United States: COVID-19 Litigation Update: Contractual Defenses

It has been nearly seven months since the COVID-19 pandemic hit our country hard. Early on, many businesses were looking at their contractual agreements and potential defenses for lack of performance under those contracts, whether it was cancelling an event, paying rent or other monetary obligation, or supplying goods and services. Seven months in, we are starting to see decisions from lawsuits involving force majeure contractual provisions and other equitable defenses to contract performance. This alert highlights a few of these early decisions.

Force Majeure

We previously issued an alert discussing force majeure provisions and when they can be invoked to excuse contractual performance.

In June, the United States Bankruptcy Court for the Northern District of Illinois, in In re Hitz Restaurant Group, BR 20 B 05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 3, 2020), issued one of the first decisions applying a force majeure provision to a commercial tenant's rental obligations in light of the COVID-19 government-mandated shutdown in the state of Illinois. The court ultimately held that the force majeure provision supported a 75% reduction in rent. More information on this case can be found in our previous alert, Landlords Beware: Pandemic Alerts Post-Petition Rent in Bankruptcy.

Conversely, in July, the United States District Court for the District of Massachusetts, in Future Street Limited v. Big Belly Solar, LLC, 2020 WL 4431764 (D. Mass. July 31, 2020), in ruling on a motion for a preliminary injunction, found that a licensee had not demonstrated it was reasonably likely to succeed on its declaratory judgment claim that its non-performance was excused under the force majeure clause of the agreement at issue, which provided that "[n]either party shall be deemed in default pursuant to this Agreement so long as its failure to perform any of its obligations hereunder is occasioned solely by fire, labor disturbance, acts of civil or military authorities, acts of God, or any similar cause beyond such party's control." The court assumed, for the sake of argument, that the pandemic and its effects were a force majeure event under the agreement. However, it found the licensee had not shown that its failure to perform its obligations was caused by the effects of the pandemic.

More recently, the United States District Court for the Southern District of Florida, in Palm Springs Mile Assoc., Ltd. v. Kirkland's Stores, Inc., 2020 WL 5411353 (S.D. Fla. Sept. 9, 2020), denied a tenant's Motion to Dismiss seeking to dismiss a landlord's lawsuit that was filed for an alleged breach of the lease due to the tenant's failure to pay rent and other charges since April 2020. The tenant asserted that the force majeure provision in the lease excused any failure or delay in paying rent. The force majeure provision in the lease agreement provided:

Relying on this provision, the tenant argued that the government restrictions and shutdown orders impacting non-essential businesses excused its obligation to pay rent, and therefore, it was entitled to dismissal of the landlord's complaint. The court disagreed. First, the court reasoned the tenant failed to show a causal connection between the government regulations and its inability to pay rent. Second, the court noted that even if the tenant could show a causal connection between the restrictions placed on the tenant's business and its inability to pay rent, the resolution of a force majeure defense was not proper for a motion to dismiss as the court would need to look at the evidence beyond the pleadings.

Impossibility, Impracticability, and Frustration of Purpose

As discussed previously in our alert, Coronavirus (COVID_19): Excusing Contract Performance, there may be other equitable defenses to contractual performance, depending on your jurisdiction—impossibility, impracticability and frustration of purpose.

A couple of decisions from New York have highlighted the challenges of asserting these defenses. In Latino v. Clay, LLC, 2020 WL 2239957 (S.D.N.Y. May 8, 2020), the parties entered into a class action settlement that required certain defendant gym owners to pay $300,000 over a period of time. If they failed to pay, plaintiffs were permitted to file a consent judgment against defendants without any notice to defendants or other condition. In April, plaintiffs filed the consent judgment as a result of defendants' failure to pay. Defendants opposed the consent judgment arguing that their performance under the settlement agreement should be excused based on the doctrine of impossibility (which in New York is treated synonymously with impracticability) because of their inability to pay as a result of COVID-19 and the resulting Executive Order issued by New York Governor Andrew Cuomo. The judge disagreed that defendants' obligations were excused. The judge stated that, at best, the defendants established financial difficulties arising from the pandemic, which made it difficult for the defendants to make their payments under the settlement agreement; however, "where impossibility or difficulty of performance is occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy, performance of a contract is not excused."

