The spread of Covid-19 has affected so many aspects of our personal and working lives in the U.S. and around the world. Work and travel restrictions, quarantines, and the slowing pace (or even shutdown) of manufacturing, shipping, and distribution of goods in many regions has led to a worldwide question that applies on a scope never before contemplated – How does COVID-19 affect performance under contracts? Below, we discuss force majeure provisions and common law contractual remedies, both of which are ways of excusing non-performance under a contract in light of entirely unforeseen events.
Countless businesses are unable to perform their obligations under various contracts. Similarly, such businesses face non-performance by their suppliers, shipping companies, manufacturers, distributors, service providers and others. Many contracts contain what is called a “force majeure” provision. Such a provision excuses a party’s (or both parties’) performance under a contract in the event enumerated significant acts occur which are outside the reasonable control of the parties, such as the COVID-19 pandemic.
Countless lawyers are scrambling to review and better understand their force majeure provisions in contracts, as, to be frank, many attorneys include such provisions as boilerplate, standard language without considering the specific content. Many other attorneys, of course, understand the boilerplate and carefully craft the provision to encompass a range of extraordinary events outside a party’s control and a catch-all category.
A party providing materials, goods, or services (the “Provider”) is more likely to fail to perform and claim the protection of force majeure than the recipient of the Provider’s materials, goods or services, whose only duty is payment (the “Recipient”). A Provider will therefore, argue for a broad force majeure provision that includes a wide range of natural disasters, government actions (such as seizure of factors or nationalization of industries), insurrection, war, terrorism, or other social unrest, inability to obtain materials from any source, epidemic or pandemic, and a broad catch-all including any other cause out of the control of the Provider, whether similar or dissimilar to those expressly listed.
The Recipient will seek a narrow provision, avoiding a catch-all and excusing performance for only the specifically listed reasons. If there is a catchall, a Recipient will attempt to negotiate its language to include only other reasons similar to those enumerated, narrowing the scope of the force majeure language. Problematically, some parties will find epidemic or pandemic may not have been expressly included, leaving a question as to whether it was contemplated by the parties and litigation.
In interpreting these provisions, many courts look to whether the occurrence of a potential force majeure event was foreseeable, and that a failure to include such potential event prohibits a court from unsettling the parties’ distribution of risk. For existence, after the terrorist attacks of 9/11/01, terrorism was foreseeable and was quickly added to force majeure provisions; if terrorism were omitted it would likely not be implied, depending on the wording of the force majeure provision. The same will likely be true with respect to epidemic or pandemic after COVID-19’s eventual temporary or longer-term retreat.
Generally, a party claiming the protections of a force majeure provision must provide notice to the other of its intent to do so, a description of the force majeure event and its impact on the party’s performance.
A force majeure provision can be time limited. Some will excuse performance for a maximum period of time, weeks or months. This time limit would apply regardless of the duration of the force majeure event, after which the non-affected party could terminate the agreement or seek damages after the excused period of non-performance. A provision’s time frames can begin upon the sending of the notice, upon the receipt of the notice, or the first instance of non-performance.
Commonly, a party claiming force majeure has a duty to mitigate the effects of the relevant event. If there are means to obtain other materials, locate other suppliers, find different transport means, etc., the affected party must do so and take reasonable steps to avoid disruption.
In the U.S., there are common law contractual remedies that are akin to force majeure events. Often, these remedies apply more broadly than a force majeure provision in a contract. In some instances, without language to the otherwise, a force majeure provision discussing unforeseen events will foreclose the application of common law remedies permitting non-performance. It is wise to include a provision stating that the force majeure provision in an agreement should be read as a supplement to, not a replacement for, common law remedies that a judge can apply.
Frustration and impracticability are not normally applied where performance has simply become more expensive by one party through normal or foreseeable market events. For example, the price of oil is known to fluctuate greatly, and absent some extremely abnormally compelling circumstances, an increase in price does not remove the obligation to provide the commodity.
These doctrines apply in circumstances where an unforeseen event undermines the very purpose of the agreement, or where unforeseeable changed circumstances make performance so commercially unreasonable that principles of basic fairness and equity require the contract be unwound.
Frustration of Purpose
A party may assert frustration of a contract’s purpose when:
A simple example of a situation where frustration may apply could be as follows: A business is holding a large conference at a hotel. The business hires a marketing company to publicize the event for a sum of money. Because of COVID-19, however, the governor issued an order prohibiting persons meeting in large groups and the conference had to be cancelled. Thus, the business has the funds to pay for the marketing efforts, and nothing is preventing the marketing from occurring, but the entire underlying purpose of the agreement is nullified by the conference’s cancellation.
An unforeseen event changes the inherent nature of performance to make it more difficult, complex, or challenging, contravening a basic assumption of the contract between the parties. As a result, the cost of a party performing its obligations under the contract increases excessively and unreasonably. These changes make performance commercially impractical and can excuse a party’s performance based on a judicial determination.
To assert impracticability, the following test must be satisfied:
Example of Impracticability:
The following is a potential example of a situation where impracticability could be asserted:
Company 1 is set to provide Company 2 with a rare mineral mined in only a few select locations. The largest producing area, where Company 1 has entered into its supply contracts, suddenly and unexpectedly the area sees a once-in-a-century flood and the mines are cut off. Finding a new source of the mineral is nearly impossible without immense delays and exorbitant cost, such that Company A would lose multiple times the amount it will be paid in connection with the agreement.
A court could find performance to be impracticable under these circumstances, although it is difficult to posit a sure set of facts given the variations in the application of the common law doctrine by courts.
The common law doctrines must be judicially applied, and are rarely satisfied under normal circumstances. COVID-19, however, will place new emphasis on the terms of force majeure provisions in existing and future contracts and the application of the common law contractual remedies of frustration of purpose and impracticability.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source's content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.