Private Equity

As the economic impact of the various governmental and private actions intended to slow the spread of COVID-19 continues to be felt across various industries, there is an increased focus by many on whether the impact of these actions can excuse their or their company’s performance under what may have become burdensome contracts, as well as a countervailing concern, by those with favorable and business-critical contracts, that their counterparty may be able to avoid performance of those contracts.  Unfortunately, there is no easy, one-size-fits-all, answer to this question.  Indeed, the answer depends on the precise language of the specific contract, as well as the common law principles and statutory overrides applicable in the state law that governs the particular contract.  There are, however, a number of fundamental principles that apply in almost any consideration of this question:

Courts do not generally excuse contractual performance in the absence of a specific provision providing such an excuse.

Enforcement of contractual obligations in the United States is largely a function of applying the common law of contracts as it was originally adopted from England by each of the several states (except Louisiana).  That common law enforces contracts made by the parties and does not excuse their performance based upon circumstances that could have been provided for expressly in the contract.  Thus, in an early 19^th century English case (which was cited frequently in early U.S. cases and has some applicability to our current circumstances), the owner of a ship, which had contracted to pick up cargo in a foreign port was required to pay damages for failing to pick up that cargo as agreed notwithstanding that an unnamed disease had ravaged the port in question, and it was acknowledged that meeting the obligations of the contract would have put the entire ship at risk of infection and violated a foreign governmental order applicable as a result of the outbreak of pestilence in that port.^[1]  According to the court, while the ship’s owner could not be compelled to take delivery of the cargo at the affected port, it could certainly be held liable for the counterparty’s resulting damages.  An early version of this rule, as adopted in the U.S., was stated as follows by a Massachusetts court:

[W]here the party by his agreement voluntarily assumes or creates a duty or charge upon himself, he shall be bound by his contract, and the non-performance of it will not be excused by accident or inevitable necessity; for if he desired any such exception, he should have provided for it in his contract.  … In these and similar cases, which seem hard and oppressive, the law does no more than enforce the exact contract entered into.  If there be any hardship, it arises from the indiscretion or want of foresight of the suffering party.^[2]

And you can find other similar pronouncements in more modern decisions.^[3]  Thus, never assume that a court will excuse a party from the strict terms of an agreement, even when circumstances make compliance with that contract exceedingly onerous. 

But my contract has a “force majeure clause,” doesn’t that excuse performance?

While many “force majeure” clauses have similar features, each is potentially unique in what it actually covers.  Thus, although the purported universal purpose of a force majeure clause is to excuse performance when unforeseen circumstances, beyond the control of the parties, prevent, delay or hinder that performance, the exact language of the force majeure clause matters.  And equally important to the specific language of a clause is how the courts have interpreted similar clauses involving similar circumstances in the state whose law applies.  While it is possible the words epidemic and pandemic are included in the specific events that potentially trigger your specific clause, chances are they are not.^[4]  The absence of those words is not determinative, of course, but careful state-specific analysis is necessary to determine whether, and to what extent, you can rely upon the force majeure clause to suspend continued performance without adverse consequences. And it is far from clear whether the term “act of God” encompasses epidemics and pandemics even though they are the result of natural causes.  The reason for this is the law’s insistence that an “act of God” be something that is free of human intervention, either through action or inaction.  Failing to appropriately plan for and take actions to guard against foreseeable natural occurrences may result in such occurrences, no matter how catastrophic, failing to qualify as an “act of God.”  Unless, of course, the force majeure clause provides otherwise.  Again, the specific words will matter.

Even when your force majeure clause covers impacts related to the current situation, force majeure clauses are not typically triggered just because one of an enumerated set of events occurs.  Instead there is a further requirement that the named event actually result in a party being “prevented” or “hindered” or “delayed” in performing.  And the difference between “prevented” and “hindered or delayed” might matter a great deal. And some clauses are even more restrictive.  For example, in a 2015 Michigan case, a force majeure clause specifically referenced governmental actions as being among the events that would excuse the party’s performance.  However, the clause specifically required that any of the listed items within the reach of force majeure had to “prevent[] Buyer’s ability to use [the purchased product] in Buyer’s manufacturing operations.”  While the governmental action had effectively made the product worthless to the Buyer, it had not actually prevented the Buyer from using that product.  According to the court:

Plaintiff opted not to protect itself with a contractual limitation on the degree of market price risk that it would assume. It cannot now, by judicial action, manufacture a contractual limitation that it may in hindsight desire, by broadly interpreting the force majeure clause to say something that it does not.  . .  . Plaintiff does not allege any “act[] of the Government” that directly prevented its performance under the contract.  It merely alleges that the depression of prices in the solar panel market caused performance by plaintiff to become unprofitable or unsustainable as a business strategy. But plaintiff did not (although it again could have) negotiate a contractual force majeure clause that by its terms would have excused contractual performance resulting from unprofitability due to governmental market manipulation.  Having failed to do so, plaintiff cannot now, through judicial action, effectively reform the contract to say that for which it opted not to negotiate as part of its contract with defendant.^[5]

And it bears noting that in a case with some similarities to our current situation, an egg producer’s attempt to terminate a contract for the construction of an additional facility to handle anticipated business that was alleged to have been severely impacted by the Avian Flu, was ultimately unsuccessful despite the attempted invocation by the egg producer of a force majeure clause and the common law doctrine of frustration of purpose.^[6]  It is also important to note, however, that the egg producer survived summary judgment and only lost at trial.

