March 24, 2020
On top of its catastrophic human impact, COVID-19 has caused substantial disruption to commerce of all types. Small personal service businesses, construction companies, food service providers, and manufacturers large and small have had their ability to produce products and fill orders on a timely basis disrupted, which in turn has impeded the performance of countless supply chains. Businesses need defenses to a breach of contract claim when they are unable to fulfill the terms of an agreement due to circumstances not in their control like COVID-19. Defenses may be available such as a force majeure provision in the contract, or, in the absence of such a provision, common law principles such as excuse due to an “Act of God”, impracticability, and frustration of purpose. The Uniform Commercial Code (UCC) also contains some relief in certain situations. This Alert provides an overview of these potential defenses to contractual performance, and practical considerations to keep in mind when evaluating next steps in your business relationships.
If a business is unable to perform its contractual obligations as a result of COVID-19, the contract’s force majeure provision will become important. An event of Force majeure, translated from the French to mean “superior force”, can excuse or defer a party’s performance under a contract in the event of circumstances beyond the parties’ control. Generally, an “Act of God” is part of every contract, whether or not it is written as part of a force majeure clause, and can excuse the performance of a legal contract so long as the occurrence at issue is so extraordinary and unprecedented that human foresight could not foresee or guard against it.
If a contract contains a force majeure clause, it will typically include language excusing or deferring performance upon the occurrence of events like natural disasters, war or other hostilities, acts of God, government actions and other events reasonably beyond the control of a party. The list of events is often negotiated so that the parties allocate the risk of these events, and as a result courts will often construe force majeure provisions very narrowly. Although some contracts’ force majeure provisions may specifically encompass an epidemic or pandemic, many will not and the applicability of force majeure to the COVID-19 pandemic will be the subject of disagreement among the parties. As an example, the construction industry standard American Institute of Architects (AIA) form A201-2017 provides that the contractor is entitled to a time extension for labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions, and other causes beyond the Contractor’s control, but it does not specifically enumerate “epidemic” as a force majeure event or grounds for excusing delay. Moreover, a reduction in workforce due to coronavirus may be insufficient to excuse delay if the contractor assumed the responsibility of employing and utilizing a competent workforce. Then again, if the contract requires the use of specific materials from affected areas, the resultant shortages may warrant an excusable delay of performance.
Whether a party’s performance may be deferred or excused in light of the current COVID-19 pandemic will depend on the specific language and context of the contract. As a general matter, if the force majeure provision contains public-health related events, such as epidemics, pandemics or outbreaks of disease, then in many situations the clause may be triggered given COVID-19’s classification as a “pandemic” by the World Health Organization. In recent days, governments have also imposed unprecedented travel and large-gathering restrictions, and instituted other restrictive interventions, such as closing schools and forcing restaurants to only offer takeout service; therefore, if a force majeure provision includes governmental orders or regulations, the clause may then again be triggered. If it is, evoking the force majeure clause may delay or change the timing of performance or absolve the parties from liability for their failures. This can be as important for the seller of a product or service that has been disrupted, as it is for the purchaser who, now delayed, may want to reject delivery on the order.
In practice, force majeure provisions are usually intended to temporarily relieve the parties of liability until events stabilize. Some contracts provide the right to terminate in force majeure situations, and some may relieve the non-performing party of liability for non-performance. The impact and effect of a force majeure clause will vary from contract to contract depending on the wording of the provision, the parties’ intent and applicable state law. In all events, once it is clear a party cannot perform under an agreement, proper notice of the force majeure should be given, and an attempt to mitigate the situation should be made as well.
In addition to the language of the force majeure clause, the contract’s choice of law and dispute resolution clauses may affect the outcome of a dispute related to force majeure events. Parties should also consider whether force majeure events are covered or excluded by their commercial general liability, business interruption or other insurance policies. Although the fact that a contract contains a force majeure provision is important, that alone is not the end of the inquiry and there are a number of considerations that should go into a decision as to whether the provision can, or should, be invoked as a result of COVID-19. Indeed, due to the widespread and deep impact of the COVID-19 virus on every aspect of society, a practical approach to solving supply chain issues is warranted by considering alternative sources of supply, loss mitigation strategies, and, potentially, even debt forgiveness.
Common Law and Uniform Commercial Code Defenses
In addition to force majeure provisions, there are several common-law affirmative defenses that can excuse performance of a contract in certain situations and may apply in the case of COVID-19. Impracticability, impossibility, frustration of purpose, and business necessity are all similar terms that can act as defenses to nonperformance and excuse a failure to perform due to an occurrence of an event that is not the fault of either party. In general, these doctrines excuse a promisor’s failure to perform a duty under a contract where performance has been rendered severely impracticable or impossible by unforeseen circumstances. To take advantage of this defense, the circumstances must be such that: (1) the occurrence of the event causing the impracticability was unexpected, (2) performance of the duty by the promisor would be extremely difficult and burdensome, if not impossible, and (3) the promisor did not assume the risk of the event’s occurrence. Applying these requirements to the COVID-19 crisis, one may be able to argue that (1) COVID-19’s existence and impact was highly unexpected, (2) in a number of contractual cases the performance of obligations is impossible either due to supply chain disruptions, government actions such as quarantine, or illness; and (3) the promisor did not assume the risk because it did not have any warning as to the size and scope of the pandemic.
Although these common law doctrines should be considered in assessing contractual obligations and nonperformance risks, they are not without limitation. For example, in some situations, these common law doctrines can come into conflict with the actual terms of an agreement, in which case the agreement’s terms may control and cancel out the ability to excuse nonperformance (through a force majeure provision or some other clause). Furthermore, courts are abundantly clear in that the frustration of purpose/impracticability defense does not result from and cannot be used to avoid an imprudent or bad bargain.
In the right case, certain provisions of the UCC may also help avoid liability if a contract’s terms cannot be fulfilled. The doctrine of “substituted performance” under UCC Section 2-614 might apply in certain sales transactions if a supplier or other entity is impacted by the various issues inherent with a pandemic. Usually, if the failure of a material term of the agreement can be mitigated by substitute performance, then the deviation is allowed. Conversely, should there be suitable substitute performance which the breaching party did not take advantage of, the failure to perform will not be excused. UCC Section 2-615 additionally may excuse delay or non-delivery if the performance has been made impracticable by the occurrence of a contingency the nonoccurrence 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. Again, the applicability of these sections to COVID-19 are case-specific and involve a fact-intensive inquiry.
In addition to the common law and UCC defenses discussed above, industry-specific statutes in a state may also define force majeure events and provide remedies when such events occur. Foreign law, public international law and treaties may also recognize and/or limit the impact of force majeure and related defenses to contractual performance. One should consider the impact of all of these sources of law when evaluating its contractual rights and business decisions.
COVID-19 has created unprecedented disruptions in our commercial dealings with each other. Analyzing whether the COVID-19 pandemic triggers a force majeure clause or related defense under common law or the UCC will be a fact-based evaluation focused on the specific contractual language and the impact of the pandemic on a party’s performance or failure to perform. Further, other factors including the law governing the contract may impact the analysis as well, so that under the same set of contract terms and facts, performance may be excused in one jurisdiction that is not excused in another. The attorneys listed below from our Business and Corporate, and Litigation, Insurance & Risk Management groups, are part of our COVID-19 Response Team and can assist clients in navigating these murky waters.
McGrath North’s COVID-19 Response Team includes:
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|Litigation, Insurance and Risk Management:|