By Chris Zheng, J.D.
As businesses continue to confront the harsh economic realities of the ongoing coronavirus pandemic, many are looking for legal solutions to cut costs and stay afloat. Even as consumer spending has increased over the past few months, evidence of recovery is mixed at best. As such, many businesses and consumers have been revisiting contracts to look for ways to free themselves from costly obligations. One major avenue of litigation is the invocation of Force Majeure clauses, which are provisions that excuse or delay contractual obligations due to the occurrence of an interrupting event. This post will provide an overview of how Force Majeure works and then examine COVID-19 as a triggering event as applied in recent cases. Finally, it will explore suggestions for how such clauses should be drafted in light of the ongoing pandemic.
What is Force Majeure?
Force Majeure clauses, also known as “Acts of God” provisions, usually address natural disasters such as floods, tornadoes, earthquakes, and hurricanes or manmade disturbances such as terrorism, riots, strikes, and war. A typical Force Majeure clause lists triggering events excusing performance, agrees upon a standard for excusing performance, and establishes consequences of invoking a Force Majeure event. While it is not uncommon to see contracts that include “diseases,” “epidemics,” or even “pandemics” in their Force Majeure clauses, such contracts often do not define key elements of the triggering events, such as who has the authority to define a pandemic. For the large number of agreements that do not include pandemic-specific language, opting instead to rely on catch-all wording, courts generally try to determine cause, as it relates to performance, and what constitutes an event “beyond a party’s reasonable control.” While the Uniform Commercial Code provides general guidance for how to interpret “Excuse by Failure of Presupposed Conditions,” it is important to note that there is some divergence in state law.
There are many options for building Force Majeure clauses which have substantial impacts on when and how parties can use Force Majeure. First, in determining what qualifies as an interrupting event, parties can agree on specific prescribed triggers or use catch-all wording that relies on natural meaning. Second, the parties’ choice of standard for excuse can give rise to different treatments by the courts; for instance, clauses requiring impeded ability to perform will provide more leeway than clauses requiring impossibility of performance. Third, most parties will also include a requirement of mitigation, which imposes on parties the duty to use all reasonable means of performance. In the COVID-19 context, this could mean taking a variety of steps like creating pandemic protocols, sourcing alternate suppliers, or making updated delivery arrangements. Fourth, when establishing consequences of Force Majeure, language can range from suspending or extending performance timelines to terminating the contract, or otherwise altering terms. Force Majeure clauses will also often include a notice requirement, obligating a party to provide written notice to the counterparty describing the occurrence of a triggering event and the expected duration of the event’s effect on the party’s performance. The latter term would be complicated by events that have no foreseeable end, such as the current pandemic.
Notably, a Force Majeure clause is not always necessary to have the same effect. Force Majeure is closely related to general principles of frustration in contract law that can apply unless overridden by the terms of a Force Majeure provision. Frustration is a common law doctrine that discharges a contract where an event occurs making it physically or commercially impossible to perform. Courts are willing to apply frustration but do so narrowly to prevent its overuse as a tool to get out of bargains which become unfavorable. In order to win on a claim of frustration, a party must prove that 1) an event substantially frustrated a party’s principal purpose; 2) the contract assumed that the event would not occur; 3) the event was not the fault of the party invoking frustration. The first and second prongs are likely to be a focus of much COVID-related litigation.
For instance, In re Pier 1 Imports, Inc., No. 20-30805 (KRH) (Bankr. E.D. Va. Filed Feb. 17, 2020) involves a current dispute in which debtor Pier 1 is seeking an indefinite suspension of rent obligations on impracticability and frustration (in the absence of a Force Majeure clause) due to the pandemic. The creditor, however, argues that the causal event is not the pandemic, but rather the decline of use of premises, which was within the basic assumptions of the original contract. The case is pending and will likely turn on the court’s determination of what event actually resulted in “substantially frustrating” performance. Similar trends have been found with litigation in the insurance industry over COVID-19 claims. While policyholders assert that the pandemic qualifies under business-income coverage, insurers have argued that such coverage typically requires direct physical loss or damage (such as from a fire), whereas the pandemic causes only economic losses.
Is COVID-19 a Force Majeure Event?
COVID-19 presents unique challenges for parties seeking to use Force Majeure, specifically on the elements of cause and mitigation. Most courts require proximate causation between the triggering event and hindered or impossible performance, but do not require that event to be the sole cause. However, it may be difficult to disentangle whether the proximate cause of a company’s nonperformance was due to the pandemic, government shutdowns, or the global financial crisis resulting from the pandemic. Attributing more weight to the economic downturn would likely disqualify a Force Majeure claim. Additionally, the mitigation requirement may be a stumbling block for some parties who did not pursue all reasonable avenues of performance, even where pandemics and governmental orders are expressly covered under a Force Majeure clause. For instance, an event planner who is looking to terminate a rental agreement for a concert hall due to a governmental ban on large gatherings could still have complied by hosting a smaller, socially distanced event despite decreased revenue.
