Coronavirus (COVID-19) and Your Business Contracts
Coronavirus is a serious pandemic, the likes of which we have not seen before. The law recognizes that certain uncontrollable circumstances (like the Coronavirus pandemic) may make performance of business obligations impossible or impractical under the circumstances. Force majeure clauses are contract provisions that excuse a party’s nonperformance when “acts of God” or other extraordinary events prevent a party from fulfilling its contractual obligations. Due to the risks that COVID-19 poses to ongoing business operations, companies should proactively consider the potential impacts a global pandemic could have on their operations and take steps to mitigate their operational risk. Taking these proactive measures will decrease the likelihood of force majeure disputes in the future; it will also help any party asserting a claim of force majeure to establish that it took reasonable steps to avoid contractual interruption.
Basic Principles of Force Majuere Clauses
Courts look to several elements when considering the applicability of a force majeure clause: (1) whether the event qualifies as force majeure under the contract, (2) whether the risk of nonperformance was foreseeable and able to be mitigated and (3) whether performance is truly impossible.
The primary focus is on whether the clause encompasses the type of event a contractual party claims is causing its nonperformance. Force majeure clauses are generally interpreted narrowly; therefore, for an event to qualify as force majeure it must be outlined in the clause at issue. However, even when a potential force majeure event is encompassed by the relevant clause, a party is under an obligation to mitigate any foreseeable risk of nonperformance, and cannot invoke force majeure where the potential nonperformance was foreseeable and could have been prevented or otherwise mitigated. Furthermore, depending on the relevant contractual language and governing law, a party generally will be required to establish that performance is truly impossible rather than merely impracticable. In many force majeure cases, nonperformance will not be excused if it is merely financially or economically more difficult to satisfy contractual obligations. Some jurisdictions, however, may only require that performance be impracticable, and some contracts may set a different standard (e.g., performance is “inadvisable”). As a result, companies should closely scrutinize both the language of their force majeure clauses and the applicable law when considering their obligations and potential nonperformance risks.
Impact of COVID-19 on Force Majuere Clauses
The coming weeks will bring many assertions of force majeure in response to business closures and travel restrictions. Whether such assertions of force majeure will be successful will be depend on the particular contracts and businesses at issue. Note that many force majeure clauses do not expressly include public health events like a pandemic, making it uncertain whether the clause can provide relief for a defaulting party.
If the contract has no force majeure language, then a court will base its decision regarding whether to excuse the default of an affected party during the force majeure event on the foreseeability of the event. In these instances, a variety of laws that may come into play; for example, the Uniform Commercial Code (UCC) excuses a seller of goods from timely delivery or for non-delivery of goods where its performance has become impracticable either: (a) by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made; and (b) by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid. (UCC § 2-615(a)). Accordingly, any government-ordered isolation or travel bans will be important factors in the assessment.
What Steps Should My Business Take?
Companies would be wise to take proactive steps to ensure continuity of operations sufficient to meet existing contractual obligations and be evaluating whether their counterparties are also taking steps such that they will not have the need to invoke force majeure.
Taking affirmative steps now is especially important given the ability that companies currently have to foresee and attempt to mitigate any potential operational impacts in advance of the outbreak spreading further. Ideally, businesses will be able to plan accordingly to avoid any disruptions in their operations if the virus continues to spread.
Examples of steps companies might actively consider taking now (and seek to ensure that counterparties are taking) include:
- Securing alternate supply streams in the event a supplier’s operations are impacted;
- Planning for how employees can continue working remotely, or how functions can be transferred to other locations, in the event of quarantines and business closures; and
- Mitigating the impact of restricted travel both within the US and around the globe.
Even if such steps are not successful in avoiding the need to declare a force majeure, a company’s attempt to mitigate its risk in advance will be highly relevant to a court’s determination of whether reasonable steps were taken to continue to satisfy contractual obligations, and whether performance was truly impossible. Affirmative measures to help ensure a company is prepared for the possibility of business interruption resulting from COVID-19 include a careful review of insurance policies that may cover such an event.
Business Interruption Insurance
Business interruption insurance is intended to cover losses resulting from interruptions to a business’s operations, and may cover lost revenue, fixed expenses, or expenses from operating from a temporary location. While these policies usually relate to physical property damage, businesses should nonetheless assess whether they might be covered for losses due to business interruptions resulting from COVID-19.
By way of example, several companies were able to recoup losses through business interruption insurance for various operational disruptions resulting from outbreak of Severe Acute Respiratory Syndrome (SARS) in 2002-2003. In turn, however, many insurers have now excluded viral or bacterial outbreaks from standard business interruption policies. As a result, it is critical for companies to assess the specific terms and conditions of their insurance policies to determine whether interruptions from COVID-19 would be covered. In addition, companies should review their policies’ notice requirements to ensure compliance with those provisions in the event coverage is sought. Taking these proactive steps will help companies be prepared for any financial or legal implications that may arise from the continued disruptions caused by COVID-19.
We intend to closely monitor the legal and business implications associated with the global fallout from the COVID-19 outbreak. Every situation is different, but timely assessments of your options and effective communication are key to successfully navigating these uncharted waters. If you have questions, please contact us to help you assess your situation, develop a strategy and execute.