The coronavirus pandemic has caused business disruptions on multiple levels: for suppliers, individual businesses, landlords, municipalities and end customers.
Take, for example, a raw-materials supplier that can’t deliver its carbon fiber to a skateboard shop on time because of factory closures in China. Or a restaurant owner who can’t access her property because of a government shutdown. Is she obligated to pay rent?
For businesses, these issues pertain to a legal term that many CFOs are learning more about: force majeure. Understanding this concept and how your existing contracts are structured is important as you work with suppliers, customers and other stakeholders.
Brainyard reached out to attorney Mark Del Bianco to find out how force majeure clauses might affect your company. Del Bianco’s firm focuses on cloud, telecom and regulatory and privacy law, among other specialties.
Grow Wire: First, what is force majeure?
Mark Del Bianco: Force majeure is a French term that literally means “superior force.” In contract law, the term refers to an event that is beyond the control of the parties and whose occurrence prevents one or both parties from fulfilling their contractual obligations in whole or in part on a timely basis.
GW: What are other important terms to understand?
MD: “Impossibility of performance” is a term for when one party can be released from a contract due to unforeseen circumstances that render performance under the contract terms impossible.
GW: Do businesses commonly have these clauses in their contracts with upstream suppliers?
MD: In most cases, yes. For example, force majeure clauses have long been included in international contracts for the sale of goods because of the additional risks posed by international operations, such as currency fluctuations or supply chain interruptions. Thus, small and mid-size businesses that are purchasing from larger suppliers, or suppliers in another country, will usually find that the contracts they are signing have force majeure clauses.
Force majeure clauses have also long been common in contracts in certain domestic industries, such as communications services, finance and construction. Since the disruption caused by the 9/11 terrorist attacks and natural disasters, such as Hurricanes Katrina and Sandy, force majeure provisions have been included in a wider variety of other U.S. commercial contracts.
GW: Conversely, do most businesses commonly have these clauses in their contracts with customers?
MD: The answer is hopefully yes, but this will depend on the sophistication of the specific business and of the attorneys who draft its customer agreements.
GW: Do you believe COVID-19 represents a force majeure event? And if so, is that nationally, on a state-by-state basis or by industry? Or will it vary by contract?
MD: Determining whether the pandemic (or federal, state or local governments’ responses to it) constitutes a force majeure event requires a fact-specific analysis and depends on a variety of factors. The two most important are the specific language of the force majeure clause at issue and the state law that governs the contract.
The scope of a force majeure clause depends on its express language and, under nearly all states’ laws, that language is to be narrowly construed to minimize actual force majeure situations. So the first thing a business or its lawyer needs to do is carefully review the language of the applicable clause. Does it clearly refer to epidemics, pandemic, disease, plague or health emergencies? Does it identify impossibility of performance or the acts of governmental authorities as force majeure events? Does it identify other types of events that might be applicable?
If the answer to any of these questions is affirmative, what does the clause say about when non-performance is permissible or excused?
The devil is in these details, for there is no uniform rule as to when a force majeure clause excuses performance.
GW: How would a business demonstrate that COVID-19 had a “material impact” such that it can invoke the clause?
MD: This will depend on the language of the clause. For example, a mere increase in a party’s cost will not usually excuse the party’s performance; courts will generally require a finding that performance is impossible. And, it may be important to distinguish between impossibility of use and impossibility of performance.
For example, many commercial real estate contracts provide that the inability of a lessee to use the premises is not a force majeure event that makes it impossible for the lessee to pay rent. Thus, unfair as it may seem, many businesses may find themselves bound to pay rent for premises they cannot access (either practically or legally or both) during the outbreak.
If there is no specific language in a force majeure clause, most state laws will require that there be a causal relationship between the force majeure event and the party’s nonperformance. Assume, for example, that a restaurant business was closed for three months by a governor’s order, and a fishing boat charter business located next door was not closed down but suffered a 90% drop in business because the governor closed so many other nearby businesses and urged people to stay home. The restaurant would have a much stronger case for invoking any “act of governmental authorities” language in its force majeure clauses.
GW: Are there proactive steps a supplier can take to minimize the financial impact of customers invoking force majeure clauses, such as insurance or offering to extend or improve terms?
