In this Orwellian time of global pandemic, worldwide commercial interruption and governmental indecisiveness, business owners and employers are scrambling to implement emergency plans against an unknown and largely unforeseeable future. Given the emergency nature of this pandemic and its unprecedented impact on businesses worldwide, few owners have had the luxury of a focused look at how COVID 19 will impact previously settled areas of contract law. This article attempts to provide a brief outline of consideration points.
I. Force Majeure
A. Don’t Assume Force Majeure Is Applicable to Your Situation
A force majeure clause is a contract provision which excuses one (unilateral) or both (bilateral) parties’ performance when circumstances arise beyond the parties’ foreseeable control, thus making performance of the contract impractical or impossible. Its wording identifies the triggering events invoking the clause. Assuming your contracts contain a force majeure clause, contract performance may be excused based upon those events itemized in the clause, typically including acts of God, labor shortages, strikes, or governmental orders.
To effectively use a Force Majeure clause, it must:
a. Be included in the contract and interpreted according to its specific language
b. Identify specific applicable triggering events
c. Be narrowly applied by the courts and strictly construed against its specific contract language,
d. Be supported by:
i. facts showing performance has become impossible, not merely more difficult or expensive, and
ii. facts establishing the triggering event directly caused the inability to perform.
Thus a key issue in determining whether a party can successfully invoke its protection under the COVID19 scenario is whether your contract clause lists “epidemic”, “pandemic”, or “emergency actions” as a triggering event. In addition, listing “government acts” as a triggering event may also apply. However, where these clauses are narrowly construed by the courts, lacking such verbiage you may have a problem claiming a force majeure defense.
Additionally, force majeure clauses typically require prompt and specific form of notice by you or your company to all other parties to the contract that a triggering event may have occurred, even before the total impact of the event is known. Failure to appropriately comply with the form and timing of your contract’s notice requirements may render your force majeure defense useless.
Finally, even the best structured force majeure clause will not excuse you from your own negligence or failure to anticipate foreseeable risks and take appropriate measures to avoid same.
II. Uniform Commercial Code and Equity Defenses
Lacking a force majeure defense, the business owner should also consult with legal counsel regarding the defensive impact of other statutory or common law defenses. These include the statutory defense of “impracticability of performance” under each state’s Uniform Commercial Code, and/or the common law doctrines of impossibility or impracticability of performance.
A. Uniform Commercial Code (UCC)
Section 2-615 of the Uniform Commercial Code, adopted in some manner and form by most states, is a specific statutory code which applies to the sale of goods and some services, and which excuses a seller’s performance where “that performance has been made impracticable by the occurrence of a contingency, the non-occurrence of which was a basic assumption on which the contract was made”. While not a total defense to non-performance, the clause permits a reallocation of performance among customers “in any manner which is fair and reasonable”.
B. Common Law Impossibility or Impracticability of Performance
The common law “impossibility of performance” defense applies where there is literally no possible way for a party to perform its contract duties. An example would be the delivery of alcohol at the time prohibition was implemented, where such delivery was made illegal by legislative authority. By analogy, certain manufacturing operations or other similarly situated businesses deemed “non-essential businesses” under the COVID19 situation could claim an “impossibility of performance” defense based upon government ordered shutdowns prohibiting employees from working.
In comparison, the common law defense of “impracticability” applies where performance is still possible, but would be extremely burdensome for the party whose performance is due. Therefore, “impossibility” of performance can be determined objectively, while “impracticability” is a subjective and fact detailed analysis requiring proof:
- There was the occurrence of a condition, the nonoccurrence of which was a basic assumption of the contract,
- The occurrence made contract performance extremely expensive or difficult
- The difficulty was not anticipated by the parties to the contract
III. Insurance Coverages
Many business owners may be currently relying on the mistaken belief that their economic losses created by COVID19 impacts will be covered by their Business Interruption / Loss of Income insurance policies. While this analysis will be policy specific, such reliance is most like misplaced.
Business interruption coverage is defined by the policy, and typically is “triggered” only after the occurrence of “a direct physical loss or damage” of some type. Only when that occurs is “actual loss of business income” covered during the suspension of operations while restoring the property. While state and fact specific, the “physical loss or damage” requirement” typically does NOT exist under the COVID 19 scenario, lacking arguments of product damage, spoilage or contamination which can be directly tied to COVID 19 delays or disruptions.
In addition, following the SARS and H1N1 flu outbreaks earlier in this decade, many insurers contractually limited their risk exposures by inserting “virus and bacteria” exclusion clauses to their policies, thus explicitly refusing to cover losses related to viral or bacterial causes.
