By Tyson Horrocks, Dirk Gaspar & Michael Wadley
There is no doubt that the COVID-19 pandemic has had an unprecedented impact on contractors and businesses throughout the world. In response to the virus, we have seen many countries and their local jurisdictions issue a variety of emergency declarations and orders to slow the spread of the virus. In the United States, most of the emergency orders that have impacted its citizens’ daily lives have come from state and local governments. Many of these orders, such as limiting the occupancy of establishments or closing certain industry sectors altogether, have directly or indirectly impacted most businesses.
These impacts have often resulted in decreased revenue and the inability for businesses to meet their obligations under certain contracts, such as commercial leases, construction and vendor agreements, mortgages and loans.
If a global pandemic and government emergency declarations make it difficult or impossible for a business to meet its contractual obligations, what legal relief does that business have? Can the business assert a “force majeure” defense even if its agreements are silent on the matter? For contracts in the United States, the answer is generally no.
Force majeure events are generally defined as “acts of God” and typically include wars, terrorism, epidemics and pandemics, major weather events and other events that are unforeseen and/or unpredictable. How jurisdictions treat force majeure events with respect to private contracts varies throughout the world.
Most of Latin America and Europe are “civil law” countries, where the nature and extent of laws are predominantly based on codes and statutes. In such countries, the law typically provides remedies for force majeure events in private contracts. Where a contract does not specifically address force majeure, the law often implies such a provision and a party adversely affected by the force majeure event may be able to obtain relief from the performance of the contract.
The United States, Canada, United Kingdom and Australia, on the other hand, are “common law” countries. Although these countries also have codified laws, published judicial decisions interpreting the laws are of significant importance. A primary distinction between civil law and common law countries is that unless a particular common law jurisdiction has codified force majeure relief, the law will not imply it in private contracts.
Because the United States is a common law jurisdiction, force majeure relief is not implied in private contracts. Relief from force majeure events will only be afforded to a party to a contract where that contract has specifically provided for such relief.
In addition to common-law precedent, the United States Constitution provides a substantial barrier for state or local governments to compel the inclusion of force majeure relief in a contract that does not otherwise address it. Article I, Section 10, Clause 1 of the United States Constitution states that: “No State shall ... pass any ... Law impairing the Obligation of Contracts...” This provision, known as the “Contracts Clause,” prohibits a state from passing laws that retroactively interfere with private contracts. As such, emergency orders or other administrative actions by state and local governments regarding COVID-19 are generally prohibited from interfering with the substantive terms of contracts between private parties and providing force majeure relief in contracts that do not contain force majeure language. Instead, such emergency actions are generally limited to procedural matters such as the timing to bring civil actions to enforce the terms of the contracts. Of course, we have seen several states implement far-reaching emergency orders to address COVID-19 (e.g., the temporary halting of all eviction and foreclosure proceedings), which may retroactively impact private contracts and thus violate the Contracts Clause.
Other emergency orders, such as orders by state governors suspending certain statutes of limitations, arguably violate the principle of separation of powers since the establishment and extension of statutes of limitations are generally within the sole purview of a state’s legislature. These are unprecedented issues that will undoubtedly be the subject of future litigation, including review by the states’ and/or United States Supreme Court.
Many construction agreements, commercial lease and loan agreements, and other business contracts are silent as to force majeure events. As can be seen above, the law in the United States will not imply force majeure relief in these contracts and business owners will still be responsible to comply with the contracts notwithstanding the occurrence of an unforeseen event such as COVID-19. This can leave a business owner in the unfortunate position of having delay damages, significantly decreased revenue or no revenue at all if the business is forced to shut down, while still having to make, for example, payroll, monthly rent or loan payments. Although such a situation may seem dire, there are few contractual defenses that may be available to business owners impacted by a force majeure event.
One defense, known as “frustration of purpose,” can discharge a party’s contractual obligation where performance remains technically possible, but the expected benefit of the contract has been destroyed by the unforeseen event. As an example, if a hotel (required to make monthly mortgage payments) in a tourist-dependent area may remain open despite state COVID-19 stay-at-home orders, these orders may have nevertheless essentially halted tourism and the prospect of any reliable stream of revenue for the hotel during the closure. In other words, the value of the hotel’s continued operations has been effectively destroyed, thus giving rise to a frustration of purpose defense if it is not able to pay its monthly mortgage.
Another defense, “impossibility” or “impracticability,” is available to a party whose performance under a contract is made impossible or highly impracticable by the force majeure event. For example, many commercial leases require businesses to remain open on certain days and times where the rent obligation includes a share of the businesses’ revenue. If a business is subject to a mandatory closure by the state as a result of COVID-19 (e.g., gyms, salons, etc.), it would be clearly impossible for that business to comply with the lease. In such a circumstance, that business may be able to assert the defense of impossibility to excuse its non-performance.
Of course, whether the above contract defenses apply is highly dependent on the particular facts of the case. Moreover, these defenses are in no way certain to be successful as any litigation can involve substantial risk, including the prospect of a business having to close down and/or seek bankruptcy protection. A business owner may be able to negotiate differing terms with the creditor. Whether the contract involved is a lease, loan or other business contract, many creditors have recognized the wide-ranging impact of COVID-19 and are often amenable to working with the business owner to provide some relief. Of course, the nature and extent of relief available will depend on various factors and the leverage, if any, the business owner may have. Regardless, most creditors are now recognizing that working with impacted business owners is in their best interest since getting something now is often better than ultimately getting nothing at all.
If you haven’t recently, everyone should test their agreement forms to ensure they will not be infected by COVID-19 and its adverse effects.
Tyson Horrocks is an employment attorney at Holland & Hart LLP in Salt Lake City and serves as legal counsel for Associated Builders and Contractors of Utah. He counsels employers on the full spectrum of issues and challenges they face to efficiently and effectively manage their workforce .
Dirk Gaspar is a construction attorney at Holland & Hart LLP who focuses his practice on all aspects of construction law, including contract negotiation and drafting, construction defect litigation, disputes and liens.
Michael Wadley is a construction attorney at Holland & Hart LLP. He represents construction companies and owners in project development and complex litigation and commercial, residential, gaming, stadium and transportation projects, large or small.
This article is designed to provide general information on pertinent legal topics. The statements made are provided for educational purposes only. They do not constitute legal or financial advice, nor do they necessarily reflect the views of Holland & Hart LLP or any of its attorneys other than the author. This publication is not intended to create an attorney-client relationship between you and Holland & Hart LLP. Substantive changes in the law subsequent to the date of this publication might affect the analysis or commentary. Similarly, the analysis may differ depending on the jurisdiction or circumstances. If you have specific questions as to the application of the law to your activities, you should seek the advice of your legal counsel.