When entering into a written agreement, the parties are better off as they allocate risks and spell out their assumptions upfront. This level of clarity maximizes the chances that the contract will be an effective means for resolving potential disputes.
With the slowdown in business activity this year, businesses have been seeking to invoke force majeure provisions to suspend their performance due to COVID-19 and the related disruption.
What is a force majeure provision?
“Pacta sunt servanda” (Lat. agreements must be kept) is an essential principle of contract law. Only truly special circumstances allow for an exception.
When performance becomes impractical, impossible, or illegal, a force majeure provision may come to the rescue to introduce this kind of exception. This provision has the power to suspend performance temporarily or even permanently.
It is a key mechanism for reducing a party’s risk of liability and losses in the face of extraordinary circumstances.
How does a force majeure provision work?
Force majeure provisions allocate the risk of supervening events.
A solid provision would typically list specific occurrences. The event or circumstance must be beyond the reasonable control of the affected party. Hence, a solid provision would be broad and include a catch-all phrase (“… any other similar event beyond the reasonable control of the parties.”).
Common specified events include hurricanes, tornadoes, floods, droughts, earthquakes, and other disturbances of natural causes as well as acts of God. They may also contemplate war, threats of war, civil unrest, blockades or interventions, embargoes, expropriations, interferences by civil or military authorities, labor strikes or disruptions, failures or delays to deliver equipment or supplies, failures in electrical power or telecommunications, diseases, and epidemics or outbreaks.
THE SEVEN PILLARS OF A FORCE MAJEURE PROVISION
Pillar #1: Read the contract carefully as every term counts and the express language governs.[1]
The express terms of a contract govern provided the contract is valid and enforceable.
For parties that have entered into a written contract, several scenarios appear plausible in the world of supervening events. If the contract contains no force majeure provision, the parties would resort to the UCC or extra-contractual common law doctrines like impossibility, impracticability, and frustration of purpose. If the contract contains a force majeure provision, but it does not address the specific event or is open to subjective interpretation, the parties would aid with interpretation and may look to preceding discussions and context as well as the UCC or the common law for gap-filling.
A party seeking to suspend its performance must look both to the contract’s specific terms and applicable law to assess the likelihood of success in invoking the force majeure provision. When success seems unlikely, the party may assert the defenses of impossibility, impracticability, or frustration of purpose as an alternative.[2]
These common law doctrines, however, are difficult to prove. For impossibility to apply, courts require that the subject matter of the contract be permanently destroyed – for all time, not just temporarily unavailable – and the cause of impossibility must not be reasonably foreseeable. Impracticability excuses performance where it would cause extreme and unreasonable difficulty.
For a party to assert frustration of purpose successfully, the value of the contract must have been totally destroyed and the destructive event must be unforeseeable. Increased costs of performance or inconvenience are not sufficient to frustrate the purpose of a contract. If the business is not entirely shut down and can still operate in some way, the value of the contract has not been totally destroyed and frustration of purpose won’t be successful.
In South C. Street, LLC v. Charlotte School of Law, LLC, the tenant asserted frustration of purpose when it lost accreditation as an educational institution.[3] The Superior Court ruled that the school’s loss of accreditation did not excuse it from its obligation to pay rent under the lease.[4] Charlotte School of Law still had to pay rent because its lease specified other uses for the premises aside – for example, business administration.[5]
Pillar #2: It is wiser to be safe with a force majeure provision than sorry without one.
A robust force majeure provision would address the specific event and the associated consequences for the parties.
Without a force majeure provision, the occurrence of a supervening event that precludes a party’s performance is anticipatory repudiation.
Anticipatory repudiation is a breach of contract resulting from the party’s unwillingness or inability to keep a contractual promise. It exposes the breaching party to liability for damages resulting from that breach and allows the other party to walk away by discharging its performance entirely.[6]
Pillar #3: Parties should exercise care in declaring force majeure.
The force majeure event must be a direct cause of the impacted party’s inability to perform.
A premature declaration of an unwarranted force majeure may be viewed as anticipatory repudiation (see Pillar #2). If unsuccessful, the party invoking a force majeure provision may have to pay damages.
Pillar #4: Drafters should use specificity and allow for unforeseeability in force majeure provisions.
If the event is foreseeable, the parties should list it as a specified event in the force majeure provision, so that it would be covered by the express terms of the contract.
If the event is not listed in the force majeure provision and the provision is a broad one, the event may fall under its catch-all language. To be successful, however, the party declaring force majeure must prove the event is unforeseeable.
Wise drafters include specified contingencies that would excuse a party from its obligation to perform. In M&A agreements, failure of financing is a contingency that may excuse a buyer from going through with a business acquisition.
If one is relying on a third party, make it known in the contract that the third party’s performance is a contingency. If one party is the exclusive or sole source of supply, the procuring party should specify its reliance on that in the contract. If time is of the essence, that should be specified as well.
