Contracts in tough times:
Does COVID let me out of the contract and what exactly is a “force majeure” clause anyway?
What a world we’re in right now. Businesses are hugely impacted. Cancellations, suspended operations, people and businesses asking for (and needing) grace periods on everything from their contracts to their leases and mortgages. I won’t belabour it – we all know what it’s like.
Who would have predicted the sort of world we’re in now, right? Well, that’s the big question when it comes to contracts and things like early terminations and putting the deal on pause.
On the one hand, we have movies like “Contagion” and, not to be alarmist at all, but this kind of thing is sort of what the movie is all about. More realistically, the world also saw a major pandemic in the 1918 – 1919 flu, commonly called the “Spanish flu”.
But, really, who thought it could happen to us and our businesses? Does it mean that we can get out of contracts? Can we put them on pause? That’s what is on a lot of minds.
In this article, we’re going to get into some burning questions:
- Does the law give people the right to back out of a contract because of the COVID situation?
- What does your contract say about something like COVID? Does it have an “out” (e.g. a “force majeure” clause)?
- If we don’t want to let each other out of the contract but need to pause it for a while, what do we do?
- The law might give people the right to back out of a contract because of the COVID situation, but we don’t know for sure.
- It depends on if you can show the COVID situation makes your contract impossible to perform or impractical due to extreme and unreasonable difficulty, expense, injury, or loss. Courts have a high standard for that hurdle.
- The COVID disruption, especially if it continues longer and to have such a massive impact, is the kind of situation with enough punch to it to possibly frustrate contracts in the legal sense to excuse the parties from their agreement.
- It also depends on what your contract says. If the agreement has a “force majeure” clause that lets the parties out of the agreement if a major, disruptive, and unpreventable situation comes up, COVID may be the right kind of trigger. Again though, it’s a high standard to show that a force majeure clause should apply, and courts will look for strong arguments about the situation and facts about how you’re impacted.
- The easier way through this is to agree with the other party to your contract about how you will manage the problem – maybe you put payments on hold, reduce them, or pause everything and start again in a few months, for example. You should put that sort of agreement in writing in a formal document called a “waiver”.
Does the law give people the right to back out of a contract because of the COVID situation?
It’s a frustrating time, isn’t it? “Frustration” is what we’re feeling, but it’s also a principle of contract law. When a contract is frustrated, it means the agreement can be set aside because it just isn’t reasonable to expect the parties to be stuck with it. In other words, the parties get to say the agreement is done, it’s no one’s fault, and we’re all let out of it.
Let’s go over what “frustration” means in contract law and if COVID could be a case of it.
What is frustration of a contract?
To know if the COVID situation could be a frustration of contract, we need to see if it fits into any of the categories of frustration that the law has. There are two of them that we’ll go over:
- Impossibility; and
- Frustration of purpose.
We’ll get to this in the next part, so just hold it in your mind for now – this “impossibility” scenario can be overridden by what the contract says. But if the contract doesn’t talk about it, the impossibility principle is what we look to.
Impossibility means there’s just no way to do the contract. For example, if you hired a famous singer to perform at your wedding and the singer dies before the performance, short of s miracle, there’s no way to complete the contract. It’s just impossible.
As another example, think of a business that rents a venue for a performance or conference. The event is coming up in a few weeks. There’s a fire and the building for the venue is burned down. There’s no time to rebuild the venue in a few short weeks and there are no substitute locations owned by the host. Without the building, there is no place for event. So, we could consider the contract frustrated. It’s impossible to hold the event in the venue now.
An impossible situation can also come up because there is a change in the law. This one could be important for COVID. In this type of “impossibility”, the government makes a new law and it means the contract is now illegal or no longer allowed.
Let’s recap to this point. An “impossibility” that could frustrate the contract, meaning that everyone is let out of it, comes down to three possible scenarios:
- A contract for the personal performance of someone and that person dies or is incapacitated because of illness.
- The contract requires a certain thing to be around and that thing no longer exists, or is unavailable, due to no fault of the other person.
- The contract is no longer allowed because of a change in the law.
Frustration of purpose
“Frustration of purpose” generally is not a strong argument. Courts set a high bar for this one. The idea is that you contract with someone and for reasons beyond the fault or control of either of you, the whole purpose of the contract becomes pointless. It’s not that it’s impossible, it’s just pointless or makes little economic sense to do it.
Without going into a long law school type of lecture (and it could be long lecture), the legal test for this type of “frustration” is that the contract has become impractical due to extreme and unreasonable difficulty, expense, injury, or loss.
So, does COVID count as frustration of contract?
As a remember, if a contract is considered frustrated in the legal sense it means the parties are excused from the agreement. They’re out of the contract. As you may imagine, for a court to be willing to go that far it will want a very good reason. Does COVID get us there?
I know this may be frustrating (no apologies for the bad joke), but the answer is “maybe”. I usually like to advise my clients with probabilities. For example, if we can show points 1, 2, and 3, it’s an 80% chance that the answer is “_________”.
With COVID, we just don’t know yet. It’s only been a few weeks (while I agree, it feels like years already) and the impacts aren’t known completely.
