The COVID-19 (the “Coronavirus”) pandemic has the potential to cause business disruptions that may make the performance of a party’s obligations under a commercial contract difficult, unprofitable or impossible. Such disruptions include the loss of employees, disruptions in supply chains, travel restrictions and other governmental restrictions. Various legal considerations implicate the rights and obligations of the parties to a commercial contract when the ability to perform is compromised by such a disruption.

To assess the legal implications of such a disruption, key points to consider include: (i) whether the contract contemplates the occurrence of such an event and (ii) relevant provisions of governing law.

Typical Contractual Provisions

Force Majeure

• Force majeure provisions are included in many commercial contracts and operate to excuse a party’s nonperformance when an event outside of a party’s reasonable control prevents them from fulfilling their obligations under the contract. Well-drafted force majeure provisions specify what qualifies as a force majeure rather than relying on judicial interpretation in the jurisdiction governing the contract.
• Example Force Majeure Provision:
• Force Majeure. Seller shall attempt to overcome but shall not be liable for any loss or damage from delay in delivery of any equipment or completion of any work as a result of causes of any kind beyond the reasonable control of Seller, such as, but not limited to, strike or other labor difficulties, war, riots, changes in laws and regulations, other acts of governmental authorities, fires, floods, unavoidable casualties, epidemics or health emergencies, delays in transportation of materials, or inability to obtain timely delivery of materials from suppliers where such transportation or delivery has been properly procured and appropriately expedited. In the event of any such delay, Seller will notify Buyer within a reasonable time after Seller becomes aware of such cause of delay and it is agreed that the time for delivery or completion shall be extended for a period of time at least equal to the time lost by reason of delay.
• Many commercial contracts permit the buyer to terminate the contract and source elsewhere if a force majeure continues beyond a designated time period.

Material Adverse Change

• Many commercial contracts address the circumstance in which one of the parties suffers a material adverse change or material adverse effect on its business. Typically, such provisions allow the other party to declare a contract default or terminate the contract entirely.
• Example Material Adverse Definition:
• “Material Adverse Change” means with respect to either party any change, event, effect or occurrence that is materially adverse to the business, assets, or financial condition of such party, provided that a “Material Adverse Change” shall not include changes, events, effects or occurrences (individually or in the aggregate) caused by, relating to or resulting from: (i) changes in general economic conditions, the financial markets or such party’s industry generally; (ii) earthquakes, hurricanes, floods, acts of God or other natural disasters; (iii) acts of war, terrorism, military action or the escalation thereof; (iv) any action required or permitted by this Agreement or any action taken (or omitted to be taken) with the written consent of or at the written request of the other party; (v) any matter of which the other party is aware on the date hereof; (vi) any changes in applicable laws or accounting rules (including GAAP); or (vii) the execution, announcement or pendency of this Agreement or the transactions contemplated herein; provided, however, that with respect to clauses (i), (ii), (iii) or (vi), such matters will be considered but only to the extent that such change, event, effect or occurrence disproportionately negatively affects the Business or the Assets relative to other similar businesses.
• Note that in the foregoing definition of Material Adverse Change, an adverse change caused by many categories of force majeure events does not constitute a Material Adverse Change unless it has a disproportionate adverse effect on such party.

Legislative Relief

Uniform Commercial Code (U.C.C.)

• U.C.C. § 2-615 (Excuse by Failure of Presupposed Conditions) applies to commercial contracts in the U.S. for the sale of goods and provides a potential excuse to a party who fails to timely deliver goods where timely performance has been made “impracticable” by the occurrence of an event “the nonoccurrence of which was a basic assumption on which the contract was made” or by “compliance in good faith with any foreign or domestic governmental regulation or order….”
• If the impediment has adversely affected only a part of the party’s capacity to perform, the party must allocate his production and delivery in a fair and reasonable manner but may include in such allocation his regular customers, customers under contract and his own requirements for further manufacture.
• The affected party must reasonably notify his buyer that there will be a delay or non-delivery and, if allocation is required, the quota that will be made available to the buyer.

Article 79 of the U.N. Convention on Contracts for the International Sale of Goods (CISG)

• Some international commercial contracts (when both parties are citizens/residents of treaty countries) are governed by Article 79 of the CISG, unless the parties expressly waive the application of the CISG. Article 79 provides that “[a] party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.”
• The party who fails to perform must give notice to the other party of the impediment and its effect on his ability to perform within a reasonable time after he knew or ought to have known of the impediment.
• Most authorities agree that the ability to claim an Article 79 excuse from performance requires that impediment renders performance impossible, not merely more expensive or more difficult.

Common Law Defenses

• In the absence of a force majeure provision, contracting parties may be able to rely on contract defenses arising under state law. For example, the common law of many states excuse a party’s non-performance in circumstances similar to those addressed in U.C.C. § 2-615 even if the underlying contract is not for the sale of goods and, therefore, not governed by the U.C.C.

Insurance

Although business interruption coverage is typically provided in conjunction with a commercial property insurance policy, there are specialized policies that provide coverage for certain force majeure events such as trade disruptions and political risks.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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