COVID-19 HAS KILLED MY BUSINESS – MAY I LEGALLY TERMINATE MY CONTRACTS?

COVID-19 HAS KILLED MY BUSINESS – MAY I LEGALLY TERMINATE MY CONTRACTS?

By: Jeffrey M. Goldstein jgoldstein@goldlawgroup.com www.goldlawgroup.com

The coronavirus (COVID-19) (“the Virus”) has made it impossible or impracticable for many businesses to comply with their contracts. The party who must ultimately bear the loss associated with the Virus largely depends on whether the explicit language in their contract contains a ‘force majeure’ clause. In the absence of such language, liability for the non-performance will turn upon the law of ‘impossibility’ in the applicable jurisdiction. 

Not only has the Virus physically disabled those responsible for meeting contractual obligations, but it also has caused many state and local authorities to issue orders banning or severely restricting association, gatherings and travel, for instance, which, in turn, create such impossibility or impracticability. The evolution of the Virus, as well as government and business responses thereto (quarantine and containment orders), has caused many businessmen, and lawyers in unrelated niches, to ask whether any legal excuses exist to discharge promisors from contractual obligations impacted by the Virus.

As discussed below, and as will be discussed in more detail in subsequent articles in this series, businesses, including franchisees, distributors and dealers, who find themselves unable to meet certain obligations in their contracts, should seek legal assistance to determine whether force majeure or the common law of impossibility or impracticability excuses their contractual performance. While force majeure generally refers to unforeseeable “acts of God,” impossibility is a broad-sweeping doctrine that picks up events and occurrences that arguably substantially impede performance even though they are not nature related (e.g., blindness or death of famous artist in a contract for a painting by that artist; destruction of building undergoing construction).

Absent the applicability of such a legal excuse to performance, every party to a contract assumes the risk of his or her inability to perform a contract; hence, liability under contract, absent an excuse, is considered strict. So, even if the parties at the time they sign the contract are unable to anticipate an unforeseen destructive event, absent an exception, courts generally will place the risk of the occurrence of the unforeseen event on the party unable to meet its obligations under the contract. While this may seem unfair, it is the reality of strict liability.

Many have offered the potential applicability of the doctrine of force majeure (or “acts of God”) as a legal solution for those unable to meet their obligations as a result of significant negative unforeseen events. As future articles in this series will demonstrate, force majeure itself is a concept not necessarily explicitly tethered to existing common law principles of impossibility governing contracts in common law jurisdictions like the United States and England. In this regard, a force majeure excuse is correctly viewed as applicable only when it is specifically written into a contract. Accordingly, many force majeure cases involve contractual interpretation focusing exclusively on the meaning of the explicit language included in the particular force majeure clause. Analytically, force majeure conditions cover terms describing an outbreak (e.g., epidemic or disease); emergent conditions to deal with such an outbreak (e.g., closing of businesses); as well as acts of people (e.g., riots or wars). Common instances of force majeure events set forth in contracts include floods, hurricanes, earthquakes, strikes, and shortages – acts considered beyond the parties’ control. Catch-all language to include “all other acts of God” or “consequences out of the control of the parties” usually do not provide much protection to the party trying to excuse failure or inability to perform. For instance, not all courts would view COVID-19 as an ‘act of God’ because, based on prior epidemics, the Virus would have been foreseeable at the time the contract was signed.

Regarding the Virus in particular, one issue is whether the words pandemic, epidemic, government closing orders, or similar words have been identified specifically in the force majeure clause. So, although the World Health Organization or other national governments might classify the Virus as a pandemic, this would not necessarily implicate a force majeure clause that does not specifically include the word pandemic or epidemic. Moreover, inclusion of the word by itself in the contract would not necessarily absolve a party of its obligations, as some courts would require some type of additional showing including, but not limited to, notice, mitigation efforts and lack of foreseeability.

