Turkish Law Blog

Force Majeure under U.S. Law

Mehmet Baysan Mehmet Baysan/ Breeding Henry Baysan
Adam Duggan Adam Duggan/ Breeding Henry Baysan
10 April, 2020
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As of 8 April 2020, nearly 1.5 million people have contracted COVID-19, equity markets across the globe have shed trillions of dollars of gains, and unemployment has shattered previous highs.  As a result, businesses are struggling to fulfill their contractual obligations and looking for ways to mitigate their damage.  Can they not perform and be excused? It depends. Importantly, most U.S. jurisdictions recognize that such unforeseen pandemics may excuse businesses from performing their contractual obligations, allowing businesses to pare losses.  This update will examine the doctrine of force majeure under U.S. law, consider when businesses should invoke the doctrine, and provide best practices when invoking force majeure

Force Majeure Under U.S. Law

A force majeure event is one beyond the control of the parties which prevents performance under a contract and may excuse non-performance.  The doctrine of force majeure is a creature of contract; thus, whether you can invoke force majeure depends on the precise language of the contract and the facts giving rise to the invocation. 

Absent contractual language, there are related doctrines that may excuse contractual performance: impossibility of performance and frustration of purpose.  Impossibility of performance must be caused by an event that was unforeseen and could not have been guarded against in the contract.  Frustration of purpose exists when an unforeseen event—sometimes characterized as a “virtually cataclysmic” event—renders the contract valueless to one party. 

Under force majeure, impossibility of performance or frustration of purpose, an event that that results in mere impracticality or unanticipated difficulty does not completely excuse performance.  See, e.g., Health-Chem Corp. v. Baker, 915 F.2d 805 (2d Cir. 1990) (holding that performance was not excused where the stock market dropped, making a stock purchase provision in settlement agreement substantially more onerous to one party).  Whether performance is impractical or impossible is a fact-intensive inquiry.  Accordingly, it is imperative that performance be made impossible or that the purpose of the contract be totally frustrated.

Under a wide-ranging set of facts, courts across the U.S. have held that non-performance should be excused.  For example,

  • Toyomenka Pacific Petroleum, Inc. v. Hess Oil Virgin Islands Corp., 7771 F. Supp. 63 (S.D.N.Y. 1991) – Under New York state law, Force majeure clause in contract excused defendant’s failure to take timely delivery of cargo and to pay damages for the delay. Defendant’s terminal and refinery were damaged by Hurricane Hugo, and the force majeure provision provided that neither party was liable for damages for any event outside the party’s control, acts of God, floods, and perils of the seas.
  • Castor Petroleum v. Petroterminal De Panama, 107 A.D.3d 497 (N.Y. Sup. Ct. App. Div. 2013) – The court held that the force majeure clause—which provided that a “government embargo or interventions or other similar or dissimilar event or circumstances”—would discharge the duty of performance. There, a Panamanian court attached the plaintiff’s oil for failure to obtain the appropriate business licenses.  Defendant was to use the attached oil and make it available to plaintiff, which it could not do as a result of the attachment.  Accordingly, non-performance was excused.
  • VICI Racing, LLC v. T-Mobile USA, Inc., 763 F.3d 273 (3d Cir. 2014) – Applying Delaware state law, the court excused non-performance under the contract pursuant to the force majeure The clause required that (1) non-performance resulted from a condition beyond the party’s control, (2) notice be promptly given, and (3) that performance resume as soon as the interference was removed.  Under the contract, the non-performing party was required to enter a racecar in a race, but the party failed to do so after the racecar was crashed and out of commission for nearly 2 months.  Due to unforeseen damage, the required special repairs, and the lack of parts to complete those repairs, the court held that the force majeure clause excused performance.
  • Mueller v. Marvel, C.A. No. 04-07-110 (Del. Com. Pleas Dec. 8, 2004) – Two parties entered into an oral contract for the leasing of a chicken house. As a result, there was no force majeure  During the lease, the chicken house collapsed.  The court held that defendant’s failure to pay rent was excused by the collapse, under the doctrine of impossibility.  The court reasoned that (1) the viability of the chicken house was necessary to defendant’s performance under the contract, (2) the chicken house materially deteriorated, and (3) fortuitous circumstances, as opposed to foreseeable circumstances, caused the material deterioration.
  • Scruggs v. Roach, 1993 WL 93362 (Tenn. Ct. App. March 31, 1993) – Doctrine of frustration of purpose resulted in rescission of contract to purchase a gas service station.  The court held that defendant knew or had reason to know that several storage tanks were leaking and would render the gasoline station unusable as intended by the parties.  After the sale, the purchaser had to stop selling gasoline, which represented 70% of purchaser’s business.  The court reasoned that the entire commercial purpose of the contract was destroyed, allowing purchaser to unwind the transaction.

