Protecting Your Business Operations During a Global Pandemic

03.27.2020
Nossaman eAlert

The global impact of COVID-19 increases by the day.  Supply chains, manufacturing and transportation are being significantly disrupted while businesses’ rights and obligations under contracts are coming into sharp focus.  What can you do if COVID-19 prevents you from performing your contractual obligations?

You may be able to seek relief through reliance on a force majeure provision in the contract.

What are force majeure provisions?

Force majeure provisions are commonly included in commercial contracts as a way to allow parties to agree to change, suspend or cancel their contractual obligations in the event of an unforeseen circumstance.  The term “force majeure” translates to “superior force” and is designed to exclude liability of a party where that party’s failure to perform is caused by forces beyond its control.  These forces can include an act of God (such as earthquake, flood or drought), human events (such as war or strikes) or any other causes beyond the control of either party.

Force majeure is a creature of contract governed by state law.  Whether a particular provision relieves a party of contractual liability will depend on the precise wording used, the allocation of risk between the parties provided for by the contract as a whole, and the situation that has arisen.

Does your force majeure provision cover COVID-19?

Whether disruption caused by COVID-19 is covered under a force majeure provision ultimately depends on the language in the contract.  Different contracts will define force majeure events differently.  The provision may call out specific events, may include a “catch all” for other similar events, or specify that the list is non-exhaustive.  A detailed review of the provision and its context will be required.

Given the novelty of a global viral outbreak such as COVID-19, it may be that force majeure provisions in existing commercial contracts do not contemplate an epidemic, pandemic or public health emergency.  If this is the case, you should consider if the existing provision accounts for consequential events arising from COVID-19, such as quarantines, industry shutdowns or governmental actions, including work stoppages, travel bans and lockdowns of affected areas.

The party seeking to rely on a force majeure provision bears the onus of proving that the event falls within the definition of “force majeure” under the contract, and that the event has prevented that party from performing its obligations under the contract.

During these unprecedented times involving COVID-19, the effective date of the contract also will be critically important.  In general, a party seeking to use a force majeure provision in a contract entered into prior to the time of the COVID-19 outbreak in China stands to fare better than one who entered into a similar contract after news started reporting that a pandemic was a possibility or after governmental orders establishing restrictions were issued.

If COVID-19 is covered under a force majeure provision, what are your options?

The force majeure provision will likely set out the contractual mechanics if the provision is invoked.  Of note are the following:

  • What are the notice requirements? Note that a failure to timely send such notice when and in the manner required may result in waiver or have other adverse consequences.
  • Does the event excuse you from performing the contract in whole or in part?
  • Does the event give you or the other party the option to terminate the agreement or does it only entitle you to suspend or extend time for performance?
  • If the event gives rise to a termination right, is the termination immediate or is there a requirement to mitigate and mediate first?

You should note that many force majeure provisions are drafted to expressly exclude relief from any obligation to pay money.

What if there is no force majeure provision?

If there is no force majeure provision, or if COVID-19 falls outside the ambit of an existing force majeure provision, you will have to look at other provisions of the contract for potential routes out of performance.  If the contract does not provide any such routes, alternative bases for termination might be the doctrine of “impossibility of performance” or the doctrine of “frustration of purpose”.

American law has long recognized that it would be inequitable to hold a contracting party to its contractual obligations if intervening and unforeseeable events beyond their control have made a party’s performance of the contract objectively impossible or impracticable.  Every state in this country recognizes some form of the doctrine, either in the common law of contracts or by code.  California has codified the doctrine in its Civil Code. 

A closely related legal doctrine that you may invoke is frustration of purpose.  Frustration occurs when, without fault of either party, a contractual obligation has become incapable of being performed due to an unforeseen event (or events) resulting in the obligations under the contract being significantly different to what the parties had initially intended.  The event which brings about the “radical” change is referred to as the frustrating event.

Establishing impossibility or frustration of contract can be difficult – and usually more difficult than invoking a force majeure provision.  Both doctrines are not established merely because circumstances have made performance more difficult or less profitable.  Rather, you must demonstrate that the ability to perform the contract has been significantly diminished or commercially impossible.  Determining whether a contract can be terminated for impossibility or frustration involves an in-depth consideration of all of the terms of the contract and the events which have occurred.

Analyzing your commercial contracts and practical steps to take

Now is the time to review your commercial contracts to determine what force majeure rights, remedies and requirements (if any) may apply if your business operations are disrupted, what your options are if the force majeure provision is triggered, or whether impossibility or frustration should be claimed.

Parties seeking to rely on a force majeure provision, impossibility or frustration should take the following practical steps:

  • Consider in detail the precise wording of the force majeure provision, the contract as a whole and the circumstances that have arisen. Determining whether performance is excused by a force majeure provision can be a difficult and highly fact-sensitive exercise, so early legal advice should be sought.
  • Serve any notices as required under the contract as soon as possible and in accordance with the notice provisions. Consider carefully what event or circumstances you are alleging constitutes the force majeure event, taking into account the wording of the provision and the time period required for service of notice, e.g., the outbreak of COVID-19 itself, or subsequent government restrictions put in place.  If complete information is not available, you should supplement your notice as additional information becomes available.
  • Keep a written record, particularly of the following: the timing of the force majeure event, the number of impacted people/facilities/products/services; why performance is impossible, hindered or delayed (as the case may be); the steps taken to find alternatives and mitigate losses; efforts to comply with the contract terms; when the event is expected to conclude; and the service of any notices.
  • Do not attempt to rely solely on increased costs to excuse non-performance or delay, as this will not usually be sufficient.
  • If there is no force majeure provision, consider the doctrines of impossibility or frustration, but be aware of the high bar for establishing that a contract is impossible to perform or its purpose has been frustrated.
  • Consider negotiating a modification to the underlying contract to take into account the impact of COVID-19 and allow extra time to perform.
  • Manage communications with counterparties, bearing in mind the importance of a company-wide, consistent approach.
  • Consider the effect of a force majeure, impossibility or frustration declaration in one commercial contract across other agreements and legal obligations. For example, some financial agreements include representations regarding, or covenants to provide notice of, material events that could lead to litigation or anticipated loss outside of the ordinary course of business.  Such events may also constitute an event of default in related agreements.

Suspension or termination of any contract is always a high risk activity.  If you are considering relying on a force majeure provision or the impossibility or frustration doctrines, or if you are responding to a claim of force majeure, impossibility or frustration, we strongly recommend you first seek legal advice and counsel.  Nossaman attorneys are here to help you in this endeavor.

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