No. Fear. Here. This is our mantra. That being said, we also note that the global business landscape is rapidly changing. As we heed the advice of health officials in the face of COVID-19 (coronavirus), we must also know our rights in the process. The coronavirus has sent shockwaves through the global economy in an unprecedented way. It is affecting companies in every single sector since its discovery in Wuhan, China in December 2019.
Once this virus was declared a pandemic, governments across the globe began implementing measures such as social distancing, quarantines, curfews, border restrictions, avoidance of public gatherings at churches, social events, gyms, restaurants, movie theaters, and more. Sometimes it feels like we’re living in a science fiction movie. However, this is real life. Graduations at universities across the country, weddings, study abroad programs, and more have all been cancelled. People have taken steps to protect themselves from the virus. Some individuals have installed an under sink reverse osmosis system in their homes.
The full impact of the virus and its effects are still unknown, yet what we do know is that this has deeply impacted many. With events and social gatherings over 10 discouraged, this affects a number of industries and the contracts they are a part of. When commercial leases must be paid or contracts cannot be performed, who pays? Can you get out of that contract? Below are seven strategies for U.S. and international contracts in the face of a global pandemic. Know your rights and be confident during this international crisis.
1. Force Majeure
There is no doubt that you have heard a lot about this one recently. This is a common contract clause and here’s how it works. If an extraordinary event occurs that prevents one or both parties in a contract from fulfilling their obligations, you may be protected under a force majeure provision. To be released from contractual obligations under this clause, the following is required: (1) the event causing a release is beyond the party’s control and (2) it was without the party’s fault or negligence[1].
Such events may include acts of God, sudden illnesses, fire, natural disasters, government regulations, or other occurrences in which the party could not have attempted to protect itself from sudden risk. A force majeure clause can only protect a party from liability when nonperformance is due to causes beyond the party’s control[2]. Therefore, this is a limited defense in that it can only be used in certain extraordinary events which may be at the court’s discretion; it cannot be used in the cases of economic hardship, an increase in expenses, or other such instances. Additionally, a force majeure clause must be already written into the contract in order to use it as an affirmative defense. So, if is not part of your contract at signing, this is not an option for your situation.
How does this apply today? I’m so glad you asked! For example, let’s say that Big Events has contracted with High-End Restaurant to plan a corporate party. Big Events will pay Restaurant $5,000 to use its venue. Due to the recent outbreak of COVID-19 (an event beyond the control of either party), the state is requiring a 30-day closure of all restaurants and bars. The state is also preventing public gatherings with a 50-person or 50% cap on dining room capacity. Big Events has already booked the restaurant, but it must cancel its event and refuses to pay the $5,000.
With a well-written force majeure provision in place, the duty of Big Events to pay is discharged, the contract is cancelled, and the company does not have to pay Restaurant. In addition, Restaurant is not able to penalize or charge Big Events a cancellation fee. The parties return to how they were prior to the contract. Depending on how your clause is drafted, a COVID-19 outbreak can constitute a force majeure event.
2. Frustration of Purpose
A force majeure clause is great when it’s already in your contract, yet what do you do if you don’t have one? Great question! There are still options available. If you are part of a contract and an event occurs that disrupts the main purpose of the contract, you may be able to be released from that contract. Frustration of purpose is a defense that parties can use in cases of non-performance when an unforeseen event impedes the party’s main purpose for entering the contract[3].
The rule states that to use this defense, you must show that (1) the frustrated purpose must be the principal purpose why the party made the contract, (2) the frustration must have been substantial, and (3) the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made[4]. This means that this defense can only be used when the event completely disrupts the original purpose of the event and renders the contract virtually worthless.
Some courts also require that a party shows that both parties were aware of the principal purpose of the contract at the time of making the contract. Additionally, this doctrine cannot be used when the event is reasonably foreseeable, so the event must be extraordinary and unpredictable. While defenses that use the doctrine of frustration of purpose do have limitations, it can be used in many instances where a party cannot perform due to a frustrating event.
