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March 31, 2020

Legal Update
John G. O'Neill, Kenneth N. Thayer

Protecting your contractual rights in the wake of COVID-19

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Retail stores, restaurants, and other commercial tenants are shut down.  Shipments of parts are delayed.  Long-planned vacations and wedding celebrations have been cancelled.  Childcare facilities and gyms are closed indefinitely.  From corporate boardrooms to kitchen tables, the economic impacts of the coronavirus (COVID-19) pandemic and the resultant lockdowns are impossible to ignore—to say nothing of its devastating public health impacts.  Among the myriad ways the virus has disrupted life in recent weeks, COVID-19 is wreaking unprecedented havoc on the performance of contractual agreements—from industrial to personal—raising thorny questions about who bears the costs when obligations aren’t met, and what remedies are available to parties who do not receive the benefit of their bargain.

While the challenges presented by this pandemic may be unique, there are a number of established legal concepts that provide a framework for addressing these questions and determining the respective rights and obligations of companies and individuals whose contracts have been affected by COVID-19.  Specifically, we can look to the doctrines of force majeure, impossibility of performance, and frustration of purpose to better understand what forms of relief may be available to contracting parties when one party cannot perform its obligations due to the COVID-19 outbreak.  Depending on the particular language used in the contract, and the particular jurisdiction in which the contract was formed, these doctrines may dictate whether a party will be excused from a failure to meet its obligations due to the outbreak.

Force Majeure

The legal concept most likely to be implicated when COVID-19 interferes with the performance of a contract is force majeure (literally, “superior force”).  This is a legal doctrine incorporated into many commercial contracts that, in certain cases, relieves a contracting party from liability for not performing its obligations when that nonperformance is due to circumstances beyond the party’s control—sometimes referred to as “Acts of God.”  In many contracts containing force majeure clauses, a nonperforming party will not be deemed in breach where its ability to satisfy its obligations was hindered by unforeseeable conditions such as natural disasters, like floods and fires, or certain types of man-made crises, like riots and war.

In some contracts, the force majeure clause expressly includes “disease,” “outbreak,” and “quarantine” as superseding events that excuse performance of the contract.  For example, contracts entered into pursuant to the U.S. government’s Federal Acquisition Regulations require that government suppliers’ nonperformance will be excused where it is due to “epidemics” or “quarantine restrictions.”  48 CFR § 52.249-10(b)(1).  In contracts containing this type of language, there is little doubt that COVID-19 will excuse nonperformance.

Many contracts include force majeure clauses that do not expressly relieve the parties from performance in the event of a disease outbreak such as the COVID-19 pandemic.  In such circumstances, a party may have to rely upon generalized language that, for example, excuses performance where it is inhibited or delayed by “circumstances [that] were not reasonably foreseeable . . . and, by the exercise of reasonable commercial due diligence, could not have been prevented” by the nonperforming party. Not surprisingly, there is some disagreement as to how broadly open-ended language such as this should be construed, making the question of where the contract was entered into—and whether it contains a choice of law provision—critically important. New York courts, for instance, have found that “force majeure clauses [are] to be narrowly construed” and only apply where contractual language “specifically includes the event that actually prevents a party’s performance.” Reade v. Stoneybrook Realty, LLC, 63 A.D.3d 433, 434 (N.Y. App. Div. 2009).  But legal commentators in other jurisdictions have argued that the force majeure doctrine always encompasses disease outbreaks, regardless of the specific terminology used.  See Suzen M. Grieshop Corrada, The Best Laid Plans: Force Majeure Clauses in Travel and Event Contracts, 31 Nova L. Rev. 409, 421 (2007) (arguing that an “outbreak of a virus” should always be considered “a force majeure event [that] is beyond the control of the” nonperforming party).

While Massachusetts courts have not taken a definitive position on how broadly to apply the force majeure doctrine, the relevant cases suggest that nonperforming parties may avoid liability only where they can demonstrate that COVID-19 inhibited their performance in a manner that was “unforeseeable, unanticipated, or uncontrollable.”  Harper v. N. Lancaster, LLC, 95 Mass. App. Ct. 1119 (2019).  Application of this standard will likely require resolution of several factual questions, such as the information available to the parties at the time of contracting and the efforts that could have reasonably been made to anticipate and avoid the effects of the governmental orders at issue.

