Contract Conundrum: Whether Force Majeure, Frustration or Termination Can Protect Your Business
As businesses try to cope with the serious threats arising from the coronavirus (COVID-19) pandemic, virtually all of them are looking to see what relief and protections might be available in their various contracts and other agreements with suppliers, partners and customers.
A variety of avenues may be available to a business to address contract concerns. Many contracts contain a force majeure provision – as we’ve noted in other alerts relating to real estate, litigation and construction – but even if a contract does not have such a provision, frustration or even a simple termination can be considered to help protect the business.
Following is a brief overview of each potential option:
Force majeure is a provision commonly found in contracts that frees one or both parties from obligation if an “act of god” or other extraordinary event prevents performance. Examples of such events are earthquakes, floods, terrorism and hurricanes, as well as pandemics. These events must be reasonably unforeseeable and unavoidable in terms of the contract’s provisions, and they cannot be the result of a party’s actions.
Before declaring a force majeure event, be sure to analyze (a) the scope of the sometimes-negotiated, sometimes-overlooked “boilerplate” language, and (b) any specific requirements in the agreement (such as notice, cure, timing, etc.), taking into account how it may affect other areas of your contract.
Some things to consider:
- Is there a notice provision?
- Does it require you to mitigate? Often the provision may require that performance has been prevented, not just made more difficult or costly.
- How is the government involved, if at all, and what might it require? (Government agencies may get involved, which may affect specific areas of business.)
- Are there other provisions in your contract that may be impacted by enforcing the force majeure provision (for example, exclusivity, liquidated damages or termination rights)?
- Is the relief sought suspension or termination? Note that it is one or the other, and not reformation. As a practical matter, invoking such a clause need not lead to draconian, black-or-white remedies and can initiate a renegotiation between the parties.
While it may be necessary to enforce a force majeure section of your contract, it may be beneficial to all parties to communicate early and often. The parties may be able to agree to amend or suspend the contract until the event no longer effects performance.
In the alternative, the long-term effects of canceling a contract may cause irreparable harm to the business relationship. In addition to the above terms in commercial contracts, another area where force majeure can arise is in material adverse effect clauses in M&A transaction agreements.
If the contract does not contain a force majeure provision, most states recognize common law doctrines such as “frustration” or “impossibility.” Frustration is applied to discharge contractual obligations when no party is at fault. Under the frustration doctrine, an event occurs where a party is unable to perform under the contract through no fault of its own, analogous to the circumstances giving rise to invoking force majeure provisions. The event makes performance physically, commercially or legally impossible, or the contract, as originally negotiated, becomes extremely different from the terms negotiated.
Even though frustration has been used as a defense dating back to 1902 as a result of King Edward VII’s postponement of his coronation, this doctrine is rarely used nowadays. In that set of cases, parties entered into various contracts to see the King’s parade route. When the King first postponed the coronation and parade due to illness, lawsuits sought recovery or unwinding of the contracts. Then the coronation was back on, and new contracts were entered into as the route changed. However, at the last minute, the King decided to change the route, and anyone renting apartments or balconies on the old route could not see the coronation parade, thus eviscerating the underlying premise of the contract. Lawsuits again were brought seeking rescission due to commercial impossibility. The plaintiffs who won tended to have specified the purpose of the contract and those who lost tended not to have so specified.
In a situation involving the COVID-19 pandemic, it may be worth exploring the application of frustration or commercial impossibility to contracts (likely on a case-by-case basis) as more restrictions and laws are passed directly pertaining to the outbreak.
After exploring the many options on how to best deal with your contract obligations and the relevant law, you may come to the conclusion that terminating the contract will yield the best outcome for your business. If this is ultimately the option you choose, it is important to review the impact it may have on your business, both short and long term. Additionally, it is imperative that you review your contract on how to invoke at a valid termination.
Considerations for Future Contracts
Now more than ever, the force majeure section should be carefully drafted to protect the interest of your business. While negotiating your contract, keep in mind who will bear the risk of loss in the event one party is unable to perform due to no one’s fault. This often-overlooked section can dramatically impact the potential liability of a breach. Taking into account the specific aspects of your contract, you may not want a narrow force majeure provision that does not allow for risk-shifting.
With restrictions increasing on the general public and businesses alike, it is impossible to predict the full impact of the coronavirus pandemic. Businesses locally and globally will experience increased disruptions leading to abnormal operations. If you are considering force majeure, frustration or termination because of the pandemic’s impact, you should carefully review your contract and explore all options. At some point business will return to normal, and you want to ensure the decision you make today will not impact you negatively in the future.