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    May
    01
    2020

    The Legal Domino Effect: COVID-19 & Contracts

    Businesses that have been negatively affected by COVID-19 might attempt to avoid or evade contractual obligations, but not every contract can or should be negated.

    Robert L. Gegios & Lance Duroni

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    COVID-19 has precipitated extreme dislocations and hardships. Every aspect of life worldwide has been affected, often in shocking and unprecedented ways.

    Clients of all sizes, and across all industries, are facing a new reality of supply disruptions, cutbacks in demand for their products and services, massive governmental prohibitions, and strains on their ability to use or maintain workers. Contracts might not be performed or available as anticipated, leading to unexpected disturbances that reverberate from business to business.

    The resulting concerns are many and lead to daunting questions from business clients, such as the following:

    • Can customers who agreed to purchase from us simply ignore our contracts?

    • Must we honor our contractual commitments with our suppliers if nobody wants our products or services at present?

    • Must we honor our contracts with purchasers even though we have difficulty maintaining supplies and labor because of illness and governmental limitations on activities?

    Various doctrines and rules help to answer these and related questions. They are complex and generally call for detailed legal analysis of the specific facts of each situation.

    Force Majeure Provisions

    The starting point is an in-depth review of any affected contract. This review should not be limited to formal agreements only; force majeure protections may be found in the terms and conditions included on the back of a purchase order or invoice. There might even be a conflict between force majeure language in a formal agreement and that used in day-to-day sales documentation under the formal agreement.

    Robert L. Gegioscom rgegios kmksc Robert L. Gegios, U.W. 1981, is a shareholder at Kohner, Mann & Kailas S.C., Milwaukee, focusing his practice on business and corporate litigation and counseling in national and international settings.

    Lance Duronicom lduroni kmksc Lance Duroni, Marquette 2019, practices with Kohner, Mann & Kailas S.C., in business, commercial, and complex litigation. Milwaukee.

    A force majeure provision excuses performance as a result of events it identifies that are outside the parties’ reasonable control. These events might include such things as wars, terrorism, labor strikes, specified shortages and delays, governmental orders, natural disasters, “acts of God,” and many other circumstances that the contracting parties have agreed will excuse performance of the contract. Force majeure provisions can vary greatly in scope and specificity, and state laws and courts nationally and internationally can differ in interpreting them.1 Wisconsin businesses might need to evaluate the law of another jurisdiction if a contract specifies a different state’s (or country’s) law as controlling.

    Wisconsin case law, particularly in recent decades, provides relatively little guidance on the proper scope and application of force majeure clauses in contracts. However, some lessons can be drawn that may have relevance to force majeure in the specific context of the COVID-19 pandemic. For instance, at least one Wisconsin court has enforced a force majeure provision when the triggering event was a governmental decree.2 That could be instructive in the current crisis, in which much of the economic fallout is not caused directly by the disease itself but by lockdown orders instituted to prevent its rampant spread. As with all force majeure inquiries, the Wisconsin court’s decision hinged on the specific language of the agreement (the contract was subject to “other causes incident to manufacture or delivery beyond control of seller”).3

    It is not enough simply that the force majeure event occurred; the event must be the reason why the party is unable to perform under the contract. The purported force majeure event generally must render performance impossible under the contract’s specific terms, as opposed to merely inconvenient or financially burdensome. A contract to deliver canned tomatoes, for instance, was not negated by an early frost that destroyed the local crop the tomato cannery had intended to use.4 The cannery, the court held, could have sourced its tomatoes from elsewhere and still delivered under the contract, which did not provide for tomatoes from any specific source.

    Moreover, with the widespread failure of companies due to COVID-19 almost inevitable, Wisconsin businesses cannot count on a force majeure defense to shield them when the insolvency of a customer or supplier impinges on their contractual obligations to a third party. As an example, the infamous collapse of the federally backed solar-panel maker Solyndra LLC did not trigger the force majeure provision in a contract between Wisconsin-based TecStar Manufacturing Co. and a third party that supplied component parts to Tecstar. In rejecting Tecstar’s force majeure defense under Wisconsin law, the court noted that “the specter of financial failure is omnipresent in human existence and so is eminently foreseeable.”5

    No cookie-cutter answer suffices as to whether the COVID-19 outbreak has created an event of force majeure. Obviously, if a force majeure clause lists “epidemic” or “pandemic,” coverage is far more likely than if the most relevant included language is “act of God” or a general catch-all phrase. Often, courts will narrowly interpret such catch-all phrases, including using the principle of ejusdem generis (meaning “of the same kind”), to pull in only similar terms to those listed.6 The actual language the parties inserted in their contracts is the first and foremost consideration. That is because the ability to declare a force majeure is a matter of ascertaining the parties’ agreed intent – the contract language in the clause is paramount.

