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With unprecedented global travel restrictions, social isolation policies requiring a majority of employees to work remotely, closures of non-essential businesses, and orders to shelter-in-place implemented in response to the COVID-19 pandemic and public health crisis, many businesses are experiencing a decline in productivity and difficulty performing their contractual obligations. Businesses will be further impacted as their contractual partners experience similar issues. Not surprisingly, these resulting business disruptions are expected to lead to an increase in contract dispute litigation. As a result, companies should evaluate their current approach to negotiating contracts and review their existing contractual obligations to anticipate and mitigate contract performance issues. This article addresses considerations for negotiating new contracts and navigating disruptions in the performance of existing contracts in the era of COVID-19.
Negotiating New Contracts
As companies continue to operate in this uncertain and constantly-changing landscape, they should carefully evaluate their approach to negotiating new contracts, particularly the force majeure provision in such contracts. A force majeure provision is a contractual term that excuses a party’s contractual performance obligations when certain circumstances arise that are beyond the party’s control and make the performance of the contract impossible or impractical. Examples of force majeure events include (i) acts of God such as earthquakes, hurricanes, floods, fires, and other nature/weather-related events, (ii) acts of government such as changes in laws and regulations, (iii) acts of terrorism and war, and (iv) strikes and other labor disputes. Determining whether force majeure can be invoked depends on the language of the contract at issue and the jurisprudence of the jurisdiction where the contract dispute will be litigated. As a result, care should be taken when selecting not only the language contained in the force majeure provision, but also the dispute resolution and forum selection provisions in the contract.
Businesses should consider the events that trigger the force majeure provision, the notice requirements in the force majeure provision, and the intended and unintended consequences of such provision. Pending or new contracts should be drafted or revised to include protections from business disruptions caused by pandemics such as COVID-19. For example, the force majeure provision should include the following as force majeure events: epidemics, pandemics and “public health events of international concern (PHEIC)” as well as supply chain delays from countries or regions affected by such events. Although force majeure provisions may already designate change of law or regulation as force majeure events, these provisions should also include: governmental actions or orders, such as the imposition of shelter-in-place, closure of non-essential businesses, quarantines, and travel restrictions or bans. The party more likely to be affected by a pandemic like COVID-19 should consider inclusion of other protections such as the extension of performance periods due to delays beyond the party’s reasonable control.
Considerations for Existing Contracts
Businesses should proactively review their existing contracts on a case-by-case basis to determine how the COVID-19 pandemic may affect the obligations and performance of each party under the contract. If performance is likely to be affected by the COVID-19 pandemic, a party may be able to invoke the force majeure provision in the contract. Whether a party may rely on this provision as an excuse from contractual performance depends on the specific language of the provision and the relevant governing law. Companies should review existing contracts to determine whether an event qualifies as a force majeure event under the contract, what notice is required to be given and when, and the effect of providing notice on each party’s performance. Even if an event appears to be covered by the language of a force majeure provision, additional analysis must be conducted to determine whether force majeure can be successfully invoked. For example, certain states require a force majeure event to be unforeseen or outside the invoking party’s control while other states require the party seeking to invoke force majeure to attempt to perform its contractual duties regardless of the event. As businesses review the contractual requirements for force majeure and consider making a declaration under this provision, keep in mind that these provisions are often narrowly construed. Therefore, a review of applicable legal authorities in the relevant jurisdiction is just as important as reviewing the language of the contract.
Companies should be mindful that an improper declaration of a force majeure event could be considered an anticipatory breach or repudiation of the contract, which may provide the other party with an immediate cause of action for breach of contract. Additionally, companies should recognize that force majeure is typically a temporary defense that only applies until the triggering event can be overcome and contractual performance can resume. Therefore, a party should consider whether the relevant language in the contract and governing law permit only the temporary suspension of performance or entitle a party invoking force majeure to modify the contract or terminate it altogether.
In addition to reviewing the force majeure provision, businesses should ascertain whether any other contract provisions are implicated, such as the right of the other party to terminate the contract, the obligation of the party invoking force majeure or other contract provisions to mitigate damages, and the consequences of a default or termination precipitated by the COVID-19 pandemic. Similarly, a review of the contract’s dispute resolution and choice of law provisions will be important to determine where and how disputes will be resolved.
If the relevant contract does not include a force majeure provision or if a pandemic such as COVID-19 does not qualify as a force majeure event, a company should determine whether any other contractual or common law defenses to performance may apply. These include the defenses of impracticability or impossibility of performance, frustration of purpose, and whether the relevant event constitutes a material adverse change, or would have a material adverse effect under the contract provisions. Again, these common-law doctrines are typically narrowly construed and, as a result, a review of the governing state law is necessary to assess their applicability and viability.
Other Considerations and Best Practices
Even though contractual language may provide a party with an opportunity to delay or avoid performance under a contract, that does not necessarily mean that litigation is the best means of resolving the issue. Instead, engaging with suppliers and customers proactively in a helpful and cooperative manner can result in an efficient and successful resolution of the dispute without the need for litigation. For example, notifying the other party to address a potential performance disruption or to suggest alternative performance solutions, such as extending the time for contract performance, can result in a resolution that is acceptable to both parties and preserves the business relationship between them. Companies, however, should be mindful to take the necessary steps to document their position and preserve relevant evidence in case a dispute escalates and litigation cannot be avoided.
Additionally, events such as the COVID-19 pandemic should serve as a reminder to companies to have contingency plans that can help avoid supply or other issues that can impact contractual performance. For example, companies should review their supply chains to ensure that they have multiple suppliers from different geographic regions. Employing such practices will enable a company to be more nimble and minimize the risk of disruptions from unforeseen events in the future.
Jared S. Hawk is a Partner and Jillian K. Walton is an Associate at Saul Ewing Arnstein & Lehr