The Covid-19 pandemic is circling the globe, causing chaos everywhere it goes. Businesses are faced with dwindling consumer demand, disruptions to supply chains, and shut-down orders from local and state governments. A business owner may be reduced to near panic or despair, bemoaning his or her plight, because the business has obligations it simply cannot meet. The business can’t do what a contract requires it to do. What should a business owner do and what does he or she need to know?
In many instances, businesses have continuing relationships and depend on each other both to survive and to thrive, e.g. landlords and tenants, suppliers and restaurants, wholesalers and retailers. Ideally, they will cooperate and work together to address their mutual predicament, either through direct discussion and negotiations or perhaps through mediation or some other form of alternative dispute resolution. But whether they are able to work out things that way, or they eventually resort to litigation and redress through the courts, they need to know some basic legal principles and have the guidance of able legal counsel.
In this article, I will touch on some of those basic principles, specifically force majeure provisions in contracts, the common-law principle of frustration of purpose, and the related principle of impossibility (also occasionally referred to as impracticability). Courts’ treatment of the two common-law doctrines occasionally overlaps, with different jurisdictions using different and sometimes conflicting terminology. In short, courts may view the doctrines differently and they may essentially combine them into one comprehensive doctrine. As one court has observed, “courts are not always careful to distinguish between frustration, impossibility, and impracticability.
The confusion is understandable because the governing rules are quite similar.” Island Dev. Corp. v. District of Columbia, 933 A.2d 340, 349 (D.C. 2007) (internal quotation marks omitted) (citation omitted). Careful attention must be paid to which jurisdiction’s law applies to each specific situation. In addition, in contracts involving the sale of goods, provisions of the applicable version of the Uniform Commercial Code must be consulted.
In “COVID-19 Litigation – What Business Owners and Their Advisors Need to Know,” my colleague Bill Goldberg discusses four types of lawsuits that could arise from the pandemic, with litigation concerning the interpretation of force majeure provision being one. A force majeure provision in a contract allows parties to escape their obligations due to an extraordinary event beyond their control. The provisions often refer to a specific kind of events, such as wars, riots, crime, plagues, or Acts of God (e.g. hurricane, flood, or earthquake). As true with any contractual provision, the precise language of the particular provision will control. Thus, it is imperative that anyone who thinks his or her contractual rights or obligations might be affected by such a provision should consult with a lawyer.
Frustration of purpose
Even in the absence of a force majeure provision in a contract, other legal principles might apply. What many courts call “frustration of purpose” is one such principle. Where the principal reason a party entered a contract is substantially frustrated by an unforeseeable event that the parties assumed would not occur, the party might be excused from further performance under the contract. See Restatement (Second) of Contracts § 265. Different states have adopted different versions of the doctrine, express it in different terms, and apply it in different ways. So again it is important to know what state’s law applies to a particular contract.
For example, in Maryland, “where the purpose of a contract is completely frustrated and rendered impossible of performance by a supervening event or circumstance, the contract will be discharged.” Harford Cnty. v. Town of Bel Air, 348 Md. 363, 384 (1998); Montauk Corp. v. Seeds, 215 Md. 491, 499, 138 A.2d 907, 911 (1958). Maryland courts consider the following factors in determining whether the doctrine applies: “(1) whether the intervening act was reasonably foreseeable; (2) whether the act was an exercise of sovereign power; and (3) whether the parties were instrumental in bringing about the intervening event.” Id.
The District of Columbia closely follows Restatement (Second) §265’s formulation: If “a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary.” Island Dev. Corp. v. District of Columbia, 933 A.2d at 349. Under the doctrine, “the promisor’s performance is excused because changed conditions have rendered the performance bargained from the promisee worthless.” Id.
Under Maryland’s doctrine of legal impossibility, “[i]f a contract is legal when made, and no fault on the part of the promisor exists, the promisor has no liability for failing to perform the promised act, after the law itself subsequently forbids or prevents the performance of the promise.” Wischhusen v. American Medicinal Spirits Co., 163 Md. 565, 572–573 (1933). In order to succeed under this theory, however, performance under the contract must be objectively impossible. But where some circumstance beyond the party’s control has made it impossible for that party to perform its obligations under the contract, performance is excused. See, e.g., Acme Moving & Storage Corp. v. Bower, 269 Md. 478, 483-84 (1973) (holding that the inability to obtain a governmental permit necessary to perform a contract, without the fault of the applicant, gives rise to the defense of impossibility of performance “if such interference was not foreseeable at the time of the execution of the contract and the risk was not assumed by the promisor”).
In applying Virginia law, the label “impossibility of performance” has been applied to an analysis similar to what other courts label “frustration of purpose.” After noting that “application of the doctrine” requires “that the frustration of performance [be] substantial,” the court said, “a party relying on the defense of impossibility of performance must establish (1) the unexpected occurrence of an intervening act, (2) such occurrence was of such a character that its non-occurrence was a basic assumption of the agreement of the parties, and (3) that occurrence made performance impracticable.” Opera Co. of Boston, Inc. v. Wolf Trap Found. for the Performing Arts, 817 F.2d 1094, 1101 (4th Cir. 1987).
After acknowledging the similarity to the frustration of purpose analysis, the District of Columbia Court of Appeals explained what a court must consider in determining “whether an event caused performance of a contract to become impossible.” There are three steps to the analysis. “First, a contingency—something unexpected—must have occurred. Second, the risk of the unexpected occurrence must not have been allocated either by agreement or by custom. Finally, occurrence of the contingency must have rendered performance commercially impracticable. Unless the court finds these three requirements satisfied, the plea of impossibility must fail.” Island Dev. Corp. v. District of Columbia, 933 A.2d at 350 (citations omitted).
Uniform Commercial Code
Each state has adopted some version of the Uniform Commercial Code, or “UCC.” A major component of the UCC is Article 2, which governs contracts for the sale of goods. For contracts involving the sale of goods, the common-law principles discussed above have been largely supplanted by express provisions in Article 2 of the UCC. See, e.g., Section 2-615. It is obviously important that the appropriate version of the UCC be carefully reviewed if a contract is for the sale of goods.
These are challenging and frankly somewhat scary times. Uncertainty abounds and no businessperson likes uncertainty. The first step in dealing with that uncertainty requires analysis of all applicable contracts, with particular attention paid to the existence of force majeure provisions. The second step requires consideration of common-law principles of frustration of purpose and impossibility. Finally, an eye must be kept on the applicability of the UCC. Each of these steps can be complicated and confusing. Prudent business people should consult counsel to help them traverse these steps.