    Wisconsin businesses cannot count on a force majeure defense to shield them when the insolvency of a customer or supplier impinges on their contractual obligations to a third party.

    It is a certainty that courts will be asked to resolve COVID-19 force majeure issues, especially when bet-the-company’s stakes are involved. This will make for difficult decisions, as courts grapple with key issues of respect for agreed contract language versus recognition of the horrific and unforeseen effects of COVID-19 on blameless parties. The unprecedented reach of COVID-19 into all aspects of people’s lives, personally and work related, will no doubt precipitate arguments for liberal readings of force majeure clauses to encompass COVID-19.

    Even if the force majeure clause is found to reach the event in question, the clause may have other requisites, including lack of knowledge or mitigation showings, which raise other questions:

    • Was the event not foreseeable when the parties formed the contract? If not specified in the contract as a force majeure event, the event must have been unforeseeable to excuse performance under a catch-all provision.7 (With COVID-19, foreseeability for contracts entered into before December 2019 would be far different than for contracts that were not signed until April 2020).

    • Is the party who wants to invoke a force majeure provision truly unable to perform or is the party trying to get out of a contract because performance would involve merely higher costs or inconveniences during the crisis?8

    • Can the party invoking force majeure show causation – or is the cause of their nonperformance actually unrelated to COVID-19?9

    • Can the entire contract be terminated or should only parts of it be ended or suspended for a limited time?

    • Has the requisite notice been given at the proper time?10

    Complicating the analysis will be the recovery a party may receive under federal or state legislation providing governmental relief. Will such compensation forfeit an otherwise-available force majeure right or require some performance, even if less than that agreed? It is too early to predict how business partners and courts will regard the implications of the many billions of dollars that governments are making available to injured businesses and their employees.

    Even a party that has a force majeure clause available must consider the future consequences of invoking the clause against an important supplier or customer. The potential harm to future business (including possible loss of a supplier or customer altogether) may greatly exceed obtaining such a short-term benefit. Nonetheless, handled carefully, such a clause could provide leverage in negotiation toward satisfactory resolution.

    Almost overnight, force majeure clauses have become a dominant consideration in commerce. Thus, at a minimum, clients should review the force majeure provisions in their contracts to determine whether they can be improved going forward.

    Webinar: COVID 19: Hot Topics in Navigating Contracts Amid Crisis 2020

    Prepare to advise your clients about their options when contracts formed pre-pandemic are not being performed as anticipated.

    In this timely program, Lance Duroni and Robert L. Gegios will cover a range of topics including:

    • Force majeure provisions and related defenses to enforcement of contracts
    • Levels of proof necessary to suspend or limit performance
    • Legislative initiatives that could alter legal rights and obligations of contracting parties

    Webcast airs on Thursday, May 21, 12-1:15 PM CT, with replays available throughout June. Register now.

    Impracticability, Impossibility, and Frustration of Purpose

    Even if a contracting party does not have a force majeure provision that it may invoke, there are other potential legal avenues (although often requiring difficult proof) to suspend or limit performance. These related doctrines and force majeure overlap considerably. Indeed, courts turn to the principles underpinning these doctrines to address force majeure disputes when there is not case law directly on point.11

    When the sale of goods is involved, the Uniform Commercial Code (UCC) provides a justification of impracticability, meaning that delivering goods as agreed would be impracticable because of an occurrence that the parties assumed would not occur.12 Under the UCC, “three conditions must be satisfied before performance is excused: (1) a contingency has occurred; (2) the contingency has made performance impracticable; and (3) the nonoccurrence of that contingency was a basic assumption upon which the contract was made,” with the third condition hinging on whether the occurrence was foreseeable.13 This is a high standard to meet: The seller must not have assumed the risk of the occurrence, must have acted in good faith, and cannot rely on a mere increase in cost to justify nonperformance. Reasonable allocation of available goods among customers may be required as well. 14

    The purported force majeure event must truly render performance under the contract impossible, as opposed to merely inconvenient or financially burdensome.

    Common-law doctrines also must be considered, even if they do not involve the sale of goods. The doctrine of impossibility provides a closely related justification for nonperformance. Intervening events must render performance impossible. That is something very difficult to show; in essence, the basic fabric of the contract must have been destroyed through no fault of the party. The mere loss of profitability or increased difficulty in performance is not enough.

    Another doctrine, frustration of purpose, calls for a similarly high level of proof. It is difficult for a party to argue that payment is impossible, “but if something has happened to make the performance for which he would be paying worthless to him, an excuse for not paying, analogous to impracticability or impossibility, may be proper.”15 To excuse its performance, a party first must show the principal purpose of the contract and then establish that through no fault of its own, that purpose has been substantially frustrated because of an event that the parties did not assume or foresee.16 Again, this calls for a legal analysis that carefully evaluates the nature of the agreement and the effect of the event in question (here, COVID-19) on the contract.