What Early Cases Tell Us
It is still too early to tell whether courts will readily accept COVID-19 as a Force Majeure event in the absence of a direct reference to a pandemic in the language of the clause. However, early cases indicate that generally district courts are setting a high bar for Force Majeure. One particularly illustrative bankruptcy case is In Re Hitz Restaurant Group. (Bankr. N.D. Ill. June 2, 2020), in which the defendant restaurant sought a Force Majeure defense for nonpayment of rent due to Illinois’ stay-at-home pandemic order, and language in the lease explicitly mentioning laws and government action as permitted frustrations of performance. While the court decided that the stay-at-home order qualified as an “order of government” under the lease, it did not preclude complete performance since the restaurant owner could have offered curbside takeout but chose not to do so. As such, the court held the restaurant was excused from full rent payments to the property owner but was still partially responsible for rent proportionate to potential revenue from takeout.
Other cases, mostly dealing with nonpayment of rent, indicate an even more unfavorable view towards Force Majeure defendants. In MS Bank S.A. Banco de Cambio v. CBW Bank, 5:20-cv-04049 (D. Kan. Oct. 9, 2020), the Kansas District Court held that a Brazilian bank did not meet the necessary likelihood of success required for granting a temporary restraining order because it failed to identify a specific contractual obligation unable to be performed as a result of the pandemic. Similarly, in Palm Springs Mile Assocs. v. Kirkland’s Stores Inc., No. 20-cv-21724 (S.D. Fla. Sept. 9, 2020), the District Court for the Southern District of Florida held that Kirkland stores did not qualify for rent reduction under its Force Majeure clause because it failed to explain how the relevant government regulations on non-essential activities directly resulted in inability to pay rent. Thus, the current trend suggests that the courts are reading existing Force Majeure clauses very narrowly and require specific, substantial causal links between a governmental restriction and the exact act of performance.
This is not to say that there are no good options for parties who are unable to pay rent and want to excuse performance. Even where pursuing Force Majeure is disfavored in court, parties may find success submitting claims to arbitration, using hardship clauses to empower arbitrators to adapt the contract to new conditions. Additionally, more and more retail landlords are drafting agreements with concessions that allow for deferred rent payments, cutting minimum base rent during shutdowns, or changing to percentage rents (rates proportional to revenue). Generally, landlords prefer to steer clear of including pandemics in the express language of Force Majeure due to its negative impact on owners’ ability to obtain financing for their properties. However, given COVID-19’s continuing devastating economic impact with little relief on the horizon, agreeing to include pandemic language in present and future contracts may provide a dependable consistency that benefits all involved. Ultimately, at least clarifying current Force Majeure clauses between parties is a prudent advantage for both sides, and some larger parties have taken steps towards providing the wiggle room necessary for renters and lessees to continue operating during the pandemic.
Drafting Contracts in the Age of COVID-19
Given a much better understanding of the global, long-standing, and devastating effects of the coronavirus pandemic, parties entering into agreements should now have the foresight necessary to add pandemic-specific language into Force Majeure clauses. By adding “epidemic,” “pandemic,” or “quarantine” to such clauses, parties not only add clarity, but also bolster their chances of success in court. This is especially important in states like New York, which only excuse performance if a triggering event is expressly listed in a Force Majeure clause.
Of course, where inclusive language is important, exclusive language can be just as helpful. Thus, it may be advantageous to articulate events that should not trigger Force Majeure or describe what rights are not altered in the event of a triggering event (e.g., clarifying that obligations of the contract do not rely on continuation of present market conditions). Additionally, courts’ treatment of the proximate cause standard suggest that parties should contract to include governmental measures interrupting performance in Force Majeure clauses, not relying only on the inclusion of the COVID-19 pandemic itself. Finally, since notice requirements that define the timespan of affected performance are impossible in current conditions, parties should consider qualifying notice requirements to allow for good faith estimates with no binding effect.
Lastly, there is still much room for discussion on whether parties with substantially greater economic power should attempt to escape contractual obligations in the first place. Given the rise of Corporate Social Responsibility and ethical concerns over responsibilities to weakened suppliers, perhaps more companies should follow the lead of companies like H&M, which announced it would take delivery of any already produced garments or goods in productions under previously agreed upon terms to support supplier communities.
At the moment, the decision to pursue a Force Majeure claim is an uphill battle. However, still developing case law and the ever-changing conditions of the pandemic make the wisdom of invoking Force Majeure far from settled. As companies and consumers both learn how to navigate this new normal during the pandemic and beyond, contracts will have to adapt accordingly.
Chris Zheng Graduated from Harvard Law School in 2022.
This post was originally published on the COVID-19 and the Law blog
