How Your Business’s Contractual Rights and Obligations May Be Impacted by the Coronavirus (COVID-19) Pandemic

As COVID-19 (commonly known as the coronavirus) continues to infect people around the world at staggering rates, it is also causing massive disruptions to the global economy that will likely make it difficult for many businesses to operate. One of the principal issues that has emerged for businesses is how to evaluate their rights and obligations under their contracts in the wake of the COVID-19 pandemic. This article discusses the various principles under contract law that may apply to relieve a party of its contractual obligations as a result of COVID-19 and the practical issues businesses should consider as they strategize about how to respond to the challenges COVID-19 places on contract performance.

Force Majeure — Contracting for the Unexpected

The first step for anyone tasked with evaluating their company’s rights and responsibilities under a contract is to determine whether the contract contains a force majeure provision. Literally meaning “superior force,” force majeure contract clauses identify events that are outside the reasonable control of a party and thereby prevent a party from performing its contractual obligations. If one of these events occurs, force majeure clauses have the effect of excusing nonperformance by a party to the contract. Common events listed in force majeure clauses include acts of God, acts of federal or state government, epidemics, quarantines, acts of terrorism, extreme weather events, labor disputes, or other events that are beyond the reasonable control of the parties.₁

A party’s ability to avoid its performance obligations as a result of a force majeure event depends on the precise terms of the contract. Courts construe force majeure clauses narrowly, and as a general matter, will excuse a party's nonperformance only if the contract has expressly defined the event that caused party's nonperformance. ₂ Whether a force majeure clause excuses performance in a given circumstance depends largely on whether the specific language can be reasonably interpreted to encompass the event relied upon by the performing party to excuse non-performance.

For example, in One World Trade Center LLC v. Cantor Fitzgerald Securities, defendants, tenants at the World Trade Center building at the time of the 9/11 terrorist attacks, filed counterclaims against the plaintiff-landlord, seeking to recover front-loaded rent payments the tenants had made before the 9/11 tragedy destroyed the World Trade Center building.₃ The lease, however, contained a force majeure clause that expressly excused the plaintiff-landlord from performing its obligations for causes or conditions beyond its control, including “acts of God . . . war . . . and acts of third parties for which the [plaintiff-in-interest] is not responsible.”₄ Noting the general rule that “only if the force majeure clause specifically includes the event that actually prevents a party’s performance will that party be excused,” the court concluded that the language of the force majeure provision specifically shielded the plaintiff from acts of third parties (the terrorists who destroyed the building). ₅

Further, even if a contract specifies a particular force majeure event such as a pandemic (which could cover the COVID-19 pandemic), a party still has a duty to mitigate any “foreseeable” risks of nonperformance. In other words, if potential nonperformance was foreseeable and could have been avoided or mitigated by the performing party, courts will not hesitate to find force majeure provisions inapplicable.₆

In light of the foregoing, deciding whether COVID-19 constitutes a force majeure occurrent that will excuse a party from its contractual obligations will turn on the exact language used in the provision and the events it attempts to anticipate. Broad language, for instance, “acts of God,” might arguably be broad enough to encompass COVID-19. More precise wording, such as “epidemic,” “pandemic” or “disease” provides a stronger basis to invoke COVID-19 as a force majeure event. Regardless, the party seeking to invoke the force majeure event must also establish a causal link between its failure to perform and the force majeure event in question — here, COVID-19.

As a practical matter, if you are a party to a contract whose performance has been disrupted by COVID-19, you should review the contract to determine:

1. If it contains a force majeure provision
2. Whether the specific language of the provision can be reasonably interpreted to apply to the COVID-19 pandemic
3. Your obligations should you seek to rely upon the provision to excuse your business’ failure to perform contractual obligations as a result of COVID-19 related business disruptions.

These obligations vary, but many force majeure clauses impose one or more of the following:

1. Notice requirements. The enforceability of many force majeure clauses is dependent upon providing precise and prompt notice of the force majeure event to the other party to the contract.
2. Mitigation efforts. Many clauses require organizations to document and demonstrate that they have undertaken “commercially reasonable steps”, “all reasonable steps” or “best efforts,” to avoid or mitigate the impact of COVID-19 before the provision may be applied to excuse performance.
3. Remaining obligations. Not all clauses relieve the parties of all performance obligations. Many clauses excuse certain specific obligations, such as the payment of fees, but do not excuse others. As such, even if a clause excuses the performance of some contractual obligations, other obligations may remain in effect. Ensuring the provision applies to excuse performance obligations actually impacted by COVID-19 may require careful analysis. Finally, for businesses with hundreds or even thousands of contracts that need to be analyzed promptly, contract analytics software may be used to quickly determine if a business’s contracts contain force majeure provisions, how they affect its rights and responsibilities, and what notice or mitigation obligations, if any, those provisions impose on the business.

