Businesses dealing with Coronavirus developments are suddenly faced with many pressing concerns, from whether they will be allowed to continue to operate, to employee relations and supply and delivery issues. One question that may become urgent is: What are the effects of Coronavirus and COVID-19 events on your business’ existing contracts? Can you cancel that big product order you placed, when government closure orders or other disruptions will make it difficult for you to sell it? Can you be forced to deliver products when you can no longer get the ingredients due to supply chain disruptions? Who bears those risks?
First, Does Your Contract Have a Force Majeure Clause?
All contracts are in some ways a method of allocating risks between the parties. Many (but not all) contracts contain what is commonly called a force majeure clause. These clauses explain what will happen when an unexpected and uncontrollable event disrupts performance of contractual obligations. Such a force majeure event is sometimes loosely referred to as an “Act of God,” but it is more accurately an unanticipated event that the parties could not have controlled. A key element is that the parties could not have reasonably anticipated the event at the time of contracting. As a result, the contract date becomes an important consideration: In a force majeure analysis, a contract entered into during March 2020 may well be treated differently than one entered into in March 2019.
Next, Read and Comply with the Requirements of the Force Majeure Clause
The primary purpose of a force majeure clause is to allocate the risk of such unanticipated events – effectively excusing one party’s failure to perform a contractual obligation due to such an event. It is regarded as a term that is negotiable between the parties, like price or delivery time. Whether the parties have any force majeure clause, and its specific terms, will vary from contract to contract. So it is essential to read your contracts carefully and be sure to comply with their terms.
If a contract has a force majeure clause, the first question that will arise is what kind of event can trigger it? Common events identified may be floods, earthquakes, wars and terrorism. Relatively few force majeure clauses refer to “pandemic,” “epidemic” or “state of emergency,” which seem most applicable here. But some may, and others may include events that result from such occurrences, such as “government action or order.” Others may refer to inability to obtain supplies, which could also be triggered by worldwide Coronavirus effects. And some may just generally refer to “force majeure” without identifying any specific event, or include a “catch all” term of some kind. Courts tend to apply such non-specific force majeure terms narrowly, so it is important to read and understand your specific contract and how its terms are likely to be applied.
Many force majeure terms include written notice requirements. Strict compliance with such notice requirements is often required, including giving written notice of inability to perform the contract within a specified time after the unanticipated event. Here, the Coronavirus pandemic and its effects, such as new government orders, may be viewed as a series of events that have varying effects – whether any one or more triggers the required notice will depend heavily on the contract terms and the specific circumstances.
The decision about whether and when to give the required notice can be daunting: Giving notice too early may itself be a breach of the contract – an anticipatory repudiation in legal terminology – but giving notice too late may waive the force majeure excuse. In many instances, it may be advisable to have communications with the other side about the issues, without formally giving notice.
Then, Give Consideration to the Controlling Law
Another important consideration is what jurisdiction’s laws control the contract. Many contracts include an agreement on which state or country’s law will control. But when the contract does not include such an agreement, it may become a fact question driven largely by where the parties were located, where the contract was made and where the performance was required.
The law of the controlling jurisdiction can be very important because states differ in what they require to apply a force majeure excuse for non-performance. California, for example, invokes a standard of “commercially impracticability,” which is more flexible than the standards of many other states. Some states require that actual impossibility be shown. All states require some showing of causation – meaning that the alleged disruption in fact was a cause of the inability to perform. But some states require that the force majeure be shown to be the sole cause of the inability to perform, and not just one among many causes.
Some states, including California, require substantial effort to mitigate the disruption (meaning, taking all reasonable alternative measures to eliminate or limit the effects of the force majeure), but other states are less demanding of mitigation efforts. For example, if the seller has unanticipated problems getting expected supplies of required ingredients, a court may require that the seller seek other more expensive supplies, or may even require that the seller take legal action against its suppliers. Courts may also require partial performance, if the unanticipated disruption does not preclude all performance.
Be Judicious in Your Use of the Force Majeure Clause
In all instances, the focus will be on the event that caused the disruption, not on the disruption itself. Just showing that performance has become more costly, difficult or inconvenient will not usually suffice to establish a force majeure. Courts may assume that the parties allocated ordinary risks of post-contract changes in costs and profitability, although contract terms can set different standards that could control this assessment.
Business managers should readily see that a contract’s force majeure clause can be a powerful tool in this Coronavirus emergency, but it can be double-edged if not wielded carefully. Managers may also have to face the difficult position of being on both sides of this issue – on the one hand, dealing with a business partner that is unable to perform a contractual obligation, and on the other hand, being unable to perform yourself. Conkle, Kremer & Engel attorneys routinely help clients with complex business matters, including contract terminations and force majeure disputes. In our next blog post on this subject, we will turn to what happens when your contract did not include any force majeure clause. In California, as in many states, the Uniform Commercial Code or other doctrines of Impossibility of Performance and Frustration of Purpose can come into play.