In contrast to the narrow force majeure concept under civil law are the doctrines of impossibility or impracticability under common law. Although these doctrines are related to the notion of force majeure, they are applied in many cases when a force majeure clause has not been included in the agreement. Similar to force majeure, however, they generally pivot off whether the risk of nonperformance was foreseeable, preventable or subject to mitigation at the time the contract was signed. Also, of course, the issue whether performance of the obligation is truly impossible or just more difficult is relevant to both.

Under the current common law in the United States, there are three general categories of legal excuses associated with a party’s hardship in trying to perform its obligation. The first ground of discharge is associated with the promisor’s claim that circumstances make its own performance impracticable (“impracticability”). (Restatement Sections 261-264) The second ground of discharge arises when a promisor argues that some circumstance has destroyed the value to the promisor to the extent that it has frustrated that person’s reason for entering into the contract (“frustration of purpose”). (Section 265) .

Restatement of the Law, Contracts 2d

§ 261 Discharge by Supervening Impracticability

§ 262 Death or Incapacity of Person Necessary for Performance

§ 263 Destruction, Deterioration or Failure to Come Into Existence of Thing Necessary for Performance

§ 264 Prevention by Governmental Regulation or Order

§ 265 Discharge by Supervening Frustration

§ 266 Existing Impracticability or Frustration

§ 267 Effect on Other Party’s Duties of a Failure Justified by Impracticability or Frustration

§ 268 Effect on Other Party’s Duties of a Prospective Failure Justified by Impracticability or Frustration

§ 269 Temporary Impracticability or Frustration

§ 270 Partial Impracticability

§ 271 Impracticability as Excuse for Non-Occurrence of a Condition

The Uniform Commercial Code (“UCC”), applicable to the sale of products, also excuses performance based on several of the underlying common law theories of impossibility (e.g., foreseeability and impracticability). While there can be substantial overlap between force majeure and doctrines of impossibility, there may be cases where the inclusion in a contract of a narrower force majeure clause will legally foreclose the applicability of a broader common law impossibility rule.

The determination of whether an unanticipated event will suffice to excuse a party’s performance is a fact-based inquiry. Accordingly, relevant court precedent, although useful, is not dispositive. It is interesting to note, however, that courts in both civil and common law jurisdictions have ruled whether types of disease epidemics excused the breaching party’s performance of the relevant contract (e.g., civil law: typhoid fever, cholera, influenza; common law: cholera, animal disease).

From a law and economics point of view, issues of force majeure and impossibility are viewed through the lens of efficient risk allocation, or more specifically, the theory of efficient risk-bearing. As an initial proposition, assuming the transaction costs of negotiating and allocating risks do not exist, the contracting parties themselves will identify and allocate all risks to one party or the other in the contract. However, the costs of identifying and allocating every risk cannot justify such complete identification and allocation. Accordingly, where a contract in litigation has a gap in allocating a particular risk, a court or arbitrator must determine liability for the risk that has come to fruition. Very simply, under an economic efficiency rationale, the party who can eliminate the risk at the least cost should be held liable for the unexpected event. In turn, bearing such risk involves determining which party is best able to decrease the probability of the risk, spread the risk, or both.

If performance under your agreement or contract has been hindered, delayed, impeded, or frustrated due to COVID-19, you should promptly consult an attorney with expertise and experience in complex or commercial contract litigation. You should not simply assume that the existence of the Virus alone will excuse your contractual obligations in part or in whole. Not all force majeure clauses or common law rules of impossibility are the same; before attempting to cancel, terminate or modify the terms of your contract based on COVID-19, you should discuss your specific legal rights and obligations with an attorney.

The consequences of asserting an invalid claim of force majeure or impossibility could be harsh, as such a claim could be interpreted as wrongful anticipatory repudiation of your contract. And, for companies now involved in contract negotiations, the specific language and existence of a force majeure provision in the contract can mean the difference between bankruptcy and success in the future.

Jeffrey M. Goldstein

www.goldlawgroup.com

jgoldstein@goldlawgroup.com 202-293-3947