Checklist for Issuing and Responding to Force Majeure Notices in Real Estate Contracts and Loan Agreements

COVID-19 is occasioning executive orders, regulations and other statutes enacting business restrictions, closures and shelter-in-place lockdowns. Consequently, many businesses are sending notices to selected counterparties asserting an excuse for nonperformance based on contractual force majeure clauses.

This alert discusses factors to be considered before delivering or responding to such notices, including the risk of misfiring on a legally deficient force majeure notice. Any specific analysis must be fact intensive, as the choice of law provision and contract language are often dispositive.

The following are general comments – each state has unique case law and exceptions. Consideration of the Uniform Commercial Code’s Article 2-615 force majeure provision is not within the scope of this article.

Choice of Law

If there is no choice of law clause in a contract, there may be a battle over which state’s law applies in interpreting the contract¹. While most jurisdictions will apply similar basic principles of contract law, there are nuances from one state to another. For example, some jurisdictions will bar a claim based on the common law defenses of impossibility or impracticality if the contract has a force majeure clause even if that clause is not found to permit application of force majeure². And as discussed in more detail below, different jurisdictions vary in how they resolve issues as to whether a particular event is an “act of God,” so the choice of law may be significant.

Force Majeure Clauses, Generally

Force majeure clauses are provisions in contracts that either (i) release or (ii) defer a party’s contractual obligations due to specific circumstances beyond the control of the breaching party³. Force majeure clauses allocate risks of selected unforeseeable events that may result in a party’s permitted nonperformance⁴, and in many cases are carefully drafted with the type of transaction in mind⁵.

Prior to 9/11 and the outbreak of Severe Acute Respiratory Syndrome (SARS), most force majeure contract provisions were based on total impossibility of performance. Subsequently, force majeure provisions were often revised to allow for partial impossibility – meaning that if one party to the contract was partially prevented from performing its obligations under the agreement because of impossibility or impracticability (incapable of being accomplished by the means available), that party was still required to perform to the extent to it was capable of doing so, but was otherwise excused from performing the contract as a whole.

Therefore, using the year 2003 as a benchmark, epidemics and diseases that could affect the performance of a contract (e.g., travel, the safety of attendees to a convention, construction work) are likely to be considered foreseeable events.

Typical Events That Constitute Force Majeure

Historically, examples of what might constitute force majeure events include acts of God, riots, war, strikes, casualty, labor disputes, terrorist attacks, earthquakes, floods, civil unrest, shortages of, or delays in, obtaining or an inability to obtain labor, utilities or materials, and generally any event beyond the control of the relevant party⁶.

As litigators will tell you, the more specific the items listed in the force majeure clause, the less likely it is that the clause might apply to an event that does not fit in one of the specific definitions. The ejusdem generis ("of the same kind") rule of construction applies to resolve the problem of discerning the meaning of groups of words where one of the words is ambiguous or inherently unclear – i.e., if there is an extensive list of specific items, then a general term may not apply to a non-specified item that is not similar to the others⁷. Bear in mind as well that frustration of purpose may remain a defense, where even if performance is possible, the point of it no longer exists.

Post-SARS (and to a lesser extent, H1N1, or swine flu), pandemics, epidemics and diseases were often included in force majeure clauses to address circumstances where such events were not considered "acts of God.” On March 11, 2020, the World Health Organization (WHO) declared COVID-19 a pandemic⁸. While an “epidemic” refers to an increase in the spread of a disease within a specific community, a “pandemic” is an epidemic that has spread across a large region – for instance, multiple continents, or worldwide.

A pandemic declaration is unusual. SARS did not reach pandemic status, for example. The WHO last used the “pandemic” label during the 2009 H1N1 outbreak⁹, but this received pushback¹⁰. A widespread endemic disease with a stable number of infected people likely does not constitute a pandemic. Furthermore, flu pandemics generally exclude recurrences of seasonal flu.

Is COVID-19 Covered in a “Legacy” Force Majeure Clause?

As noted above, courts historically construe force majeure clauses narrowly to limit them to their express terms only¹¹. Consequently, if the clause specifically covers such events as epidemics, pandemics or diseases that have caused nonperformance, there is an excellent argument that the COVID-19 pandemic would trigger the force majeure clause. At the same time, if a catch-all clause includes “other emergencies,” it could also capture a party’s inability to perform due to COVID-19, in light of the president, governors and mayors having respectively declared emergencies or other disaster declarations.