MD: At this point, there are probably not a lot of proactive steps that a supplier can take to improve its legal position. It is too late to insert or amend the force majeure clauses in existing contracts if they don’t already cover governmental activities or an epidemic/pandemic.
So any proactive steps would have to be taken on the business side. I would recommend that suppliers review the force majeure provisions in their customer contracts now in order to identify any potentially problematic language that customers could use to make force majeure claims. Once those situations and customers are identified, suppliers should develop possible responses in the event that customers exercise the clauses.
Suppliers should also consider taking proactive actions to forestall key customers from invoking force majeure, such as offering to extend or improve their service or payment terms.
GW: What if a business receives a force majeure notice from a customer and wants to contest it? What sort of grounds might help it make a case?
MD: First, any supplier should read the contract clause carefully and see if the customer has followed the clause’s requirements for notice of a force majeure event. The supplier should also check to see if the clause lists the specific type of event claimed to be preventing the customer’s performance. If it does not, then you may have an argument to contest it.
A second possible approach is to determine whether state law imposes additional requirements. Numerous states, for example, require that the event be unforeseeable, even if that is not a requirement spelled out in the contract. Some states, such as New York, also require that the party seeking to invoke the force majeure clause must attempt to perform its contractual duties despite the event.
Finally, the supplier should consider carefully whether the claimed force majeure event is actually the cause that makes it impossible for the customer to perform under the contract.
For example, here in the United States, a national state of emergency has been declared. The governors of most states have imposed orders that, to a greater or lesser degree, restrict residents’ movements and close numerous non-essential businesses, such as bars, restaurants, cafes and theatres. Other cities and counties are currently under similar government-imposed lockdowns. While all of these orders differ in their legal effect and in the scope of businesses affected, none to my knowledge prevent customers from making payments due under a contract and, except for those providing for rent abatement, few specifically relieve a party from a contractual obligation to make payments.
If a customer’s major duty under a contract is to pay for the goods or services provided, a supplier ought to be able to challenge a claim that a customer is prevented from performing that duty by a governmental action. One could argue in that situation that, if there is impossibility at all, it results directly from a business downturn that is caused by the governmental action, and only indirectly from the action.
GW: Are there factors that might make a party more successful in invoking a force majeure clause?
MD: The important factors for an invoking party are the flip side of those mentioned in the preceding answer. First, any party, whether supplier or customer, should make sure that it follows the clause’s requirements for notice of a force majeure event. The party should also confirm that the clause lists the specific type of event that it intends to claim prevents its performance.
The party should also develop an argument demonstrating that the force majeure event is the cause that makes performance under the contract impossible. Ideally, the party will be able to show that the event was the direct cause, but if that is not possible, a plausible showing that it is at least an indirect cause will be necessary (but perhaps not sufficient).
In the example above, if the charter boat business was not directly prohibited by the applicable government orders from offering charters, it would probably not prevail on a governmental action force majeure claim unless it could demonstrate that the governmental actions had the inevitable but indirect effect of making it impossible to operate the business.
GW: What didn’t we ask that a business should know?
MD: They should also examine possible common law solutions. Many state commercial laws include concepts similar to force majeure, such as the doctrine of impossibility or frustration of the intent of a contract. Under the former, a party may be relieved from a contract in very limited circumstances if its performance is made impracticable or impossible, through no fault of that party, by the occurrence of an unanticipated intervening event. The latter doctrine may excuse a party’s performance when the expected value to the party seeking to be excused has been destroyed by the intervening event.
Another alternative is to see if their business interruption insurance covers any losses. If not, it is too late to insure against the current pandemic, because any new business interruption insurance policy a business could obtain today would almost certainly exclude pre-existing situations such as the coronavirus outbreak and related government actions. But the insurance may prevent similar future losses.
Mark C. Del Bianco specializes in law for the digital age. His firm, which is based in Kensington, Md., helps clients in the telecommunications, cloud services, drone and related industries reduce risks, expand their businesses and solve legal problems. His U.S. and international clients include mobile app developers, data centers, metropolitan area fiber networks, broadband service providers, satellite resellers, and channel partners.
Many of the firm’s projects are transactional, such as negotiating agreements for data center space or cloud services. Mark also represents clients in a variety of license transfer, enforcement, and rulemaking proceedings at the federal (FCC) and state levels, and in arbitrations and litigation involving communications-related business disputes.
Contact him at firstname.lastname@example.org.