Confusion and uncertainty abound in the business world, with many business owners unable to meet a variety of contractual obligations as a result of the COVID-19 pandemic, and related government shut downs, employee limitations, and supply chain disruptions. Naturally this never-before-seen set of circumstances are leading to questions from both sides of the contract around force majeure, the doctrines of impossibility and frustration of purpose, and how California business owners can most effectively deal with current contractual obligations that may be substantially impacted by the pandemic’s fallout.
This article discusses how California courts interpret and apply explicit force majeure provisions and how/when California courts infer force majeure relief in agreements without such provisions, as well as analysis of related contract defenses. In so doing, it will examine how California businesses may benefit from aggressive or proactive litigation tactics, including early dispute resolution, identification of key issues, and language, and potentially the early commencement of actions for declaratory relief before a breach of contract claim is filed.
Whether the ultimate goal is to excuse the contractual obligations in their entirety, or simply delay the obligations until the force majeure event has concluded, a proactive litigation strategy can not only increase the leverage in negotiations with the opposing party for an alternative (better) resolution, but can also provide valuable and necessary clarity with respect to a company’s current and future liabilities—something every California company (and person) is in short supply of. Additionally, this article will look forward to a post-coronavirus world, and provide suggested language for force majeure provisions so as to best protect the company from similar pandemic shut downs in the future.
Explicit force majeure provision in agreement
The principle underlying the doctrine of force majeure is simple and set forth in Cal. Civ. Code § 3526: “No [wo]man is responsible for that which no [wo]man can control.” Generally, a force majeure clause is triggered when the occurrence of a force majeure event, sometimes generally referred to as an “act of God,” ultimately renders performance so impracticable that it is excused.
As always should be the case, one must first look to explicit language in the contract relating to “force majeure,” “impossibility or impracticability of performance,” “ purpose,” and “early termination.” In California and around the country, where the parties’ written agreement evidences an intent to address specific contingencies, those terms will generally control and be enforced by courts.
In many states around the country, such as New York, the specification of any force majeure event necessarily precludes other force majeure events from being included within the definition. In other words, if earthquakes and fires are listed, but viral pandemic is not listed, many of these courts will not find the force majeure provision to excuse performance obligations. However, California interprets these provisions a bit “less narrowly” than other states, in as much as a non-listed event can still fit within a written force majeure provision if it is “unforeseeable at the time of contracting”. See Autry v. Republic Productions (1947) 30 Cal.2d 144.
This isn’t to say that the legal argument over applicability and scope of such clauses is over, but it is to say that California courts may be more willing and capable to open the door for non-listed force majeure events to be covered under such provisions, providing the equitable considerations outlined below are also considered and weighed.
Force majeure and other reasons California courts excuse contractual obligations
When there is no applicable contract language (or when an unforeseeable event occurred that was not listed in a force majeure provision), contract law has long recognized and accommodated situations in which one party’s contractual performance is made impossible or impractical by intervening and unforeseeable events—such as the outbreak of a war or a similar catastrophic event—notwithstanding any language in the agreement.
In fact, the California legislature codified its equitable protections in Cal. Civ. Code § 1511(2), providing that the performance of an obligation is excused “when it is prevented or delayed by an irresistible, superhuman cause, or by the act of public enemies of this state or of the United States, unless the parties have expressly agreed to the contrary.” (emphasis added)
Again, unlike some other states in the country, California applies this equitable principle broadly, holding that “force majeure…is not necessarily limited to the equivalent of an act of God.” Pac. Vegetable Oil Corp. v. C.S.T., Ltd., 29 Cal.2d 238 (Cal. 1946). As such, one could argue in other states that while the virus may not have been man-made, the spread of the virus and resulting epidemic is certainly man-made, and therefore not an “act of God” in the traditional sense. However, the analysis in California is different. In the Golden Bear state, the test for whether a force majeure / act of God situation is present is “whether…there was such an insuperable interference…as could not have been prevented by the exercise of due diligence.” Id. (emphasis added)
Citing Witkin Summary of Law, California courts have specifically held that “force majeure is the equivalent of the common law contract defense of impossibility and/or frustration of purpose: performance of a contract is excused when an (1) unforeseeable event, (2) outside of the parties’ control, (3) renders performance impossible or impractical. Citizens of Humanity, LLC v. Caitac Int’l, Inc., No. B215233, 2010 WL 3007771 (Cal. Ct. App. Aug. 2, 2010). (emphasis added)
As it pertains to impossibility, California courts hold that the inability to perform “must consist in the nature of the thing to be done and not in the inability of the obligor to do it.” El Rio Oils, Canada, Limited v. Pacific Coast Asphalt Co. (1949) 95 Cal.App.2d 186.
