BUSINESS AND LEGAL IMPLICATIONS FOR CONTRACTS:
BETTER DUST OFF YOUR AGREEMENTS
The novel coronavirus virus “COVID-19” presents complex and quickly evolving legal issues for companies navigating their businesses contracts. We are advising clients on numerous legal issues relating to COVID-19 and the following white paper provides a brief discussion of legal issues relating to contracts and commercial agreements to consider in the current environment.
While fact-specific to any particular contract, COVID-19 is likely to have a profound impact on business contracts. Parties to existing contracts that are or may be disrupted by COVID-19 should promptly assess their legal rights and obligations, including: (i) identifying key provisions of material contracts that may be affected by the recent events (e.g., representations/warranties, covenants, termination rights, conditions, force majeure clauses or “change in law” clauses), (ii) identifying any relevant notice requirements; (iii) analyzing the potential consequences of a default or breach under the agreement, and (iv) determining or negotiating alternative means to perform under the contract, where possible.
Companies currently negotiating contractual agreements should proactively consider the impact of COVID-19 and appropriately allocate potential risk in the agreements.
One issue for companies to consider is whether the COVID-19 outbreak constitutes a force majeure event such that a contract party is excused from its contractual obligations. Contract parties may consider issuing force majeurenotices or may receive such notices to excuse a party’s non-performance. Many contracts require that any party who seeks to assert force majeure as a basis for suspending performance must provide notice to its counterparty. Failure to send such notices within a certain number of days, may result in arguments that the force majeure defense is waived or have other consequences.
Additionally, some contracts provide the continuation of a force majeure event for a certain period of time (e.g., 90 to 180 days) may be grounds for termination. Any declaration of force majeure must be evaluated under the terms of the agreement and analyzed under the law governing the terms of the contract.
Parties should also consider taking into account the following considerations:
- Whether the parties’ agreement includes notice obligations before declaring force majeure;
- Whether the force majeure event actually made the party’s performance impossible, or just more burdensome;
- Whether the impacted party is required to mitigate by using diligent efforts to end the failure or delay and ensure the effects of the force majeure event are minimized;
- Whether immediate relief is available for the impacted party;
- Whether force majeure-related disputes must be arbitrated; and
- Whether force majeure events are covered by the parties’ insurance policies (including general liability, business interruption, contingent business interruption, or other insurance policies), and if so, what conditions must the party meet for its claim to be satisfied.
Impact on Other Agreements
Parties seeking to invoke, or who are faced with, a declaration of force majeureshould also consider the effect of such a declaration on other agreements or legal obligations (e.g., financing agreements or disclosure obligations). Many financial agreements contain representation or covenants to provide notice of material litigation (or potential material litigation) or anticipated loss outside of the ordinary course of business. Likewise, a business interruption may constitute a default either expressly or through its impact on financing or other covenants.
Frustration or Impossibility
If a contract does not contain a force majeure provision, it may be possible to argue that the COVID-19 outbreak has frustrated the contract or that performance of the contract becomes impossible.
The doctrine of frustration may excuse the performance of a contract in situations where the performance of a contract is possible, but no longer provides a party with the benefits that induced them to make the bargain because of intervening unforeseeable events.
The availability of relief based on the doctrine of frustration varies across different jurisdictions but will generally turn on the foresee-ability of the event in question and the purpose of the agreement. Frustration of purpose will generally not apply when a contract simply becomes less profitable, or even when performance causes one party to sustain a loss.
The doctrine of impossibility excuses a party’s nonperformance when performance becomes objectively impossible because of the destruction of the subject matter of the contract or the means of performance. The test for impossibility is a strict one and courts will only apply this defense in extreme circumstances, where the events in question were truly unforeseeable.
Contract parties can also look to relevant statutory law to evaluate whether nonperformance would be excused. For example, under the UCC, a seller may be excused from timely delivery or non-delivery of goods due to (i) unforeseen supervening circumstances not within the contemplation of the parties at the time of contracting; or (ii) compliance in good faith with an applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid. It’s worth noting that the UCC’s force majeure provisions only apply to sellers of goods, not services.
Material Adverse Change or Material Adverse Effect
Some commercial agreements allocate risk among the parties in the event of a material adverse change (“MAC”) or material adverse effect (“MAE”) to the business. If triggered, a MAC or MAE may allow a party to terminate the agreement or otherwise avoid performance. Companies should consider and abide by any notice requirements associated with a MAC and MAE.
Contract parties making important decisions regarding force majeure, frustration or impossibility of performance, and/or MAC or MAE issues should consult with counsel to help analyze these issues within the context and circumstances of each contract as a wrong decision could have serious consequences.
Companies should also consider whether insurance may cover losses sustained from COVID-19-related disruptions. This coverage may apply to commercial properties that sustain disruptions to their operations, trade disruption for losses related to quarantines or other travel restrictions and closures, or general liability insurance. Businesses should not only assess the insurance policies that may apply but consider providing notice under such policies at this time. Additionally, there are already a number of lawsuits that have been filed requesting courts to weigh in on whether business interruption insurance will cover losses due to the impacts of COVID-19, and the results of these cases will provide valuable guidance in analyzing potential claims under similar insurance policies.
The impact of COVID 19 on businesses and their contractual relationships is highly fact-specific requiring case by case analysis. Concerned companies should undertake a review with their counsel of the rights and obligations under their various agreements, financing instruments and applicable law, including notice requirements, the potential impact on other agreements, insurance coverage and disclosure.
Whatever legal avenue companies choose as they evaluate their contractual agreements, it’s important to keep lines of communication open and companies should explore all reasonable commercial solutions before claiming a force majeure. At the end of the day, preservation of good relationships with customers, vendors and those you contract with is just good business.
Please feel free to contact Tom Jolley [email protected] or Erin Stone[email protected] at York Howell & Guymon with business contract questions or you may contact any York Howell & Guymon attorney with whom you regularly work with for assistance.
This memorandum is provided by York Howell & Guymon for education and information purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.