Mar 24, 2020

Force Majeure in the Time of COVID-19 – FAQS for the Middle Market Executive

Force Majeure photo

In these exceptional times, to paraphrase the Scottish poet Robert Burns, “The best laid plans of mice and men / Often go awry.” The millions of contracts, agreements, purchase orders, arrangements, and customary practices, and the broad-scale coordination that underpins the global economy and supply chain, have become fractured in a matter of weeks due to the sudden appearance of COVID-19. The widescale, hopefully temporary, waves of disruption have left many businesses casting about for anything to grab hold of to help steady their ships. It is in this context that the much-neglected Force Majeure clause (“FMC”) has had a sudden renaissance.

What does Force Majeure mean?

The term derives from French and basically means “major force.” In contract law, it is an outside force or circumstance that makes delivery or performance under a contract practically impossible and excuses delays or failures. Whether and how Force Majeure applies in any specific context depends on the written contract, the circumstances giving rise to a claim under the FMC, and the jurisdiction and laws governing the respective parties to the contract.

What about a Purchase Agreement? Can Force Majeure save me from closing this deal? Can I make the other side close this deal?

Similar in spirit to the FMC, is the Material Adverse Change provision in deal documents. These clauses are in most business purchase agreements whenever there is a delay between signing and closing and are typically found as part of the closing conditions. Many of the same considerations discussed with respect to the FMC equally apply to Material Adverse Change clauses. How the term is defined, who may exercise it and under what circumstances, depend primarily upon the written agreement, as well as in which jurisdiction and under what laws the clause is to be enforced. Just as an anecdotal observation, the frequency with which both clauses have been called upon in recent weeks eclipses the last several years.

What if I do not have a Force Majeure clause in my contract?

It is not uncommon that contracts may lack a FMC. They may appear near the end of an agreement, sometimes hidden in the miscellaneous section, and discarded as part of the boilerplate that the parties do not heavily negotiate, if at all. They may be viewed as extremely unlikely to ever be needed, but like insurance can be the most important thing to have when it is actually needed. Others may view it as a fool’s errand to try to contract around something that itself supersedes the power of contract. Notwithstanding, in order to rely on Force Majeure one needs a FMC in their contract.

In the absence of a FMC, a party may be forced to rely on non-contractual common law doctrines such as impossibility and frustration of purpose in order to excuse non-performance under a contract. Despite being grounded in English common law, American courts have so narrowly construed these doctrines and set the bar so high on proof, that they should be relied upon only as a last line of defense. For business contracts that relate to the sale of goods (but not services), Section 2-615 of the Uniform Commercial Code has been adopted by all 50 states in various forms and provides rules for notice, mitigation, and excuse of delay and non-performance where the express provisions of the contract do not provide for an alternative rule.

How is my Force Majeure clause interpreted?

The FMC will contain a list of words that describes various Force Majeure events. A typical example might contain: acts of God, fire, flood, storm, revolution, acts of terrorism, riot or civil commotion (but excluding strikes and industrial disputes of the affected party or a subcontractor of such party), or any other event beyond the reasonable control of a party. What is within any particular list may be customized to the situation. For
example, if a supplier is located in New Orleans then the list may include hurricanes, while a supplier in Maine may include snowstorms. The need for specificity, on the one hand, should be balanced against listing so many terms so that a court would presume that if a term is left off it was intentional (e.g., if there are 15 potential events listed in the FMC, but none of them refers to disease, then the risk of disease may have intentionally omitted and is not applicable).

The terms “pandemic,” “epidemic” and “outbreak of disease” may be part of the catalogue of Force Majeure events, but they are less commonly seen than others. This will probably change. Each of these terms has a specific meaning, from the most restrictive definition – “epidemic” which means the widespread occurrence of a disease in a local community, to the phrase “outbreak of disease” which is so ambiguous as to cover a multitude of potential scenarios. “Pandemic” means the presence of a disease throughout a country or the whole world. Now that the World Health Organization has categorized COVID-19 as a pandemic, that should lend support to parties seeking to enforce FMC clauses in contracts that contain the term. Where a FMC does not refer to disease, the question is whether catch-all phrases like “acts of God” and “events beyond the reasonable control of a party” may be extended in meaning to cover something like COVID-19, or whether they only denote similar events as are already listed (e.g., the meaning of storm covers tornadoes, hurricanes, ice storms, storm surges). Cases that turn on this kind of interpretive alchemy will depend as much on the judge, jurisdiction, and equities of the case as anything written in the contract.

