03 Apr What if the Coronavirus (COVID-19) Causes Breach of a Contract? Consider Force Majeure, Frustration of Purpose, and Managing Your Legal Risk and Liability
The novel coronavirus (COVID-19) has rapidly evolved into a national crisis, and the country’s economy is scrambling to keep up. As more states ramp up restrictions to counter the looming threat, numerous industries face uncertainties and disruptions. Emerging issues include disruption of supply chains, reduced labor forces, stagnated and temporarily halted productions, complete business shutdowns, consumer defaults, event and vendor cancellations, and diminished cash flows, impacting companies and consumers alike.
A climate of uncertainty with no set end date raises immediate questions for businesses: how can parties effectively manage their contractual obligations amidst this pandemic, and how should parties approach legal risks and avoid liability? This blog explores the general contractual arguments under California law of force majeure and frustration of purpose, which the COVID-19 crisis has made prominent, and provides tips for approaching such contractual issues. The law differs by jurisdiction, contracts vary in language, and disputes arise from different facts, so consult with an attorney to evaluate your unique circumstance and analyze the best approach to your contract.
Force Majeure Clauses
Your contract may contain a force majeure clause. A force majeure clause (French for “superior force”) is a contract provision that allows parties to suspend or terminate the performance of contractual obligations when circumstances beyond their control arise. In the wake of the COVID-19 pandemic causing industry disruptions, border restrictions, government shutdowns, and employee layoffs, this formerly-considered “boilerplate” clause has jumped to the forefront of contract discussion. California courts have used the following test to determine whether performance is excused under force majeure principles: “whether under the particular circumstances there was such an insuperable interference occurring without the party’s intervention as could not have been prevented by the exercise of prudence diligence and care [sic].”[1] A court may relieve a party by such an event of force majeure from performing the contractual obligation for the duration and extent that the party is affected.
This analysis fundamentally relies on fact-intensive inquiry. To evaluate the strength of a force majeure argument in your circumstance, you should identify (1) the specific event that prevents performance, such as the pandemic itself or the consequences of the pandemic; (2) whether performance is impossible or extremely impracticable to perform; and (3) whether you could have reasonably prevented the interference to your ability to perform. For example, are you unable to perform because of a voluntary human response to the pandemic, or because the government ordered your factory to halt production? A government prohibition or order, when not contemplated at the time of contracting, may provide for a strong force majeure argument.[2] Is your obligation the delivery of goods to a buyer located in another state that has shut down the buyer’s nonessential business, or is your obligation simply to pay for goods that now exceed your budget? A mere increase in expense will not excuse performance unless you face extreme and unreasonable difficulty, injury, expense, or loss.[3]
Your contract may also govern how force majeure must be invoked. Pay special attention to notice provisions within force majeure clauses, which control the timing in which you may exercise this defense, and to the specific method of notice required. Invoking force majeure the wrong way – for instance, after the deadline, or in a different way than the contract requires – can backfire. An improper assertion of force majeure may be treated as an anticipatory repudiation of the contract, which may in turn empower your counterparty to terminate the contract or treat the repudiation as a breach.
Frustration of Purpose
Where performance is not impossible or impracticable, but the contract has lost its purpose, the common law doctrine of frustration of purpose may prove useful. This defense applies where “[p]erformance remains possible but the expected value of performance to the party seeking to be excused has been destroyed by a fortuitous event, which supervenes to cause an actual but not literal failure of consideration.”[4] The occurrence must be unforeseeable; i.e., the party seeking to excuse performance must be able to demonstrate that the supervening event was unanticipated – that he or she did not assume the risk.[5] In other words, a party may be excused for failure to perform if (1) an unforeseeable event has supervened (2) which has destroyed the countervalue of the contract.
With contracts predating COVID-19, there is likely a strong argument that an unforeseeable circumstance has supervened. For those who decide to contract amidst a global pandemic, their arguments against foreseeability and assumption of risk may not fare as well. But many contract disputes will undoubtedly turn on the main purpose of the contract: what did the parties contemplate and intend at the time of contract execution, and has that value been destroyed for the party seeking recourse? To illustrate, if Hotel contracts with Golf Course to furnish golfing privileges to Hotel’s guests for a specified term, the contractual purpose – furnishing golfing privileges to Hotel’s guests – is frustrated in the event the physical hotel burns down. Although Hotel can pay the specified amount for club privileges, the value of the contract is destroyed where the physical hotel ceases to exist and can no longer host guests to enjoy the privileges.[6] Similarly, contracts to provide services for businesses or events shut down by COVID-19 may be excused by this doctrine.
