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COVID-19: Force majeure, material adverse change clauses and related common law contract defenses under New York law

Publication April 2020

The impact of the COVID-19 pandemic is increasingly impacting business operations, including the ability of companies to meet their contractual obligations. Whether your business is having such difficulty or trying to enforce performance under an agreement, it is important to understand the concept of force majeure, material adverse change clauses and related contractual defenses that could provide a basis to excuse performance. This article explores the parameters of these contract clauses under New York law, the common law doctrines of impossibility and frustration, as well as impracticability under the Uniform Commercial Code.

Force majeure clauses

"Force majeure" comes from the French phrase "superior force," and commercial contracts often contain a "force majeure" clause, the purpose of which is to relieve a party from its contractual duties when its performance has been prevented by a force beyond its control. These clauses provide parties with a way of allocating risk based on the circumstances identified in the clause. The language of these clauses varies in detail and in scope. The specific language used will be critical to determining the scope and applicability of force majeure clauses, which generally are construed narrowly under New York law.

Commercial contracts often include an "act of god" specifically among the circumstances that would trigger a contract's force majeure clause, while inclusion of a "pandemic" or an "epidemic" among the specified circumstances is less common. Unfortunately, New York case law is silent on whether a pandemic or epidemic would qualify as an "act of god," which term often has been applied in connection with natural disasters. New litigation is certain to test the scope of what is meant by an "act of god" and similar terms in the coming weeks and months.

In light of the number of government-imposed restrictions recently put in place, the inclusion of "government actions" among the list of circumstances enumerated in a force majeure clause is likely to provide parties a strong basis to seek to excuse performance. Interpreting this type of contract language will be critical to determining the applicability of force majeure clauses because much of the difficulty in conducting business for many industry sectors is not as a direct result of COVID-19 itself, but rather a result of government actions taken in response to the outbreak, including stay-at-home orders, mandated business closings and travel restrictions, which have deep impact on business operations. Parties should bear in mind that there may be more than one specific force majeure event that impacts the performance due under the contract.

Some force majeure clauses also include catch-all language, which, after listing specific events, may have broad phrasing such as "any other event beyond the reasonable control of a party" or narrow phasing such as "any other like events." New York courts construe catch-all phases narrowly, and will look to the specific language used to determine their reach. Broader catch-all language likely will assist a party in establishing a force majeure event connected to the COVID-19 pandemic. However, if the contract uses narrower language, the force majeure events that are described in the contract will play an important role in determining whether the force majeure clause will apply to events connected to the novel coronavirus.

Impracticality or unanticipated difficulty is generally not enough to excuse performance under a force majeure clause, so the party claiming force majeure must demonstrate its efforts to perform its contractual duties despite the force majeure event. It is also critical to understand whether the contract imposes prerequisites for invoking the force majeure clause, such as a notice requirement, to ensure that contractual requirements are followed.

Material adverse change or event

Another common contractual clause to bear in mind at this time is a material adverse change or event (herein, "MAC") provision. Depending on the language of the contract, MAC clauses will suspend or otherwise change performance obligations due under a contract after a material adverse event has occurred. In general, New York courts will read a MAC clause in the context of the entire agreement and in conjunction with other evidence of the parties' intent.

In particular, New York courts will consider whether the alleged MAC was the type of event contemplated by the parties at the time they executed the contract, whether the MAC was within the control of the parties, and the magnitude of the impact from the MAC on the relevant party's business. New York case law addressing MAC clauses is limited, and we are not aware of any New York cases addressing these clauses in the context of an epidemic or other health crisis and its associated effects. Interestingly, courts applying New York law have considered factors such as duration (whether the condition was temporary or durable) in assessing the applicability of MAC provisions, which may indicate that the longer the COVID-19 crisis and its resulting economic impact continue, the more likely it is that a MAC will be found. Conditions such as the duration and magnitude of the MAC will be viewed in the context of the parties' transaction and will influence any finding of the impact on the business of the party relying on the MAC provision.