    COVID-19 is not the first epidemic to afflict the entire United States. While its most recent analogue – the influenza pandemic of 1918 – has largely faded from memory, it raised similarly confounding legal issues. For example, in that era, courts in Indiana and Illinois came to starkly different conclusions on similar facts in addressing whether the doctrine of impossibility excused a school district from paying teachers whose schools had been shuttered by health officials.17

    Also of Interest:

    COVID-19 & Contract Issues: Contract Law in Wisconsin

    Drafting airtight contracts starts with clearly understanding the contract’s ultimate purpose and drilling into the details. This State Bar of Wisconsin PINNACLE® book guides lawyers through the key questions that arise when a contract is created and enforced.

    Find numerous practice tips and points to consider when drafting or reviewing a contract. The book is filled with examples based on hypothetical facts to help readers understand many different contract law scenarios.

    Contract Law in Wisconsin; State Bar of Wisconsin PINNACLE, 894+ pp.; 5th ed. 2018-2019; available in print, members $235 (nonmembers, $295). Product ID: AK0040. Order, https://marketplace.wisbar.org.

    The Legal Domino Effect Created by COVID-19

    Courts also will need to address thorny issues stemming from chains of circumstance, for example, when a business’s customer claims a legal excuse not to purchase its product, but the business’s supplier will not accept a similar excuse not to purchase the supplier’s product. The business in the middle of this quandary is then faced with the very real and daunting prospect of the customer prevailing on a force majeure or related defense but the business losing on a similar argument against the supplier. The problem is exacerbated if litigation with the supplier may occur in a different case or even in a different jurisdiction. Once again, how courts will look upon such situations is unclear, thereby contributing to more uncertainties for businesses in addressing such circumstances and highlighting the need for workarounds and other creative solutions to the dilemma.

    Possible Insurance Protection

    First-party and third-party (liability) insurance policies should be evaluated as well. Although general business interruption policies often limit coverage to physical loss or damage and have exclusions related to viral or bacterial outbreaks, particular policies may provide civil authority coverage. Captive insurance policies (designed for specific events) might also apply. COVID-19 issues could also lead to liability claims against clients, so commercial general liability and related liability insurance policies should be reviewed as well. Such liability policies often do not provide coverage in the absence of personal injury, and sometimes include exclusions similar to those found in business interruption insurance contracts, but those exclusions should be carefully reviewed.

    Insurance policy exclusions are only as good as state and federal laws allow them to be. Legislative efforts are underway in many states to require insurance companies to cover COVID-19 claims irrespective of stated policy exclusions.18 Accordingly, clients should monitor this fast-moving legislative environment and court decisions on enforceability of exclusions to determine whether protections may be made available. As a prudent course, clients should consider filing insurance claims to protect their rights in the interim. The laws of the state where the insurance company is chartered or has its principal place of business should not be overlooked in this regard, even if the client is located in Wisconsin.

    Practice Tips

    Consider these key takeaways to assist you in advising clients:

    • Promptly evaluate existing agreements for force majeure clauses and their requirements. Look for ways to strengthen force majeure provisions for use in future agreements. Bear in mind that other legal doctrines can accomplish the same result as a force majeure clause if special requirements are satisfied.

    • Focus on the broader view when feasible. Consider whether the first step in dealing with clients’ valued suppliers and customers should be to negotiate around or mediate COVID-19 problems. Litigation related to COVID-19 issues may be expensive and the results uncertain. Make sure that clients, while negotiating, reserve all rights and make no admissions that could be used against them if the dispute later ends up in court or arbitration.

    • Review clients’ insurance policies for business interruption and liability protections, both for the clients’ losses and for potential claims that might be brought against the clients by their contracting parties related to COVID-19. Monitor all legislative developments.

    Conclusion

    Lawyers will need to understand these and many other considerations as they help clients navigate through COVID-19 and its overwhelming effects on business and commerce.

    Meet Our Contributors

    What was your oddest experience in a legal context?

    Robert L. GegiosAs a young litigator, I assisted in the deposition of the other side’s key witness in a hotly contested case. Two highly respected trial lawyers (who will go nameless) spent several hours strongly disagreeing over the propriety of questions, the responsiveness of answers, and the legitimacy of objections and instructions to the witness. Tensions increased. Finally, as voices raised, one of the lawyers stood up and angrily asked: “So, should we go at it, mano a mano?” The other lawyer then stood up and they both leaned over the table yelling over each other for quite some time. What was about to happen next was unclear, and the court reporter seemed terrified as she tried to take down everything that was being said while she watched events unfold. After several minutes standing, the lawyers restrained themselves, and we somehow completed the deposition with everyone sitting.