Considerations to Manage Legal Risk and Liability
Parties to a contract must invoke their rights carefully, because a mistaken assertion of legal rights can be catastrophic. For example, erroneous reliance on a force majeure or frustration of purpose theory may amount to a breach or anticipatory breach of the contract, resulting in legal liability. Consider the following tips to help manage your legal risk and liability:
- Identify key terms of your particular contract. Notable provisions include:
- Provisions of the contract which may be affected by current events (e.g., force majeure/ impossibility/ impracticability clauses, conditions, representations or warranties, restrictions on alternative delivery, termination rights, or “change in law” clauses)
- Notice requirements (determine whether they will be/ have been triggered and note timing and specified method of notice requirements)
- Waiver clauses
- Choice of law (forum) clauses
- Dispute resolution clauses
- Identify the exact nature and facts of your dispute.
- Determine what remains to be performed.
- Determine exactly why performance is not possible/ is hindered. For example, if you are a supplier unable to fulfill your obligation to supply goods, identify whether this is due to staff layoffs, a government-ordered shutdown, a source cutoff, employee illness, etc. Understand your reasons as they may affect your available options.
- Identify the date you executed your contract in relation to the timing of events that impacted your ability to perform.
- Analyze allocation of risk under your contract and the controlling law.
- Assess your particular contract, facts, and the law governing your dispute, as this careful analysis is crucial to understanding allocation of risk and your options thereon. For example, not all contracts and governing laws provide for a force majeure defense. Improperly invoking defenses not provided for by law and/or contract may expose you to legal risk and liability.
- Preserve your evidence.
- Save all correspondence and documents pertaining to your dispute.
- Document all relevant facts. In the event your dispute proceeds to litigation, your ability to prove your facts will be vital to your case.
- Obtain written evidence to the extent possible; however, beware memorializing what may prejudice your position as your dispute progresses.
- Consider Alternatives
- Consider alternative means to perform obligations. For example, are you able to reasonably find a different manufacturer to produce the goods you’re obligated to supply to a buyer? Taking reasonable action may ultimately help your position.
- Negotiate with counterparties (e.g., negotiate new deadlines and later performance or partial/ full refunds).
- Consider the propriety of seeking declaratory relief before a breach of contract claim is filed.
- Consider early and/or alternative dispute resolution to litigation.
- Mitigate your losses.
- Identify what you can do to mitigate damages and consider whether it is reasonable to do so.
- Note that many governing laws and contracts preclude a force majeure defense if you could have overcome the consequences of the force majeure event.
As courts rule on cases emerging from the effects of the COVID-19 pandemic, the resulting and profound disruption to the economy will inevitably set the stage for contractual arguments and interpretation. Before you take action on your contract, delay or temporarily suspend performance, or express anticipatory breach or termination, make sure you fully understand your potential exposure to legal risk and liability considering current events. Brown White & Osborn, LLP’s experienced litigation and dispute resolution lawyers are well-situated to assist you with identifying your legal risks and liability whilst calibrating an approach to resolution specific to your needs.
[1] Pac. Vegetable Oil Corp. v. C. S. T., Ltd., 29 Cal. 2d 228, 238 (1946).
[2] See Pac. Vegetable Oil Corp. v. C. S. T., Ltd., 29 Cal. 2d 228, 228 (1946) (war, which necessarily caused the intervention of governmental action rendering seller’s performance impossible, warranted termination of the contract under force majeure principles).
[3] Butler v. Nepple, 54 Cal. 2d 589, 599 (1960).
[4] Lloyd v. Murphy, 25 Cal. 2d 48, 53 (1944).
[5] See Lloyd v. Murphy, 25 Cal. 2d at 56 (automobile dealer failed to prove that the possibility of war and its consequences on the production and sale of new automobiles was an unanticipated circumstance – he assumed the risk in executing his lease when the government and automotive industry were already preparing for war).
[6] See La Cumbre Golf & Country Club v. Santa Barbara Hotel Co., 205 Cal. 422 (1928) (hotel was properly excused from its obligation to pay golf course to maintain club privileges for hotel’s guests where an unforeseeable and supervening event – the hotel burning down – destroyed an implied condition of the contract: the existence of the hotel with its guests).
Elizabeth Quach