22 March 2020
How do I get out of Performing Under a Contract During COVID-19 Disruptions?
Many contracts have force majeure clauses that allow for non-performance without penalty in the event of an “act of God” or other cause beyond the reasonable control of the affected party. Due to the risks that COVID-19 poses to ongoing business operations, companies should proactively consider the potential impacts this global pandemic could have on their operations and ability to fulfill contractual obligations, take steps to mitigate their operational risk, and assess the availability of insurance coverage. Taking these proactive measures will decrease the likelihood of force majeure disputes; they will also help a party asserting force majeure to establish that it took reasonable steps to avoid contractual interruption.
What Classifies as Force Majeure?
In order to determine whether your company can declare force majeure to delay or cease performance, let’s first discuss how courts interpret a force majeure event. Courts typically look to several elements when determining whether a force majeure clause applies to a particular situation: (a) first and foremost, whether the event qualifies as force majeure under the contract, (2) whether the risk of nonperformance was foreseeable and able to be mitigated and (3) whether performance is truly made impossible due to the event.
The primary focus is on whether the contract’s clause encompasses the type of event a party claims is causing its ability to perform. Force majeure clauses are generally interpreted narrowly; therefore, for an event to qualify as force majeure it must be outlined in the clause as a covered event. Even when a potential force majeure event is encompassed by the relevant clause, however, a party is under an obligation to mitigate any foreseeable risk of nonperformance, and cannot invoke force majeure where the potential nonperformance was foreseeable and could have been prevented or otherwise mitigated. The questions to ask then become whether a company may have mitigated the effects of the force majeure after witnessing the outbreak in China and whether it was foreseeable that the virus would spread to the United States.
Additionally, depending on the relevant language in the contract and governing law under the contract, a party will be required to establish that performance is truly impossible rather than merely impracticable. Courts will not excuse performance if it is merely financially or economically more difficult to satisfy contractual obligations. It is important to note however, that some jurisdictions may only require that performance be impracticable, and some contracts may set a different standard (e.g., performance is “inadvisable”). As a result, companies should closely review both the language of their force majeure clauses and the applicable law when considering their obligations and potential nonperformance risks.
Is COVID-19 a Force Majeure Event?
Many businesses will be unable to perform under agreements due to force majeure in response to quarantines, business closures and travel restrictions. Whether such assertions of force majeure will be successful will be heavily dependent on the facts relevant to the force majeure clause in the applicable contract and the business at issue.
Because COVID-19 started and developed in other countries prior to hitting the United States hard, there is an argument to be made that the pandemic was foreseeable, and thus not covered under a force majeure clause. As a result, if a company is unable to perform their contractual obligations, it is of utmost importance to mitigate any potential operational impacts in advance of the outbreak spreading to the jurisdiction where the company is incorporated. Ideally, businesses will be able to plan accordingly to avoid any disruptions in their operations.
Examples of steps companies might actively consider taking now (and seek to ensure that counterparties are taking) include: securing alternate supply streams in the event a supplier’s operations are impacted; planning for how employees can continue working remotely, or how functions can be transferred to other locations, in the event of quarantines and business closures; and mitigating the impact of restricted travel both around the globe and within countries. Even if such steps are not successful in avoiding the need to declare a force majeure, a company’s attempt to mitigate its risk in advance will be highly relevant to a court’s determination of whether reasonable steps were taken to continue to satisfy contractual obligations, and whether performance was truly impossible as a result of the force majeure event.