A How-to Guide for Gauging COVID-19’s Effect on California Commercial ContractsApril 23, 2020 – Alerts
These are unprecedented times for businesses and individuals. While the health and safety risks are of paramount concern, the economic impact from the COVID-19 virus cannot be ignored.
State-mandated closures, “social distancing” and stay-at-home orders and travel restrictions caused by the COVID-19 pandemic have left many California businesses wondering whether they are entitled to relief from existing contractual obligations that they can no longer perform, or ― conversely ― wondering what their options are in the event that another party to a contract fails to perform its contractual obligations.
Many commercial contracts contain force majeure provisions that account for the possibility of circumstances beyond the control of the parties that interfere with performing the obligations under the contract.
What follows is a brief, step-by-step guide through the major issues to consider if you anticipate that the COVID-19 crisis may interfere with performance on a commercial contract relating to your California business.
1. What State’s Law Governs the Contract?
If you are trying to determine whether your (or another contracting party’s) contractual obligations are excused in light of the COVID-19 pandemic, the first question is what law governs the contract at issue. Your contract may have an explicit choice of law provision that dictates which state’s law governs. If the contract is silent as to the governing law that applies, it will likely be governed by the laws of the state in which the agreement was made or where the agreement will be performed.
This alert specifically addresses contracts governed by California law. For general guidance or other state-specific information, check out Fox Rothschild's Coronavirus Resource Center.
2. Does Your Contract Contain a Force Majeure Clause?
What Is a Force Majeure Clause?
A force majeure clause is a contract provision intended to protect the parties in the event that the contract cannot be performed due to forces outside the parties’ control that could not be avoided by the exercise of due care. California codified this doctrine in Cal. Civ. Code § 3526 which provides: “No man is responsible for that which no man can control.”
Does the Language of Your Force Majeure Clause Cover the Triggering Event?
Just because your contract contains a force majeure clause does not mean you are out of the woods. An analysis of how the force majeure clause is defined is necessary to determine whether the COVID-19 outbreak is a “covered event.” The provision in your contract may list specific events applicable to the current COVID-19 crisis such as “pandemics,” “quarantines,” “acts by government entities” or “war or civil disorder.”
However, even if “pandemic” is not specified among the listed events, in California you may still be covered. While some states interpret language listing specific force majeure events as excluding non-listed events, California is a bit more forgiving. Under California law, a non-listed event can still be covered if it is unforeseeable at the time of contracting. See Autry v. Republic Productions (1947) 30 Cal.2d 144.
Keep in Mind
- Causation: Most courts require the party claiming force majeure to show that the event was not foreseeable and directly caused the failure to meet its contractual obligations.
- Inconvenience or increase in expense of performance is not enough: Mere increase in expense does not excuse performance unless there exists “extreme and unreasonable difficulty, expense, injury, or loss involved.” Butler v. Nepple, 54 Cal.2d 589, 599 (1960).
- Notice: If you are relying on a force majeure clause to excuse performance, request an extension of time to perform, or file for declaratory relief, your contract may require that you provide notice (and may have specific requirements for what that notice entails). Look carefully to ensure that you are complying with any technical requirements in the contract for invoking the force majeure clause.
3. No Force Majeure Clause? Other Common Law Remedies May Still Apply
Even if your contract does not contain a force majeure clause (or if the force majeure clause does not apply to the current situation), you may still be able to take advantage of common law defenses such as impossibility, impracticability or frustration of purpose.
Under California law, performance of a contract is excused by the doctrines of impossibility or impracticability when: (1) an unforeseeable event, (2) outside of the parties’ control, (3) renders performance impossible or impractical. Citizens of Humanity, LLC v. Caitac Int’l, Inc., No. B215233, 2010 WL 3007771 (Cal. Ct. App. Aug. 2, 2010) (emphasis added).
Generally, California courts have held that the inability to perform “must consist in the nature of the thing to be done and not in the inability of the obligor to do it.” El Rio Oils, Canada, Limited v. Pacific Coast Asphalt Co. (1949) 95 Cal.App.2d 186. In other words, the obligation must be objectively impossible for anyone to perform, not merely impossible for the specific party to the contract for reasons particular to them. That said, “impossibility as excuse for nonperformance of a contract is not only strict impossibility but includes impracticability because of extreme and unreasonable difficulty, expense, injury, or loss involved.” Autry v. Republic Productions (1947) 30 Cal.2d 144, 148-149.
For example, in Mineral Park Land Co. v. Howard (1916) 172 Cal. 289, the defendant, a bridge builder, contracted to procure all the gravel he would need for construction from the plaintiff’s land. After some performance, he refused to take any more on the grounds that the rest of the gravel was under water and the expense of removal and drying would be over 10 times the amount originally contemplated. The court held that any further performance under the contract was excused because the extraordinary increase in cost and difficulty rendered performance impracticable.
As noted above, mere increase in inconvenience or expense does not excuse performance unless “extreme and unreasonable difficulty, expense, injury, or loss [is] involved.” In Mineral Park Land, the fact that performance would be over 10 times as expensive as anticipated was sufficient to excuse it on the basis of impracticability. To take advantage of this doctrine, the party seeking to avoid its contractual obligations will need to make a showing of more than a minor increase in inconvenience or expense.
Frustration of Purpose
Another doctrine that may excuse performance is frustration of purpose. This is where performance remains possible, but “the whole value of performance to one of the parties at least, and the basic reason recognized by both parties, for entering into the contract has been destroyed by a supervening and unforeseen event.” Dorn v. Goetz (1948) 85 Cal.App.2d 407, 411.
For example, in 20th Century Lites, Inc. v. Goodman, a business owner entered into an agreement to lease neon sign installations to advertise his business at night. An emergency measure during World War II subsequently ordered the cessation of all outside lighting at night and the business owner stopped making payments under the contract. The neon sign company claimed that the business owner should not be excused from his obligations under the contract because it remained possible to light the signs during the daytime. The court, however, rejected this argument, observing that “illumination at night was the desired object to be obtained by the parties… [and] the possibility of such illumination formed the basis on which both parties entered into the contract." Accordingly, the government blackout order frustrated the purpose of the agreement, and termination of the agreement was therefore justified.
4. What Now?
Even if your force majeure clause covers the instant crisis, beware of neglecting to mitigate damages caused by nonperformance. California law requires that even a party invoking force majeure demonstrate that they made “sufficient” or “reasonable” efforts to avoid the consequences of a force majeure event, including (for example) seeking an alternate supplier or pursuing other methods of performance. Whether your agreement contains an applicable force majeure provision or not, the party seeking to avoid its contractual obligations must mitigate their damages.
Consider Seeking Declaratory Relief
If you determine that you cannot perform your contractual obligations, but suspect that you may be excused under one or more of the doctrines discussed above (and assuming your good faith attempts to resolve the issue informally have failed), consider bringing an action for declaratory relief. While most courts have limited capacity for hearing civil matters for the time being, the issues of contract interpretation, impossibility and frustration of purpose are all questions of law that the court can decide without a jury. Instead of waiting to get sued, you have the opportunity to be proactive and to frame the issues for the court.
You should review your company’s insurance policy to see if it includes business interruption coverage that would provide coverage in a force majeure event. The specific language in your policy will determine what coverage may be available to you and if business interruption coverage is available.
Whether you are analyzing prior agreements or negotiating new agreements, it may be vital to have force majeure clauses. We recommend that businesses concerned about COVID-19's effects on California commercial contracts consult with their attorney to analyze what relief may be available.
Mhare Mouradian is a partner in Fox Rothschild’s Litigation Department. He can be reached at (424) 285-7051 or [email protected].