Thus, in addition to highlighting the impact the pandemic has on individual companies, focusing on the industry-wide impact of the pandemic or shutdown may also bolster any argument for force majeure to apply. Moreover, the disruption of different supply chains and other vendor shut downs may also contribute to an inability to perform due to the “nature of the thing being done”, even if they do not directly disable the obligor from performing. However, it must be noted that “impossibility as excuse for nonperformance of a contract is not only strict impossibility but includes impracticability because of extreme and unreasonable difficulty, expense, injury, or loss involved.” Autry v. Republic Productions (1947) 30 Cal.2d 144.
Closely related to impossibility is the legal concept of frustration of purpose, where “performance remains possible, but is excused whenever a fortuitous event supervenes to cause a failure of the consideration or a practically total destruction of the expected value of the performance.” Id. (see also Restatement (Second) of Contract 265 and Lloyd v. Murphy, 25 Cal. 2d 48, 54, 153 P.2d 47, 50 (1944), enumerating the frustration of purpose doctrine when “a party’s “principal purpose is substantially frustrated.”) This situation is now arising as a result of the cancellation of numerous trade shows and other similar events due to the pandemic, where vendors are still able to perform the services to support the trade shows, but the “principal purpose” of the transaction (thousands of attendees) is now frustrated, delayed, or cancelled altogether.
Application of force majeure provisions
Unfortunately, no published California decision has squarely confronted a virus or pandemic in relation to these contract and equitable principles. And as is very often the case, the unique factual circumstances present with each industry, each party and each agreement will dictate the result.
However, the California Supreme Court has been clear that compliance with a contract that involves greater expense or hardship than anticipated does not by itself excuse the obligation. Instead, the party bearing the burden must prove that there exists “extreme and unreasonable difficulty, expense, injury, or loss involved.” See Metzler v. Thye (1912) 163 Cal. 95, 98; see also Oosten v. Hay Haulers Dairy Emps & Helpers Union (1955) 45 Cal.2d 784, 788.
California law similarly requires that parties invoking force majeure demonstrate that they made “sufficient” or “reasonable” efforts to avoid the consequences of the force majeure event, such as seeking other suppliers or other methods of performance. A prime example is the case of Butler v. Nepple (1960) 54 Cal.2d 589. 599, where force majeure did not excuse a drilling company from its contractual obligations where the company could not obtain necessary tools because its supplier was on strike. Although strikes were among the force majeure events enumerated in the clause, the court found the company was obliged to source the tools from an alternate supplier, even though doing so would cause the company to incur additional expense, and there was no showing that the additional expense or other methods to drill were “extreme or unreasonably difficult.”
In Mitchell v. Ceazan Tires, Ltd. (1944) 25 Cal.2d 45, a tenant who had leased space for a tire store argued World War II triggered governmental regulations on the sale of new tires making performance impossible. The California Supreme Court rejected this argument, not only because the contract was entered into when the country was debating entry into the war, making this not entirely an unforeseeable or remote possibility, but also because the contract still retained value notwithstanding the limitation.
While it is necessary to provide evidence of unreasonable difficulty and/or lack of value, the landmark Autry case also brings up another threshold question that will need to be considered after impossibility is determined or a force majeure provision is enforced—and that is whether the circumstances merit only a delay in performance, or a complete termination of all contractual obligations. In such situations, courts will look to whether “time is of the essence” in the contract, and if it is, then a complete termination of all contractual obligations may be the most equitable result for the court to adopt (see, e.g. Autry, supra, which held that by the time Word War II was over, the economic conditions had changed to such a degree that the famous actor was excused from the performance of a contract he signed prior to the war).