Impossibility of Performance

Another legal doctrine that nonperforming parties may seek to invoke in the face of COVID-19 disruptions is the doctrine of impossibility of performance, which provides that parties may be excused from their contractual obligations where “performance becomes impossible . . . without the fault of either party.”  Chase Precast Corp. v. John J. Paonessa Co., Inc., 409 Mass. 371, 373 (1991).  Notably, most courts have ruled that the doctrine does not require that performance would be literally impossible; it is generally sufficient that the circumstances are such as to render performance illegal. This is likely the case in many contracts affected by the pandemic, where performance would require a party to violate a governmental order requiring a party or its workers to stay at home or closing businesses.

For the doctrine to apply, however, performance must not only be rendered substantially impossible, but the nonperforming party must also show that the parties did not anticipate and allocate the risk that performance would become impossible.  Wheelabrator Envirotech Operating Servs., Inc. v. Mass. Laborers Dist. Council, 88 F.3d 40, 44 (1st Cir. 1996).  Thus, where a contract contains language indicating that one of the parties will bear the risk of nonperformance, even a historically anomalous occurrence like the COVID-19 pandemic may not relieve that party’s burden. See Wiggins v. Warrior River Coal Co., 696 F. Supp.2d 1356, 1359 (11th Cir. 1983) (“impossibility” did not excuse commercial tenant from its lease payment obligations where its lease with real estate owner contemplated the risk that regulatory changes would prevent tenant from generating income at that location).

On the other hand, courts have found that, where a party’s own actions render performance impossible, the doctrine will not apply. Winchester Gables, Inc. v. Host Marriott Corp., 70 Mass. App. Ct. 585, 596 (2007).  It is therefore crucial to distinguish between contractual obligations that COVID-19 has rendered impossible to perform due to government restrictions and those obligations that were not met because individuals or businesses chose to terminate or postpone performance that would have otherwise still been physically and legally possible.

Finally, it should be noted that while the doctrine of impossibility may excuse a party from rendering its promised performance, the non-breaching party is often entitled to reimbursement or some other form of restitution to return it to the position it was in before the contract was entered. Thus, where a party has paid for goods or services prior to the occurrence that rendered the other party’s performance impossible, the former party would likely be entitled to a refund.  See M. Ahern Co. v. John Bowen Co., 334 Mass. 36, 38-39 (1956) (There may be “recovery in cases of excusable impossibility for such performance as has been received.”).  The availability and adequacy of restitution to a non-breaching party will turn on the specific circumstances of each case.

Frustration of Purpose

Even in circumstances where performance is both physically and legally possible, a party may in narrow circumstances potentially escape liability for nonperformance under the frustration of purpose defense.  This doctrine operates as a defense where a “fortuitous event” has “destroyed…the expected value of performance.”  Chase Precast, 409 Mass. at 374.   To determine whether the purpose of a contract has been “frustrated” so as to negate one party’s duty to perform, courts ask whether the “fortuitous event”—here, the COVID-19 outbreak—was the type of risk for which the parties “tacitly assign[ed] to the promisor by their failure to provide for it explicitly.” Id. If so, performance will be required. If not, the failure to perform will be excused.

Frustration of purpose is not applicable “merely upon a showing that it would be financially disadvantageous to perform” the contract.  NPS, LLC v. Ambac Assur. Corp., 706 F. Supp.2d 162, 177 (D. Mass. 2010).  The nonperforming party must show that an unforeseeable, supervening event has occurred, which the parties assumed would not occur and which renders performance of no value to the other party.  In the context of COVID-19, the question is whether the pandemic and its attendant closures and cancellations fall into the narrow category of risks that “are so unusual and have such severe consequences that they must have been beyond the scope of the assignment of risks inherent in the contract.”  Mishara Constr. Co. v. Transit–Mixed Concrete Corp., 365 Mass. 122, 128–29 (1974).  The answer to this question is likely to differ depending on the specifics of a given contract, including the types of goods or services being withheld due to the pandemic.  Where the party seeking performance can plausibly argue that the other’s performance still holds value in spite of COVID-19’s impact, the doctrine is unlikely to apply.

Conclusion

With COVID-19 infections rising and new restrictions on professional and personal activities being implemented daily, an unprecedented number of contractual obligations will likely go unmet in the weeks and months ahead.  The cancelled events, suspended services, unpaid rents, and delayed shipments will inevitably lead to complex disputes about who should bear the legal and financial consequences of a pandemic that neither party may have contemplated when their agreement was made.

Understanding the specific terms of your contracts and how the relevant legal doctrines are construed and applied in your jurisdiction is critical to protecting your rights, whether you are the party expecting performance or the party rendered unable to perform by COVID-19.  With effective counsel on these factors, you will be well-positioned to obtain a favorable resolution if and when a dispute arises.

For more information contact Kenneth N. Thayer or John G. O’Neill