Performance Under the UCC and the CISG

Every state, excluding Louisiana, has adopted Article 2 of the Uniform Commercial Code (“UCC”).  Briefly, Article 2 governs the sale of goods, including how performance is to be made, when performance is excused, what constitutes a breach of contract, and the remedies following a breach. 

Under the Uniform Commercial Code, performance may be excused if it was made impractical following an event, which was not a basic assumption on which the contract was made or was in good faith compliance with any governmental regulation or order.  For example, in Harriscom Svenska, AB v. Harris Corp., the court held that commercial impracticability excused non-performance where the manufacturer of goods refused to ship parts to the plaintiff after the U.S. government prohibited sales of goods to Iran, the original destination of the parts.

Under Article 79 of the UN Convention on the International Sale of Goods, performance is excused if the non-performance was due to an uncontrollable event that the party could not reasonably have been expected to have taken into account when entering into the contract and could not otherwise have been avoided or overcome.  COVID-19’s effects, including governmental responses, are likely uncontrollable events.  Thus, under Article 79 of the CISG, the issues are whether (1) non-performance is due to COVID-19’s effects, (2) COVID-19 and its effects could have been addressed at the time of contracting, and (3) the non-performing party could have acted to avoid or overcome the events.

As is clear, there are common threads under the doctrines of force majeure, impossibility of performance, and frustration of purpose under U.S. law, commercial impracticality under the UCC, and non-performance under the CISG: (1) unforseeability/uncontrollability of (3) impossibility vs mere impracticability; and (4) the ability to mitigate or otherwise avoid non-performance.

Pros and Cons

Of course, the decision to stop performance under one of the non-performance doctrines discussed above may have significant consequences—good and bad—for your business. 

Excusing performance may allow your business to:

  • Reduce financial spending in a time of serious budgetary tightening;
  • Potential to renegotiate contract following invocation of force majeure; and
  • Refocus on viable contracts.

Potential consequences of failing to perform may include:

  • Future litigation—either by the counterparty for damages or by your business to seek past performance;
  • The counterparty may allege that force majeure was inapplicable and cease performing—e.g., paying on previously completed performances; and
  • Loss of goodwill.

Invoking Force Majeure

After consulting with counsel, if you determine that invoking force majeure to stop performance under the contract is the appropriate remedy for your business, you should implement the following best practices:

1. Due Diligence – Gather all the facts concerning COVID-19, governmental responses, operational difficulties, etc. You should also carefully review any force majeure clauses in the contract.

2. Consider Mitigation – Determine whether it is possible to mitigate COVID-19 and its effects or otherwise complete performance (even with the event; (2) the event’s causation of non-performance;

3. Clear Decision – In determining to cease performance, make clear NOT to use COVID-19 as simply an excuse to backout of an undesired contract. The decision to cease performance must flow from points 1-2.

4. Adequate Authority – Ensure that the appropriate parties in your business have weighed-in on the facts giving rise to the inability to perform.

5. Internal Notification – Inform all employees and agents of the business that need to know, ensuring no inadvertent or misleading representations from employees of your business to the counterparty.

6. Counterparty Notification – Provide notice to the counterparty.

7. Negotiate – Be prepared to negotiate new terms with the counterparty.

8. Assess – Continue to assess the situation to ensure that performance does not later become possible (if segregated into distinct parts). Consider whether these events fall within your business interruption insurance coverage.

If the counterparty files suit, they will be most likely entitled to discover information that led to the decision to stop performance.  These materials may include board meeting minutes, internal memoranda, internal and external correspondence including emails, instant messages, WhatsApp messages, etc.  It is important to articulate a clear and persuasive reason why COVID-19 was an unforeseen event that did more than simply make performance more impracticable or difficult but, rather, made performance impossible or otherwise completely destroyed the purpose of the contract.

 

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