On March 11, 2020, the World Health Organization declared the spread of coronavirus COVID-19 a pandemic. The virus has caused disruptions to business activity worldwide. Countries and cities have implemented quarantines and lockdowns, impacting businesses and disrupting supply chains. Businesses in all major industries, including travel, food and beverage, retail, technology and manufacturing, have faced disruptions that directly impact their ability to perform their contracts.

A wide variety of contracts could be affected by this pandemic, including:

  • Manufacturing contracts or contracts involving supply chains;
  • Shipping or delivery contracts;
  • Travel or entertainment tickets/contracts;
  • Contracts that generally involve time-sensitive provisions. 

This alert is intended to identify a few concerns that might help guide businesses and attorneys in navigating their response to the commercial disruptions potentially caused by this pandemic, especially regarding whether performance of contractual obligations may be excused due to the pandemic.

Written Force Majeure Clauses May Excuse Performance

Many commercial contracts contain a "force majeure" provision, which typically identifies specific triggering events that excuse performance. These provisions are intended to allocate the risk if performance becomes impossible or impracticable as a result of an event that the parties did not anticipate or control. Force majeure clauses may often be invoked due to "Acts of God" that cannot be avoided or prevented, such as tornados, floods and earthquakes. Some contracts may specifically identify pandemics or epidemics as events that excuse performance. The precise language of the agreement's force majeure provision will determine the availability and scope of a force majeure defense and may address other issues, including whether the excuse of performance is permanent or temporary, if notice must be provided and if there is a requirement to mitigate damages.

Courts strictly construe the language of force majeure provisions. The party that relies on a force majeure clause to excuse performance generally bears the burden of proving that the event was beyond the party's control and without its fault or negligence, and that the triggering circumstance is the sole cause of the failure to perform. To establish a force majeure, the performance generally must be impossible, not merely frustrated or economically impractical. Mere economic hardship alone is not sufficient to excuse performance under a force majeure provision. See OWBR LLC v. Clear Channel Commc'ns., Inc., 266 F. Supp.2d 1214 (D. Haw. 2003) (holding that the cancellation by attendees of a convention due to travel concerns related to the September 11, 2001, terror attacks did not trigger the force majeure clause as the convention still could have been held at the plaintiff's resort as it was only "economically inadvisable" to hold the event). Similarly, courts have found that government policies that stop short of outright prevention of the performance of a contract, merely resulting in unprofitability, are not sufficient to establish force majeure. See Seaboard Lumber Co. v. United States, 41 Fed. Cl. 401 (Fed. Cl. 1998).

Courts are also mindful of timing considerations with regard to when a party invokes a force majeure provision relative to the time of the event. Invoking force majeure may be premature if it is unclear whether performance is impossible and if there has been no effort by the parties to resolve the issue prior to the attempted enforcement of the provision. See Sherwin v. Alumina L.P. v. AluChem, Inc., 512 F. Supp.2d 957 (S.D. Tx. 2007) (holding that the declaration of force majeure was premature as the state had not yet compelled a shutdown of the facility and the parties had not held a discussion to find a solution). Such timing considerations may be especially important in the context of the COVID-19 pandemic, where many state and local governments in the United States are developing their own approaches to regulating large crowds and other activities. A court may find, for example, that a force majeure does not excuse performance of an obligation that is not due to be fulfilled for several weeks. 

It will be important to assess the particular facts and contract language at issue in any potential case. Case law suggests that a number of factors should be considered with counsel before invoking a force majeure provision with regard to COVID-19, including the language of the agreement, the timing of the events and the extent to which performance may be possible. Communications with counterparties regarding force majeure should be carefully tailored and comply with any notice requirements.

Performance of Obligations May Be Impracticable

The U.C.C. and Restatement have each adopted the common-law impracticability doctrine that excuses performance as a result of some unforeseen circumstances where a party is unable to legally or physically perform under the contract. Restatement (Second) of Contracts §261. As with force majeure, increased cost alone does not excuse performance. La. Power & Light Co. v. Allegheny Ludlum Indus., 517 F. Supp. 1319, 1325 (E.D. La. 1981) (internal quotation omitted) ("[T]he unforeseen cost increase that would excuse performance must be more than merely onerous or expensive. It must be positively unjust[.]"). Further, "mere market shifts or financial inability" is not sufficient to support a claim of impracticability. Restatement (Second) of Contracts § 261, comment b.

The U.C.C. provides a potential excuse for nonperformance where such performance has been made "impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made." U.C.C. § 2-615(a); See Whittaker Corp., Power Sources Div., 1979 ASBCA LEXIS 363, 79-1 B.C.A. (CCH) P13, 805, at 67, 688-89 (1979) (granting relief where a seven-month production contract turned into a four-year development effort that was unsuccessful and had 148 percent cost overrun). The U.C.C. further requires that if the frustrating circumstance only affects part of a seller's capacity to perform, the seller must reasonably and fairly allocate the deliveries among its customers. U.C.C. § 2-615(b). The U.C.C. further requires that a party must seasonably notify the other party that there will be a delay or non-performance. U.C.C. § 2-615(c).  

