March 25, 2021 Articles

The Importance of Force Majeure Clauses in the COVID-19 Era

One year after the pandemic started, case law developments provide cautionary lessons.

By Paula M. Bagger

Not that long ago, the force majeure clause risked being dismissed as a laundry list of potential catastrophes, each unlikely to happen, embedded in the boilerplate at the back end of a commercial contract. Then came 2020, and force majeure came to the fore as COVID-19 and governmental shutdowns wreaked havoc with commercial leases and contracts. Disruption led to litigation, and a growing awareness that we must not ignore the potential applicability of force majeure to our commercial agreements. One silver lining is that the early case law provides cautionary lessons on what we need to consider about force majeure when drafting and interpreting commercial contracts.

Force Majeure

A force majeure clause allocates the risk of loss if performance is hindered, delayed, or prevented because of an event that the parties could not have anticipated or controlled. It provides a contractual defense, the scope and effect of which will depend on the express terms of a particular contract. These terms may have been negotiated, if the parties took the time to tailor the clause to their specific transaction, but they often are boilerplate.

A boilerplate force majeure clause may look something like this (although the variations among them are great and can have significant impacts, as discussed herein):

Neither party shall be held liable or responsible to the other party nor be deemed to have defaulted under or breached this Agreement for failure or delay in fulfilling or performing any obligation under this Agreement when such failure or delay is caused by or results from causes beyond the reasonable control of the affected party, including but not limited to fire, floods, embargoes, war, acts of war, insurrections, riots, strikes, lockouts or other labor disturbances, or acts of God; provided, however, that the party so affected shall use reasonable commercial efforts to avoid or remove such causes of nonperformance, and shall continue performance hereunder with reasonable dispatch whenever such causes are removed. Either party shall provide the other party with prompt written notice of any delay or failure to perform that occurs by reason of force majeure.

A force majeure clause that is not informed by thoughtful consideration of general or particular risks and their effects on the parties can lead to unfortunate results because a court will construe the clause as if it represents an allocation of risk that the parties bargained for.

There are four necessary components of a force majeure clause:

  1. It must define the breach for which a promisor seeks to be excused.
  2. It must define the “force majeure event” itself.
  3. It must require (and define) the causal connection between these two.
  4. It must explain what will happen if performance is excused.

Each component raises considerations that contracting parties need to consider with some care.

The Promisor’s Failure of Performance

The breach from which a promisor may seek to be excused by invoking force majeure in fact drives the breadth of the force majeure clause, though it is often ignored as the parties worry about defining the force majeure event. The parties may agree that force majeure will excuse a default, or a delay, or a failure to satisfy some condition. The failure of performance entitling the breaching party to invoke force majeure can be described in broad terms or very specifically; it can excuse the performance of either party, both parties, or one party only.

When drafting or reviewing a contract, consider what type of breach an unforeseen and calamitous event might cause your client to commit. Then ensure it is covered, because your client may be out of luck if that hypothetical future breach does not fall within the contract’s description of a breach that force majeure may excuse. Narrow or inartful drafting may lead to difficult results. In a recent tuition refund case, a student sued his university, claiming that it breached a contract to provide in-person learning after COVID-19 caused the school to turn to remote learning. The force majeure clause said “[t]here will be no refund of tuition . . . in the event the operation of the University is suspended at any time as a result of [a force majeure event].” The university’s motion to dismiss was denied: the clause did not apply because the school’s alleged breach was not “suspend[ing] its operation” but rather offering an alternative mode of teaching. Gibson v. Lynn University, No. 20-cv-81173 (S.D. Fla. Nov. 29, 2020). (The court was troubled by the fact that the university would have won a Fed. R. Civ. P. 12(b)(6) dismissal if it had simply shut down rather than “try to provide some continuity for its students through remote learning,” and suggested that it might reconsider on a fuller record).

Sometimes, a particular type of breach is carved out of a force majeure clause. This is seen most frequently in commercial leases, which often carve-out the tenant’s inability to pay rent and other fees. The court almost always honors this carve-out, acknowledging that the parties have agreed that the risk of non-payment remains with the tenant, even in the face of an unanticipated calamity and enforce it. See, e.g., In re CEC Entertainment, Inc., No. 20-33163 (Bankr. S.D. Tex. Dec. 14, 2020) (enforcing an exclusion from the force majeure clauses of multiple Chuck E. Cheese restaurant leases for tenant’s “inability to pay any sum of money”). One recent restaurant lease case displayed an interesting though decidedly minority interpretation. Although the lease in In re Hitz Restaurant, 616 B.R. 374 (Bankr. N.D. Ill. 2020), stated, “Lack of money shall not be grounds for Force Majeure” (id. at 377), the court ruled that because the restaurant’s inability to pay was directly due to “government restrictions,” a listed force majeure event, it would trump the quoted provision on lack of funds (which could result from many causes). Id. at 377–378.