The bottom line is that each force majeure clause needs to be considered on its own terms in light of the actual events that have occurred and the impact that those events have had on the ability of a party to continue to perform.  And mere unprofitability will seldom win the day.

What if there is no force majeure clause?

The harshness of the general rule of strict enforcement of contracts led to some limited relief in the common law, even in the absence of a specific force majeure provision.  The common law doctrines of impossibility, impracticability and frustration of purpose (all of which are different versions of essentially the same concept) can sometimes provide the functional equivalent of a force majeure clause.  And if your agreement involves the sale of goods and is covered by the Uniform Commercial Code (UCC) there is a statutory force majeure clause (of sorts) built into your contract.  It is difficult to provide any general advice on the applicability of the common law doctrines, as the requirements vary by state.  Nonetheless, the following statement by the United States District Court of the District of Columbia captures what the courts are trying to achieve in applying these doctrines:

The doctrine ultimately represents the ever-shifting line, drawn by courts hopefully responsive to commercial practices and mores, at which the community’s interest in having contracts enforced according to their terms is outweighed by the commercial senselessness of requiring performance.  When the issue is raised, the court is asked to construct a condition of performance based on the changed circumstances, a process which involves at least three reasonably definable steps. First, a contingency — something unexpected — must have occurred. Second, the risk of the unexpected occurrence must not have been allocated either by agreement or by custom. Finally, occurrence of the contingency must have rendered performance commercially impracticable.  Unless the court finds these three requirements satisfied, the plea of impossibility must fail.^[7]

Suffice it to say that application of these doctrines is highly fact specific.  In this District of Columbia case the doctrine was found inapplicable to a shipper who tried to use the doctrine after the closing of the Suez canal because the shipper still had another route to deliver its goods, albeit a much more expensive one (around the Cape).  And past efforts to utilize these doctrines to avoid payments on leases have seldom succeeded, even in the face of governmental action severely restricting (but not totally prohibiting) the conduct of business on the premises.^[8]

To the extent your contract involves the sale of goods, of course, the UCC (Section 2-615) contains its own limited force majeure clause that is built into your agreement unless overridden:

Except so far as a seller may have assumed a greater obligation and subject to the preceding section on substituted performance:

(a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a contract for sale if performance as agreed 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 or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.

(b) Where the causes mentioned in paragraph (a) affect only a part of the seller’s capacity to perform, he must allocate production and deliveries among his customers but may at his option include regular customers not then under contract as well as his own requirements for further manufacture. He may so allocate in any manner which is fair and reasonable.

(c) The seller must notify the buyer seasonably that there will be delay or non-delivery and, when allocation is required under paragraph (b), of the estimated quota thus made available for the buyer.

The UCC’s built-in force majeure for contracts involving a sale of goods may be much more useful when the non-performance results from a governmental order impacting the production or deliver of the goods.  Obviously, there are some direct governmental actions taking place right now in response to COVID-19, and those actions may provide a basis for invoking UCC §2-615. 

But be aware that if your contract contains its own force majeure clause and it is more restrictive than the common law doctrines or the UCC’s built-in provision, you may be stuck with whatever the force majeure clause actually says, at least in some jurisdictions.^[9] 

What if none of the available contractual avoidance methods outlined previously apply, but my company still can’t perform?

While it may be difficult culturally, times like these require consideration of an “efficient  breach.”  What is an efficient breach?  An efficient breach is a breach that has been determined to result in less loss to you by paying the damages to the non-breaching party, than would be the loss sustained by continuing to perform the contract.  As noted by one court (quoting the Restatement (Second of Contracts):

The traditional goal of the law of contract remedies has not been compulsion of the promisor to perform but compensation of the promisee for the loss resulting from the breach. “Willful” breaches have not been distinguished from other breaches, punitive damages have not been awarded for breach of contract, and specific performance has not been granted where compensation in damages is an adequate substitute for the injured party.^[10]

While there are exceptions to this rule, which need to be carefully noted and navigated, the option of an efficient breach may be the only sensible and fiduciarily responsible decision that can be made.  And when made the breaching party may be entitled to the benefits of the breaching party’s obligation to mitigate the damages that the breaching party might otherwise sustain.

Because this is a merely a brief note, we have not delved into the many details that must be considered in evaluating your contractual liabilities in light of the events arising from COVID-19, and events will undoubtedly continue to evolve.  But hopefully, we can begin to put into context the various responses to a potential contractual default that may be available.