    My task was to review the transcript for accuracy. Obviously, I was very interested in reading this particular portion of the deposition. The court reporter had done her best, but in the shock of the moment, she had recorded the shall-we-fight comment inaccurately, writing instead, “So, should we go at it, minnow to minnow”! After having quite the laugh, I let that phrase stay as written and didn’t tell either lawyer involved in the skirmish until years later (when both claimed not to recall the episode).

    com rgegios kmksc Robert L. Gegios, Kohner, Mann & Kailas S.C., Milwaukee.

    What was your funniest or oddest experience in a legal context?

    Lance DuroniBefore going back to law school, I worked as a journalist reporting from the courtroom and on the legal industry generally. I was covering a patent trial presided over by a judge who had special disdain for anyone using a smart phone in his courtroom or, worse yet, interrupting proceedings with an errant ring. One day as an expert was testifying, a ringtone blaring Jay-Z’s “Empire State of Mind” echoed throughout the courtroom. It went on for a while as the judge frantically adjusted his robes. Eventually, the judge located his iPhone and sheepishly silenced the ringer. I got a kick out of that.

    com lduroni kmksc Lance Duroni, Kohner, Mann & Kailas S.C., Milwaukee.

    Become a contributor! Are you working on an interesting case? Have a practice tip to share? There are several ways to contribute to Wisconsin Lawyer. To discuss a topic idea, contact Managing Editor Karlé Lester at (800) 444-9404, ext. 6127, or email org klester wisbar wisbar klester org. Check out our writing and submission guidelines.

    Endnotes

    1 See., e.g., United Nations Convention on Contracts for the International Sale of Goods, Article 79 (exempting performance of a contractual undertaking occasioned by force majeure).

    2 Canadian Steel Foundries v. Thomas Furnace Co., 186 Wis. 557, 203 N.W. 355, 357 (1925) (embargo on iron shipments to Montreal excused performance under force majeure provision).

    3 Id. (embargo encompassed by “other causes incident to manufacture or delivery beyond control of seller”) (emphasis added).

    4 Newell v. New Holstein Canning Co., 119 Wis. 635, 97 N.W. 487, 488 (1903).

    5 A. Raymond Tinnerman Mfg. Inc. v. TecStar Mfg. Co., No. 12-CV-667-JPS, 2013 WL 787367, at *5 (E.D. Wis. Mar. 4, 2013)(unpublished).

    6 Clean Unif. Co. St. Louis v. Magic Touch Cleaning Inc., 300 S.W.3d 602, 610 (Mo. Ct. App. 2009) (catch-all phrase in force majeure clause did not cover nonrenewal of contract when only “strikes and lockouts” were specifically enumerated).

    7 TEC Olmos LLC v. ConocoPhillips Co., 555 S.W.3d 176, 183 (Tex. App. 2018) (review denied).

    8 30 Willison on Contracts § 77:36 (4th ed.) (force majeure clauses generally do not guard against recession or other broadly adverse market conditions).

    9 Industrias Magromer Cueros y Pieles S.A. v. Louisiana Bayou Furs Inc., 293 F.3d 912, 923 (5th Cir. 2002) (rejecting force majeure defense where party admitted that adverse weather conditions supporting defense were not the cause of its failure to deliver).

    10 Wisconsin Elec. Power Co. v. Union Pac. R. Co., No. 06-C-515, 2008 WL 2412979, at *3 (E.D. Wis. June 12, 2008) (unpublished), aff’d, 557 F.3d 504 (7th Cir. 2009) (delayed notice of force majeure event excused by nonwaiver provision in contract).

    11 Rexing Quality Eggs v. Rembrandt Enters. Inc., 360 F. Supp. 3d 817, 840-41 (S.D. Ind. 2018.)

    12 U.C.C. § 2-615(a).

    13 Waldinger Corp. v. CRS Group Engineers Inc., 775 F.2d 781, 786 (7th Cir.1985).

    14 U.C.C. § 2-615(b).

    15 N. Indiana Pub. Serv. Co. v. Carbon Cty. Coal Co., 799 F.2d 265, 277 (7th Cir. 1986).

    16 Restatement (Second) of Contracts § 265.

    17 Compare Phelps v. School Dist. No. 109, Wayne Cty., 302 Ill. 193, 198 (1922) (upholding judgment to pay furloughed teacher because contract did not provide for exemption in event of school closing due to epidemic), with Gregg School Tp. v. Hinshaw, 132 N.E. 586, 587 (Ind. Ct. App. 1921) (refusing pay to teacher when parties contracted with knowledge of public health officials’ authority to close schools).

    18 Leslie Scism, Pressure Mounts on Insurance Companies to Pay Out for Coronavirus, Wall St. J.




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