COVID-19: Force Majeure Clauses in Contracts – Court Decision

COVID-19: Force Majeure Clauses in Contracts – Court Decision

These are trying times.  Did your business get shuttered by governmental mandated closure orders due to COVID-19?  Are your business vendors and contract parties still looking to your business to timely pay and perform as normal?  Contracts often include a force majeure clause meant to protect one or the other, or both parties in case of a disaster.  Have you reviewed your contract terms?

In addition, by statute in many states, including, for example, California, the default rule is that a party’s failure to perform its obligations under a contract is excused when performance is prevented by: (1) the operation of law, (2)  the act of the other party, (3) an “irresistible, superhuman cause,” or (4) the “act of public enemies” of the government.  California Civil Code section 1511.   Any agreement by the parties to waive causes (1) and (2) is void.  However, the parties may agree to waive causes (3) and (4).  As such, the force majeure defense is available to any party in a contract by default and can only be waived in part.

So, while a business’s contracts may not have force majeure clauses, failure to perform is arguably excused under Civil Code section 1511 if a party argues that the governmental shut-down orders fall within the meaning of cause (1) operation of law.  If a contracting party was allowed to continue to operate, however, because it qualifies as an essential business, the case for excusable nonperformance is less compelling.  And, if the contract at issue required a specific employee’s efforts to perform and such employee was hospitalized due to infection of the coronavirus, that party would likely argue that its obligation to perform should be excused because of an “irresistible, superhuman cause.”  Terms of the contract may play a more direct role in analysis.

Force majeure is a common clause in contracts that essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as a war, strike, riot, crime, epidemic or an event described by the legal term act of God, prevents one or both parties from fulfilling their obligations under the contract. In practice, most force majeure clauses do not excuse a party’s non-performance entirely, but only suspend it for the duration of the force majeure.  But unforeseeable circumstances that prevent someone from fulfilling a contract may completely relieve a party from further performance under the contract.  These unforeseeable circumstances are what a force majeure clause is meant to cover.

However, many contract parties have taken the position that a virus or a governmental closure order is not an act of God and not covered by force majeure.  These issues are not typically litigated and the issues of a pandemic or governmental closure has not affected a broad swath of the business world in quite some time.  So, there are few cases to use as guidance.

The United States Bankruptcy Court for the Northern District of Illinois – Eastern Division just issued a ruling that held a force majeure clause in a lease required rent abatement from closures arising out of the COVID-19 pandemic.  This is the first case we have found where a court granted relief under a force majeure clause triggered due to the COVID-19 pandemic.  While this case involved a lease and is of keen interest to both tenants and landlords, the issue of enforcement of a force majeure clause is being watched by contracting parties of all sorts.  The case is: In re Hitz Restaurant Group (2020 Bankr. LEXIS 1470 (N.D. Ill. June 2, 2020)).

The Hitz case tenant, which operated a restaurant in the City of Chicago, filed Chapter 11 (reorganization) bankruptcy and then argued that under its lease, its obligation to pay post-petition rent for the months of March through June was excused by the lease’s force majeure clause, which stated:

Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any obligations are prevented or delayed, retarded or hindered by . . . laws, governmental action or inaction, orders of government . . . . Lack of money shall not be grounds for Force Majeure.

The Hitz tenant in bankruptcy asserted that the March 16, 2020 executive order by Illinois Governor J. B. Pritzker’s limiting the operation of restaurants to carry-out, pick-up, and delivery service only triggered the force majeure clause in the lease.  The court agreed, holding that the executive order triggered both the “governmental action” and “orders of government” provisions of the clause.

The court also stated that the executive order was “unquestionably the proximate cause of Debtor’s inability to pay rent, at least in part, because it prevented Debtor from operating normally and restricted its business to take-out, curbside pick-up, and delivery.”  So, in the end, the bankruptcy judge granted the tenant bankruptcy debtor restaurant a seventy-five percent (75%) rent abatement, based on the percentage of the restaurant’s square footage rendered unusable by the executive order.

While the landlord valiantly argued against application of the force majeure clause in this circumstance and why the Hitz restaurant tenant in bankruptcy should be required to pay rent despite the governor’s order, the bankruptcy judge rejected the landlord’s arguments and stated that the landlord’s argument that the executive order did not make payment impossible because it did not [completely] shut down the banking system or post offices was “specious” and “lacking any foundation in the actual language of the force majeure clause of the lease.”  And, while the landlord also argued that the Hitz restaurant tenant could have used other sources of funds than its operating revenues to pay the rent, the bankruptcy judge rejected that argument too and noted that the force majeure provision in the lease did not require such efforts.

As the economic repercussions of the COVID-19 pandemic continue and place more financial hardship on one or both parties to a contract, considering whether force majeure allows some relief will be more important.  This case may represent just the beginning of a string of decisions by state and federal courts interpreting application and terms of force majeure clauses.

Review of the specific wording of your contract is always important and we recommend that you have an attorney review all business contracts- especially in light of COVID-19 related complications.  However, whether a force majeure clause could apply is just the beginning of contract review.  Other questions that must be considered include: What is the allocation of cost and expense under a force majeure clause?  How do you determine whether the force majeure clause does not excuse a party’s negligence or fault?  How do force majeure clauses interact with “make good” clauses? If a party has (or is required to have) business interruption insurance as a source of payment under the contract, does the force majeure clause apply?  How should a party to a contract invoke a force majeure clause?  Are there other contract terms that would get the parties to the same result (e.g. terms regarding impossibility and frustration of purpose, and commercial impracticability)?  Legal review of these and other related issues to provide practical solutions is important.

Epps & Coulson, LLP will be closely monitoring these issues and new cases as the courts catch up with the fallout from COVID-19.

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Information contained in this Memo is intended for informational and educational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.  While intended as information and educational, it is considered advertising under applicable various laws of some states, and as such, Epps & Coulson encourages you to call us in order to discuss these matters as they apply to you or your business.