A more difficult question surrounds the term “act of God” and how that phrase might apply to cases involving COVID-19. It is important to recognize, however, that each case will turn on specific facts and context, and additional contract language that might limit application of an act of God, such as whether the act of God must have been unforeseen.

Is COVID-19 an Act of God?

This question is different from state to state. In a recent case, a U.S. District Court in Virginia indicated – based on law from outside Virginia – that an act of God could be covered as a force majeure event even if could be foreseen, so long as the force majeure clause did not specifically require the lack of foreseeability as one of its terms to apply¹². Thus, as applied here, even if COVID-19 could have been “foreseen,” (arguable, given recent epidemics such as SARS, H1N1 and Ebola) it might be covered as a force majeure “act of God” where unpredictability of that act of God was not a condition required by the contract for the force majeure clause to apply.

But in other states, even if COVID-19 constitutes an act of God, a court may not allow a force majeure defense to the extent that a party contributes to and causes failure of performance. Accordingly, a party in certain states seeking to invoke a force majeure clause under the guise of an act of God must attempt to mitigate a breach or nonperformance of the contract in question.

Is the Event Foreseeable?

If (i) there is a contract and (ii) the contract has a force majeure clause, then unless the clause reinserts a condition of foreseeability, foreseeability is not an element of the proof – it will be a function of the contract language as risk allocation. If there is no force majeure clause, then foreseeability will matter, and the course of dealings between the parties and the particular nature of the relationship and business become relevant.

Suppose a Contract Does not Contain a Force Majeure Clause?

Even where there is no force majeure clause or where the clause does not contain specific or catch-all language applicable to COVID-19, the doctrines of (i) frustration of purpose and (ii) impossibility (or impracticability) of performance may still apply to void a contract.

Generally, to apply these doctrines, a party has the burden to present evidence that the contract's principal purpose has been substantially frustrated and/or its performance is made impracticable, without the party’s fault, by the occurrence of an event, the nonoccurrence of which was the basic assumption on which the contract was made¹³.

For example, if because of COVID-19, people are unable to attend an event such that it is impracticable to go forward with the event (since no one or very few people will participate), the principal purpose of a contract with the host venue may be rendered so frustrated as to make it null and void.

Applicability of Force Majeure Clauses

Typically, parties will agree that force majeure is applicable to only certain types of breaches, such as a borrower’s obligation to (i) restore its collateral after a casualty or (ii) finish the construction of improvements by a date certain pursuant to a construction loan.

In some agreements, force majeure may apply to any breach of the agreement, without limitation. However, many agreements provide for a limit or “cap” on the period of time during which force majeure may apply, such as 90 days. In addition, it is typical that nonpayment of monetary obligations is carved out as an event that is beyond the control of a party seeking to invoke force majeure. Typically, a force majeure provision will NOT apply to an obligation to pay rent or an obligation to pay debt service. However, if the borrower’s failure to pay its monthly debt service is the direct result of a government mandate requiring its tenants to shut down, and the definition of force majeure includes governmental restrictions without any carve out as to monetary breaches, then the force majeure clause may apply.

Risk Allocation

A force majeure clause provides a contractual risk allocation, comparable in some ways to indemnification provisions. A force majeure “situation” may be labeled differently (such as “impossibility of performance”) or it may be treated as a contract condition. For example, a contract may have an “if, then” provision itemizing certain events. If so, courts seek to hold parties to the contract they wrote and will generally enforce the condition. On the other hand, trying to fit an otherwise unspecified event into the definitions of the force majeure clause may be more difficult, particularly where the clause appears to be pure “boilerplate” and the court cannot discern the intent of the parties.

Government Actions/Shelter-in-Place Orders

Over the past two weeks, in an effort to curtail the spread of COVID-19, multiple governors have issued statewide orders closing all nonessential businesses, and in some states, governors have also issued “shelter-in-place” orders mandating residents to stay indoors. At this rate, a growing number of borrowers may no longer have adequate cash flow to pay the monthly debt service on their loans, or may be in breach of other nonmonetary obligations or covenants as a result of tenants whose businesses have been shut down and are unable to pay rent. In these cases, borrowers may begin looking to force majeure clauses for protection from what is hopefully a temporary condition.