More recently, in Backal Hospitality Group LLC v. 627 West 42^nd Retail LLC, 2020 WL 4464323 (N.Y. Sup. Ct. Aug. 3, 2020), the court rejected a commercial tenant's attempt to excuse its rent under the doctrine of impossibility. The tenant, a private event facility and caterer, entered into a lease for property in New York City for the purpose of hosting and organizing large-scale private parties and events. A $500,000 letter of credit was established. Pursuant to the lease, the landlord was authorized to draw upon the letter of credit in the event of a breach. Under the New York Governor's March 22, 2020 Executive Order, the tenant was prevented from operating its leased space for events and, as a result, could not pay rent. The tenant sought to terminate the lease and vacate the space. In response to the tenant's failure to pay rent, the landlord drew upon the letter of credit. The tenant and its guarantors filed suit seeking a declaratory judgment that the lease had been terminated and an order permanently enjoining the landlord from preventing the tenant from cancelling its letter of credit. The tenant also brought an emergency application seeking an order directing the landlord to refund the amount of credit previously withdrawn, or alternatively, an order requiring the landlord to post a bond in the amount of the letter of credit until final resolution of the case.

As the tenant filed an emergency application, it was required to establish that it was likely to succeed on the merits of its claim. The tenant argued that Governor Cuomo's Executive Order made it impossible for it to operate its business and generate the revenue required to pay the landlord. The court rejected this argument and denied the tenant's request relating to the letter of credit. The court reasoned that the lease contained a provision that "[i]f fixed rent or additional rent shall be or become uncollectable by virtue of any law, government order or regulation, or direction of any public officer or body, Tenant shall enter into such agreement or agreements and take such other action (without additional expense to Tenant) as Landlord may request, as may be legally permissible, to permit Landlord to collect [rent]..." The court found that this provision made it clear that the parties contemplated a scenario in which performance of the lease by the tenant may become prohibited by a government order and that, if such situation arose, the parties would reach an agreement regarding the collection of rent at the conclusion of the restrictions. Thus, the court concluded that the tenant was not likely to succeed on the merits of its claim and, therefore, denied its request for emergency relief.

The United States District Court for the District of Colorado addressed the doctrine of frustration of purpose in the context of the COVID-19 pandemic in Federal Trade Commission v. A.S. Research, LLC, et al., 2020 WL 4193507 (D. Col. July 21, 2020). In that case, the FTC filed a complaint against defendants for engaging in alleged unfair and deceptive acts in violation of the FTC Act in the course of marketing and promoting the drug Synovia. Simultaneously, the FTC filed an Unopposed Motion for Entry of Proposed Stipulated Order for Permanent Injunction and Monetary Judgment, asserting that, prior to filing the complaint, the FTC and the defendants had agreed to resolve all matters in dispute in the case. The defendants subsequently moved to withdraw their consent to the stipulated agreement in light of the COVID-19 pandemic. Defendants argued that "COVID-19 has resulted in the parties' objectives being impossible to meet and the obligations of [defendants] under the [Stipulated Agreement] impossible to perform in a timely fashion, or to perform at all, compared to the parties' expectations at the time" the parties entered into their settlement agreement.

The defendants conceded that "it [was] possible for Defendants to pay" the amount specified in the Stipulated Agreement, making the doctrine of impossibility inapplicable. Instead, defendants argued they could avoid enforcement of the Stipulated Agreement using a frustration-of-purpose defense. The court rejected this argument, finding the defendants had made "no attempt in their motion to identify the intended purpose of the Stipulated Agreement, and do not argue that this specific purpose was frustrated."

These decisions are illustrative of just some of the approaches courts are taking with respect to the contractual defenses of force majeure, impossibility and frustration of purpose. As these cases and others work their way through the trial courts, and eventually appellate courts, we can expect to see more case law on these issues. At a minimum, you will note that the decisions are highly fact specific and difficult to generalize about.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.