Is my Force Majeure clause applicable?

Taking a contractual provision and applying it to a set of facts is more an art than a science. However, several considerations are at the forefront when analyzing a FMC:

Is performance under the contract impossible, or merely difficult, inconvenient or unprofitable?

If Party A agreed to sell widgets to Party B for $20/widget when the input costs were $15/widget, but now there is a resource shortage so the input costs are $21/widget, or the resources are unobtainable except Party A can acquire widgets from another producer at $21/widget that can be resold to Party B, then it is not likely on these limited facts that a genuine Force Majeure event exists. It is not impossible for Party A to perform under the contract, only more difficult and not as profitable as previously projected.

Is the alleged Force Majeure event self-created?

A common carve-out from the FMC is a strike at the affected Party. The idea is that the contracting party should manage its labor relations so that a strike does not occur as would delay performance. However, a railway strike may prevent a party from shipping its goods to a counterparty, in which case a Force Majeure event may well exist. Likewise, in a possibly very current scenario, if a company voluntarily sends its workforce home because of COVID-19, it is less likely to be able to avail itself of a Force Majeure excuse than a company facing a mandatory lockdown order from government authorities.

Is there a link between the Force Majeure event and the failure to perform?

Based on facts and circumstances, if a court finds that a party would not have performed regardless of the existence of the Force Majeure event, or is only using the existence of a Force Majeure event to evade performance, that the breaching party would still be held liable. On a set of less devious facts, there still needs to be a link between the Force Majeure event and the non-performance. Certain hightech, modern service economy functions may be able to be performed at home, in fact, many such workers routinely work from home. In that case, unless the workers themselves come down with the coronavirus, can COVID-19 really be a Force Majeure event?

What performance is suspended?

Imagine a company that provides both goods and services, or varying mixtures of each. It is possible that the assembly line may be closed off and no new products are being shipped, so that part of the relationship may be suspended under Force Majeure. However, services related to supporting the products may be entirely done in a virtual environment or remotely, from workers sitting in their home offices, in which case performance under these provisions in the contract may not be suspendable.

Another common carve-out from the FMC is payment of fees. Even if there has been a Force Majeure event that applies to the balance of the contractual relationship, payment under the contract for goods and services rightfully provided may not be delayed or suspended. A best practice is to consider adding this carve-out to the FMC to avoid an argument later over whether the payment provisions in the contract are also affected by the determination of an event of Force Majeure.

How do I enforce my Force Majeure clause?

The FMC is a creature of contract, so it largely depends on the terms of the contract and particularly the notice provisions – another too often neglected clause. It may be email, phone call, overnight, certified mail or some other method of delivery, so long as it complies with the terms of the contract. There may also be timelines associated with enforcing the FMC, the duration of the event, and allocation of recourses during the event (e.g., can I prefer supplying my own needs, or the requirements of my best customers, or am I required to treat all customers equally and ship product to them pro rata as available). Another contractual provision is whether the existence, projected duration, or extent of the Force Majeure event may give rise to the rights to terminate the contract by either party. Without a strong or well-defined FMC, the suggested best practice is to put things in writing and be clear and precise about why and how the purported Force Majeure event is affecting the contractual relationship, and any attempts to mitigate.

Now that we are dealing with COVID-19, may I add a Force Majeure clause or rely on my old one for acceptance of new orders?

Like many things in the law, yes and no. There are two conflicting principles in this case – (1) the clear terms of a contract should control, and (2) a Force Majeure event should not be foreseeable at the time of the contract. If a new FMC contains language about disease, epidemic or pandemic, it is questionable and depends on the jurisdiction whether the current outbreak of COVID-19 (and any new development related to it) may be a Force Majeure event. However, if the contract specifically refers to COVID-19 and details the circumstances under which COVID-19 may apply, such a clause is more likely to be effective and achieve its intended purpose. Companies should review their current contracts and terms & conditions, as well as any new purchase orders, to confirm that they are still protected by the FMC for any subsequent orders that they accept.

In conclusion, for the foreseeable future, the FMC will no longer be relegated to an afterthought. It will be meticulously crafted and fervently negotiated, at least until the next string of good fortune lulls professionals and their clients into a sense of complacency. Whether the increased use and reliance on the FMC will result in greater resilience in commercial relationships or fragility remains to be seen, though one can hope for the former. Even the proverbial field mouse of the Burns’ poem deserves a break every now and again.

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