This week the World Health Organization (WHO) declared COVID-19, otherwise known as the coronavirus, a pandemic, and President Trump declared a national emergency. Rising concerns over the spread of the disease and resulting uncertainty, supply chain disruptions, and changes in consumer behavior dominated the news and social media and resulted in sharp declines in the financial markets and the suspension or cancellation of numerous events. As the world scrambles to respond to the coronavirus, businesses are considering what rights and remedies their existing agreements provide.
Many agreements contain a force majeure clause, which “allocate[es] the risk of loss if performance becomes impossible or impracticable, [especially] as a result of an event or effect that the parties could not have anticipated or controlled.”[1] Evaluating the application of a force majeure clause requires assessing:
- How “force majeure” is defined (if at all) in the agreement.
- If a force majeure event has occurred, what rights or remedies are available?
Has a “Force Majeure Event” Occurred?
The term “force majeure” does not have a fixed meaning in most jurisdictions, so courts typically will rely on any definitions contained in the agreement, which they have construed narrowly.
Agreements often broadly define a force majeure event as one that is not within a party’s control, but some agreements limit the definition to events like acts of God (e.g., earthquake, tornado or flood), terrorism, or war. If an agreement defines a force majeure event as any event outside of a party’s control or specifically includes pandemics as an example of force majeure events, it is likely the force majeure clause applies, though some jurisdictions may interpret broad catch-all provisions differently. Force majeure clauses that include acts of governments or regulatory bodies likely apply when such bodies impose travel restrictions or quarantine measures.
An “act of God” refers to a “natural phenomena that are exceptional, inevitable, and irresistible, the effects of which could not be prevented or avoided by the exercise of due care or foresight.”[2] While parties could argue about whether the spread of an infectious disease is preventable or avoidable by the exercise of due care, it is highly unlikely that either party to an agreement would have the ability to prevent the spread of coronavirus. Therefore, the inclusion of acts of God in a force majeure clause may possibly include coronavirus.
If an agreement does not contain a force majeure clause or it does not apply, the parties may consider whether the doctrines of impracticability of performance or frustration of purpose apply.
The doctrine of impracticability requires a party to prove that performance under an agreement was rendered impracticable by a supervening event, the occurrence or non-occurrence of which was a basic assumption of the agreement.[3] The doctrine has been applied because of the death of an individual or destruction of a thing, but a prohibition of law, such as quarantine or travel restrictions, might be sufficient for the doctrine to apply.[4]
Frustration of purpose excuses a party from performing its obligations if performance is made impossible (not merely more difficult or expensive) by an event the parties could not reasonably anticipate at the time of contracting.[5] The doctrine is unlikely to apply simply because performance has become unprofitable as a result of economic or political events; but, in situations where coronavirus makes performance impossible because specific personnel who cannot be replaced are ill, the doctrine may apply. Proving frustration of purpose is difficult. When the parties entered into an agreement plays a crucial role in determining whether an event like coronavirus constitutes a frustration of purpose. If the parties entered into the agreement around the time of the pandemic declaration by the WHO, it is unlikely that the doctrine would apply, but an agreement signed well before the threat of coronavirus would have a stronger argument.
The Limitations of Relying on a Force Majeure Clause
If a force majeure event has been deemed to exist, what happens depends on the force majeure clause in the agreement. This is a fact-intensive exercise and varies on a contract-by-contract basis.
Some agreements allow a party to stop or suspend performance without notice or obligation. If a party’s performance is excused during a force majeure event, some agreements require the non-performing party to provide notice and updates regarding when performance may resume. Some agreements require a non-performing party to exercise commercially reasonable efforts to provide a workaround or substitution (e.g., find alternative shipping routes, use secondary manufacturing sites, or host live events without an audience) until regular performance is resumed. What these workarounds or substitutions require and whether there are any limits on the expense the non-performing party must incur in implementing a workaround or substitution often is unclear if not specified in the agreement.
Agreements for services like data hosting or mission-critical services may require a service provider to initiate business continuity and disaster recovery plans in a force majeure event. Many of these plans focus on the unavailability of certain facilities or functions because of natural disasters like a flood or earthquake but not the unavailability of a party’s workforce or a global pandemic. A plan that allows for the transition to an alternative workforce located in an area less affected by the virus may alleviate concerns regarding availability of the affected service or delays in schedules. If application of a plan is unlikely to resolve the underlying problem, then a party may consider waiving these types of requirements as a gesture of goodwill and an attempt to gain more favorable treatment from a vendor.
An agreement may include a backstop right to terminate if performance is not resumed within a certain period of time. If a party desires to terminate because of a force majeure event, be sure to comply with all applicable requirements in the force majeure clause and notice provisions in order for the termination to be valid.
Conclusion
Even if an agreement contains a force majeure clause, parties need to determine how applicable law interprets “force majeure” and whether a court will excuse performance. Many courts require the event to be unforeseeable and outside of the party’s control and will not excuse performance simply because of economic hardship or change in economic conditions. Parties to agreements signed in the past month may have a more difficult time asserting that the effects of coronavirus were “unforeseeable,” and courts may reject a force majeure defense. In determining whether to cease or suspend performance under a force majeure clause, businesses should consider where is the greatest and more immediate risk, whether to exercise or waive certain rights under a force majeure clause, and whether to bargain for priority on available resources or to seek new contractual relationships in areas less affected by coronavirus.
This content was reprinted in the April 2020 issue of The Licensing Journal.
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1 Black’s Law Dictionary (11th ed. 2019), force-majeure clause.
2 Black’s Law Dictionary (11th ed. 2019), act of god.
3 See Restatement (Second) of Contracts § 261 (1981).
4 See Id. at § 264.
5 See Id. at § 265.