Availability of common law defenses

Whether or not your contract has a force majeure clause or a MAC clause, there are additional doctrines under New York law that should be considered to determine whether performance is excused, including the common law doctrines of impossibility and frustration.

Impossibility

The doctrine of impossibility excuses performance of a contract when an unforeseeable event destroys the subject matter of the contract. Impossibility is a common law alternative and is not available where the parties' contract contains an express force majeure clause. Historically, New York courts have applied this doctrine rarely and generally recognize only "acts of god, or law" as a basis for successfully invoking it. Again, the specific circumstances of the contract and events preventing performance will be important to the inquiry, but there is some precedent in New York finding that government orders may qualify. For example, a New York appellate court held under this doctrine that a government terminating striking air traffic controllers just a few days after the strike started was an unforeseeable event that excused performance under an insurance contract.

In applying the doctrine of impossibility, it may be important to assess whether the promisor is at fault, and whether the promisor challenged the government action or assumed the risk of performance, among other circumstances. It also is important to note that severe economic hardship is not a basis for an impossibility defense because New York courts view economic hardship as foreseeable.

Frustration

The common law doctrine of frustration of purpose applies to void a contract when an event occurs that is (1) unexpected and unforeseeable and (2) the event destroys the reasons for performing the contract, such that entering the contract would have made little sense. Essentially, the contract must be virtually worthless to the affected party.

Often, frustration of purpose is used as a defense with respect to contracts for unique services. For example, a New York court determined that a contract enrolling a student at a dance school was frustrated when she was forced to withdraw due to serious illness, even though the contract included a clause entitling the dance school to keep the student's tuition money if the student withdrew. Although the dance school could still perform its part of the contract by providing dance instruction, the court determined that this was immaterial because the purpose of the contract, which was to study dance at the school, was frustrated entirely by the student's illness. Thus, for parties who hold unique contracts that will be fundamentally disrupted by the COVID-19 pandemic, frustration may provide an avenue for relief.

The doctrine of frustration is narrowly applied, but it might be more accessible than the doctrine of impossibility because it is not necessary that the contract be impossible to perform in order to invoke the doctrine of frustration. It also may be used even where a force majeure clause is present in the parties' contract.

Impracticability under the Uniform Commercial Code

Contracts for the sale of goods, which are subject to provisions of New York's Commercial Code, may give rise to additional defenses. More specifically, Section 2‑615 of that code excuses a seller from timely delivery of goods where the seller's performance has become commercially impracticable. Three conditions must be met: (1) a contingency must occur; (2) performance must thereby be made impracticable; and (3) the non-occurrence of the contingency must have been a basic assumption on which the contract was made.

New York courts have recognized commercial impracticability in light of government orders in the context of trade embargoes and environmental standards regulation. We are not aware of any New York court that has recognized the defense of impracticability pertaining to a government-ordered business closure for public health reasons. Nonetheless, there may be circumstances where this doctrine is appropriate where the impact of COVID-19 has made a seller's performance commercially impracticable. Again, the specific circumstances leading to the non-performance will be critical to determining whether a seller can avail itself of the excuse provided by Section 2‑615.

Conclusion

Parties to contracts with and without force majeure and MAC clauses should carefully consider their options if those contracts are impacted directly or indirectly by the COVID-19 pandemic. The applicability of force majeure clauses, the common law doctrines of impossibility and frustration, as well commercial impracticability, will be highly dependent on the language used in the contract and the specific circumstances at play. Moreover, the party seeking to excuse its performance may be required to take certain actions to bolster its position before ceasing performance.

Norton Rose Fulbright would be happy to help you navigate the scope of your business' contractual obligations in light of the impact of disruptions stemming from COVID-19.


Special thanks to law clerk Nicholas Poe (New York) for his assistance in preparing this content.



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