Let’s see this in practice. On January 15th, a California businesswoman books a flight to attend an upcoming conference in Vancouver, Canada, at the end of March. The airline and the businesswoman know that the principle purpose of the contract is to fly her to Vancouver, Canada. However, in early March, the state governor orders a full quarantine of all individuals in her state and only essential air-travel (medical or emergency reasons) is permitted. Non-essential travel (for leisure, business, academic, or missions) is to be canceled due to the COVID-19 outbreak and the need to not spread the virus even further.
Groups of 10 or more are strongly discouraged, so a plane full of several hundred is against the guidelines. In addition, in mid-March, the Canadian Prime Minister closes the Canadian border to any non-citizens and any non-permanent residents. As a U.S citizen traveling on business, she would most likely not be permitted into Canada if they closed their borders. The principle purpose of the contract was to fly to Vancouver, Canada, yet it was never contemplated at the time of buying her ticket that the Canadian border would close or the U.S president would discourage nonessential travel. These are substantial changes, and it was assumed at the time of booking her ticket that there was no concern that the Canadian border would close. However, as such, the purpose of the contract has been frustrated. The businesswoman, depending on the additional terms of her flight ticket, has additional grounds to cancel her flight and has a defense for demanding a refund of her flight ticket.
3. Impossibility of Performance
If it becomes impossible for a party to perform their duties under a contract without any fault of their own, the doctrine of impossibility of performance may apply. This rule requires that unanticipated circumstances make performance of the contract vitally different than what should be reasonably within the contemplation of the parties[5]. While this can mean that something has happened to the individual (ex. serious illness or death) to make their performance impossible, it can also mean that property that is the subject of the contract may have been destroyed or became unavailable (ex. house destroyed by fire).
It may also apply when a regulation or government order makes performance illegal and thus impossible to perform. This doctrine is limited in some ways; for example, even if an individual in a contract has fallen seriously ill and it becomes impossible to perform, the doctrine can only be used if the individual is personally required to fulfill the duties of the contract. Additionally, impossibility of performance is interpreted rather narrowly, meaning that financial or other similar reasons cannot be used to determine impossibility.
You may wonder, if this doctrine is so narrowly interpreted, how does it apply today? For example, let’s say the National Ballet Company had contracted with a Performance Hall to have an event for 2,000 people to attend. Because of the spread of the coronavirus, the state recently issued an order stating that there are to be no public gatherings of 10 or more people and that people are supposed to practice social distancing of at least 6 feet from any other person in a public place. Even if the National Ballet Company still wants to perform at the Arts Hall, it is impossible to do so without breaking the law due to the newly issued government regulations. As such, the Ballet Company cannot be made to pay the fee to reserve the Performing Arts Hall and can be released from its contract without being held liable for breach of contract.
4. Supervening Impracticability
Next is the defense of supervening impracticability. Let’s see how it works in practice. If a party’s performance in a contract is made impracticable by an event without any fault of their own, they may be able to be released from their duties that were laid out in the contract. The rule of discharge by supervening impracticability is that (1) the event occurred without the party’s fault and (2) the non-occurrence of the event was a basic assumption on which both parties made the contract.
Typically, this doctrine has been used in the cases of supervening incapacity of an individual required for performance, supervening destruction of an object necessary for performance, and supervening government restriction[6]. This means that something must have occurred outside of the party’s control that made performance impracticable, and that both parties assumed that such an event would not occur when they formed the contract. While this seems broad, under this doctrine, financial inability typically does not release a party from their duties. Additionally, courts have interpreted this doctrine narrowly.
For example, let’s say that Big Corporation rented out an event space from Big Events to view a parade, and Big Corporation paid $10,000 to rent this space. Due to the COVID-19 outbreak and the state’s order to shut down large public gatherings, the parade has been canceled. The parade was canceled by an unforeseeable event outside of both parties’ control and it was assumed by the parties at the time of contract that there would not be any pandemic virus that would spread across the globe and cancel the parade. As such, Big Corporation is not liable for breach of contract and does not have to pay the $10,000 and Big Events is not able to force Big Corporation to pay.
