- Supply chain disruptions and declining demand as a result of the COVID-19 virus are creating uncertainty for businesses.
- Force majeure clauses in commercial contracts may apply in these circumstances and provide some relief, but a careful examination of the clause is required to determine its scope and application.
- Even if your force majeure clause applies, there are other important factors to consider before invoking force majeure.
The uncertainty and supply chain disruptions caused by the outbreak and spread of the novel COVID-19 coronavirus continue to impact manufacturers around the world. As affected businesses encounter difficulties in fulfilling contractual obligations, they are evaluating their rights and obligations and any available remedies and relief. Commercial contracts typically contain force majeure clauses that allow a period of relief in performance where circumstances arise that are beyond the parties’ control.
There are several issues to consider in declaring a force majeure and trying to manage the risk brought about the challenging circumstances surrounding the COVID-19 virus, some of which we outline below as an initial guide.
1. What is force majeure?
A force majeure clause is a contract provision that relieves the parties from performing contractual obligations for a period of time or allows the parties to terminate the contract when certain circumstances beyond their control arise. In general, force majeure becomes relevant when an “act of God” or other extraordinary event prevents performance.
2. Does your contract have a force majeure clause applicable to the coronavirus?
The first step is to determine whether your contract contains a force majeure clause. If it does not, one will not be implied by common law in the United States.
If your contract does contain a force majeure clause, the scope and application of the clause depends on the specific terms of your contract. The fact that a contract contains a force majeure clause does not mean you have the right to invoke relief as a result of impacts to your business from the COVID-19 virus. You will need to determine whether an event of force majeure under your contract has occurred. Force majeure clauses are generally drafted to identify specific events that may excuse performance and often require that the events be beyond the reasonable control of the parties and that the event was not reasonably foreseeable. The “force majeure events” specified in contracts often include acts of God, labor shortages or strikes, governmental order or regulation, fire, or terrorism. Favorable force majeure clauses may be so expansive as to include supply delays, material shortages, increased costs or delays in obtaining goods, workers or transportation.
Whether the current circumstances impacting your business constitute a “force majeure event” is a matter of contract interpretation that requires legal advice. Your clause almost certainly does not identify the COVID-19 virus by name, but it may specify events like pandemics, epidemics, or work stoppages, that may enable you to argue the outbreak constitutes one or more of the specified force majeure events. Moreover, the current situation with the COVID-19 virus is changing daily. Even if the circumstances are such that a force majeure cannot be declared today, that may not be true in the coming days or weeks. Not all force majeure clauses are the same and your contract should be carefully reviewed to determine if you are able to invoke the clause.
3. What should you consider when evaluating whether to invoke your force majeure clause?
If your contract appears to contain a force majeure clause that applies to the circumstances your business is experiencing as a result of the coronavirus outbreak, the following is a non-exhaustive list of several factors you should consider before declaring a force majeure event:
(a) Does the force majeure clause require you to show the event could not have been mitigated by preventive action? Such clauses typically include these requirements so that the clause can only be invoked if performance has been prevented, not just made more difficult, costly or commercially undesirable.
(b) How are government agencies treating the outbreak? How organizations like the Centers for Disease Control or World Health Organization classify the outbreak at the time you want to invoke the clause may or may not provide support to your claim that a force majeure event has occurred. In addition, government agencies may get involved like the Chinese government has to issue force majeure certificates to forestall breach of contract claims and limit liability.
(c) What are the long-term consequences of invoking the force majeure clause to your business? Although you may obtain relief in the near term, could your customers cancel their orders or contracts?
(d) Have you discussed the supply disruption with the relevant constituencies? A conversation with your supplier, customer, distributor or dealer about the impact on your business and what it means for them and how to resolve any delays or shortages may resolve the issues you confront. This approach will require care to ensure that liability is not admitted, and contractual rights are not waived.
(e) Are there other provisions of your contract that may be relevant or may be impacted by invoking the force majeure clause? Provisions related to exclusivity, governing law, liquidated damages or termination rights should be factored into your decision.
4. What recourse do you have if your force majeure clause does not cover disruptions due to the coronavirus?
In the absence of an applicable force majeure clause, parties to the contract may only have the limited doctrines of “commercial impracticability” or “frustration of purpose” to try to excuse performance, which rarely apply.
The Uniform Commercial Code (“UCC”) may excuse your performance if delivery (both delivery delays or complete non-delivery) pursuant to your contract’s terms has been made “impracticable” by the occurrence of a contingency, the non-occurrence of which both parties assumed when the contract was made. In other words, the analysis under the UCC centers on the questions of (1) did you and your customer foresee the contingency (i.e., the coronavirus outbreak); and (2) did you and your customer have an expectation about how it would be handled? Additionally, proving that performance is truly “impracticable” is a high bar. If you can perform, albeit at a higher cost, a court may find that your performance was not truly “impracticable.” For example, if alternative supply sources, alternative raw material sources, or expedited freight options are available to you, a court may find that your performance was not truly made “impracticable” by the COVID-19 virus outbreak, even if those options are significantly more expensive. Additionally, if your ability to perform is only partially impacted by the coronavirus outbreak, the UCC requires that you must allocate your supply among your customers in a fair and reasonable manner.
The related common-law doctrine of frustration of purpose applies in some jurisdictions when a party’s “principal purpose is substantially frustrated” without fault by that party, and the non-occurrence of which both parties assumed when the contract was made. Frustration of purpose differs from impracticability in that the analysis is whether your principal purpose in entering into the contract, versus your performance, is affected by the coronavirus outbreak. In other words, the inquiry is not whether you can perform pursuant to the contract, but whether you have the motivation to do so.
Both the commercial impracticability and frustration of purpose doctrines are very narrow. Whether the current circumstances qualify as a situation when these doctrines might apply to your contract is a matter that requires legal advice.
5. What steps should you take for contracts currently being negotiated?
Although often viewed as boilerplate or an afterthought, force majeure clauses are bargained-for assumption of risk provisions: which party to the contract will bear the risk of loss in the event one party is unable to perform? Although rarely invoked, a force majeure clause can radically alter parties’ expectations and potential liability for a breach. Depending on your specific situation, you may or may not want a broad force majeure provision that allows for significant risk-shifting.
At this time, it is impossible to predict the full impact of the coronavirus around the world. In the coming weeks and months, it is likely that there will be increased disruptions to businesses and their ability to continue normal operations. If you are considering declaring a force majeure event because of the coronavirus outbreak, you should carefully review your agreement and consult with legal counsel. Likewise, if any of your business partners have invoked the force majeure clause in an existing agreement, there are many issues to consider, including the scope of the force majeure clause, the ability to enforce the agreement against the other party (particularly in the context of international agreements), and how your response may impact your long-term relationship with your contract partners. Likewise, if you are in the process of negotiating any new contractual arrangements, you should carefully consider the scope of the force majeure clause and how it may affect your business.