor impossible. If the Suez Canal was closed while the ship was in the canal, preventing the ship from completing the voyage, the ship’s owner would have been excused for non-performance under impracticability or impossibility.
(iii) The port is closed due to a quarantine. The ship’s owner is excused from performing because it is impossible to deliver to a closed port.
The coronavirus is unlike anything we have seen in our lifetimes. While other outbreaks in relatively recent history, such as influenza, Spanish Flu, SARS, Ebola and the like, had a significant impact on our world, little guidance exists in modern American courts as to how to deal with the widespread impacts and effects of a pandemic on businesses, including forced shutdowns and shelter-in-place regulations. Courts may become more lenient toward non-performance or try to extend doctrines that would normally not apply. However, there is no guarantee and attempting to use these, or similar doctrines, will likely result in a disagreement and, potentially, a lawsuit with the other party, which may ultimately be very costly.
These three doctrines — force majeure, frustration of purpose and impracticability — are not all-encompassing solutions and are not the only options for businesses dealing with the fallout of the coronavirus. One doctrine may be the legal solution for one business and factual scenario, but not for another. In addition, businesses should not assume these doctrines will provide a "get out of jail free card” to avoid performance under a contract. Businesses should review their contracts and situation carefully, consult with an attorney for guidance on any action or inaction the business may take, and consider working with the other party to reach an agreement that is mutually beneficial (or at least not mutually destructive!) before a breach occurs.
Eric Duhon is an associate with law firm Fennemore Craig who focuses his practice on commercial law, real estate law and business and finance law. A fifth-generation Nevadan, he resides in Reno.
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