The Ripple Effect of COVID-19 On Contracts

By now, most people have heard of the virus commonly called the “Coronavirus,” more scientifically known as COVID-19 (“coronavirus disease 2019”).  COVID-19 was first detected in China and as of March 12, 2020 has now spread to over 90 countries internationally, including the United States.  Over the last month the Dow Jones Industrial Average has lost more than 27.5%, international sports leagues are suspending or canceling play, consumers are hoarding sanitation and medical supplies, and businesses in general are feeling the effects. Simply put, the situation is just plain scary.

Although the health and well-being of all citizens is a top priority, the ripple effects from this pandemic on the economy are real and need to be discussed.  Businesses relying on manufactured goods coming out of China are seeing their inventories shrinking at an alarming rate.  International and regional travel restrictions are interfering with business operations and consumer demand.  Service providers, suppliers, and consumers alike find that they are unable to honor contractual obligations in the face of COVID-19.  Uncertainty, for business owners, employees, and consumers alike, has everyone wondering how long the business can withstand this situation before having to close their doors or lay-off workers.

No matter how small your business, chances are you are involved in a supply chain affected by COVID-19.  For instance, if you offer hand sanitizer at your service counter or in your bathroom, you are likely experiencing a supply shock to both the availability and price of that very basic “convenience” item.  Taken from a larger perspective, businesses that rely on other parties for the production of their goods or the furnishing of their services are wondering if their contracts and purchase orders are going to be fulfilled.  Will manufacturing supplies be shipped, delayed, or canceled altogether, and if delayed or canceled, which party is responsible?  For service providers faced with supply shortages, what are the consequences for not fulfilling your own customer’s contract demands?  One of the most important provisions that some may think of as unimportant boilerplate is “Force Majeure”.  Even with a Force Majeure provision in your contract, individuals and businesses should take a thoughtful and calculated approach with how to proceed in the event of a dispute.

I strongly recommend reviewing your contracts to determine whether you have a Force Majeure provision, and if so, whether your provision covers the current situation.[1]  A typical Force Majeure provision allows an affected party to suspend or terminate (depending on how long the situation lasts) the performance of its obligations because of a specified event or situation, which makes performance impracticable, impossible, or illegal.

So, what does your Force Majeure’s provision mean, or in the absence of the provision, what should one contain?

The first component is to include a specific definition of “Force Majeure.”  Depending on the goals of each party, the provision can be drafted narrowly or broadly.  If narrowly drafted, the definition may explicitly list all qualifying events.  Examples of relevant language that may be included are “disease,” “epidemic,” “pandemic,” “quarantine,” or “acts of government.”  If narrowly drafted, parties must also consider what, if anything, should be excluded from the definition of “Force Majeure.”  Examples of exclusions could include shortages of labor (strikes) or materials, increases in material costs, and/or a party’s financial inability to perform.  If broadly drafted, the provision could define “Force Majeure” simply as “an event beyond a party’s control,” thereby leaving more room for interpretation.  One concern with such broad, catch-all language is that it may be interpreted differently depending on the situation, applicable law, and where the dispute arises.  Ambiguity in the Force Majeure provision may result in the provision being unenforceable or even interpreted by a judge in a way that you didn’t intend.

Once you define what a Force Majeure event is, the next component is determining what, if any, factors must be present in order to excuse performance. For some, the mere occurrence of a Force Majeure event is sufficient to excuse the performance of one or both parties.  However, this broad approach can be risky because without a causal connection between the event and the party’s inability to perform, it is easier for a party to take advantage of this provision to get out of performing under the contract.  As an alternative, it would be prudent to require certain steps be taken in the presence of a Force Majeure event before performance under the contract will be excused.  Some of the elements that often excuse performance in the face of a Force Majeure are (a) it must prevent performance under the contract; (b) the event must be beyond the reasonable control of and not the fault of a particular party, and (c) the party has been unable to avoid or overcome the Force Majeure by the exercise of reasonable diligence.  For example, in a contract between a domestic wheat supplier and a bread maker in which the wheat supplier is the bread maker’s exclusive supplier of wheat, in the presence of a domestic wheat crop blight, the bread maker may demand that in the face of a Force Majeure event that the wheat supplier attempt to import wheat prior to being relieved of its obligation to supply to the bread maker.

That said, depending on your industry and contractual obligations, you can add any number of events or elements to a Force Majeure provision and make it custom for your contract.  This is why it is important to not use a form contract and to customize all the provisions for your situation. Does “delayed” performance trigger the Force Majeure provision or must the threshold of interference be “complete impossibility”?  Does the Force Majeure provision require notice be given to the non-breaching party, and if so, what sort of notice is required? Which of the contract obligations are excused?  For example, taking the wheat supplier example above, are the bread maker’s payment obligations completely excused (e.g., the bread maker is no longer obligated to pay the contractually-obligated monthly minimum fee) or does the Force Majeure event simply excuse the bread maker from exclusively purchasing wheat from the wheat supplier?  Or, does the occurrence of the Force Majeure event terminate the contract in its entirety?

Ultimately, whether a party can exercise its rights under a Force Majeure provision must be determined on a case-by-case basis and should assess the real-world concerns of the situation in which they find themselves.  If a longtime customer fails to pay their bill on time because they are experiencing a cashflow disruption, are you going to take them to court to get a judgment against them?  If you get a judgment, will it be collectible if the company is bankrupt? These decisions are yours, but must all be thoroughly examined before taking action.  Chances are you would not ruin a longstanding relationship with a customer over a short-term business disruption. Long story short, there is a lot more thought that must be applied other than just asking “is there a default?”

The point is this: discuss, plan, agree, and write it down.  Doing so helps to ensure that during a crisis, your contracts are clear, there are no disagreements as to the parties’ responsibilities, and you will avoid the need to rush to court to settle a dispute.

[1] As an aside, you should also review to ensure that you have a fully signed (or “executed”) agreement.  I am frequently surprised to find that new clients overlook this contract formality. A failure to execute a contract certainly undermines even the best-drafted contract.

 

This article was authored by Attorney Danielle Johnson , a graduate of the University of St. Thomas School of Law, practicing business law as part of Neider & Boucher, S.C.’s business team.  She was recognized as a 2019 Up and Coming Lawyer by the Wisconsin Law Journal.

 

 

The guidance provided above is general in nature and readers are encouraged to reach out to Neider & Boucher, S.C., or to their own legal counsel to determine the applicability of these issues to their own personal and/or business needs.