ALERT: COVID-19 and Contract Issues

Lyons Gaddis COVID-19 Alert

This Alert is one in a collection of articles created by Lyons Gaddis in our effort to get important information to our clients regarding the effect of the novel coronavirus (COVID-19) outbreak in the United States.  This Alert focuses on clients dealing with contract rights and obligations in the wake of the spreading coronavirus. Parties to a contract should confer with counsel regarding the particulars of your contract and your specific situation.

March 25, 2020
ALERT: COVID-19 and Contract Issues

The current COVID-19 pandemic is upending everyday business and life in ways few envisioned mere weeks ago. As politicians, businesses, nonprofits, and individuals continue to react to the ever-changing situation, an ongoing area of uncertainty concerns contractual and commercial relationships. Questions have arisen regarding whether contractual agreements entered into before the public health crisis remain valid and enforceable, or at least to what extent such agreements may be enforceable in light of rapidly-changing circumstances on the ground. Certain contract law principals or concepts, such as force majeure, impossibility, and frustration of purpose, concepts which rarely come into play, are now receiving increased attention. The primary questions arising from the COVID-19 pandemic are whether these various contract principals and concepts apply and, if so, what such application will mean with respect to parties and their obligations under such contracts.

Force Majeure

In a negotiated contract, one way in which parties seek to protect themselves from matters outside of their control is through the inclusion of a force majeure provision. Such provisions are drafted to either excuse or limit obligations of performance when specific circumstances arise that would or could render performance impossible. Historically, force majeure provisions were drafted to address potential circumstances like the outbreak of war, strikes or other labor issues, natural disasters, or acts of God. After September 11, 2001, force majeure provisions increasingly included acts of terrorism in the list. Other common inclusions in force majeure provisions could include government regulations or orders from competent authorities preventing or otherwise rendering performance impossible.

Because force majeure provisions are terms of a negotiated contract, courts in Colorado looks to the specific contract language.  A successful party must establish that the event constituting a breach of contract does not trigger a breach because it is a force majeure event. Whether, for instance, the COVID-19 pandemic triggers the relief of a force majeure provision will turn on the language of the provision. If the provision in the contract expressly includes “public health emergency,” “epidemic,” “pandemic,” “outbreak of disease,” or something similar, then the force majeure provision will likely provide some protection for the party whose performance has been rendered impossible by the current pandemic. Likewise, if the provision excuses performance in the event of “government action or other lawful order,” and present government action has caused the breach, then it is likely the breaching party can seek relief under the force majeure provision. Therefore, careful review of the language of the provision, together with a review of the specific issues the pandemic is causing, are necessary to determine what relief, if any, the force majeure provision might provide.

If an event is covered by the force majeure provision of a contract, there will often also be a notice requirement, whereby the party seeking to invoke force majeure must notify the other party of the cause and impact of the circumstances giving rise to such invocation. It is critical that a party who believes that the COVID-19 pandemic is causing them to fail to meet their contractual obligations abides by any notice requirement in the force majeure provision to ensure they do not lose their ability to invoke such a clause.

Generally, the force majeure provision will excuse a party’s failure to fulfill its obligations under the contract. Depending on the provision, for example, the force majeure provision may temporarily or partially limit obligations of the parties during the force majeure event (e.g., reduced rental obligations, delayed delivery). The contract, however, remains in effect and binding upon the parties.

Impossibility of Frustration of Purpose

Where there is no provision in a contract that addresses a situation beyond the parties’ control that renders one or both parties’ performance impossible, a party in violation of obligations under the contract may seek to defend any claim of breach on the grounds of impossibility or frustration of purpose. To establish a frustration of purpose, the party seeking to avoid the obligations in the contract, or to rescind the contract, must show a total or near total destruction of the essential purpose of the transaction. The frustration must be “so severe that it is not fairly to be regarded as within the risks that (the party seeking rescission) assumed under the contract.” Restatement (Second) of Contracts § 265, Cmt. A. For impossibility to apply, the circumstances must be so unforeseeable that they would fall outside of the risks the parties assumed under the contract. “Impossibility of performance is determined by whether an unanticipated circumstance has made performance of the promise vitally different from what should reasonably have been within the contemplation of both parties when they entered into the contract.” Magnetic Copy Services, Inc. v. Seismic Specialists, Inc., 805 P.2d 1161, 1165 (Colo. App. 1990) (quotations omitted). If the occurrence is reasonably foreseeable, courts will typically take the position that the promisor has assumed the risk of impossibility or frustration.

It remains to be seen whether either impossibility or frustration of purpose will be applicable to the current COVID-19 pandemic. Generally, such concepts have been reserved for the most extreme and unusual circumstances, such as the terror attacks of September 11.

Impossibility may excuse performance based upon the COVID-19 pandemic, especially where government actions, like bans on travel, bans on gatherings, closures of certain nonessential business, or quarantines, make the performance of a party’s contractual obligations objectively impossible.

For frustration of purpose to apply, the principal purpose of the contract in question must be so upended by the unforeseen circumstance (here, the pandemic) so as to render the contract effectively worthless to a party. The frustrated purpose must be so much at the heart of the contract that the parties would have been unlikely to enter the transaction without it. The burden is particularly difficult to meet, and ends in the rescission of the contract. It is certainly possible to imagine how frustration of purpose may apply in the current circumstances, but historically there is very little precedent.

As conditions and circumstances of the COVID-19 pandemic continue to develop, there will certainly be need to examine agreements and legal relationships through these various lenses.

The Business Attorneys at Lyons Gaddis are available to advise you in relation to your existing contracts and other COVID-19 related matters impacting your current and future business operations.