COVID-19: Knowing Your Contract and Getting Ahead of the Curve

By Rachel A. Morgenstern

In light of business interruptions caused by COVID-19 and the resulting executive orders issued by Governor Cuomo and President Trump, there is no better time than now to consider and prepare for liability that may arise when the tide turns and business resumes, at least to some degree, throughout the state and the nation. Those able to do so should use this time to take a close look at contracts new and old – as those contractual relationships already affected by the pandemic may give rise to litigation, and those still in good order may yet be tested.

Below is a cursory review of some of the many legal doctrines and concepts that may come into play when dealing with a potential breach of contract due to COVID-19.

Termination for Non-Performance

One of the first questions to ask is whether the contract contains a provision for termination in the event of non-performance and, if so, whether it provides for immediate termination upon non-performance. In the alternative, it might specify some permissible window of delay — a certain number of days, i.e. 30 days — within which to cure the alleged breach. Moreover, the clock on that hypothetical 30-day window might not even begin to run until one party issues the other notice of the alleged breach. Whether the contract specifies that “time is of the essence” may also be relevant, though such may be implied if not explicitly stated.

Force Majeure

A force majeure clause is a contractual provision that may exempt a party from liability for breach of contract where the breach is caused by “circumstances beyond the control of the parties,” such as “act of God.” See Kel Kim Corp. v Cent. Mkts., Inc., 70 NY2d 900, 902 (1987). Such provisions are construed narrowly under New York law, and where a contract does not contain a force majeure clause, the parties cannot rely on force majeure as a defense. See id.

Moreover, where the parties have listed examples of what constitutes a force majeure event, i.e. flood, storm, war, rebellion, etc., a force majeure provision will generally apply only in those circumstances. See e.g. Reade v Stoneybrook Realty, LLC, 63 AD3d 433, 434 (1st Dept 2009). Even if the list is followed by a catchall phrase, such as “or other circumstances,” the Court is likely to apply the principle of ejusdem generis, and consider only circumstances of the same kind or nature as those expressly listed. See Kel Kim Corp., 70 NY2d at 903. Accordingly, whether the current COVID-19 pandemic will constitute a force majeure will depend on the specific language of the contract and, therefore, may only be determined on a case-by-case basis.

While it is reasonably common for force majeure clauses to contemplate some form of national emergency or government intervention, it is less common for them to contemplate a “pandemic.” However, that is not to say the pandemic is not a force majeure. In Touche Ross & Co. v Manufacturers Hanover Trust Co., the court stated, inter alia, that epidemics are generally accepted by international practice as “Force Majeure.” 107 Misc 2d 438, 441 (Sup Ct, NY County 1980). In that case, however, the parties were dealing with a volatile political situation, so the inclusion of “epidemic” in the clause was not determinative of any legal issue.

Material Adverse Change

A “material adverse change” (“MAC”) is generally understood to be a change in one party’s business or financial condition that prevents the fulfillment of a contractual obligation. See Katz v NVF Co., 100 AD2d 470, 471-472 (1st Dept 1984). The term “material,” however, though commonly understood to mean “significant,” is not clearly defined. Whether changes such as those caused by COVID-19 are significant enough to constitute a “material adverse change” will depend on the specific language of the contract, and the context of the dispute.

Impossibility and Frustration of Purpose

Those unable to rely on either a force majeure or MAC clause may nonetheless be able to rely on the common law doctrines of impossibility and frustration of purpose. The doctrine of impossibility generally applies to situations where performance was physically impossible. See e.g. Warner v Kaplan, 71 AD3d 1, 5 (1st Dept 2009). However, it also may apply where impossibility is legally impossible and/or due to an act of government. See e.g. Metpath, Inc. v Birmingham Fire Ins. Co., 86 AD2d 407, 411 (1st Dept 1982). However, in all cases, performance must have been objectively impossible, and the event that rendered it so must have been unforeseeable.

A similar precept, known as the doctrine of frustration of purpose, may also be relevant with respect to COVID-19. It applies when a change in one party’s circumstances makes performance “virtually worthless” to the other. See e.g. PPF Safeguard, LLC v BCR Safeguard Holding, LLC, 85 AD3d 506, 508 (1st Dept 2011). However, the obligation allegedly frustrated must have been central to the contract such that, without it, the contract would have made little sense. See id. Moreover, as with impossibility, the event that allegedly frustrated the contract’s purpose must have been unforeseeable. See id.

Takeaway

In many instances, the application of the above doctrines will be affected by whether one party has given notice to another, be it notice of an alleged breach, notice of an attempt to cure a breach, or simply a notice memorializing that an event, such as a flood or emergency, has in fact occurred. In certain circumstances, the failure to provide such notice might later be construed as a waiver of the right to rely on the above doctrines. Accordingly, even if neither party intends to litigate, it may be worthwhile to seek the advice of counsel to determine what remedies may be available, and if necessary, when and how to reach out to your counterparty regarding the contract.