COVID-19 has disrupted our economy.
COVID-19 has created considerable medical, social and economic problems for medical personnel, governments, individuals and businesses around the world.
Can I breach a contract because of COVID-19? Maybe.
Disruptions are real for various sectors of the economy and the supply chain, affecting nearly business in Maryland. Individuals and Businesses are very concerned that they cannot perform under their contracts. Do such businesses have the legal ability to cancel or fail to perform a contract? Maybe.
Although Spence | Brierley attorneys generally never recommend breaching a contract, as economic disruptions caused by COVID-19 continue and businesses strive to continue their crucial operations, some businesses may have no option but to breach in their performance obligations. However, there are important legal tools that you should be aware of which can help you defend against damage claims if you have to break a contract.
MORE: Resources for Small Businesses During COVID-19 (Working Remotely)
Concepts to Consider (NOTE: Always consult with an attorney BEFORE breaking a contract).
1. The Sometimes Unfair Risk of Liability Imposed by Contract
The COVID-19 pandemic has many businesses and individuals wondering if the fact of a pandemic itself can relieve them of their contractual obligations. Unfortunately, when a party to a contract defaults because of an “Act of God” or other unforeseen circumstances such as a pandemic, they ordinarily would not be relieved of their contractual obligations.
Imposing liability on a party even though they could not perform seems unfair and it certainly is unfair. Take, for example, a manufacturer who agrees to make a certain amount of goods for a purchaser. Requiring a manufacturer to supply a certain amount of products is common and allows purchasers to have known purchasing rights and pricing stability. What happens, however, when that manufacturer is barred by the Government from operations, as has occurred with COVID-19? Again, ordinarily, the manufacturer would be in breach for failing to deliver possibly even if it was prevented from doing so by the government!
2. A Force Majeure Clause Addresses this Unfairness.
To avoid this unfair allocation of risk, many contracts contain “force majeure” clauses.
A force majeure clause is a contractual provision that parties can include which excuses a party of performance under a contract or permit reasonable delays. The causes of such delay must beyond either party’s control and make performance difficult or impossible for a party to perform. Situations contemplated by Force majeure clauses may include events such as “Acts of God,” natural disasters, war, terrorism, labor strikes, and often, disease or pandemic. With such a clause in effect, a party who has delayed or breached because of circumstances beyond their control may be able to assert the force majeure clause as a defense to breach.
Thus, parties can use a force majeure to excuse a party from performing under the contract if a defined event occurs that renders performance under the contract very difficult or impossible to perform. A force majeure clause in the above example might allow the manufacturer to avoid any liability due to its breach that resulted from government mandated-closure.
3. Force Majeure Must be Explicitly in Contract
What constitutes an event that allows a party to invoke the contract’s force majeure clause must be defined in the contract. The contract must explicitly provide for the use of force majeure or include language to a similar effect as a force majeure clause. This means that enforcement of force majeure clauses is done on a case-by-case basis, as each contract could be interpreted in different ways based on the language and business background between the parties.
Force majeure clauses are typically construed narrowly by Maryland courts. Accordingly, whether a party may invoke force majeure in the face of the COVID-19 pandemic depends on the particular language of that contract’s force majeure clause. If a party includes a “catch-all” force majeure clause that does not include specific triggering events, for instance, it solely mentions “Acts of God,” Maryland courts are less inclined to apply force majeure and excuse performance or delays by one of the parties.
4. COVID-19 . . . an “Act of God”?
The party asserting force majeure must prove its applicability. If the clause lists specific viruses or pandemics, they would have an easy case. On the other hand, if the clause is not explicit and simply uses the term “act of God,” which is typically included in many force majeure clauses, they would have a harder time.
Definitions of “Acts of God” typically use words like “extraordinary,” “sudden,” “unexpected,” and “unanticipated.” The Maryland Insurance Administration (MIA) defines an “Act of God” as a natural occurrence beyond human control or influence. This means that for an event to qualify as an Act of God, it must be so extraordinary or unusual that it could not be anticipated or expected under normal circumstances. Such events often include hurricanes, earthquakes, and floods. While a flash flood, for example, might be an Act of God, if an area has historical flash-flooding during April rains, then such flooding would not be covered by a force majeure because it would be “expected.
It is possible that courts in Maryland will consider the COVID-19 pandemic an Act of God. However, the foreseeability of the pandemic is likely to be a topic of debate. On the one hand, we have had pandemics in the past, so they are certainly anticipated at some point and parties should have contracted for the situation if they wanted to avoid liability. On the other hand, given the difficulties faced by federal, state, and local governments in responding to the COVID-19 pandemic, it is not clear that the scope of this particular pandemic was anticipated or expected. Unfortunately, there is little guidance on whether courts in Maryland will consider the COVID-19 epidemic as an “Act of God.”
