Insight

How will Covid - 19 Impact my Contracts

How will Covid - 19 Impact my Contracts

JD

Jacob Dunlop

August 13, 2020 02:59 PM

As individuals and businesses seek to comply with the restrictive measures set in place to contain COVID-19, an organization’s ability to perform its contractual obligations may become difficult or impossible placing significant burdens on contracting parties.

While this particular pandemic is unique, contract law has long acknowledged that unforeseen circumstances may arise after a contract is executed, but before it is fully performed, that affects a party’s ability to perform. These changed circumstances are known as force majeure, or sometimes “Acts of God.”

What is Force Majeure?

Absent contract language to the contrary, a party is typically excused from performing a contractual obligation if performance is prevented by an unforeseeable circumstance arising after the contract was executed. A party defaulting on a contractual obligation may claim that its performance was rendered impossible or impractical, or that the essential purpose of the contract has been frustrated, by the unforeseeable circumstance. These defenses allow a breaching party to rescind, or cancel, the contract. In order to invoke these defenses, the changed circumstance must truly have been unforeseeable, and cannot be caused or under the control of the breaching party.

Contracts often incorporate language allocating risk and responsibility in the event of unforeseen changed circumstances. This language usually appears in the form of a “force majeure clause.” These clauses typically define the types of events that relieve a party of a contractual obligation. Courts enforce these clauses, and will only excuse nonperformance of an obligation if both: (a) the intervening event was unforeseeable; and (b) the specific contractual obligation breached, is within the scope of the force majeure clause. Often, the obligation solely to pay money will not be excused by a force majeure, because in most situations, a party obligated to pay money is still practically able to make the payment—performance is just more difficult or less lucrative because the unforeseen event has negatively impacted the payer’s business or finances.

Force majeure provisions can provide risk allocation and less uncertainty in such situations by specifically defining contractual obligations that will not be suspended in the event of a force majeure. For example, force majeure provisions in a lease agreement may specify that the obligation to make periodic rental payments is not relieved in the event of a force majeure.

Does COVID-19 Constitute a Force Majeure?

With respect to the COVID-19 pandemic and accompanying legal restrictions on businesses and social interactions, these events may constitute a force majeure under many contracts. The coronavirus and its effects on commerce and society are beyond the control of any contracting parties, and until the risk posed by the virus became widely known, were not reasonably foreseeable. Where a contract contains a force majeure clause, whether the COVID-19 pandemic constitutes a force majeure will depend upon how broadly or narrowly the clause was drafted. For example, the pandemic will likely constitute a force majeure if the force majeure clause contains language encompassing “legal requirements” or “causes beyond the reasonable control of any party.”

In the event that a force majeure clause applies to a particular contract obligation that can no longer be performed, the party obligated to perform may be relieved of its obligation and may elect to cancel the contract. In such a case, the parties may wish, by agreement, to modify the contract in order to preserve the transaction and accommodate the force majeure.

What Contractual Obligations could be suspended as a result of COVID-19?

Specific examples of contractual obligations that might be suspended include:

  • Commercial lease requirements in which the tenant is obliged to maintain specific hours of operation
  • Supply contracts in which disruptions to supply chains have been caused by the pandemic
  • Construction or services contracts in which performance of the service is rendered illegal due to governmental orders restricting business operations and social contact
  • Purchase and sale agreements containing “material adverse change” clauses, which tend to be drafted more broadly than force majeure clauses and typically give the buyer an option to cancel the agreement where certain changed circumstances adversely affect the subject property

There are many other examples of contractual obligations that will be rendered impossible by the pandemic, and may be excused due to force majeure.

How does a Business Invoke a Force Majeure Provision?

In order to invoke a force majeure provision as a defense to nonperformance, the breaching party must typically give some form of notice within a specified timeframe. Failure to give the specified notice can constitute a waiver of force majeure protections, and a defaulting party may be held in breach of the contract notwithstanding the party’s inability to perform due to the force majeure. Any party who believes that its contractual obligations may be suspended due to the COVID-19 pandemic should have an attorney review the contract to determine what steps must be taken to preserve those rights.

If a contract does not contain a force majeure clause, yet the performance of the contract has been rendered impossible or impractical due to the COVID-19 pandemic, the defenses of impossibility/impracticability or frustration of the contract’s purpose may still be available to cancel the contract. The extent to which such defenses apply will depend on a case-by-case review of the contractual relationship and the obligation that cannot be performed.

A force majeure determination is very facts and circumstances dependent and may not apply in all cases. You should consult with an attorney before acting (or failing to act) in reliance on a force majeure defense.

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