The Force Majeure Event

A force majeure clause needs to describe what sort of unforeseeable event will excuse the breaching party. Definitions of a “force majeure” event often start out generally, with words like, “unanticipated events beyond the parties’ control, such as . . .” and then tack on a long list of examples. Or they start with a long list of calamities and follow up with a catch-all, like “and such other events as are outside the parties’ control.” Occasionally, a contract will simply provide a list, long or short, of potential force majeure events, although this approach seems inconsistent with the presumption that the parties are grappling with the unforeseeable when negotiating a force majeure clause. It is far less risky to include some language to cover the truly unanticipated development.

To provide a contemporary example, what if the list doesn’t include the word “pandemic?” A recent case in the Southern District of New York provides a good example of how a court decides whether and how the parties intended, at the time of contracting, to allocate the risk that a pandemic might delay, hinder, or prevent contract performance. In JN Contemporary Art LLC v. Phillips Auctioneers LLC, No. 20-cv-4370 (S.D.N.Y. Dec. 16, 2020), the court noted:

  • The words of the force majeure clause itself were open-ended, defining a force majeure event as “circumstances beyond our or your reasonable control,” followed by a lot of examples. Even though none of the examples was “pandemic,” the court relied on the broader catch-all statement. 
  • Common reference materials, such as Black’s Law Dictionary, confirmed that one of the examples (“natural disaster”) was broad enough to encompass a “pandemic.”
  • Other cases arising from COVID-19, outside the force majeure context (e.g., emergency powers authorizations) supported the conclusion that a “pandemic” could be considered a “natural disaster.”

Taking these together, the court ruled that the pandemic did qualify as a force majeure event in the contract before it.

Another contract interpretation tool is an examination of the “four corners” of a contract. Because the purpose of force majeure is to allocate the risk of the unforeseeable, a court will likely not find something that the parties appear to have considered to be a force majeure event. When drafting a contract, this warrants paying attention to internal consistency. For instance, in Zhao v. CIEE, Inc., No. 2:20-cv-00240-LEW (D. Me. Aug. 31, 2020), the court noted that while the contract for a foreign study program, interrupted by COVID-19, broadly provided for refunds in the event of program cancellation, it also included a liability waiver providing the company would not be liable for any loss or damage arising inter alia from “epidemic.” The plaintiff student received no refund for the program cancellation because the risk of epidemic was specifically foreseen and allocated in a different contract provision.

  • Trade usage and commercial practice are also interpretative tools an attorney must take into account when drafting or considering a force majeure clause: If the allocation of risk your client prefers is counter to prevailing commercial practice, it is important to lay it out clearly. In AB Stable VIII LLC v. Maps Hotels Resorts One LLC, Case No. 2020-3130-JTL (Del. Ch. Nov. 30, 2020), dealing with a “material adverse effects” provision in an acquisition agreement, dueling experts provided extensive testimony about what the word calamities customarily meant in such a document and whether it should be deemed to include a pandemic. Similarly, under the UCC, trade usage must be considered when construing a contract for the sale of goods. See UCC §2-615 comment 8 (whether a party has assumed the risk of an unforeseen event “is to be found not only in the expressed terms of the contract but in the circumstances surrounding the contracting, in trade usage and the like,” including whether they are “among the business risks which are fairly to be regarded as part of the dickered terms, either consciously or as a matter of reasonable, commercial interpretation from the circumstances.”).

Causation

The force majeure clause will articulate some necessary causal connection between the failure of performance and the force majeure event. When drafting, there is some latitude to express how direct the causation must be. “Caused by,” “due to,” or “as a result of” are likely to be read as expressing a need for proximate cause, while “solely caused by” imposes a higher, perhaps insurmountable, burden on the breaching promisor. In the cases reported thus far, courts have not become too embroiled in the question whether it was the pandemic, or governmental shutdowns, or generally depressed economic conditions that have caused a promisor’s losses. It is important to note that these distinctions are one of the primary reasons why the common law of impossibility and frustration of purpose has proved so inhospitable to parties over this past year, as courts, particularly in the commercial center of New York, declare that financial difficulty or economic hardship, even if caused by an unforeseen event like COVID-19, will not excuse contract performance under impossibility or frustration theories. See, e.g., Lantino v. Clay LLC, No. 1:18-cv-12247 (S.D.N.Y. May 8, 2020).

