May 11, 2020

COVID-19 and Contractual Non-Performance

Managing Risk on Existing Projects

In contractual relationships extreme events may occur through no fault of the impacted party, temporarily inhibiting or completely preventing performance. During this pandemic, the inability of businesses to provide goods or services due to interrupted supply chains, governmental restrictions or other factors, has interfered with fulfillment of contractual obligations.  Fortunately, there are multiple legal remedies to consider. 

Some remedies are found within the contract itself (force majeure, renewal and termination clauses).  In the absence of contractual remedies, protections also exist through Maine’s Uniform Commercial Code (“UCC”) and judicial legal precedents (also known as the “common law”).  If a contract is for the sale of goods, the UCC controls; if a contract is for services or some other purpose, the common law applies.

Contractual Remedies

Businesses should review any contracts with outstanding performance obligations for potential mitigation tools in the form of force majeure, termination and renewal clauses.  Force majeure clauses may provide a remedy to failed performance due to a pandemic such as COVID-19. Whether COVID-19 triggers a contract’s clause depends on the negotiated terms.  Renewal and termination provisions should also be reviewed to determine whether termination or non-renewal are cost-effective options. 

What is a Force Majeure Clause? Generally, force majeure is defined as an event that can be neither anticipated nor controlled. Many agreements contain force majeure clauses to mitigate the risk of breach by partial performance or non-performance due to an unforeseeable event that impacts a business.

Is the Coronavirus a Force Majeure Event? Whether a contract captures pandemics as a force majeure event, depends on the terms negotiated by the parties.  In reviewing a contract’s force majeure clause, determine whether the list of qualified events is unrestricted or is a finite list.  Typical open-ended clauses which allow for events outside those expressly enumerated within the contract contain the following phrases:

    • including; including, without limitation; and including, but not limited to; or
    • other [similar] events beyond the [reasonable] control of the Impacted Party.

Terms that may apply to COVID-19 include reference to:

    • “pandemics,” “epidemics,” “diseases” and “quarantines”;
    • “government action” (a government-mandated quarantine or shelter-in-place may meet the definition); or
    • “Act(s) of God.”

How is the Force Majeure Clause Invoked?

    • Notice:  Most contracts require the impacted party immediately notify the other party.  Some contracts contain a deadline to provide written notice.

    • Mitigation:  Once invoked, force majeure clauses entitle the other party to terminate the contract in the event of a force majeure occurrence, and may impose additional obligations on the impacted party to assist in resourcing substitutions, delivering inventory and work in process, etc. 

  • How Will a Court Apply a Force Majeure Clause? Application of a particular event like COVID-19 to a contract breach, is fact-driven.  But in general, courts consider the following factors:
    • whether the force majeure clause specifically references an event as beyond the parties’ control;
    • whether the force majeure event was foreseeable at the time of the contract;
    • whether the force majeure event caused the party’s non-performance;
    • whether the impacted party tried to find an alternate method to perform the contract; and
    • whether notice requirements were followed.

If a contract has no force majeure clause, both the UCC and the common law contain defenses for failure to meet contractual obligations due to an unforeseeable event.

UCC Impracticability

Under the UCC, a party may be excused for non-performance when performance becomes commercially impracticable because of unforeseen circumstances.  Where a supplier’s performance is only partially impacted, the supplier must fairly allocate the available inventory among its customers.

  • Is Notice Required of a Delay? As with force majeure clauses, the supplier must timely notify the buyer that delivery will not occur or may be materially delayed, along with notification of any partial inventory available.

  • What about Installment Contracts? Failure to respond to the seller within a reasonable time not exceeding 30 days causes the contract to lapse with respect to the affected deliveries.  If the delay or quantity deficiency will substantially impair the whole contract’s value, the Buyer must notify the Seller in writing that:
    • the contract is terminated, discharging any unexecuted portion of the contract; or
    • the contract is modified by agreeing to available substitution.

Common Law:  Impossibility, Impracticability, and Frustration of Purpose

For contracts not governed by the UCC, the common law recognizes situations in which one party’s performance is impacted by intervening, unforeseeable events. 

  • Doctrine of Impossibility:  A party's contractual obligations can be excused if performance becomes objectively impossible because of a supervening event. Courts apply the doctrine narrowly and only to contracts where performance is truly no longer possible.  The doctrine does not apply to situations where performance is just financially unappealing or performance difficult, but not impossible.  Performance is not considered impossible if a substitution could fulfill contractual obligations.

  • Frustration of Purpose:  Frustration of purpose is a limited excuse that applies when, due to a supervening event, a party's principle purpose for entering the transaction is destroyed or obviated. With this excuse, performance is not impossible but one party's reason for doing the deal no longer exists. Frustration of purpose can excuse performance only if:
    • the party seeking to be excused can no longer accomplish his purpose for the transaction;
    • both parties knew of the frustrated party's principal purpose for entering the contract; and
    • a qualifying supervening event caused the frustration of purpose.

  • Doctrine of Impracticability:  This doctrine excuses performance by a party due to a supervening event which caused performance to be so difficult and expensive that it becomes impracticable, though technically possible.  Again, like with Impossibility, the bar is set high in considering whether an event caused an unreasonably high cost increase that truly impaired performance.

In addition, courts considering a contract breach due to partial or complete non-performance analyze the foreseeability of the breach. Parties to contracts negotiated prior to the coronavirus outbreak could not have foreseen the possibility of the major commercial disruption caused by this pandemic.  Accordingly, a party’s failure to fully meet their contractual obligations due to the coronavirus may be excused to the extent performance remains commercially impracticable.

Suggested Best Practices in the Wake of COVID-19

  • Identify Potentially Impacted Supply and Service Lines
    • Determine mitigation steps to any potential vulnerabilities
    • Consider alternate suppliers or vendors

  • Review All Contracts
    • Prioritize contracts that have current performance requirements
    • Understand and track notice obligations under key contracts
    • Review Force Majeure, Termination, Cancellation, and Renewal Clauses
    • Analyze the basis for any current non-performance and whether it fits into the force majeure clause

  • Notify Vendors, Suppliers and/or Customers Regarding Potential Impacts
    • Notification of performance issues should be done as soon as possible. 

    • In the case of an applicable force majeure clause, given the extent of this pandemic’s effects change daily, an impacted party may want to proactively issue a “protective” or “continuing” force majeure notice that accounts for the evolving nature of the COVID-19 pandemic and its impact on that party’s inability to perform its obligations under the contract.

  • Modify or Terminate Existing Contracts

    • Renegotiate current contracts, including any long-term performance agreements.  Identify ways to modify obligations with alternative product/service or delivery postponement.

    • Consider terminating contracts and seek agreement from other parties.

  • Ensure Adequate Contractual Protection on New Contracts

    • Carefully review contracts prior to engaging in new contractual relationships to ensure provisions adequately consider ongoing COVID-19 impacts and future pandemics.

  • Consult with a Business Attorney for Assistance

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