The novel coronavirus (COVID-19) pandemic was unforeseeable, and this fact has presented numerous challenges for companies worldwide. Learn what you need to know if your company needs to invoke a force majeure clause in order to avoid liability for contractual non-performance.
A force majeure clause is an integral component of almost any commercial contract as it mitigates risk due to unforeseen circumstances for both parties. Specifically, a force majeure clause frees contracting parties from liability if an unanticipated event renders performance under the contract impossible. Events commonly covered by force majeure clauses include war, acts of terrorism, epidemics, fires, hurricanes, and other “acts of God.”
If a force majeure event occurs, either party can seek to avoid enforcement of its performance obligations to the extent that the event makes it impossible for that party to perform, provided that the non-performing party must undertake reasonable measures to mitigate the other party’s damages. An effective force majeure clause can save a company from logistical and financial harm should an unforeseen event take place; and, with the coronavirus pandemic grinding much of the world’s economy to a halt, many companies in the U.S. and abroad are carefully evaluating their options under the force majeure provisions of their commercial contracts.
4 Elements Needed for an Effective Force Majeure Clause
In order for a force majeure clause to be effective, it must be carefully drafted and not merely copied over as “boilerplate” from a template agreement. Specifically, there are four main elements required in order for a force majeure clause to serve its intended purpose of excusing non-performance in the event that an unexpected event such as the novel coronavirus (COVID-19) pandemic renders performance impossible:
- Detailed language
- Appropriate timing provisions
- Mitigation measures
1. Detailed Language
Courts are notoriously strict in their interpretation of force majeure clauses in commercial contracts. As a result, when negotiating force majeure clauses, parties should endeavor to include all possible events that could render performance under the contract impossible. A simple clause such as, “All acts of God will excuse parties’ obligations under the contract,” will not suffice. “Act of God” is not defined in common law, so it is prudent for contracting parties to list as specifically as possible all events that could potentially prevent them from meeting their contractual duties.
Of course, this is easier said than done, as it forces the parties to predict the unpredictable. To deal with this unpredictability, it is often wise to have individuals who are knowledgeable about the industry participate in the negotiations so that they can anticipate unlikely events that could render performance impossible. It should be noted that even though a force majeure event may be listed in a contract, the party seeking to avoid its performance obligations must actually be able to show that the event is the cause of its inability to perform.
With the recent COVID-19 outbreak, many companies are being forced to have their employees work from home, and many more have seen their supply chains disrupted. If these (or other) disruptions prevent companies from meeting their contractual obligations, and if they have “pandemic” or “disease” listed in their force majeure clauses, then they may have the contractual right not to perform. However, if an agreement does not list “pandemic” or “disease” as a force majeure event, then it will be necessary to determine whether the novel coronavirus pandemic qualifies as an “act of God” (assuming the force majeure clause covers “acts of God”). At present, this is a question that the courts are yet to answer.
2. Appropriate Timing Provisions
A properly-drafted force majeure clause will have time limits for when it can be invoked. Such time limits protect both contracting parties’ ability to function. Without time limits, each party is susceptible to the other invoking the force majeure clause as a defense to an alleged breach indefinitely. Not only should contracting parties place a time limitation on invoking the force majeure clause due to impossibility of performance, but they should also include a provision stating the contract will be terminated after a specific period of non-performance due to a force majeure event.
3. Mitigation Measures
Though not strictly necessary from the perspective of legal enforceability, mitigation measures should be addressed when negotiating a force majeure clause a well. In the United States, if a force majeure event substantially interferes with a party’s ability to perform, that party is required to undertake mitigating efforts to limit the damages incurred by the other party. For example, if a U.S.-based company relies on a Chinese factory to produce parts for its supply chain and the factory shuts down due to factors related to the novel coronavirus (COVID-19) pandemic, the U.S.-based company must attempt to procure parts from a different factory outside of China (unless the pertinent agreement limits its choice of suppliers). If it is unable to find an alternate supplier due to the widespread economic impacts of the pandemic, only then can it invoke force majeure.
