Corporate Law
Authors: Jack Finn, Jennifer MacGregor-Greer & James Hsu
The novel coronavirus (COVID-19) has created significant challenges for contracting parties as domestic and international governments impose increasing restrictions on public gatherings and non-essential travel, with various “shelter in place” directions or “state of emergency” declarations expected or already issued depending on the jurisdiction. These restrictions may make the performance of commercial contracts difficult or even impossible.
How can you tell whether non-performance of a contract in these challenging times will be supported at law? There are two legal principles that may apply: (1) Force Majeure, and (2) Frustration of Contract.
- Force Majeure Clauses – The Contractual Remedy
- Generally speaking, the event of force majeure must render performance of a party’s contractual obligations impossible. Events that merely make performance more onerous, more costly, or different than what was expected at the time the contract was entered into are unlikely to meet the necessary “impossibility” standard.
- If, in preparing the contract, the parties used some lesser threshold for the application of their agreed force majeure clause, that lesser standard must be expressed clearly and explicitly. Absent such specific language, the courts are likely to read the force majeure clause narrowly and hold parties to the general “impossibility” standard.
- The event of force majeure that gives rise to the inability to perform must be specifically contemplated in the contract. If the language of the clause does not specifically address a particular kind of force majeure event (for example, a pandemic, a global or regional health emergency, travel advisory, government public safety order, etc.), the event of force majeure must be something unexpected and beyond reasonable human foresight and skill. A change in market or economic conditions on its own will not constitute a force majeure event.
- The event of force majeure must not be an event (or related to an event) of a party’s own making. This avoids the obvious moral hazard associated with a party evading its contractual obligations due to circumstances it failed to prevent or even caused.
- The party claiming force majeure must mitigate the effects of the event of force majeure if it is reasonable to do so in the circumstances. Unfortunately, little judicial guidance has been given on what constitutes “reasonable” in this context.
- The Doctrine of Frustration – The Common Law Remedy
- Don’t Wait: When faced with a crisis impacting supply lines, vendors, customers, and other aspects of the global economy, parties should look at their contracts and their circumstances as soon as possible in order to properly assess their potential liabilities and remedies if they may be unable to meet their contractual obligations.
- Think Outside the Contract: While this blog post has been concerned with certain contractual and common law remedies available to parties when supervening events impact their contractual obligations, parties should remember that there may be extra-contractual accommodations or settlements that can be reached particularly between parties with longstanding relationships and who intend to resume doing business together once the crisis has passed.
- Remember the Long Term: Navigating a crisis can become all-consuming but parties should not lose track of ways that they can improve their contractual relationships following the end of that crisis. A party that ignored or failed to push for a force majeure clause in its supplier contracts may well become a convert to the importance and necessity of a well drafted force majeure clause in its commercial agreements going forward.