Force Majeure and COVID-19: Boilerplate No More
In years past, force majeure provisions in leases and other contracts were typically treated as boilerplate and received little attention during negotiations. But 2020, to say the least, is not like other years. As the COVID-19 pandemic took hold, and businesses were forced to curtail or suspend operations, our restructuring attorneys began routinely advising business clients on the likely impact of these provisions.
As typically drafted, force majeure clauses excuse a party from performing its contractual obligations upon occurrence of an unforeseen event – for example: war, act of God, or if you were prescient, a pandemic. As discussed below, successfully invoking a force majeure provision to excuse performance, or defending such a claim, depends on the specific contract language, a keen sense of how to use the circumstances to the client’s advantage, and perhaps most importantly, a sympathetic court.
WHAT IS A FORCE MAJEURE PROVISION?
Force majeure translates literally from French as “superior force.” In the legal context, force majeure is an event or effect that cannot be reasonably anticipated or controlled and is usually written into contracts “to relieve a party from its contractual duties when its performance has been prevented by a force beyond its control or when the purpose of the contract has been frustrated.”[1] Most force majeure clauses list the unforseen event (like acts of war, or, if you were prescient, a pandemic) that excuses a party from performing their contractual obligations. While the overall concept of force majeure is generally and universally understood, “the scope and effect of a force majeure clause depends on the specific contract language, and not on any traditional definition of the term.”[2]
A force majeure provision in a contract “defines the scope of unforeseeable events that might excuse nonperformance by a party.” In Tennessee, an unforeseen event that causes impossibility of performance of a contract may be used as a defense. To be excused from performance, the proponent must show that (1) performance was impossible; (2) the event was unforeseeable; and (3) failure to perform could not be mitigated.[3] This means that even if the event (i.e. pandemic) was listed in the force majeure provision, the party asserting the clause must be able to also demonstrate that performance because of the event, was impossible (not just impracticable in most cases, but impossible), the event was unforeseeable, and there was no possible action the proponent could have taken to lessen the impact of nonperformance (mitigation). In practical effect, this means that just because it is economically difficult to comply, performance will not be excused unless it is impossible to perform because of the listed event in the force majeure clause (unless the contract contains its own standard).
FORCE MAJEURE IN THE PANDEMIC
Bankruptcy courts are on the front lines in deciding the many force majeure issues arising from COVID-19. There have been two types of cases involving force majeure principles that have already been decided by bankruptcy courts related to COVID-19: (1) impossibility of performance under the Bankruptcy Code provisions; and (2) assertion of force majeure as a defense.
In the first group of decisions, retailers Modells Sporting Goods, Pier1, J. Crew, Neiman Marcus, and True Religion all filed Chapter 11 bankruptcy cases. Under the Bankruptcy Code, rent obligations are statutorily required to remain current post-petition, and any arrearage must be timely cured for the debtor company to assume the lease and continue it in force. All of the retailers, in their respective bankruptcy cases, requested over the landlords’ objections, that the bankruptcy courts defer the rent which was admittedly required to be current. The requests were made on varying theories ranging from impossibility of performance to fairness that the court defer timely rent. The bankruptcy courts have largely ruled in favor of the debtor-tenants over the landlord’s objections.[4]
True Religion and J. Crew filed for chapter 11 protection at a time when pandemic restrictions had eased somewhat. Nevertheless, both were successful in having their commercial rent obligations deferred in light the conditions created by COVID-19. None of the cases specifically referred to force majeure, but impossibility of performance because of the pandemic was the crux of each of the debtors’ arguments.
At least one court has ruled directly on the effect of a force majeure provision and COVID-19. In that case, which involved a restaurant lease, the court held that the force majeure provision partially excused the debtor tenant's payment of rent under the lease where the leased premises was under a government-ordered shutdown. The Court examined the force majeure provision and the language of the Governor’s shutdown order. In what appears to be a first-of-its-kind ruling, the bankruptcy judge upheld the force majeure provision ordering the restaurant to pay 25% of rent (because take-out and curbside were still available) and excused performance of 75% of the rent.
It is very likely that these issues will be litigated in bankruptcy courts around the country, and that bankruptcy court rulings on force majeure or impossibility of performance issues will shape how other courts will interpret and enforce force majeure issues.
WHAT IF YOUR CONTRACT DOES NOT CONTAIN A FORCE MAJEURE PROVISION?
The contract between the parties is the “rulebook” by which their relationship is governed. But what if there is no force majeure provision and performance becomes impossible? There are at least two common-law fallbacks that may come into play: (1) Impracticability or Impossibility of Performance, and (2) Frustration of Purpose. These avenues are only available in the absence of a force majeure clause.
