Many of our small business clients, or families have pending contracts: lease agreements, sales agreements, loan agreements, construction contracts and the like that either they or the other party to the contract are having difficulty performing, and which difficulty is being attributed to the coronavirus.
On January 30, 2020 the World Health Organization declared the novel coronavirus disease 2019 “COVID-19” outbreak a Public Health Emergency of International Concern. Soon thereafter, on March 19, 2020, California Governor Gavin Newsom issued what many refer to as a “shelter in place” Executive Order mandating, among other things, that all individuals stay home or at their place of residence with limited exceptions for the continuity of critical business infrastructure. Businesses that are not part of the “critical” business infrastructure, also known as “essential service” providers, have since closed.
COVID-19 has immediately affected businesses, forcing many to close and layoff their employees. This catastrophic disruption of commerce has instantaneously resurrected a rarely used provision found deep within the “boilerplate” language of so many agreements – the force majeure clause. Force majeure (pronounced: fors ma-ZHOOR), is equivalent to the common law contract defense of “impossibility”. 1 Witkin, Summary of California Law (10th ed.), “Contracts,” Section 828. As explained in our State’s highest court in Pacific Vegetable Oil Corp. v. C.S.T., Ltd., a 1946 decision: “Force majeure” or the equivalent Latin term “vis major,” is not necessarily restricted to the equivalent of an act of God. “The test is whether under the particular circumstances there was such an insuperable interference occurring without the party’s intervention as could not have been prevented by the exercise of prudence, diligence and care.”
While force majeure is a shield that can be used to justify the failure to perform a contract, it’s not absolute. For example, a mere increase in expense or an inconvenience does not excuse the contract obligation or duty of care. More importantly, the ability to rely on force majeure is entirely dictated by the express language of the agreement. If force majeure language is not included in your agreement, the force majeure “defense” is not available.
The language of force majeure clauses vary significantly from one agreement to the next, here is a typical example:
If the performance by landlord [buyer] or tenant [seller] of any part of this contract is prevented, hindered or delayed by any reason beyond the control of the party whose performance is so affected, and this effect cannot be overcome by due diligence, the party affected is excused from performance to the extent that performance is necessarily prevented, hindered or delayed, during the continuance of the happening or event, and this contract is suspended so long as and to the extent that the cause prevents or delays that party’s performance. The party claiming to be affected shall give written notice to the other party within a reasonable time after the happening of the cause which they content affects their performance.
COVID 19 appears to fit squarely within the foregoing force majeure language for non-essential service providers that were forced to shut down their businesses. It is not as clear whether force majeure works for “essential businesses” that are open but that have (or will) suffer financially as a result of the invariable ripple effect COVID-19 will have on our economy. In this regard, it’s advisable that anyone considering whether to invoke the force majeure defense, not be too cavalier.
California also has a Code provision Civil Code Section 1511 that says performance is excused if it is prevented or delayed by operation of law, by an act of the creditor, irresistible, superhuman cause, or by the act of public enemies of the state or the United States, unless the parties have agreed otherwise.
The virus has been characterized as a public enemy, and is certainly a superhuman cause, but whether it is enough to excuse performance for a buyer whose business is not closed down even though it is affected by the virus at least temporarily is unknown.
There is also the doctrine of frustration of purpose in California. Unlike force majeure clauses and California Civil Code section 1511, each of which is a defense to be raised to excuse non-performance, the doctrine of frustration of purpose is available as a defense where contractual performance remains possible, but has become valueless. This defense to contract enforcement applies when performance is not impossible or impracticable, but has become pointless—i.e., the main purpose of a contract has become frustrated. Dorn v. Goetz, 85 C.A.2d 407 (1948)(quoting Williston, § 288). A party's inability to pay alone, even if unexpected, will not be sufficient to invoke a frustration defense. Likewise, an increased cost to perform the contract may not be sufficient. To be successful in asserting a frustration defense, the purpose or ‘desired object’ of both parties must have been frustrated. In other words, the total or near-total destruction of the purpose for which, in the contemplation of both parties, the transaction was entered into must be shown. Id. (emphasis in original).
Whether the coronavirus is enough to be considered something that will excuse performance or the delay of performance under either Section 1511 or the frustration doctrine will no doubt continue to develop over the next several years through litigation and ultimately appellate court decisions.
Please contact us if you have any questions in the meantime.
~ Eric Nielsen, Partner, Gianelli | Nielsen