Contracts vs. COVID-19: Force Majeure to the Rescue?
We have entered an unprecedented time with the spread of COVID-19 across the globe. The guidance from the State of Washington (and other state and local governments) to work from home or shut down many local businesses has caused ripple effects on contract performance and enforcement from the inability to pay rent under leases, to the slow down or halt in construction activities and the failure to meet financial targets for lease-up and investment returns. Is the “force majeure” clause the answer?
1. What is "force majeure"?
Force majeure is the clause in a commercial contract that excuses a party’s performance under the contract due to unforeseen circumstances which would prevent such party from fulfilling their obligations under that contract. If a commercial contract includes a force majeure clause, a party to the contract that is impacted by an event of force majeure may be discharged from performing its obligations under the contract.
2. Is there a "force majeure" clause?
If your contract includes a force majeure clause, it will likely include a list of specific events which would constitute an event of force majeure. Common examples are acts of God, work stoppage, labor strike, inability to obtain materials, government regulations, casualty and war. Your contract may also include specific language related to “pandemic disease” or “regional or national quarantine”, in which case, you can rely on this specific event to claim delay or relief from the obligation to perform under the contract. In Hearst Communications Inc. v Seattle Times Co. 154 Wn.2d 493 (2005), Washington’s Supreme Court applied general rules of contract interpretation to a force majeure clause and recognized that force majeure clauses may provide a defense to nonperformance for reasons beyond either party’s control.
In addition to the laundry list of specific events, your force majeure clause may contain an all-encompassing phrase such as “unforeseen circumstances” or “any event beyond a party’s reasonable control.” If your contract contains broad force majeure language, COVID-19 would likely be considered an event of force majeure and excuse performance or allow for delay. If the force majeure clause in your contract does not contain the broad language or the specific references to “pandemic disease” or similar phrasing, you will have to review the specific events to determine if any of them apply to show that your ability to perform under the contract was frustrated.
Keep in mind that when invoking the force majeure clause in your contract, it is important to remember that (a) you will likely need to show that the event of force majeure actually prevented your ability to perform under the contract (not just that it created added financial hardship or difficulty to your performance), (b) you will need to adhere to any specific notice requirements related to force majeure in the contract, and (c) you may be limited to the specific relief that can be sought under the clause (i.e. delay, termination, abatement, damages). In Washington, the failure to properly adhere to the notice requirements under the force majeure clause may bar you from obtaining relief under the clause.
Also, note that if the clause only permits relief for “actual delay”, the clause will permit delay of performance for the period of time that you are actually delayed in your ability to perform under the contract, which may not include costs or losses related to mobilization of a construction site, re-establishing or resuming business operations or slow rebounding economic conditions that would be incurred when the actual event has ceased or been resolved. If the clause contains broad language to permit the parties to determine the length of delay, you may be able to negotiate with the other party to determine the appropriate length of the delay (or other appropriate relief) to account for the recalibration time of your business operations after the actual delay caused by COVID-19 has ceased.
3. What if there isn’t a "force majeure" clause?
If your contract does not contain a specific force majeure clause, there are certain common law contract principles that may apply under these circumstances such as impossibility, impracticability, or frustration of purpose. Under the Restatement (Second) of Contracts §261 (1981), the general principle is that where a party’s performance is made impracticable or impossible by the occurrence or non-occurrence of an event, which was not caused by the party asserting such defense, then such party’s obligation to perform under the contract would be excused. A court may grant relief under this theory where a party, through no fault of their own, is unforeseeably unable to perform its duties under the contract as a result of a supervening event. In Washington, the courts have held that the defense of impossibility includes “extreme and unreasonable difficulty, expense, injury or loss” (25. Wash. Prac., Contract Law and Practice §10:16 (3d. ed.)). However, a “subjective inability to perform” under the contract or the fact that performance would be “more difficult or more expensive” would not excuse such party from performance. (25. Wash. Prac., Contract Law and Practice §10:16 (3d. ed.))
However, it is important to note that in order for any supervening event to excuse a party’s performance, the non-occurrence of such supervening event must have been a “basic assumption” under the contract. Assumptions about market conditions or financial ability are not basic assumptions and thereby would not be the basis for an impracticability claim. On the other hand, newly enacted governmental regulations or orders could be events, the nonoccurrence of which were a basic assumption on which the contract was made. (25. Wash. Prac., Contract Law and Practice §10:19 (3d. ed.))
Also, keep in mind that the doctrine of impossibility or impracticability only discharges the party’s duty to perform for so long as and to the extent of the impracticability or frustration. Accordingly, if the quarantine restrictions persist for six (6) weeks, you will likely only be able to claim this defense for the length of the quarantine. Similarly, if there are portions of the contract that you can perform, the doctrine of impossibility will only apply to the portions of the work you are unable to perform.
Further, an intervening governmental regulation or order may frustrate the purpose of the contract and allow a party to be discharged of their duties under the contract where having to comply with a governmental action prohibits performance or imposes requirements that make it impracticable for a party to perform under their contract (Restatement (Second) of Contracts §264 (1981)). For example, a tenant operating a saloon was excused from his lease after the enactment of Prohibition laws prohibiting the sale of alcohol. (The Stratford, Inc. v. Seattle Brewing & Malting Co., 94 Wash. 125 (1916)). If the governmental regulation or order would make it impossible or illegal to perform, you may be able to claim this defense in order to discharge your obligations under the contract.
Finally, Washington courts have determined that a party may be excused from performance under a contract due to an “act of God,” unless liability is expressly assumed. (Donald B. Murphy Contractors, Inc. v. State, 40 Wn. App. 98 (1985)). Whether a natural phenomenon is unusual or rare enough to qualify as an act of God is a question of fact that a jury must decide, or an arbitrator if your contract contains a dispute resolution provision requiring arbitration. (Franklin Park Mall v. Country Roof Coating Contractors, 84. Wn. App. 1085 (1997, unpublished)). In Washington, illness may be considered an “act of God” (Groover v. Zook, 44 Wash. 36 (1934) (tuberculosis)), which excuses performance or delays a party’s obligations under the contract only if the illness in such case would make it impossible, or at least highly impractical, for the party to perform its obligations under the contract. (Reynolds v. Travelers Ins., 1975 Wash. 36 (1934)). Whether a Washington court would interpret the outbreak of COVID-19 as an “act of God” to excuse your obligations to perform under your contract would likely depend on the impact of COVID-19 on your ability to actually perform under the contract.
4. Is termination an option?
You may want to consider whether you have the right to terminate the contract without cause or “for convenience”. Often contracts contain language that permits a party to terminate the contract for convenience upon a certain number of days’ prior notice. If your contract contains such termination clause, then your only obligation would be to perform until the date the termination of the contract is effective. If your contract has a termination for convenience clause, this may be an option to avoid economic losses that you may incur as a result of COVID-19 and the changing economic client and government recommendations for self-quarantining and social distancing.