Impact of the Corona Virus on Contractual Obligations
April 23, 2020
The ongoing Corona virus pandemic and government actions designed to stem the spread of the covid 19 virus have had an unprecedented impact on business activity. Most company to company inter-actions are governed by contracts entered into by the parties. In the typical contract, one party agrees to provide a product(s) or service and the other party agrees to make payments. Most of these contracts contain a “force majeure” clause or “act of God” clause. This contract provision is often ignored and rarely negotiated in ordinary times and is likely to be buried in the boilerplate of an agreement, if it is there at all. But in times like these, it can become of paramount importance.
The idea of force majeure is based on the English common law doctrine of impossibility of performance due to unforeseen events beyond the control of either party to the agreement. The ability to perform contractual obligations must become objectively impossible. But, under the doctrine of impossibility, not all categories of unforeseen or uncontrollable events that impact a party's ability to perform their obligations will justify suspension or termination of their contractual obligations.
The primary purpose of including a force majeure clause is to specify the types of events that the parties acknowledge will excuse or suspend their performance such as “acts of God, acts of war or other hostility, government restrictions or interference or labor disputes” But often the list of force majeure events is preceded by “included but not limited to” or followed by “and other events beyond the reasonable control of the obligated party”.
To the extent a force majeure event arises and the parties cannot resolve the issue amicably, the courts or an arbitration panel will be called upon to resolve the dispute. The case law is replete with decisions that both narrowly limit the applicability of the clause to the listed events as well as interpret the clause to include events similar to the events listed because it will “reflect the intention of the parties”. Certainly, the party seeking to invoke the clause would be well served to include the prefix or suffix mentioned above. Even if there is a force majeure clause in the agreement, unless the parties explicitly agree otherwise, a force majeure clause will not apply to a situation that is known or foreseeable at the time the parties entered into the agreement. Arguably, from this time forward, the possibility of a pandemic is foreseeable. Accordingly parties would be well served to specially mention “epidemics or pandemics” in their force majeure clauses from now on..
The content of a well drafted force majeure clause should also specify the scope of recourse available to an affected party, for example is performance of obligations excused or merely suspended during the force majeure event.
It should be noted that contract language such as the prefix and suffix previously mentioned, although often useful, may not always be enforced. Some courts may find it insufficient unless the actual event is similar to or a consequence of the specifically enumerated grounds. In the absence of a detailed force majeure clause that enumerates the particular event inhibiting a party from performing its obligations under the agreement, it may be concluded that the affected party assumed that risk and cannot suspend or terminate its obligations.
Because force majeure clauses are strictly and narrowly applied, if a specified force majeure event occurs, only the particular obligations that are stated to be subject to suspension or termination in the clause may so be suspended or terminated.
More often than not, contractual obligations are suspended not excused, unless, with the passage of time, it is clear it is impossible to perform the obligations. Suspended obligations are reinstated in accordance with the provisions of the force majeure clause. Depending on what was negotiated by the parties, reinstatement procedures may vary substantially from one agreement to the next. However, force majeure clauses commonly provide that the duration for suspension of obligations will be for as long as the event giving rise to the suspension continues, and perhaps even for a reasonable time following the event for normal activities to resume. Sometimes, however, parties negotiate that any period of force majeure suspension is limited to a maximum time period (e.g. six months). After that period expires, the contract might entitle either party to terminate the agreement, or it might reinstate certain obligations even if the event continues.
Without such details in the clause, it may be difficult to know when a force majeure event has fully passed and contractual obligations are restored. Unlike a discrete force majeure event, such as a weather event or work stoppage caused by a labor controversy that has a clear resolution, the current Covid-19 pandemic is likely to have long-lasting effects and its end-date may not be easily discernible.
As parties negotiate new agreements for rendering services or granting rights, both sides should consider how the current Covid-19 pandemic affects their relevant expectations and abilities to perform their obligations.
THE ABOVE INFORMATION IS NOT INTENDED TO PROVIDE SPECIFIC LEGAL ADVICE OR RECOMMENDATIONS. To ensure compliance with requirements imposed by the IRS under Circular 230, we inform you that any U.S. federal tax advice contained in this communication (including any attachments), unless otherwise specifically stated, was not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any matters addressed herein.