5. Adaptation Clauses
You can also include an adaptation clause in your future contracts. Adaptation clauses have two main types: (1) They consist of a price increase to counteract an increased financial burden necessary to fulfill a performance obligation, OR (2) they allow for a renegotiation of the contract’s duties if certain events occur. Some of the most common clauses to include are hardship clauses and force majeure clauses, and they tend to be fairly similar. Force majeure clauses typically allow for contract adaptation when performance has become literally or practically impossible, whereas hardship clauses also allow for adaptation and occasionally permit termination when performance has become excessively difficult beyond reasonable expectations, which can include extreme economic difficulty.
Therefore, hardship clauses may be interpreted more flexibly than force majeure clauses. In both cases, when parties fail to agree on an adaptation, this can result in termination[7]. These clauses create the opportunity to provide alternate performance options if a contract cannot be performed as originally intended. They provide a process that returns the relationship of a contract’s parties to an agreed original position when circumstances after the execution of the agreement have changed. Adaptation clauses are normally applicable to long-term, “relational” contracts. The use of these clauses can vary by jurisdiction, yet they are more frequently used in international contracts.
In practice, let’s look at an example. Let’s say Major Corporation has contracted with Foreign Corporation to manufacture and import goods at a flat and unchanging rate out of China. As a result of the COVID-19 outbreak, many of Foreign Corporation’s local suppliers have shut down because workers are either not able to come into work safely or many have contracted the virus. Either way, this has led to a limited number of workers available, increasing the time and cost necessary to manufacture the goods. As a result, the price of the manufactured goods and prices have skyrocketed! With a well-written hardship clause that includes a price increase in the event of an increased financial burden, Foreign Corporation can renegotiate with Big Corporation to raise prices to a level that counteracts the recent hardship.
6. Ex-Post Facto
If you are contractually obligated to perform a duty and the government then makes that duty illegal, you are no longer required to perform that duty. An ex-post facto law criminalizes actions that were once legal, and this can apply to contractual duties. While the government cannot punish you retroactively for a previous act that was legal at the time of contract, it can hold you liable moving forward.[8]
Government regulations do supersede contractual obligations and you do not have to perform a duty in a contract that has since become illegal. Government regulations and orders take precedence over contracts, and ex-post facto laws mean that future or current contractual duties are released if they violate those laws.
For example, let’s say a leadership conference was set to occur in Seattle, Washington, and planned to host thousands of people. However, as a result of the COVID-19 outbreak, the state governor puts the entire state of Washington on quarantine and no one is to leave their homes except to go to the pharmacy or grocery store. The state orders that any gathering of people for social and recreational reasons not occur or they be limited to 10 or fewer people. The state could not penalize the conference planners for any prior events that it had before the new order, yet the state, the police, or even the national guard could force the shutdown of the conference should they try to still hold the event because of the new executive order that is put in play.
7. Stay Positive and Stay Plugged into the Resources Available
COVID-19 is having a significant effect on business and contracts. Companies must now assess and adjust. If your company finds it difficult to perform on its contracts, identify any technology available to allow you to telecommute or provide an alternative solution to the other party. Plug into your industry and professional networks for ways to adjust to changes and continue business. Research the resources available through your state government. The federal and state governments are releasing aid and funding packages to small and large businesses to prevent the mass layoff of workers.
Evictions and foreclosures are also being prevented during a specific amount of time. See what may be available in your area. Also, check your insurance policies or see about adding business interruption insurance that would cover events outside of your control, such as the coronavirus should it interrupt your business. A licensed business broker, as explained in an earlier issue of Home Business Magazine, can be an excellent resource to make the right choice. Every situation is different. Please note that although our information today is not legal advice for your specific situation, feel free to contact us for a complimentary consult. We would love to assist. Practice safe and wise habits, yet remember that there is no fear here. Stay informed, stay positive, and be safe!
For more info, visit www.gonzalolaw.com.
[1] 30 Williston on Contracts § 77:31
[2] Legal Information Institute, https://www.law.cornell.edu/wex/force_majeure
[3] Legal Information Institute, https://www.law.cornell.edu/wex/frustration_of_purpose
[4] 102 Am. Jur. Proof of Facts 3d 401 § 8
[5] 102 Am. Jur. Proof of Facts 3d 401 § 6
[6] Restatement (Second) of Contracts § 261 (1981)
[7] 1 Transnational Business Transactions § 4:62
[8] Legal Information Institute, https://www.law.cornell.edu/wex/ex_post_facto