Strategies to deal with contractual obligations
While these inquiries are hugely fact-dependent, the issues of contract interpretation, impossibility, and frustration of purpose are all questions of law for the court to decide—not the jury. See Oosten, supra, 45 Cal.2d at 788. As a result, instead of waiting to get sued, a party who knows it will not be able to perform an obligation has the right to bring an action for declaratory relief first. While the burden of proof remains with the party who is looking to excuse the contractual obligation, there may be some additional benefits to this strategy when dealing with the current pandemic.
To begin with, it is important to remember that the issues are equitable in nature, therefore judges are asked to look at things like fairness and public policy. Accordingly, any litigation strategy should begin by a good faith attempt to reach out to the opposing party, set forth either the reasons for the impossibility (both internal and industry-wide), or the reasons for why the obligation should not be excused in light of these events, and attempt to find a resolution outside of court.
If this is ultimately unsuccessful, so be it, the action for declaratory relief can still be proactively filed, at which time the filing party will be the one framing the issues for the judge—something that may be important since, as discussed above, there is no specific California case on pandemics to guide courts on this subject.
Given the uncertainty around the availability of jurors and jury trials, as well as the backlog already created by court cancellations, an action for declaratory relief from the court without the involvement of a jury can also serve to quicken the litigation process—saving both time and money for the company. But perhaps more important than saving litigation costs, is providing some semblance of clarity and certainty for companies to know the true nature of their liabilities and financial obligations in the post-coronavirus world. And in times like these, clarity and certainty are seemingly as rare and coveted as rolls of toilet paper.
Suggested language for future force majeure provisions in contracts
Given that a pandemic and shutdown of this magnitude is, forever more, a foreseeable event, its description should be found more frequently in force majeure contractual provisions going forward, so as to erase any doubt.
Drafters of agreements need to be careful to not simply provide boilerplate / catch-all language, which has been held insufficient in California and other states—a good example being Watson Labs, Inc. v. Rhone-Poulenc Rorer, Inc., 178 F.Supp.2d 1099, 1111 (C.D. Cal. 2001), where language referring to “regulatory, governmental … action” was found to be too vague and boilerplate to reflect that the parties considered that the shutdown of the Defendant’s plant would be encompassed. In contrast, in Eastern Airlines, Inc. v. –McDonnell Douglas Corp., 532 F.2d 957, 963 (5th Cir. 1976), the court found the force majeure language was specific enough by referring to precisely the kind of governmental action that caused the delay: “any act of government, governmental priorities, allocation regulations or orders affecting materials, equipment, facilities or completed aircraft.”
Accordingly, while specificity may be a double edged sword, over-inclusiveness on all of the potential effects from a pandemic such as the coronavirus is advisable. In other words, instead of simply including “viral pandemic,” parties may want to include many of the by-products we’ve seen from the spread of the epidemic, such as shelter-in-place orders, quarantines, government shutdowns, substantial interruption to air travel, substantial interruptions in supply chains, and other economic ripples caused by the response to an epidemic or pandemic.
Below are some drafting tips to address COVID-19 or a similar future event:
- Ensure the contract has a force majeure clause or related contractual defense clause to cover COVID-19 or a similar future event, with considerations given to whether the clause should be open and unqualified or a closed list of force majeure events (as outlined above)
- Consider how the governing law of the contract affects the force majeure clause in the contract (see differences between California law and New York law, outlined above)
- Ensure the contract has clear notification provisions relating to notice being provided of the force majeure event
- Provide for rights to suspend and terminate the contract as appropriate, as well as the time period of suspension before any termination right can be exercised
- Consider provisions requiring the party claiming force majeure to mitigate the effects of the force majeure event
- Consider if all obligations should be suspended during the period of suspension, or if only some of the obligations should be suspended (such as payment obligations)
- Consider whether clauses providing for injunctive relief are appropriate to address these scenarios.
And as always, all parties are encouraged to wash their hands, thoroughly and often.