5. Frustration of Purpose and Impracticability
Even if the contract does not contain a force majeure clause, common law (case law developed over hundreds of years) may provide remedies to excuse a party from performance if their business has been affected by the disruptions caused by COVID-19.
The theory of frustration of purpose allows a party to a contract to delay or be relieved of their obligations due to circumstances beyond their control that frustrates the very purpose of the contract. In short, the idea is that if the contract is so impracticable to perform for one of the parties, or the purpose of the contract is basically not accomplished because of some unforeseen act or event, the contract might be one that can be broken and the parties relieved of their obligations to perform.
This counter-argument is that parties are generally held to have considered expected risks that one party or the other may not be able to perform.
6. Impossibility
If performance under the contract is completely impossible because of the COVID-19 pandemic, a party may be relieved of their contractual obligation to perform. In these cases, performance must not just be more costly, but must impossible. A forced business-closure could be one example of impossibility.
MORE: OPERATIONAL CHANGES & COVID-19
7. Illegality
Illegality is a term usually used to prevent claims for damages arising from contracts that have an illegal subject matter, such as an illegal drug transaction. Thus, even if a “drug dealer” breached his obligations to his suppliers, there would be no (legal) means of enforcement because courts will not enforce illegal contracts. Under current government-mandated closures of business, however, requiring a manufacturer to stay open and produce goods for a buyer might well be considered “illegal.”
The common law defenses of frustration of purpose, impracticability, impossibility, and illegality are helpful because businesses can try to rely on them to get out of a contract without having included a force majeure clause in their contract. Many businesses may not have anticipated the need to include “pandemic” or “infectious disease” in their force majeure clauses, or a force majeure clause at all. These common law legal theories can be used as tools to get businesses out of their contracts. Again, however, the impact of the pandemic and the willingness of the courts to apply such theories to COVID-19 circumstances is unknown. While lawyers like to give assurance to their clients, with breach of contracts under COVID-19, the only assurance lawyers can give is that there are defenses that can be raised to breach. Absent a strong force majeure clause, whether Courts will apply these theories to protect the breaching party is another less-answerable question.
7. Action Items
Whether or not your business wants to get out of a contract or suspects that another party you contract with may delay or not perform under the contract, there are some specific steps you can take to prepare for current and future disruptions caused by COVID-19.
Although we generally NEVER recommend that a party break a contract, if you or your business needs to get out of a contract or have contracted with a party whose business has been affected by the COVID-19 pandemic and believe that force majeure might apply, contact our offices to speak with one of our attorneys to discuss your particular situation BEFORE you break your contract.
Businesses should follow the following steps to ensure that they are complying with their contractual rights and obligations and understand the potential effects of any force majeure clauses in their contracts in the face of the COVID-19:
- Look at your business’ contracts to see what jurisdictions’ laws apply. If the contract does not state which state’s laws apply, the subject of the contract occurs in Maryland, and the parties are from Maryland, the contract would be enforced under Maryland contract law.
- Check your contracts for force majeure clauses and look for language like “Act of God,” “disease,” “epidemic,” “pandemic,” “quarantine,” “act of government” or “state of emergency.” These are triggering words to apply the force majeure clause during a pandemic like the COVID-19 pandemic. An attorney can help you if the contract is ambiguous or uses language that might or might not encompass the COVID-19 pandemic.
- Document the events that take place in your business. If your business cannot perform its obligations or will delay in its contractual obligations, document the reasons why. For instance, if you are a retailer who has been required to close due to a stay-at-home order, save documentation of the stay-at-home order and what your business did in response to the order. This could include almost any documents or other evidence you have showing that your business was affected by the COVID-19 pandemic. If you are unsure of what documentation is important and what is not important, an attorney can help you navigate the documentation of your business problems. Make sure that such documentation is consistent with any disaster loans for which you may have applied. A discrepancy may be used against you.
- Communicate with counsel to advise them of your business situation. An attorney can help you formulate a strategy for handling open contracts and obligations and possibly negotiate new contracts. The attorney can also help you formulate your best argument for application of any force majeure clause or common law defenses.
- Include language in new contracts that includes broadly-worded force majeure clauses. Try to anticipate future occurrences that would make it difficult for you or your business to meet contractual obligations. Get creative. We could not have guessed six months ago that pandemic flu would be the new normal for the time being. An experienced contract attorney can help you get creative and anticipate future disruptions in your business.
The attorneys at Spence | Brierley are experienced in breach of contract and business disputes. Although we generally never recommend that a party break a contract, if you or your business needs to get out of a contract or have contracted with a party whose business has been affected by the COVID-19 pandemic and believe that force majeure might apply, contact our offices to speak with one of our attorneys to discuss your particular situation BEFORE you break your contract.
This article is not intended to be legal advice or serve as the basis for any business or legal decision. Each legal matter is different and requires a particularized review of the law as applied to your specific facts. The attorneys at Spence | Brierley can review you or your business’ situation and advise as to how it should proceed in the face of the COVID-19 pandemic.
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