Impracticability of Performance
In Tennessee, where, at the time a contract is made, a party's performance under it is impracticable without his fault because of a fact which he has no reason to know and the non-existence of which is a basic assumption on which the contract is made, no duty to render that performance arises, unless the language or circumstances indicate the contrary.”[5] The doctrine of impossibility of performance is usually employed defensively to excuse nonperformance of a contract. The doctrine is not applicable where performance becomes impossible due to factors which should have been foreseen and provided against.[6] Tennessee law provides that impossibility of performance excuses a breach of contract only if “the promised performance was at the making of the contract, or thereafter became, impracticable owing to some extreme or unreasonable difficulty, expense, injury, or loss involved, rather than that it is scientifically or actually impossible.”[7] Thus, unlike some states that require a showing of impossibility, Tennessee has an impracticability standard. COVID-19 will likely force Tennessee state and federal courts to re-examine this common-law defense for contracts not containing force majeure provisions.
Frustration of Purpose
The doctrine of frustration of commercial purpose was first recognized and defined by the Tennessee Supreme Court in 1974, and has been subsequently articulated as occurring where “the happening of an event, not foreseen by the parties to the contract and neither caused by nor under the control of either party, has destroyed or nearly destroyed either the value of performance or the object or purpose of the contract.” When this occurs, the parties to that contract are excused from further performance.[8] The doctrine is applicable only when the supervening event in question is “wholly outside the contemplation of the parties.”[9] If the frustrating event was foreseeable, then the doctrine does not apply. Just like with impossibility and force majeure, courts will be called upon to determine when or if COVID-19 was foreseeable. Did it become foreseeable when China first experienced pandemic conditions? These are front-line issues the courts will have to decide from the COVID-19 pandemic.
Even though these two common-law doctrines are very narrowly tailored and interpreted, any business that does not have force majeure provisions in its contract should consider these doctrines as affirmative defenses where applicable.
WHAT CAN BUSINESSES DO TO AVOID FORCE MAJEURE DISPUTES?
There are several steps businesses can take now to get ready to assert or defend, or avoid, a force majeure dispute:
(1) Review and Learn. Become more familiar with your company’s contract(s). Do they contain force majeure provisions? What are the events listed? Consider carefully what “event” you assert. For example, was your unforeseen event COVID-19 (perhaps a tougher argument to win) versus a Quarantine or Executive Order that was unforeseen? Courts normally view the asserted event with an objective standard, not the subjective view of the parties.
(2) Act Carefully. The timing of declaring force majeure should be carefully considered. Once force majeure is declared, the duty to mitigate is likely triggered.
(3) Document and Gather Evidence. Businesses should carefully document all steps taken before and after force majeure is declared. All decisions with regard to crisis management, personnel, and any other steps taken should be well-documented in case there is litigation.
(4) Mitigation. The duty to mitigate damages is implied in every contract, but it is particularly important with force majeure. For example, a company might plan for mitigation by seeking out new vendors or suppliers, plan for remote working, or figure out other ways to lessen damages. When a court considers mitigation, effort and attempts, even if unsuccessful, will be very helpful to persuade a court that a business acted to try to meet contractual obligations.
(5) Other Considerations. What are the damages provisions in your company’s contracts? Do you know what your business insurance covers? Even if you are on the winning side of a force majeure argument, what is the likelihood that a judgment is collectible? Are you better off working it out with a party claiming force majeure?
CONCLUSION
Force Majeure and Impossibility of Performance are complex issues that require effort and evidence to successfully assert or defend. In these uncertain economic times, businesses should review and know their contract provisions and do an early assessment of any force majeure provisions.[10] Obtaining legal advice and knowledge about force majeure and the likelihood of success in asserting or defending those provisions forearms a business for the many COVID-19 issues likely to arise.
Nancy King is a partner with EmergeLaw, PLC who represents businesses and their owners in situations involving financial distress.
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[1] Phillips Puerto Rico Core, Inc. v. Tradax Petroleum Ltd., 782 F.2d 314, 319 (2d Cir. 1985).
[2] Acheron Med. Supply, LLC v. Cook Med. Inc., 958 F.3d 637, 651 (7th Cir. 2020). [3] Bayader Fooder Trading, LLC v. Wright, 2014 WL 5369420, at *3 (W.D. Tenn. Oct. 21, 2014). [4] For Modell’s, the bankruptcy court relied upon section 305(a) to “suspend” the case to defer rent. In Pier1’s case, the judge allowed rent deferral because the deferred rent would be treated as an administrative claim in the case at a later date and no prejudice to the landlord resulted. The reasoning of each is slightly different, but at the core of the rent deferrals are the principles of impossibility of performance and force majeure. [5] Merwin v. Davis, 2017 WL 935107, at *3 (Tenn. Ct. App. Mar. 9, 2017). [6] Silsbe v. Houston Levee Indus. Park, LLC, 165 S.W.3d 260, 265 (Tenn. Ct. App. 2004). [7] Dell'Aquila v. Head, 545 Fed. Appx. 439, 441–42, 2013 WL 5911719 (6th Cir. 2013). [8] Covenant Med. Mgmt., Inc. v. Knepper, 2006 WL 3333021, at *4 (E.D. Tenn. Nov. 16, 2006). [9] Morrison v. Circuit City Stores, Inc., 317 F.3d 646, 679 (6th Cir.2003). [10] A related to, but not discussed here topic, is business interruption insurance. A review of your business interruption policy could be very helpful in determining if COVID-19’s impact on your business is covered under the insurance policy.