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April 09, 2020

Contractual Considerations for Addressing Performance Obligations During the Coronavirus Pandemic

This Bulletin is brought to you by AHLA’s Health Care Liability and Litigation Practice Group.
  • April 09, 2020
  • Brett W. Barnett , McGuire Woods LLP
  • Tim Loveland , McGuireWoods LLP
  • David Pivnick , McGuireWoods LLP

An increasing number of factors are blocking and disrupting commerce in the wake of the novel coronavirus (COVID-19), which have led countless companies to suspend or limit their operations and have resulted in significant downstream effects for employers, including governmental action, disruptions in labor forces, and interruptions in supply chains. Whether these actions have been dictated by the ever-evolving and expanding emergency orders and proclamations of state and federal governments to limit the movement of people or have been driven by the general slowing of the marketplace, many U.S. businesses are facing unprecedented difficulties in meeting their contractual obligations.
Under normal circumstances, the failure to perform under a contract gives rise to a claim for breach. However, there are several contractual and common law defenses available when a party encounters an unforeseeable and unpredictable change in circumstances (such as in the context of a global pandemic).

Key Contractual Provisions and Common Law Defenses

Over the past month, we have seen a significant increase in the use of certain contract provisions that are, in many instances, oft-overlooked “boilerplate” provisions that are utilized in common contracts that health care entities have, such as: (1) real property (e.g., leases and rental agreements); (2) service industries (e.g., consulting, management, or administrative services agreements); and (3) manufacturing (e.g., orders, bids, and other agreements).

Force Majeure

Also referred to as “superior force” or “Act of God” clauses, force majeure provisions generally excuse performance based on the occurrence of an unforeseeable event outside the control of the parties to the contract. The specific terms of the force majeure provision at issue will dictate what types of events can trigger the clause (e.g., a worldwide pandemic or a natural disaster), and what conditions must be satisfied to invoke the clause. Generally speaking, these provisions typically require a showing that the non-performance was caused by an unforeseeable event outside of the parties’ control, that this event was the cause of the non-performance, and that the non-performance could not have been avoided or remediated through due care.
Depending on the contract language, the current pandemic often arguably satisfies the requirements of an unforeseeable event outside the control of the parties. Further, the non-performing party has a strong argument that COVID-19 is the cause of their non-performance where performance under the contract may have been rendered impossible by the orders of the federal and state government (e.g., shelter-in-place orders).
The remedy provided under the particular force majeure term will likely differ based on the type of contract. For instance, while a force majeure provision in a service or manufacturing agreement may necessitate the suspension of services, a hospitality contract (which commonly involves a single-event on a specific date) may allow the party invoking the clause to terminate the contract altogether (perhaps with an accompanying cancellation / buy-out fee).

Impossibility and Frustration of Performance

Similar in scope and effect to a force majeure clause, a number of contracts will alternatively contain clauses concerning impossibility/impracticability to render performance. Although less common, contractual impracticability or “substantially frustrated” provisions may clearly or ambiguously specify economic terms whereby a party may suspend or terminate performance. Where these types of provisions are contained in the contract, they will likely be deemed to govern any dispute between the parties, including the remedies to be afforded due to non-performance.
Even in the absence of such provisions in a contract, however, a party may be able to invoke the common law defenses of impossibility, impracticability, or frustration of performance in response to any allegations of breach. While these defenses are slightly different in their specifics, each concern excusing breaches based on non-performance where the principal purpose of the contract has been rendered impossible or substantially frustrated by an external event outside the control of the parties that was not foreseeable or contemplated at the time of contracting. Given, however, that the prevailing position under the common law defenses is that added expenses or economic issues are not enough to excuse performance, a party seeking to invoke one of these defenses needs to carefully evaluate whether the performance is truly impossible or has just become more expensive.

Practical Considerations

There may be substantial differences in how the contractual provisions and common law defenses play out in the context of different situations. For example, industry expectations for what constitutes a reasonable effort to mitigate the risk of non-performance in a force majeure defense may vary drastically, causing one party to incur substantial financial losses. In the case of merger and acquisition transactions, force majeure and impossibility may not be appropriate remedies for a breach claim brought on by a buyer’s invocation of a “material adverse change” clause due to COVID-19. Similarly, the potency of these defenses may recede for contracts being currently negotiated or which may have been executed in the last month or two, as expectations of changes to market conditions become more widely understood. Further, some contracts may provide additional clarity beyond the “boilerplate” language of most force majeure provisions and specifically exempt certain events from excusing performance, which may leave embattled companies in breach with fewer options to excuse non-performance.
However, while the contractual provisions and defenses discussed above may provide a legal basis for excusing performance, their invocations in many instances could simply serve as the catalyst for initiating communications between the contracting parties. Open and frequent communication between the contracting parties is paramount given the uncertainty surrounding COVID-19 and its potential for longstanding impact on the economy. In addition, direct and ongoing communication allows for the parties to better set expectations and preserve existing business relationships.
Likewise, the parties could creatively and proactively amend the terms of their arrangement to better reflect their actual intent and the operational reality of their business relationship. While the contract, by its very nature, may limit the parties’ rights and obligations to the four corners of the document, there may be a host of additional solutions that may be negotiated between parties. For instance, contracts that may call for termination as the sole remedy in the event of non-performance could instead be readily amended or subsequently re-negotiated to be suspended, orders modified, or rent payments deferred. Open communication between parties may result in a better understanding of the underlying goals of the business relationship and increase the business’ chances of avoiding litigation or severing a relationship that could have persisted.