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Coronavirus issues are likely to affect every business and industry, and the hotel industry is looking at an immediate and out-sized impact. JMBM partner Mark Adams deals with these issues across all industries on an international basis, and he has a deep involvement and understanding of the hospitality industry’s unique contracts, issues, customs and practices. In the second of his series of articles regarding the coronavirus, Mark discusses the importance of jurisdiction and contract wording when considering force majeure as a defense.
Force majeure provides an excuse for a party’s non-performance of its contractual obligations as a result of an extraordinary event or circumstance beyond the control of the parties, such as act of God, war, strike, riot, etc.
What law governs the contract? Common law or civil law principles?
Unless there is an express provision in the contract, force majeure does not exist as a standalone defense in common law jurisdictions such as the U.S. and the U.K. In civil law jurisdictions, such as France and Germany, however, force majeure is implied into every contract, unless the parties agree otherwise. In order to minimize unintended consequences, contracting parties in both jurisdictions include force majeure provisions in their agreements.
In common law jurisdictions, the general rule is strict liability for the breach of a contract. This reflects the principle of pacta sunt servanda (preserving the sanctity of the contract). But there are exceptions. Common law jurisdictions excuse performance when it is not practical and could only be done at excessive and unreasonable cost. In the U.S., the Restatement (Second) of Contracts § 261 (1981), states:
“Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.”
In the U.K., the similar doctrine of “frustration of purpose” is likewise a defense to non-performance. Frustration of purpose occurs when an unforeseen event undermines a party’s principal purpose for entering into a contract such that the performance of the contract is radically different from performance of the contract that was originally contemplated by both parties. Whether under an “impracticable” or “frustration” jurisdiction, the standard for relief is a high one, and is subjective. That subjectivity can only be definitively resolved by litigation and judicial intervention.
Specify conditions short of “impracticable”
To avoid the uncertainty of such subjective standards, contracting parties in common law jurisdictions typically include force majeure provisions to specify events or circumstances that will excuse performance of contractual obligations by a party. Such specified force majeure events might not rise to the level of “impracticable” or “frustration.” By negotiating force majeure provisions, the parties can better allocate the consequences of non-performance as between themselves. For example, in a supply contract for the purchase of medical grade masks, if the manufacturer/seller is suddenly unable to timely deliver the masks to the buyer because of a trucking strike, the manufacturer could suffer the consequences of the substantially increased costs of delivering the masks by a private carrier. So long as the delivery costs are not prohibitively higher, the manufacturer will be liable for breach of contract if the manufacturer does not perform.
The doctrines of “impracticable” or “frustration” are of no avail in these circumstances. And even if they might be available, the application of them would have to be litigated. But if a properly worded force majeure provision is in the contract it could excuse performance in the event of trucking strikes, and the manufacturer would be off the hook.
In civil law jurisdictions, the doctrine of force majeure is implied, irrespective of whether the contract expressly contains a force majeure clause. The problem is that each civil law jurisdiction has some differences as to when the implied force majeure is an available excuse for non-performance, and also as to what consequences or remedies are available when implied force majeure applies. So, even in civil law jurisdictions, the parties commonly include their own tailor-made force majeure clauses to identify particular events that will unequivocally qualify as excuses for non-performance and of the consequences for non-performance.
Importance of foreseeability of the event
In both common law and civil law jurisdictions, foreseeability is a primary factor in the determination of whether a non-performance will be excused. If an event is foreseeable, the happening of the event is an excuse for non-performance if the event is specifically included in a force majeure clause. When a foreseeable event occurs that is not specifically included in a force majeure clause, the non-performing party suffers the consequences. When an unforeseeable event occurs, and the burden of performance rises to the level of impracticable without fault, the non-performance may be excused – even without a force majeure clause. When an unforeseeable event occurs, and the burden of performance is below the level of impracticable, the non-performance will not be excused.
The fact is, many events are foreseeable and therefore the parties should allocate the risk and the consequences of a foreseeable event happening in a force majeure clause, based on the economics of the transaction and the party most willing and able to bear the risk. Tribunals in both common law jurisdictions and civil law jurisdictions reason that if the parties provided a force majeure clause in their contract, then the failure to include a foreseeable calamitous event is an assumption of the risk of that event by the non-performing party. The decisions where tribunals reject a force majeure defense are based on the conclusion that the party proffering the defense could have and should have identified the event that led to the non-performance and should have specifically allocated for that risk before entering into the contract.
What to put in the force majeure clause
Accordingly, the force majeure clause should include every foreseeable event to which the parties agree will provide an excuse for non-performance because, again, tribunals hold that if the event is not listed in the force majeure clause, then non-performance is not excused. And specificity for an event is important. The words matter. For example, in a force majeure clause that includes “disruptions from storms,” does that include electrical blackouts from solar storm flares? Is a drought a “natural catastrophe”?
Suppose a force majeure clause that states, “In the event of an epidemic, pandemic, quarantine restriction, or other public health restriction or advisory, the time for the performance of the obligation shall be extended or excused.” Does the present status of the COVID-19 virus fall within an “epidemic”? Is it a “pandemic”? Is a company imposed self-quarantine a “quarantine restriction”? Is a U.S. State Department cautionary travel advisory an “advisory”? So unless the event is specific and the words are clear, then the parties will likely be left with having a tribunal determine whether a non-performance falls within the force majeure clause and whether performance is excused based on general rules of contract interpretation in that particular jurisdiction.