Impossibility of Performance

Even if a contract does not contain a force majeure provision, the doctrine of impossibility of performance may still allow a party to avoid liability for breach of contract. This doctrine may be invoked when supervening circumstances have occurred that make continued performance under a contract impracticable. For the doctrine to apply, a party must show it will suffer “unreasonable and unforeseen hardship due to an unavoidable event or occurrence.”₇ Continued performance need not be literally impossible. As the Colorado Supreme Court has explained, “impossibility means not only strict impossibility but impracticability because of extreme and unreasonable difficulty, expense, injury or loss . . . Impracticability rather than impossibility is enough."₈ When determining if the doctrine applies, the “important question is whether an unanticipated circumstance has made performance of the promise vitally different from what should reasonably have been within the contemplation of both parties when they entered into the contract. If so, the risk should not fairly be thrown upon the promisor."₉

Importantly, courts consistently hold that an intervening event that “merely renders performance more costly” is not sufficient to excuse a party’s performance under the doctrine of impossibility.₁₀ This is because increased costs caused by increased labor, raw material or regulatory compliance “are not situations which are so unforeseeable as to be outside the risks” ordinarily assumed under contracts.₁₁ Thus, the fact that general underlying economic conditions have deteriorated and made a contract less profitable will not support application of the doctrine of impossibility.₁₂ However, courts will excuse performance where acts of God, war, embargo disease or other similar events have occurred that are inconsistent with the conditions the parties assumed existed and would continue to exist at the time the contract formed. Therefore, the doctrine of impossibility may apply to excuse the performance of contracts made impracticable by COVID-19.

The Uniform Commercial Code’s “Commercial Impracticability” Standard

For transactions involving the sale of goods, Article 2 of the Uniform Commercial Code (UCC) might also excuse performance. Section 615 of Article 2 provides that performance becomes impracticable by either (1) an event occurring, “the nonoccurrence of which was a basic assumption on which the contract was made” or (2) “by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.”₁₃ As a general matter, a party must demonstrate:

1. An event occurred.
2. The event made the performance “impracticable” — not impossible.
3. A basic assumption to the contract was that the event would not occur. ₁₄

Courts generally use a more flexible approach with this standard, finding it satisfied more easily than the doctrine of “impossibility” because the test is not whether performance was theoretically possible but instead whether the event rendered performance commercially impracticable, and whether that event was foreseeable.₁₅ If it was, then the party obligated to perform must bear the costs of nonperformance because it could have negotiated for greater contractual protections.

Keep in mind, however, that courts have held that the UCC’s commercial provisions may be altered by contract. For instance, parties are free to negotiate to excuse performance based only upon a showing of something less than commercial impracticability, such as predicating performance on delivery of goods to the seller by a manufacturer. And finally, the UCC only applies to the sale of goods, not to the sale of real property or services, limiting its applicability.

Negotiating Amendments to Contracts Impacted by COVID-19

To maintain strong customer goodwill and relationships and to avoid the costs and risks associated with litigation, parties to contracts whose performance has been made more difficult or impracticable by COVID-19 may also simply negotiate amendments that adjust the terms of the contract to account for these issues. For example, parties could agree to extend the deadline for performance several months until after the worst effects of the outbreak are expected to have passed or agree to accept a reduced supply of a product until ordinary production processes can resume. While litigation is sometimes unavoidable, a willingness to negotiate a solution that will allow the parties to continue to have a contractual relationship after the disruptions caused by COVID-19 has passed may be both less costly and better for a business in the long term.

Conclusion

With the scope of potential consequences from the COVID-19 pandemic still very much in flux, businesses are wise to begin assessing whether their contracts contain force majeure provisions and how the terms of those provisions and the doctrine of impossibility may impact their rights and responsibilities and the rights and responsibilities of the other parties to those contracts if they experience substantial business disruptions from COVID-19.

As the number of cases around the world grows, Faegre Drinker’s Coronavirus Resource Center is available as a resource to help you understand and assess the legal, regulatory and commercial implications of COVID-19.