The global spread of the coronavirus disease that causes COVID-19 (“COVID-19”) has sent shockwaves through the world economy in the last three months. Business operations in nearly every industry have been disrupted rapidly on a grand scale. The direct economic fallout of the pandemic has only been compounded by the necessary measures taken by governments and private industry to mitigate further proliferation.
As a result of the wide-ranging impacts of COVID-19, parties involved in existing corporate and commercial agreements are increasingly concerned about being able to fulfill their contractual obligations. In addition, companies are seeking guidance on how to appropriately allocate risk when negotiating new contracts in the wake of the pandemic. “Force majeure” is the legal term most frequently associated with the fallout from an event like the spread of COVID-19. This is a summary of force majeure provisions, alternative defenses, and related issues contracting parties should take heed of in the context of COVID-19.
Force Majeure Provisions
Force majeure provisions allocate the risk of nonperformance among contractual parties upon the occurrence of an extraordinary event. A contract party is relieved from performing when performance is made impossible by an unforeseeable event outside of such party’s control. Whether and how a party is able to claim relief for a force majeure event depends on the express terms of the agreement in question. Only those events listed as triggering the force majeure provision (or events sufficiently similar to those listed) will (i) excuse performance or (ii) allow for a suspension of obligations until the event ends. A party claiming impossibility of performance must also show that the risk was unforeseeable and that such party was unable to otherwise mitigate such risk.
Whether a contractual party can rely on COVID-19 as a reason for nonperformance under a force majeure provision depends, in part, on whether the language of the provision sufficiently encompasses the event of a viral outbreak, illness, disease, or epidemic/pandemic. Parties may also be able to rely on language related to governmental orders, regulations and emergency declarations in the event government action meant to mitigate the spread of the virus impedes their ability to perform. However, broad catch-all provisions, without more, will not be enough. Under New York law, for example, catch-all language such as “for any reason” will be read to include only events similar to those expressly listed.
A party wishing to assert force majeure as a basis for suspending performance must be careful to comply with the specific requirements of the force majeure clause. If notice is untimely or improper, the nonperforming party risks exposure to a claim for contract repudiation or breach of contract. In particular, a party seeking the shelter of force majeure should send notice to the counterparty of the inability to perform as a result of the extraordinary event. Failure to send such notice in a prompt manner may jeopardize the right to relief. The complication with COVID-19 is that it continues to proliferate. This rolling threat makes sending a timely notice difficult because determining when COVID-19 actually impacts business performance is an elusive target. One strategy affected parties can use to overcome this obstacle is to issue notices on a rolling basis for the COVID-19 event, which is developing over a longer timeline than other force majeure events such as natural disasters.
Judicial Remedies: Frustration, Impossibility and Impracticability
Parties bound by contracts without force majeure provisions can potentially rely on judicial remedies provided to those who are unable fulfill contractual obligations.
The common law doctrines of impossibility and impracticability excuse performance of a contract where an unforeseeable intervening event has occurred. Such event must be one which the parties assumed would not occur and which has made performance objectively impossible or impracticable. Under New York law, performance is excused only where it becomes impossible as a result of the event in question. Certain other jurisdictions allow excuse of performance where such performance is impracticable. Neither the fundamental assumptions the parties relied upon nor the circumstances surrounding the agreement need to change. Rather, only the ability to perform must be impeded. Where COVID-19 has sufficiently impeded the ability to perform, parties could potentially be released from their obligations under the doctrines of impossibility and impracticability.
Nonperformance may also be excused under the common law doctrine of frustration of purpose. This applies where an intervening event, the absence of which was a basic assumption of the contract, frustrates the underlying purpose of the agreement. However, the hardship must so significant that it would be unjust to expect the parties to execute the transaction as previously contemplated. Under New York law, the defense of frustration is limited and its applicability is based upon two factors. First, whether performance of a fundamental obligation under the contract becomes physically or commercially impossible. Second, whether the obligation, or purpose of the contract, becomes radically different than what was originally contemplated. Those seeking relief for frustration in the wake of COVID-19 are faced with the burden of proving the obligations altered by the impact of the pandemic are fundamental to the contract.
The applicability of each of the foregoing judicial remedies is highly fact-determinative. Parties with seemingly similar contractual duties under similar agreements may not receive similar relief.
Other Key Contract Provisions
As commercial actors position themselves to weather the economic impact of COVID-19, it is imperative that they consider certain key provisions of the agreements that govern their business relationships.
Representations and Warranties. These statements of fact, promised to be true, are used to induce parties to enter into agreements in the first place. Such statements may be rendered untrue (or soon will be untrue) as a result of the economic fallout of the COVID-19 pandemic. Contract parties should take note of the representations they made to counterparties regarding the health of their business operations, financial and otherwise, to ensure that they are not in breach of any such representations. Parties soon entering into agreements should make sure to carefully negotiate their representations and warranties in light of the current economic climate.
Covenants. Similarly, contract parties may find that they are in breach of covenants they made to counterparties (especially credit-related and restrictive covenants). Parties to commercial agreements must look closely at specific terms, enlisting the help of counsel, to ensure compliance with the promises they made, e.g. the maintenance of certain financial or operational thresholds.
Termination Rights. As the financial and operational well-being of commercial entities is called into question by the current economic climate, termination rights of counterparties in commercial agreements may be triggered. For example, certain termination provisions turn on the actual or threatened insolvency of a party to the contract.
Change of Law. As governments continue to respond to the ongoing COVID-19 pandemic by implementing new regulations and legislation, performance of existing contractual obligations may be impeded. Change of law provisions set forth parties’ obligations (including the duty to provide notice to a counterparty) in such contexts.
Practical Implications and Best Practices
As the financial and operational conditions of a business continue to evolve alongside the COVID-19 pandemic, the following steps should be considered to mitigate legal risk:
- Identify force majeure and other relevant provisions in existing agreements and develop an understanding of their specific terms.
- Determine the parameters of breach under existing agreements, and determine what can be done to cure in the event of breach.
- Act quickly to provide prompt notice to counterparties to agreements in light of updated circumstances.
- Arrange to make appropriate disclosures to relevant government authorities in light of updated circumstances.
- Remain up-to-date on developing regulations for compliance purposes.
- Keep lines of communication open with counterparties and consider reciprocal effects of invoking contract-based leverage.
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.