On the impossibility side of the argument, you would need to show that the agreement really is impossible to complete. Your argument might be:
- Social distancing and isolation laws, orders, or regulations make your contract impossible to complete. For example, your conference would have far too many people present to meet the maximum group size allowed right now and so you are disallowed from holding it.
- The contract can’t be completed because it calls for performance of a service, job, or other work by a specific person and that person is ill.
Be prepared to meet quite a high standard though. Could the conference be rescheduled to a time when the social distancing rules are ended? Could it be held by video conference instead? Could the specific person that must perform the contract do so on another day?
You see, impossible really means impossible or, at least, very close to it. If you can’t meet the impossibility test, we move on to the “frustration of purpose” category. For that one, you need to show that COVID makes your agreement extremely impractical and unreasonably difficult and expensive.
In our conference example, would it be enough to argue that it took several years to line up the speakers, the whole point of the conference is to have these specific speakers, and rescheduling would mean the conference would be delayed by say a year or more and cost 5 times as much?
COVID has caused a disruption that hasn’t been seen in 100+ years and one of the biggest market swings, ever. It will come down to what impact it continues to have, the specific facts of your situation, and how real court cases play out (and even what the government steps in to do, as we’re seeing with rent payments and landlord-tenant disputes).
I would say this – while we don’t know if it is enough and the impossibility standard is a very high one to meet, COVID is in the right weight class to be a contender.
That’s not quite the end of the story though. We still need to consider what your contract says about big, disruptive situations that come up.
What does your contract say about something like COVID? Does it have an “out” (e.g. a “force majeure” clause)?
An important aspect about a well-written contract is allocation of risk. Put simply, does the contract say who bears the risk that can come up?
In our examples, if the contract says that the venue owner is responsible for the risk of the venue being unavailable for risks like fire, then we can’t say the contract is frustrated. The parties agreed to an allocation or risk – who would be at risk for a scenario – and the law will generally hold them to that.
A common way of allocating risk for things like COVID is through a “force majeure” clause. That kind of clause says the contract will be suspended or even terminated for serious events that are beyond the control of the parties.
Here’s an example of one:
“In no event will either Party be liable or responsible to the other Party, or be deemed to have defaulted under or breached this Agreement, for any failure or delay in fulfilling or performing any term of this Agreement (except for any payment obligations arising before the events described in this paragraph) when and to the extent that such failure or delay is caused by any circumstances beyond such Party’s reasonable control (a “Force Majeure Event“), including acts of God, flood, fire, earthquake, tsunami, explosion, war, terrorism, invasion, riot or other civil unrest, embargoes or blockades in effect on or after the date of this Agreement, national or regional emergency, strikes, labour stoppages or slowdowns or other industrial disturbances, passage of law or any action taken by a governmental or public authority, including imposing an export or import restriction, quota or other restriction or prohibition or any complete or partial government shutdown, or national or regional shortage of adequate power or telecommunications or transportation. Either Party may terminate this Agreement if a Force Majeure Event continues substantially uninterrupted for a period of 30 days or more.”
Think of a force majeure clause as being the impossibility principle written into your agreement.
The main idea is that:
- something serious happens that is unexpected and beyond reasonable human foresight, skill, and control;
- that event is so impactful that it becomes impossible (or perhaps so unreasonable as to be impractical) to carry out the agreement; and
- if, like this example clause, the event has gone on for long enough to show that it is serious and long-lasting;
then, the contract can be delayed, suspended, or even cancelled.
COVID, in my opinion, likely meets point #1. The debate is whether #2 (and #3, if your clause includes a time limit) will apply in your situation or not.
If you’re relying on a force majeure clause, you need to show that there are no reasonable alternative means to complete the contract. If the contract is just more expensive or difficult, it’s unlikely that a court would say the force majeure clause applies. Like the “impossibility” standard we went over for frustration of contract, it’s a high standard to meet.
Several things will need to be considered:
- How impacted is your area by COVID? A force majeure clause is not meant to be anticipatory, meaning if you’re only expecting a major impact but have not yet felt the effects of COVID in your area, you’re not likely yet in a force majeure situation.
- Are you in an essential industry and still able to perform the agreement, just with more difficulty that isn’t so drastic as to make the effort unbearably impractical?
- How long are you going to be impacted and could you simply delay your agreement until this is over?
- Do you have any control over your obligations? Put another way, can you adapt to performing the agreement in another way that accomplishes what you agreed to do?
If we don’t want to let each other out of the contract but need to pause it for a while, what do we do?
If the parties to a contract want to, they can agree to put things on hold for a while. That agreement should be done in writing. In fact, most contracts require that much. It’s called a “waiver”. The idea is simple – you say what parts of your agreement are put on hold, for how long, and you agree to any financial or other impacts (e.g. payments stop or are paused but interest will be charged, etc.).
There you have it. Although I can’t give you a definitive answer, I hope this does two things. First, I hope it takes away some of the confusion and anxiety about these questions. Second, I hope it gives you a sense of what to do.
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About the Author
Greg is the founder of Made It Legal and a lawyer with more than 10 years of experience at large law firms and multinational enterprises. His expertise includes contract writing, data privacy and security, mergers and acquisitions, commercial lending, governance, and general corporate law. You can read up on his bio here.