An Update and Recent Cases
Last spring, as the coronavirus descended on us, closing businesses and disrupting our lives, I wrote about how it affected parties’ performance of their contractual obligations in “What to do when you cannot do what is in the contract.”
I touched on the common-law principles of frustration of purpose and impossibility of performance, as well as the effect of force majeure provisions. In my earlier article, I note that the two common-law doctrines sometime overlap, as court occasionally fail to distinguish between them. Plus, different jurisdictions sometimes use different terminology, which can cause confusion.
In short, frustration of purpose occurs where, after a contract is made, a party’s principal purpose for the contract is substantially frustrated without his fault because something happened that both parties assumed would not happen. For example, I agree to pay you $1,000 to sit by your window on Saturday to watch a parade. The star attraction can’t make it and the parade is cancelled. I can still perform. You can still perform. Yet the purpose of the contract is substantially frustrated. I don’t have to pay you $1,000, because unforeseen changed conditions have made your performance to me totally worthless.
However, an event that simply makes the contract less valuable, but does not frustrate the basic purpose of the contract, does not excuse performance. Assume you lease a gas station to me. A subsequent change in traffic regulations reduces traffic flow and make the lease less profitable to me. The purpose of the lease is not substantially frustrated and I must pay rent.
Impossibility of performance, on the other hand, occurs where, after a contract is made, a party’s performance is made “impossible” or impracticable, without either party’s fault, because something happens, which both parties assumed would not happen, and which makes it impossible to perform. For example, A agrees to sell and B agrees to buy goods to be delivered four months later at a specific port. But that port is subsequently closed by quarantine regulations during the entire month, and no commercially reasonable substitute performance is available. A’s duties are discharged, because unforeseen changed circumstances made performance, not just difficult, but impossible.
Now assume A agrees to produce a movie for B. A’s only source of money to produce the movie is in Big Bank, which subsequently fails. A’s duty to produce the movie is not excused. A change in financial conditions is not enough to make performance impossible. Plus, the Big Bank’s failure was not an event the parties assumed would not happen.
A force majeure provision in a contract allows a party to escape its obligations due to extraordinary events beyond its control. Those provisions, like any provision in a contract, must be interpreted in accordance with its specific language.
As predicted, litigation applying these concepts in the context of the coronavirus and the resulting shutdowns has begun. Here are some recent examples:
- A business entered an agreement, settling claims the FTC had lodged against the business. After the parties reached that agreement, however, the pandemic occurred, and the business tried to back out of the deal by relying on a frustration-of-purpose defense. The court rejected that attempt, noting that a party making that argument must show total, or near total, destruction of the transaction’s essential purpose. The business, however, failed to identify the intended purpose of the deal and thus also failed to show that the purpose was frustrated. The court also noted the general rule that changed economic circumstances are not a basis for changing the parties’ bargain. Federal Trade Comm’n v. A.S. Research, LLC, No. 19-cv-03423-PAB-KMT, 2020 WL 4193507 (D. Colo. July 21, 2020).
- An employer who settled a Fair Labor Standards Act claim also tried to back out of a settlement agreement, with the same lack of success. In that instance, the employer argued its performance should be excused because the pandemic, and the governor’s resulting executive order shutting down the employer’s business, made it impossible for the employer to pay the settlement amount. In rejecting that argument, the court explained that financial difficulty or economic hardship, even to the point of insolvency, does not excuse performance. Lantino v. Clay LLC, No. 1:18-cv-12247 (SDA), 2020 WL 2239957 (S.D.N.Y. May 8, 2020).
- A similar impossibility of performance defense failed in Belk v. Le Chaperon Rouge Co., No. 1:18cv1954, 2020 WL 3642880 (N.D. Ohio July 6, 2020). There, the settling defendant provided child care, development, and private elementary services. As in the preceding case, the defendant employer was charged with violating the Fair Labor Standards Act by failing to pay some of the wages it owed employees. And it too tried to avoid a settlement it had made, claiming that Ohio’s order to close all child day care centers disrupted its business and made it impossible to abide by the settlement agreement. The court again noted the general rule that financial difficulty does not ordinarily support an impossibility defense. Moreover, impossibility of performance occurs where, after the parties enter the contract, an unforeseen event occurs that makes it impossible for one of the parties to perform. But when the parties reached their settlement agreement, the pandemic was already raging, the governor had declared a state of emergency, had asked colleges and universities to switch to online and remote instruction, and had recommended that spectators not attend indoor sporting events. Thus, Ohio’s decision to close child care centers was not unforeseeable.
- A restaurateur’s reliance on a force majeure provision in a lease, however, recently met with some success. That lease provision excused performance that was prevented, delayed, or hindered by government action or inaction, or government orders. Due to the pandemic, the governor issued an executive order, suspending on-premises food service at restaurants. Curbside pickup, home delivery, and drive-through services, however, were permitted. The court agreed with the restaurant tenant’s argument that the executive order “hindered” the tenant’s ability to pay rent by prohibiting on-premises food and drink consumption. But the executive order allowed off-site food and beverage services, so the tenant’s obligation to pay rent was not totally excused. Instead, its obligation to pay rent was reduced in proportion to its reduced ability to generate revenue due to the executive order. In re: Hitz Rest. Grp., 616 B.R. 374 (Bankr. N.D. Ill. 2020)
These cases are emblematic of the disputes that are just bubbling to the surface and foreshadow the types of cases courts will be facing over the next year or so. Businesses need to take a hard look at their contracts and evaluate the obligations created by those contracts, along with the effect the pandemic and resulting government orders have had on those obligations and the parties’ ability to perform those obligations.