Recognizing the potentially devastating impact of this exclusion under COVID 19, various members of the House Small Business Committee on March 18, 2020, asked the American Property Casualty Insurance Association, the National Association of Mutual Insurance Companies, the Independent Insurance Agents and Brokers of America, and the Council for Insurance Agents and Brokers to make financial losses related to COVID 19 and other infectious disease related losses covered under existing commercial business interruption policies. The Associations immediately replied by letter indicating that their commercial insurance policies, vetted and approved by state regulators, defined applicable exposures and thus “do not, and were not designed to provide coverage against communicable diseases such as COVID 19”.
IV. Risk Management Suggestions
i. Review and Protect Any Force Majeure Defenses
a. Immediately review your contract clauses with legal counsel
b. Be sure to provide all applicable third parties with notice of force majeure triggering events, in the time and manner required by contract;
c. Keep written communication lines open with all third parties, including agreements as to mutually acceptable substituted performance terms and conditions, extended performance deadlines, contingencies, etc.
d. Keep detailed records in a centralized location related to non-performance, including but not limited to:
i. Timeline of events leading to non performance
ii. Relevant government orders and pronouncements
iii. Progression of Force Majeure events (dates and description)
iv. Efforts to avoid the event or to find alternative means for performance,
v. Negotiation efforts to find mutually acceptable solutions, and
vi. If applicable, detailed records of damages or losses incurred specifically related to the COVID 19 non-performance issues.
ii. Consider Impossibility or Impracticability of Performance Defenses
a. Consult with legal counsel regarding facts and documentation supporting this approach
b. Be sure to provide all applicable third parties with notice of potential triggering events making performance impossible or impracticable, in the time and manner required by contract;
c. Keep written communication lines open with all third parties, including agreements as to mutually acceptable substituted performance terms and conditions, extended performance deadlines, contingencies, etc.
d. Keep detailed records in a centralized location related to non-performance, including but not limited to:
i. Timeline of events leading to non performance
ii. Relevant government orders and pronouncements
iii. Progression of Force Majeure events (dates and description)
iv. Efforts to avoid the event or to find alternative means for performance,
v. Negotiation efforts to find mutually acceptable solutions, and
vi. If applicable, detailed records of damages or losses incurred specifically related to the COVID 19 non-performance issues.
iii. Consult with your insurance agent or broker about existing coverages
iv. For immediate concerns, consider submission of any contract issue to mediation for a stipulated contract modification solutions, or alternatively file for a declaratory judgment action in court
V. Other Legal Issues
Other legal issues currently discussed under the COVID 19 scenario is the interference with real and personal property owners’ access to property under the current governmental restrictions and social distancing orders. In particular, those establishments offering bailment services (i.e. storage facilities, animal and equine training and boarding stables) have been subject to government restrictions to access, public gathering limits or, in some circumstances, orders to completely bar access by owners to their personal property for the duration of government ordered closures. Thus we find many players in a fundamental conflict between: (1) owners’ rights to real and personal property, versus (2) governmental exercise of police power. How does this shake out?
A. Conversion
Owners prevented from access to their property may argue that the facility barring their access has committed “conversion” of their property. Conversion is defined as an intentional tort involving the “taking with the intent of exercising over the chattel [property] an ownership inconsistent with the real owner’s right of possession”. A civil court cause of action, “conversion” is similar to larceny or theft in criminal law. Negligence or mistaken belief is not an excuse, and conversion is subject to both actual and punitive damages.
However, a defense to conversion is any interference with property which arises under the “authority of law”. In the COVID 19 situation, the bailor (that person controlling the property) may argue that the exercise of police power in governmental restriction orders provides a total defense to their actions. While all situations will be fact specific, it’s likely this defense will hold.
B. Exercise of Police Powers
Under the U.S. Constitution, “police power” is defined as the capacity of states, and derivatively local governments, to regulate behavior and enforce order within their territory for the betterment of the health, safety, morals and general welfare of their constituents. These powers are defined in each jurisdiction by the legislative body, which determines the public purposes that need to be served by legislation.
Governmental entities thus have the power to compel obedience to these laws through whatever measures they see fit, provided these measures do not infringe upon any of the rights protected by the federal or state constitutions AND those laws are not unreasonably arbitrary or oppressive. Methods of enforcement can include restrictions, legal sanctions, and other physical means.
In the vast majority of cases addressing police power conflicts with individual rights and freedoms, the courts typically honor the existence and exercise of police power more frequently than attempting to mark boundaries or prescribe limits to its exercise. Typically, if the government can identify a legitimate legislative purpose with regulations applied equally to all under like circumstances, the exercise of that power will withstand judicial challenge.
While fact specific, property access restrictions arising under government ordered COVID 19 limits will most likely be legally supported given the extremely contagious nature of the coronavirus and the various orders restricting, limiting or barring the activities of citizens to minimize and contain exposure.
© Denise E. Farris. (April, 2020). This article may not be reprinted or reproduced in any manner without the consent of the author. This article is not intended to be the provision of legal advice. For fact-specific questions, refer to an attorney licensed in your state. Contact: Denise Farris, Farris Legal Services, LLC. [email protected].