In order to add greater certainty to their agreement, contracting parties can specify whether and to what extent mitigation efforts are required. To do this effectively, they should understand constraints of their respective industries and thoroughly evaluate all potential alternatives for continuing to perform should a force majeure event occur. Unless otherwise agreed, a party is not expected to undertake extreme financial or logistical efforts to mitigate the effects of a force majeure event; but, generally speaking, both parties should be prepared to undertake reasonable mitigation efforts should the situation arise.
As a related consideration, when invoking force majeure clauses during the novel coronavirus (COVID-19) pandemic, companies should determine whether their business interruption insurance provides coverage. Indemnification and other liability-shifting provisions can come into play as well, and companies should work with their legal counsel to thoroughly assess all potential legal options and ramifications.
A well-drafted force majeure clause will include specific notice requirements in order to invoke its protections. Additionally, it is critical that a party seeking to avoid contractual liability due to a force majeure event immediately start documenting how the event has rendered its contract performance impossible. Maintaining detailed documentation can be critical in the event of a dispute as to the force majeure clause’s applicability. On the same note, if a party is on the receiving end of force majeure notice, it should carefully evaluate whether the agreement’s force majeure clause applies and whether its counterparty has timely provided the requisite notice. If it has, then the options that are available may be limited (although it may be in both parties’ best interests to negotiate a mutually-agreeable plan for moving forward during the novel coronavirus pandemic). If it has not, then it will be necessary to evaluate potential next steps and decide on a strategy for moving forward.
When There is No Force Majeure Clause
Most commercial contracts contain force majeure clauses, but some do not. When an event such as the novel coronavirus (COVID-1) pandemic significantly disrupts business operations, parties to a contract without a force majeure clause must rely on the “frustration of purpose” doctrine, the “impossibility” doctrine, or other common law protections if and to the extent that they are available in the relevant jurisdiction.
The frustration of purpose doctrine provides that a court may excuse both parties from their performance obligations when performance of a contract becomes legally or physically impossible or the principle purpose of the contract is “frustrated” without fault on the part of either party. Similar to a force majeure clause, in order to rely on the doctrine of frustration of purpose, a party must show that the relevant event was unforeseen and has rendered performance of the contract impossible or futile.
Though asserting frustration of purpose can have very similar effects to invoking a force majeure clause, it generally is not prudent for entities to rely on the doctrine should a major event such as the novel coronavirus pandemic occur. Proving that the principle purpose of a contract has been frustrated is often difficult to prove, and the courts tend to view these arguments skeptically, particularly when the party seeking to invoke the doctrine had the ability to contractually allocate risk but chose not to. Additionally, for the present circumstances, there is very little case law on whether a pandemic qualifies to excuse contract performance under the frustration of purpose doctrine.
Moving Past the Novel Coronavirus (COVID-19) Pandemic
Companies dealing with business interruptions due to the novel coronavirus (COVIC-19) pandemic cannot retroactively modify their existing contracts to adopt more-detailed force majeure clauses that address the pandemic specifically. An event must be unforeseen in order to constitute force majeure; and, with the COVID-19 outbreak, the cat is already out of the bag. However, companies can examine other ways to address the economic and commercial effects of the outbreak and negotiate mutually-agreeable resolutions. By definition, companies are seldom, if ever, prepared for force majeure events. As a result, when such an event occurs, understanding the options that are available can be critical to a company’s survival.
Speak with a Commercial Contract Attorney at Oberheiden P.C.
Do you have questions about invoking a force majeure clause during the novel coronavirus pandemic, or are you dealing with a contract compliance issue without a force majeure clause to invoke? To discuss your options with a commercial contract attorney at Oberheiden P.C., call us at 214-692-2171 or request a complimentary consultation online today.