With non-essential businesses in many states either closed or operating in a limited capacity due to COVID-19, many companies are unable to perform existing contracts. While the basic premise under most U.S. law is that contracts must be kept and performed, an extraordinary circumstance may make performance so vitally different from what was reasonably expected as to relieve performance.
Some contracts contain provisions limiting risk or addressing unforeseen and extraordinary circumstances, such as a force majeure clause Do I have to Pay Rent During a Pandemic?. For those contracts that do not address unforeseen circumstances, the rarely invoked doctrines of impracticability of performance and frustration of purpose may be relevant during this unprecedented time.
Whether your business finds itself in a position where it is unable to perform a contract, or you are trying to enforce a contract, you should be aware of these contract defenses and how they may apply to your agreements.
IMPRACTICABILITY OF PERFORMANCE
Impracticability (or impossibility) of performance may discharge a party’s obligation to perform under a contract where events occurring after a contract is made (that are of no fault of the breaching party), make it either impossible or impracticable to perform. The Uniform Commercial Code, which governs contracts for the sale of goods, sets forth a similar, but more narrow, standard of impracticability. Application is fact-specific, and will depend upon the language of your contract and the circumstances of the breach. Typically, the doctrine has been applied to three categories of events:
- Death or incapacity of a person necessary for performance;
- Destruction of a specific thing necessary for performance; and
- Prohibition or prevention by law.
In the context of COVID-19, one can imagine several circumstances that may make performance impracticable or impossible:
- A severe shortage of raw materials or supplies because of an unforeseen shutdown of major sources of supply causes a marked increase in cost or prevents performance altogether;
- A company may no longer be able to ship product to its customers due to forced closure or closures within its supply chain;
- A contractor cannot enter the premises because someone is infected with COVID-19;
- A restaurant may no longer be able to host an event because the government is restricting gatherings of more than 10 people; or
- A hotel may have to cancel reservations because of government-issued travel restrictions.
The doctrine, however, does not apply to market shifts or the financial inability of one of the parties. Continuation of a party’s financial situation and market conditions are not normally assumed when a contract is made.
FRUSTRATION OF PURPOSE
Performance of a contract may be discharged where, after a contract is made, a party’s principal purpose for entering into the contract is substantially frustrated by the occurrence of an event, that the parties assumed would not occur at the time they made the contract. In the context of COVID-19, frustration of purpose may be caused by business closures, cancellation of events, and other disruptions.
For example, Business A contracts with Business B to create a billboard advertisement for an event scheduled to take place in April 2020, for a price of $10,000. Business B must cancel the event due to the state governor’s COVID-19 order disallowing public events with more than 10 people. Business B’s duty to pay the $10,000 is discharged and Business B is not liable to Business A for breach of contract. (Note: If Business A already created the advertisement, it may be able to recover the value of services already provided from Business B ).
Unlike the doctrine of impracticability, there is no impediment to performance by either party. In the example above, Business A can still make the advertisement and Business B can technically still pay Business A $10,000. But the advertisement is now worthless to Business B because the event had to be cancelled. Business B’s purpose in making the contract with Business A has been frustrated due to an intervening circumstance that the parties assumed would not occur and probably never contemplated (i.e., the spread of COVID-19 and the governor’s order prohibiting large public events).
To discharge performance under the doctrine of frustration, three requirements must usually be met:
- The frustration must relate to the principal purpose of the party in making the contract (both parties must understand that the contract makes little sense without the object that has been frustrated);
- The frustration must be substantial – it is not enough that the transaction has become less profitable; and
- The non-occurrence of the frustrating event must have been a basic assumption on which the contract was made.
Frustration is no defense if the intervening frustration was controllable by the promisor or if counter-performance remains valuable. The defense does not apply if the language of the contract or circumstances indicate that the parties weighed the possibility of the intervening frustration and assumed the risk accordingly. Like impossibility, the application of the doctrine is fact-specific and will depend upon the language of your contract and the circumstances surrounding the breach.
TEMPORARY NATURE OF IMPRACTICABILITY OR FRUSTRATION
Impracticability of performance or frustration of purpose that is temporary may suspend a party’s duty to perform only while the impracticability or frustration exists, but a party may still have to perform after the impracticability or frustration ends, depending on the circumstances.
Some disruptions caused by COVID-19 may be temporary. An affected by party’s duty to perform may be suspended while the impracticability or frustration lasts. When the disruptions end, a party may still be expected to perform in full and would be entitled to an appropriate extension of time for performance. However, the delay itself may make full performance impracticable or frustrate the purpose materially. If this happens, then a party’s duty to perform may be discharged completely and not just suspended.
For example, it may be impossible for a company to distribute product to its customers due to supply chain issues caused by COVID-19 for the months of April and May 2020. If the supply chain issues resolve in June, the company will still likely be expected to make June shipments (although the UCC’s rules regarding substitute performance may apply to this situation). In this example, the impracticability was only temporary. On the other hand, if a party contracted to hold a Cinco de Mayo event at a restaurant, and the restaurant is not able to host the event due to COVID-19, the contracting party’s purpose has been frustrated and delayed performance will not resolve the frustration (i.e., because Cinco de Mayo has passed).
As businesses navigate their contractual obligations during these uncertain and extraordinary times, many parties will likely attempt to employ these defenses. It is important to have an attorney evaluate your specific contract, the facts specific the breach, and determine whether the defenses may be available.