Legislation or other governmental action that makes performance illegal, legally impossible or that creates additional regulatory burdens that were not originally contemplated by the parties may be sufficient to establish impracticability. Restatement (Second) of Contracts § 264 (1981). However, government actions that were assumed to occur when entering the contract are not sufficient. Lloyd v. Murphy, 153 P.2d 47 (1944). Impracticability does not apply when performance would be merely more expensive, more burdensome or unprofitable. See Karl Wendt Farm Equipment Co. v. Int'l Harvester Co., 931 F.2d 1112 (6th Cir. 1991).

Businesses should carefully assess the facts with counsel. Whether there has been a declaration of a state of emergency or other governmental action potentially impacting performance may be significant in this context. Again, the localized nature of initial responses may matter significantly. Some jurisdictions allow the doctrine of impracticability to be argued in the alternative to force majeure; however, some jurisdictions find that they overlap, and the language of the force majeure clause may foreclose arguing for them in the alternative. See Rexing Quality Eggs v. Rembrandt Enters., 360 F. Supp. 3d 817, 842 (S.D. Ind. 2018); but see Great Lakes Gas Transmission Limited Partnership v. Essar Steel Minn., LLC, 871 F. Supp. 2d 843 (D. Minn. 2012).

The Pandemic May Frustrate the Purpose of Agreements

The doctrine of frustration of purpose applies when the "principal purpose is substantially frustrated without [a party's] fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made." Restatement (Second) of Contracts § 265. Unlike the doctrine of impracticability, in which performance has to be unduly burdensome, frustration of purpose requires that the basic performance of the contract be frustrated.

Generally, the purpose that is frustrated must be the basis of the contract, and without such the contract "would make little sense." Second Restatement of Contracts, § 265, comment a. The frustration must also be substantial. Further, Courts generally do not find economic hardship sufficient to establish frustration of purpose. See Karl Wendt Farm Equipment Co., 931 F.2d 1112, 1120 (affirming a denial of a defense of frustration where the contract was mutually profitable because of downturn in market conditions because mutual profitability was not the primary purpose of the agreement). Further, foreseeability of the circumstance is a key factor in a court's determination of the applicability of this doctrine. Gander Mt. Co. v. Islip U-Slip LLC, 923 F. Supp. 2d 351, 361 (N.D. NY. 2013) ("[T]he underlying principle of [frustration] is foreseeability ..., [it] requires foreseeability."). The more foreseeable the circumstances, the less likely a court is to find that the purpose of a contract has been frustrated.

Businesses and lawyers will need to analyze contracts closely to determine whether the performance frustrated goes to the basis of the agreement. Timing considerations may be significant, depending on whether and when some businesses could foresee the possibility of a pandemic at the time of contracting.

Material Adverse Change Provisions in Contracts May Apply

Material adverse change (MAC) clauses generally excuse contractual performance in the event of a material change in the business, operations or financial condition of a company. Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008). Such provisions are more common in merger and acquisition agreements than in other contexts, but contracts should be scrutinized closely to determine whether the pandemic may trigger a MAC event. Similar to force majeure, these are not expressly recognized under the Restatement or U.C.C. but must be included as part of a written contract. Review of the contract is therefore essential in determining what circumstances are sufficient to establish a MAC, whether the excuse of performance is permanent or temporary and if notice must be provided.

The burden is on the party invoking the provision to prove that a MAC applies. Courts analyze whether the MAC was foreseeable at the time the contract was entered. Courts generally put a high bar on the availability of this defense but will consider such things as changes in business practices, loss of key personnel and failure to meet sales forecasts as sufficient to trigger MACs. See Hexion Specialty Chemicals, Inc., 965 A.2d 715. Depending on the contract language, events that cause damage to the value of the business, including losses in profits, may be considered material adverse changes. Akorn, Inc. v. Fresenius Kabi AG, 2018 Del. Ch. LEXIS 325 (Del. Ch. Oct. 1, 2018).

Key Practical Questions for Assessing the Impact of COVID-19 on Contracts

Parties to agreements should begin assessing performance obligations by analyzing at least some of the following questions:

  • Does the contract contain provisions, including the force majeure or act of God provisions, that may apply, including whether a pandemic (or something similar) is specifically referenced in such clauses?
  • Are there time restraints/deadlines for performance contained in any of the applicable provisions?
  • What are the requirements of the notice provisions, especially regarding the mechanics of providing any required notice?
  • What does the contract or applicable law provide regarding mitigation of damages?
  • Does the inability to perform trigger other provisions of the contract, such as the right to terminate an exclusivity provision?
  • Do any insurance policies cover business interruption, and what are the notice requirements?
  • Are disclosures required to be issued to customers or regulators regarding the effect the pandemic is having on their businesses?
  • What steps are required under dispute resolution procedures?
  • How might contracts be amended to avoid potential problems with performance?

In addition to these considerations, businesses should be careful to maintain records and follow corporate communication policies. These and other considerations may affect which legal doctrines and legal provisions businesses may apply and have ramifications in the context of any dispute.

Concerns relating to specific contracts can and should be raised with an attorney. Companies can take proactive steps to understand what effect this pandemic has on a company's ability to perform its contractual obligations, what rights are provided for under the contract, and what disclosures or notices need to be provided that will help protect businesses in the future.

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.