Is Your Contract Virus-Proof? [Part II]

As the coronavirus disease (COVID-19) continues to spread rapidly throughout the United States—and the world—commercial relationships are being thrown into disarray, resulting in the disruption of supply chains, cancellations of events, and closures of restaurants and other businesses. Several states have declared a state of emergency (including banning large group gatherings and mandating that certain business shutter for the time being). Many companies are requiring that their employees work remotely. As a result of the substantial impact on “business as usual” operations, companies are facing decisions about what to do when COVID-19 circumstances make it difficult (if not impossible) to comply with certain contractual obligations. Will COVID-19 provide your company with a legal defense excusing performance?

If you are operating under a contract governed by United States law, the first place to look for the answer is within the four corners of the contract document itself. Specifically, check your contracts to determine whether there are force majeure or other impossibility of performance-type clauses. If not, are you out of luck? The answer differs depending on the subject matter of the contract.

The Sale of Goods. If your contract relates to the sale of goods, then the Uniform Commercial Code (U.C.C.), Section 2.615, may provide your company with force-majeure type protection. Section 2-615 allows a seller to raise impracticability as a defense in a sales contract. Generally, a party asserting the impracticability defense must prove: 1) that an unforeseeable event occurred; 2) the nonoccurrence of the event was a basic assumption underlying the agreement; and 3) the event rendered performance impracticable. Thus, you would need to argue that COVID-19 satisfies these requirements.

Service and Other Contracts Not Related to the Sale of Goods. But what if your contract relates to services or other subject matters not related to the sale of goods, and therefore the U.C.C. does not apply? Is a force-majeure type defense available, even if there is no written clause in your contract? The short answer is maybe. Most states recognize the common law doctrines of impossibility, impracticability, or frustration of purpose as ways to excuse non-performance in limited circumstances. However, these doctrines are often difficult to establish and vary by state.

• Impossibility and Impracticability. With no force majeure clause in place, your company may rely on the doctrine of impossibility, albeit the standard is high. Impossibility generally requires the destruction of the contract’s subject matter or when performance is objectively impossible due to an unanticipated, unforeseen event that was not contemplated by the parties. By way of example, New York and Texas apply the doctrine narrowly and performance is excused only under extremely limited circumstances.[1] Michigan and California, however, have expanded the doctrine to include not only instances of strict impossibility but also when performance would be impracticable—an easier standard to establish.[2] Impracticability may excuse performance when a party can prove that the performance would be unreasonably difficult, expensive, or when injury or loss is involved.[3]
• Frustration of Purpose. In addition, your company also may be able to rely on the related doctrine of frustration of purpose when a contract governed by common law does not contain a force majeure clause. The doctrine is sparingly applied and is also difficult to prove. In Michigan for instance, the doctrine generally requires an unforeseen change in circumstances that makes one party’s performance virtually worthless to the other, thus frustrating the very purpose in making the contract.[4] The key difference between impossibility and frustration of purpose is that the latter requires a change in circumstance that rendered the contract pointless for both parties.[5] The doctrine is similarly applied in California and New York. In Texas, however, while frustration of purpose may be referenced by this name, there is no functional distinction between it and the doctrine of impossibility as discussed above.[6]

Responsive measures likely will escalate as a result of COVID-19 and may hinder (or preclude) your company from performing its contractual obligations. Parties without a contractual force majeure clause should carefully consider the factual scenario when deciding whether COVID-19 renders performance impossible or impracticable. Alternatively, frustration of purpose may apply when the specific purpose for which a contract was entered is rendered virtually worthless as a result of the outbreak. If your company is faced with the possible inability to perform its contractual obligations due to COVID-19, seek the advice of counsel now—before the date of potential breach occurs—and discuss whether the above legal defenses excusing performance may apply. To avoid waiving these defenses, certain notices should be sent before the date performance is due.

For more information on these topics, please contact Laura Baucus (248-203-0796 or lbaucus@dykema.com) or your Dykema relationship attorney.

Stay ahead of emerging issues with Dykema’s Coronavirus (COVID-19) Resource Center and subscribe to all relevant publications so you can easily leverage information, stay up to date on evolving developments, and better position yourself for success.

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[1] Kel Kim Corp. v. Cent. Mkts., Inc., 70 N.Y.2d 900, 902 (1987); Key Energy Servs. v. Eustace, 290 S.W.3d 332, 340 (Tex. App. 2009).

[2] Bissell v. L. W. Edison Co., 9 Mich. App. 276, 285 (1967); Habitat Tr. for Wildlife, Inc. v. City of Rancho Cucamonga, 175 Cal. App. 4th 1306, 1336 (2009).

[3] Roberts v. Farmers Ins. Exch., 275 Mich. App. 58, 74 (2007); Habitat Tr. for Wildlife, Inc., 175 Cal. App. 4th at 1336.

[4] City of Flint v. Chrisdom Props., 283 Mich. App. 494, 499 (2009).

[5] Liggett Rest. Grp., Inc. v. City of Pontiac, 260 Mich. App. 127, 134 (2003).

[6] Key Energy Servs, 290 S.W.3d at 339.