Force Majeure and Other Contractual Considerations in the Wake of the Coronavirus PandemicMarch 12, 2020
On March 11, 2020, the World Health Organization (WHO) declared the respiratory illness called coronavirus disease 2019 (COVID-19) a pandemic, making it the first time that the WHO has declared an outbreak a pandemic since the H1N1 “swine flu” in 2009. As the COVID-19 pandemic continues its rapid, global spread and the numbers of cases and deaths rise, the commercial effects for businesses also increase, including labor issues, regulatory issues from governmental restrictions and quarantines, supply chain and logistics issues from transportation and facility disruptions, and privacy issues from the use and disclosure of medically sensitive personal information. Because these commercial effects may result in an impacted party’s inability to fully perform its obligations under its contracts, companies should consider the risks under existing contracts, as well as how to address COVID-19 and other epidemics and pandemics in future contracts.
Companies should review force majeure clauses in their contracts to determine the impact on the contractual performance obligations thereunder. Force majeure clauses allocate the risk of occurrence of certain events that are outside the control of one or more parties to a contract (a “force majeure event”). Force majeure clauses can excuse non-performance by a party whose performance is prevented or impaired by a force majeure event, thereby avoiding a breach of contract claim and reducing uncertainty relating to circumstances that are beyond its reasonable control. A force majeure clause defines the force majeure events and set out the effect of such events on the rights and obligations of the parties.
What determines whether COVID-19 constitutes a force majeure event?
Whether COVID-19 constitutes a force majeure event under a particular contract depends on the terms of that contract and the relevant facts. Events such as war, terrorist attacks, famine, earthquakes, floods, strikes, fire, epidemics, “acts of God,” and government action are typically included as force majeure events excusing performance. Some force majeure clauses also include catch-all language broadly excusing performance based similar or dissimilar events, and other significant events outside the parties’ control.
What constitutes a force majeure event also may depend on a court and may vary by jurisdiction. Unless the relevant contract mandates a non-judicial dispute resolution, a court would ultimately decide whether COVID-19 constitutes a force majeure event under the contract where the parties disagree. Because state law governs the application and interpretation of force majeure clauses, the laws of the state whose laws govern should be analyzed. Although most U.S. courts construe force majeure clauses according to their plain language, they do so narrowly, and courts may diverge from the plain language on the basis of foreseeability of the underlying event, particularly if the underlying event is covered by a catch-all provision in the force majeure clause (rather than being specifically listed). For example, a court might inquire into the foreseeability of an epidemic that is not specifically listed as a force majeure event, or of a governmental quarantine or restriction, which are not listed as a force majeure event, that arises out of an epidemic, which is listed.
A court may also analyze what the plain language used to list an event actually means. For example, a court faced with determining whether “quarantine,” “quarantine restrictions,” and the like include quarantine restrictions affecting a workforce, may decline to do so if, based on relevant industry practice, it finds the most reasonable interpretation is that the provision was intended to refer only to the quarantine of vessels. Similarly, not all courts interpret “acts of God” the same way, and courts may disagree on the extent to which a series of events (which may be both natural and political) should be treated as a single or combined force majeure event. Further, even if the parties explicitly allocate the risk of the specified event, courts still sometimes inquire into the foreseeability of the event.
The parties to a contract also need to determine whether an exclusion included in the force majeure clause applies to the underlying event which the impacted party seeks to declare a force majeure event. As part of the negotiated risk allocation, parties often specify that certain events are excluded as force majeure events, thus preventing an impacted party from being excused from performance on account of such event and otherwise availing itself of the benefits of the force majeure clause. Typical exclusions include changes in economic circumstances (including inability to pay), equipment failure, labor issues due to a party’s lock out of its own employees, and other issues that are reasonably within a party’s control.
What happens if COVID-19 constitutes a force majeure event?
If COVID-19 constitutes a force majeure event, as stated above, the effects depend on the terms of a contract and the specific facts and may not be the same for each party. The impacted party’s performance must have actually been prevented, impaired, or delayed due to the force majeure event in order for the force majeure clause to excuse its inability to perform. Accordingly, consideration should be given to what extent the force majeure event must cause the impacted party’s failure or inability to perform in order for the force majeure clause to apply. For example, a governmental restriction on travel, quarantine or shutdown of commerce that prevents a party from fulfilling its obligations under a contract providing for the hosting of a conference or other event may constitute a force majeure event under that contract, but a party’s decision to not go forward with the conference or event (including for fear of COVID-19 or simply a lack of demand as a result thereof) may not be a force majeure event under that relevant force majeure clause. The parties should also consider whether the force majeure clause covers prevention or impairment of performance only to the extent caused by the force majeure event, or to the extent caused by a combination of events that includes the underlying force majeure event.
Typically, a force majeure clause will impose various obligations on the parties on account of a force majeure event. For example, an impacted party usually must give notice after it becomes aware of a force majeure event promptly or within a specific period of time. The contract may also require one or both parties to mitigate the effects of the force majeure event, such as through a business continuity and disaster recovery plan. In applying a force majeure clause, courts may require an impacted party to have engaged in mitigation or attempted other efforts to fulfill its contractual obligations before excusing performance under the force majeure clause.
The parties should also consider whether the terms of a contract totally relieve a party from performance when a force majeure event occurs, or merely suspend or delay of performance until the conclusion of the force majeure event. If a force majeure event arises, the contract may provide the parties with certain remedies, including the right to terminate the contract without liability if the force majeure event remains in effect after a specified number of days.
Finally, it should be noted that invoking a force majeure clause is not without risk to the invoking party, as a party that improperly invokes a force majeure clause as justification for non-performance may be held to be in breach of contract, exposing it to damages and potentially termination of the contract by the other party.
Other Contractual Considerations
Companies should also consider how COVID-19 and its effects might implicate contractual provisions other than force majeure clauses. In particular, companies should consider whether any other provisions address the parties’ allocation of risk for material changes that impact performance. Further, parties can look to other defenses to non-performance that may be available, including frustration of purpose and impossibility of performance. However, these are narrowly applied and often require occurrence of an event that was not reasonably foreseeable, that was a basic assumption on which the parties made the made contract, and that radically changes the contract terms from what the parties agreed to.
Companies may also look to insurance policies to mitigate risks from their inability to perform under a contract due to issues arising from COVID-19. A company should determine whether force majeure events (including any specified types of force majeure events) are covered or excluded by the parties’ respective commercial general liability, business interruption, contingent business interruption, or other insurance policies. A future alert will discuss some of these insurance-related issues.
As part of a company’s response to concerns arising from COVID-19, the company should review existing contracts to assess risk and exposure and consider the use of force majeure clauses in future contracts. For new contracts entered into after the onset of COVID-19, the company should consider expressly addressing epidemics and pandemics, as well as matters arising therefrom, such as a governmental restrictions on travel, quarantines and shutdowns of commerce.
If a company anticipates that it will not be able to perform under a contract due to COVID-19, it should document support for a potential force majeure claim, including timing, size of the impact, and mitigation efforts. Further, the company should consider contingency plans and communications with counterparties.
As the full impact of COVID-19 takes shape, we will continue to monitor developments and provide additional guidance. If you have any questions about the contractual and operational implications and disruptions of COVID-19 on your business, please contact one of the authors above or another member of Lewis Rice’s Corporate Group.