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Force Majeure: How COVID-19 Created a Crisis of Contracts and Resurrected a Forgotten Doctrine

COVID-19 is no longer the Grinch that is disrupting commercial and everyday life but arising from it ruins are important lessons for the future. A stark reality from the lock down of borders and shuttering of businesses is contractual obligations could not have been fulfilled. Therefore, the life of countless contracts ended prematurely, creating a crisis of contracts. Resurrected from the commercial ruins is force majeure, an often-forgotten doctrine.

Force majeure is an event, usually beyond the reasonable control of a contractual party, that prevents that party from performing its contractual obligations. The risk that an event would prevent performance of contractual obligations, is usually insured or assumed by a contracting party. However, force majeure nullifies the risk and relieves a contracting party from the burden of performance when specified events occur.

Force majeure clauses limit damages where the reasonable expectations of the parties and the performance of the contract have been frustrated by circumstances beyond the control of the parties

COVID-19 set off what the New York Supreme Court calls, a flood of contract termination cases. From major brands such as GAP, Cole Haan and Hugo Boss, to individuals who canceled weddings and other events or couldn’t pay rent, were caught up in breach of contract disputes. Many turned to the force majeure clauses in their contract for shelter. Painfully, those force majeure provisions did not provide adequate protection from COVID-19 disruptions. The lesson? Pandemic related force majeure cases may not succeed if careful consideration is not given when the contract is formed.

When does Force Majeure Apply in a Pandemic?

In common law jurisdictions, force majeure is a creature of contract. It is what the contract says it is. For it to be invoked, force majeure must be a termination clause specifically stated in the contract. The contract could either provide for force majeure or expressly exclude its application. As a creature of contract, the contours of force majeure are set out within the agreement. The contours define the application, effect, and scope of force majeure for each contract.

The tragedy for many businesses is that the contours of business contracts do not adequately provide for pandemic related conditions as force majeure events. The deficiency is particularly pronounced in commercial leases. A series of cases that were decided in New York, reveal that the risk of pandemic related hardship is assumed by commercial tenants.

Commercial leases treat the obligation to pay rent as an exception to force majeure relief. This is the effect of a poorly drafted clause that protects commercial landlords while leaving commercial tenants to the mercy of a pandemic. Consequently, even when a commercial landlord is unable to provide access to commercial premises due to COVID-19 measures, commercial tenants may still be obligated to pay rent.

This oversight ignored a trend that that has been developing over two decades. The chart to the right shows a steady increase of force majeure cases decided by US courts from 2002 through 2021. It establishes a relationship between pandemics and spikes in force majeure cases decided by US Courts. The first spike in 2010 – 2013, coincided with the reemergence of the H1N1 pandemic. Another spike in 2016-2017 coincided with Ebola. However, the most drastic increase occurred in 2020-2021 during COVID-19.

Catch-all Force Majeure Provision May Not Work in a Pandemic?

A catch-all force majeure provision doesn’t work the same way in common law jurisdictions as in civil jurisdictions. In civil law jurisdictions, a catch-all force majeure provision covers unforeseen circumstances, not specifically stated in the contract. However, in common law jurisdictions, a catch-all force majeure clause is restricted to the specific conditions listed in the contract.

“When a force majeure clause contains a catch all phrase along with specified events, the precept of ejusdem generis is used to limit general words to events that are of the same general kind or class as those specifically mentioned.”

Broad catch-all provisions are interpreted as excluding things that are not of the same character or class as the specific events mentioned. So, general words would not be given an expansive meaning.

The Impact of COVID-19 on Supply Chains and the Implication for Business Contracts

Decades of reliance on the just-in-time management model, produced nearsighted business contracts. Just-in-time is a management system in which a business maintains a lean inventory system that is replenished just-in-time to satisfy demand. It is like walking a tight rope. To succeed, supplies must be readily available. Just-in-time works well in a world of plenty where shortages are short-lived. A pandemic changes this reality, creating a whole new world – one characterized by long-term shortages. It paralyzes industries and eliminates substitutes that may be relied on in times of hardship. The new market conditions are neither contemplated nor adequately provided for in business contracts.

COVID-19 has taught us that a pandemic could create acute demand and supply problems. Instead of the equilibrium that comes from predictive models, demand and supply are out of sync. That becomes a problem when the market’s resistance to shocks is compromised, inhibiting its ability to self-correct. So, in a pandemic world, the termination of contracts may be vital to the survival of a business. If that option is not available, the business may go under.

Why You Need Adequate Force Majeure Clauses to Survive a Pandemic

The other legal doctrines, namely frustration of purpose and impossibility, are not good substitutes for force majeure in a pandemic.

Frustration of purpose discharges a party’s duties to perform under a contract where a wholly unforeseeable event renders the contract valueless to one party. “Impossibility is a defense to a breach of contract when performance is objectively impossible because of an unanticipated event that could not have been foreseen or guarded against in the contract .”

Why Frustration of Purpose is Not Suited for Pandemics

A pandemic usually results in economic hardship because of changes in market conditions. For example, lockdowns and vaccine mandate may reduce sales or operational capacity. However, economic hardship does not excuse performance of contractual obligations. The common law considers economic hardship as a risk assumed by contracting parties. Therefore, for frustration of purpose to apply, you must establish that the basis of the contract was frustrated. So, the fact that a pandemic may cause a business to operate at a loss is not sufficient to terminate a contract based on frustration of purpose.

Further, you must also establish that the event that frustrated the purpose of the contract was disastrous and wholly unforeseen. While lockdowns that closes a business may satisfy this requirement, partial closure may not. So, restaurants operating at 340% capacity, may not rely on frustration of purpose to terminate contracts.

Why the Doctrine of Impossibility is Not Suited for Pandemics?

Impossibility only relieves performance of contractual obligations that are “impossible” to perform. So, an event that makes contractual obligations burdensome or unprofitable is not enough to invoke the doctrine of “impossibility”. This is precisely what happens in a post-pandemic world – obligations are burdensome or unprofitable. On the supply side, there may be shortages of necessary inputs for goods and services to be provided. On the demand side, changes in demand may render a profitable enterprise unprofitable. Nevertheless, this turn in fortune is considered risk a party assumes.

Impossibility is applied narrowly in New York. The Court of Appeals determined that it should only be invoked in extreme circumstances. This is due to the overarching principle in contract law that risks are allocated to parties to a contract.

Practical Issues for the Future

COVID-19 has taught us that existing force majeure clauses are not adequate to protect businesses in times of a pandemic. Common law doctrines such as frustration of purpose and impossibility are not adequate substitutes for force majeure. So, resilience in the future requires rethinking business contracts to directly address potential disruption from pandemics. Here are some practical steps that could be taken:

1. At the time of formation of the contract, consider the likely impact of a pandemic. Going forward, pandemics may no longer be considered unforeseeable. Its impact on contractual obligations must therefore be provided for in the contract.
2. Create buffers for weak links in the supply chain. To adequately provide for pandemic related disruption, businesses would need to examine each link in their supply chain and identify links that are prone to disruption.
3. Use lessons from COVID-19 to construct dispute resolution mechanism in future contracts. Incorporate lessons from current negotiated solutions to inability to perform into future contracts.
4. Suspension of the contract. In instead of termination, you could provide for suspension of specific obligations in specified circumstances.

By: Vivian M. Williams, Esq.