In re Hitz Restaurant Group, discussed above, provided an interesting twist on the role of causation. There, the tenant restaurant invoked the lease’s force majeure clause, which included “governmental action” as a force majeure event. Noting that the Illinois shutdown order prohibited only on-premises dining, the court ordered that the tenant’s rent obligations be reduced pro rata to reflect the proportion of its revenues earned from on-premises dining (as opposed to takeout or delivery).

Scope of Relief

Finally, the force majeure clause determines the scope of relief to which a promisor is entitled if his performance is excused by a force majeure event. When reviewing a commercial contract, it is important to consider whether the relief offered by the force majeure clause is the relief your client would anticipate needing should such an event occur. This includes crafting language that actually states what will happen at the end of the force majeure event.

The effect of a force majeure clause that simply excused any future performance by either party can be a pitfall if the force majeure event occurs when one party has substantially performed. For instance, in a case involving a contract for a live event at a resort, NetOne, Inc. v. Panache Destination Management, Inc., No. 20-cv-00150-DKW-WRP (D. Hawaii June 5, 2020), the pandemic was deemed a force majeure event relieving both parties from future performance under the contract. But the party that had booked the event had already put down a substantial deposit—that is, it had almost completed its performance—while the resort had done some work in preparation for the event but had not actually hosted an event. The booking party sued to recover its deposit. Its claim was dismissed because the contract was clear: Force majeure relieved both parties of future performance, and “[n]owhere in the force majeure provisions does it say that, if the contracts are terminated due to a qualifying event, the non-terminating party must return all deposits made.” (In a later decision, the court, reaffirmed its decision, suggested that the booking party bring a claim for unjust enrichment.)  

Another case that provided sweeping relief to a breaching promisor also led to an apparently one-sided result. In the JN Contemporary Art case discussed just above, an auction house agreed to auction a painting at a May 2020 auction and guaranteed the owner of the painting a $5 million minimum sales price. The force majeure clause provided that if the auction was postponed owing to a force majeure event,

we may terminate this Agreement with immediate effect. In such event, our obligation to make payment of the Guaranteed Minimum shall be null and void and we shall have no other liability to you.

The auction was postponed owing to COVID, and the auction house did invoke force majeure clause and terminate the contract—although it waited two months to do so. The timing created the impression that the auction house was waiting to see what the market for the painting would be like before pulling the plug, and the owner sued, arguing that the auction house could and should auction the painting at one of its upcoming online auctions. It lost on a motion to dismiss because the force majeure clause unambiguously protected the auction house.

The case posed the question whether this was a violation of the implied covenant of good faith and fair dealing (as the painting’s owner claimed) or simply the auction house benefitting from a wisely bargained-for allocation of risk. It was certainly an unfortunate and possibly avoidable result for the owner, which ought to have paid more attention to a one-sided force majeure clause. (The case also reinforces the benefits of a fifth component of a well-drafted force majeure clause: a notice provision. The owner would have been in a stronger position if the auction house had been forced to decide whether it was terminating the contract at the time it cancelled the auction, rather than enjoying what was in effect an option to auction the painting during COVID-19.)

Conclusion

Substantial obstacles stand in the way of parties seeking to prove impossibility and frustration, so you want to consider a force majeure clause in a commercial contract of any size or complexity.

The benefit of a force majeure clause is that it allows the parties to fashion a rational allocation of the risk imposed by unknown and uncontrollable events. In an ideal world, in which the parties have equal bargaining power and (importantly) are paying equally close attention to the entire contract, including the “boilerplate” during negotiations, a force majeure clause allows the parties to select a resolution that works best for their situation.

There is not a lot to do about unequal bargaining power, such as the landlord-friendly force majeure clauses in many commercial leases, but we can all pay greater attention to force majeure clauses presented to us in draft agreements. We should revise boilerplate, respond to seemingly one-sided articulations of force majeure rights, and potentially mitigate some of the unhappy results in other of the cases discussed in this article. The same considerations discussed above can also guide in the interpreting of force majeure clauses already in contract documents, especially in light of the COVID-19 era that has so greatly affected commercial transactions.

Paula M. Bagger is an attorney in Boston, Massachusetts. She serves as cochair of the Commercial and Business Litigation committee.

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