In the absence of a qualifying event that is ancillary to COVID-19 and can be identified as the cause of a borrower’s breach, such as a government-mandated closure of a tenant’s business operation, it is not clear whether and under what circumstances the COVID-19 outbreak alone would suffice to provide the basis for a borrower to claim force majeure. As noted above, the bargained-for language of the clause would first determine whether the clause is applicable to COVID-19 at all. Assuming the force majeure clause contains language such that it applies to “pandemics,” “epidemics,” “disease” or similar events and the specific breach in question is subject to the force majeure clause, the borrower would still have to show that its failure to perform was caused by COVID-19. It is unclear when a pandemic rises to the level of interfering with performance of contractual obligations, particularly monetary obligations. Further, to the extent that a borrower’s nonperformance is the result of its tenants voluntarily shutting down as a preventative measure, the virus may not be viewed as the direct cause of the breach.

Government regulation, by way of statutory enactment, “jawboning” and change of law can constitute an event of force majeure or impossibility/impracticability of performance, or under common law concepts of impracticability or impossibility of performance¹⁴. The “shelter in place” orders, for example, may constitute the intervening act that affects impracticability. On the other hand, certain government acts that may be anticipated in affecting the market may be found to be an assumption of the risk by the parties unless expressly dealt with; for example, certain commercial leases provide for tenants to remain obligated to pay rent and other payment obligations notwithstanding any governmental rule, order or regulation. The bottom line is that force majeure remains a narrow exception. Where a matter of contract, the language of the contract will govern, and where governmental acts are not specified, the issue will likely be analyzed in terms of whether it fits the broad description or otherwise, if the jurisdiction permits the analysis, whether it is an appropriate intervening act that is beyond the control of the party and renders performance impossible under the circumstances.

Economic Downturn/Loss of Profit

Generally speaking, it is not a force majeure event when a contract simply becomes unprofitable¹⁵. If the contract has a condition or criteria that link performance to such events or standards, that is one thing, but unless so specified in a force majeure clause as risk allocation, economic loss will typically not be considered a legitimate event of force majeure¹⁶. A dramatic shift in a currency exchange rate, for example, rendering the contract unprofitable for one of the parties, has been held to not constitute impossibility or impracticality of performance¹⁷.

Best Practices Going Forward

The above discussion has addressed dealing with current contracts in place. Whether sending force majeure notices or responding to them, do not rely on a pro forma, boilerplate recitation. Separate and apart from dealing with the current contracts, consider reviewing and revising (or eliminating) force majeure clauses in contracts for future transactions.

As part of this review or future drafting of force majeure clauses, consider the issues presented in this article, but also give thought to whether the clause is needed. This is where choice of law becomes relevant.

To the extent that economic performance is anticipated, address those issues by use of conditions, and do not try to work them into a force majeure clause. It does not make sense to add a provision in the contract providing for the same principles already afforded at common law and risk losing those benefits in jurisdictions that disallow reliance on common law where there is a force majeure clause. And be wary of listing too many items after the “including but not limited to” language, lest you dilute the broad language in other parts of the clause.

The current crisis has forced attorneys to consider the use and misuse of force majeure clauses and move beyond boilerplate.

Sample Force Majeure Definition/Updated for COVID-19 and Shutdown Orders

“Force majeure” means any act, omission or circumstance occasioned by any acts of God, acts of public enemies, wars, blockades, insurrections, riots, earthquakes, volcanoes, fires, storms, floods, disasters, sabotage, regulatory changes, extended weather conditions that broadly affect delivery of goods or materials, or other events or circumstances not within the reasonable control of a party preventing a party from performing its obligations, including, without limitation, diseases, public health emergencies, pandemics (e.g., COVID-19), endemics, travel bans, domestic or international restrictions on travel, or acts of governmental bodies (but not including governmental actions, orders, penalties, judgments or requirements which such party could have prevented by compliance with applicable laws, regulations and standards).

Other language could include "communicable disease outbreak" or "communicable and virulent disease" to capture diseases that may not qualify as an "epidemic." Another possibility, based on the need to provide specific language that triggers an identifiable event, is the addition of language that follows the authority of government officials to make declarations such as the authority to declare a "reportable, communicable and virulent disease" or a "public health emergency."

On the other hand, parties who seek to limit the risks of COVID-19 triggering an event of force majeure should consider using language that generally describes force majeure as an "act of God" with no additional specific triggering events. An all-inclusive force majeure clause may limit the possibility that the clause will apply to a COVID-19 outbreak as we have recently experienced it. However, in drafting a force majeure clause for the purpose of limiting its application to an "act of God," a drafter should be vigilant, since many state courts have indicated that ambiguous drafting of force majeure clauses may be interpreted against the drafter.

Legal clerk Eric R. Cole contributed to this article.

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