After the 1989 Loma Prieta earthquake in California, force majeure provisions adopted “earthquake” as a standard supervening event. September 11th added “terrorist acts” and “threats of terrorism” to the list. As governments responded to the COVID-19 environment, new language has been gaining significance in force majeure provisions: for example, “any law, order, regulation, direction, action or request of any civil or military governmental authority or court” and even “a governmental authority’s failure to act timely.”
Pillar #5: Specify what events will not trigger the force majeure provision.
One advantage of a broad force majeure provision is that it may be invoked even if the specific event is not included in the contract. However, a force majeure provision can keep the parties from the slippery slope of subjective and arguably triggering circumstances when it goes the extra mile to spell out circumstances that will not trigger the provision.
A force majeure provision may read: “The following circumstances will not invoke protection from liability under this force majeure provision nor will they excuse performance under this contract: . . . .”
Examples of suitable exclusions are:
- Reliance on a third party;
- Interruption or failure of electricity or communication systems;
- Curtailment of transportation facilities; and
- Enforced reduced attendance by at least __% by way of governmental order.
Mere economic hardship is ordinarily not sufficient to qualify as a force majeure event on its own, and a party’s inability to pay will not excuse that party’s performance.[7] In other words, lack of financial resources or an inability to generate revenue are usually not grounds for asserting force majeure.
If the party receiving payment wants enhanced protection, it should specify in the contract that inability to pay is not an excuse from performance.
Keep in mind that, under the right circumstances, performance may be partially excused – in proportion to the party’s ability to generate revenue.
Pillar #6: Prohibit commercially reasonable efforts that differentiate partial performance from a breach.
At times, cancellation of an entire contract may prove more harmful to both parties than helpful. A force majeure provision may specify a set standard for mitigating damages – for example, commercially reasonable efforts that can be quantified – to differentiate partial performance from a breach. In these cases, recording steps taken to employ alternatives and mitigate losses becomes critical. A contract may read: “The parties shall engage in good faith negotiations to modify the provisions of this agreement” or “unsatisfactory performance of obligations may be mitigated by . . . .”
In CertainTeed Gypsum NC, Inc. v. Duke Energy Progress, LLC, Duke Energy failed to meet minimum monthly quantities and the Superior Court ruled that Duke Energy had a supplier’s contractual obligation to use commercially reasonable efforts to maintain a stockpile in the event of production slowdowns.[8] Duke Energy was not excused and was ordered to deliver, within 30 days of the court’s opinion, such amounts as were necessary to fulfill its obligations less acceptable minor fluctuations for the period in question and amounts already accepted.[9]
Pillar #7: Include business interruption insurance as added protection.
Business interruption insurance protects against loss of income by replacing lost income and paying for extra expenses when a covered event occurs. It usually works in tandem with commercial property insurance.
Before committing to an insurance policy for your business, you should understand its exclusions should and evaluate the policy in its entirety. Read it and examine its plain language.
When it comes to business interruptions, ensure you are satisfied with the type of business interruptions that would allow for a successful insurance claim. While, on the face of the policy, it may seem impossible to assert a successful claim, never take no for a final answer.
[1] See NetOne, Inc. v. Panache Destination Mgmt., 2020 U.S. Dist. LEXIS 99089 (D. Hawaii June 5, 2020) (“. . . nowhere in the force majeure provisions does it say that, if the contracts are terminated due to a qualifying event, the non-terminating party must return all deposits made).
[2] See OWBR LLC v. Clear Channel Communs., Inc., 266 F. Supp. 2d 1214 (D. Haw. 2003) (“Plaintiff counters that the events of September 11, 2001, did not make it ‘inadvisable’ to travel to or to hold events in Hawaii five months after the terrorist attacks. . . . The Court recognizes that September 11 was an extreme, unforeseeable occurrence, which is of the magnitude to trigger a force majeure clause. . . . From an economic standpoint, it was certainly unwise, or economically inadvisable, for Defendants to continue with the Power Jam 2002 event. Nonetheless, a force majeure clause does not excuse performance for economic inadvisability, even when the economic conditions are the product of a force majeure event”).
[3] See South C. Street, LLC v. Charlotte School of Law, LLC, No. 18 CVS 787 (N.C. Sup. Ct. 2018).
[6] See Phillips Puerto Rico Core, Inc. v. Tradax Petroleum Ltd., 782 F.2d 314, 321 (2d Cir. 1985); John E. Murray & Timothy Murray, Corbin on Contracts Desk Edition § 53.07 (2019).
[7] See OWBR LLC, 266 F. Supp. 2d 1214, supra note 2 (“[A] force majeure clause does not excuse performance for economic inadvisability, even when the economic conditions are the product of a force majeure event.”).
[8] See CertainTeed Gypsum NC, Inc. v. Duke Energy Progress, LLC, No. 17 CVS 395 (N.C. Sup. Ct. 2018).
