What will happen to my contracts if I cannot perform as a result of the COVID19 crisis?
As a result of the recent measures of social distancing, many businesses have lost money, clients, and certainty. The restrictions to contain the spread of the coronavirus have impacted travel, work, study, entertainment, commerce, and social gathering. Governor Cuomo’s executive order is certainly helping reduce the spread of the decease in New York State. However, while non-essential businesses are closed, the concerns of not being able to respond increases.
Under these circumstances, many commitments will have to be restructured or canceled. Is it possible? Is the current health and economic crisis a sufficient basis to excuse performance, avoid liability, or stop bankruptcy? Is it legally possible or are there other options?
As a general rule, contracts are instruments designed to assign risks, build relationships and achieve the purpose of the contracting parties. However, parties cannot anticipate all the events that will affect their performance. Under contract law, there are three basic defenses that may support excusing performance: force majeure, impossibility and frustration of purpose.
Now, before explaining what these defense are, it is important to understand that New York courts have traditionally applied these doctrines narrowly, that in the long run, it may be better to consider restructuring over the cancellation, and that any conclusion can only be made after a close study of the particular facts of the case.
So… How can a party be excused performance?
Force Majeure may be raised as a defense against contract compliance. However, in New York, the Force Majeure defense is of narrow application and may only be effective in limited circumstances. A force majeure clause included in a well-drafted contract can save the parties from performance.
In deciding whether the contract can be canceled depends on the language of the contract and the reasonable inferences that can be drawn from it.
Considering the adverse effects of enforcing a force majeure clause courts have explained that the clause is to be in interpreted narrowly in accordance with its function, to relieve a party of liability when the parties’ expectations are frustrated due to an event that is “an extreme and unforeseeable occurrence”, the event is one of a kind, beyond the party’s control, and no-fault or negligence intervened.
The application of the force majeure defense is fact-specific and considers the context of the case and the foreseeability of the event at issue. If a contract was entered into after the “extreme” event took place, or nearly before it, it is unlikely that a party can argue it was unforeseeable.
Now, the fact that an event has the characteristics just mentioned is not enough to raise the defense of force majeure. It is also necessary that the event at issue be expressly mentioned in the language of the contract. In other words, to raise the defense of force majeure, a contract needs to include all the events that will make performance excusable. Accordingly, events not included in the language of the contract may not be raised as constitutive of a force majeure defense. For purposes of the current situation of the United States, a contract would have to include a pandemic, a national health crisis, or government actions as acts of force majeure.
Contractual force majeure clauses, or clauses excusing nonperformance due to circumstances beyond the control of the parties, under the common law provide a narrow defense. Ordinarily, only if the force majeure clause specifically includes the event that actually prevents a party’s performance will that party be excused. The principle of interpretation applicable to such clauses is that the general words are not to be given expansive meaning. They are confined to things of the same kind or nature as the particular matters mentioned. Kel Kim Corp. v Cent. Mkts., Inc., 70 NY2d 900, 901 (1987)
If contracting party cannot argue “force majeure” it may raise the defense of impossibility to make non-performance excusable and avoid liability. Under the laws of New York, impossibility excuses a party’s performance only when the subject matter of the contract is destructed or when the means of performance make performance objectively impossible. Additionally, the impossibility may only excuse performance if it is the result of an event that could not have been foreseen or guarded against in the contract.
Impossibility means that are not means to possibly perform under the contract. If the contracts became unreasonably hard to perform, if the costs of performance is higher than expected, if there will be delays in performance, or if similar events take place, a contracting party will not be able to raise the defense of impossibility. Under New York contract law “where performance is possible, albeit unprofitable, the legal excuse of impossibility is not available” Warner v Kaplan, 71 AD3d 1, 5 (1st Dept 2009).
The impossibility analysis is fact-specific and depends of the kind of contract entered into. In the case of contracts performance by parties with specific skills the defense of impossibility has much more probabilities of winning. It is not the same to hire someone to paint a house than to contract with Picasso to make a portrait. This is an extreme example of course, but it is to show how impossibility can work.
Frustration of purpose
It is difficult to imagine a situation when it is objectively impossible (by no means at all) to perform under a contract. Considering this, the law of contracts considers another scenario that allows a party to excuse performance when the underlying purpose of the transaction has been destroyed and there is no incentive for one or both parties to continue with it. This is the typical case of the bride who does not need a wedding dress that is delivered after the wedding date.
Under New York law, the doctrine of frustration of purpose focuses on events which “materially affect the consideration received by one party for his performance. Both parties can perform, but, as a result of unforeseeable events, performance by party X would no longer give party Y what induced him to make the bargain in the first place.” Burke v Steinmann, 2004 US Dist LEXIS 8930 (SDNY May 12, 2004).
In contrast to the other doctrines, frustration of purpose focuses not only on the facts that took place after the contract is entered into but also on the negotiation of the parties and their consideration for entering into the contract.
Do I need to refund money? Is contract cancellation my best option?
After a careful consideration of your legal options to opt-out of a contract or to excuse performance, it is important to consider the effects of canceling the contract and whether it is the best option for you. Contracts are made to create relationships and manage risks. Accordingly, contract cancellation is a choice that requires legal but also business analysis.
Despite the difficult situation affecting many businesses, it is important not to lose sight of the fact that this is only temporary. The effects of the crisis will impact everyone for some time. However, in the long term people and business must learn to adapt to the situation and find new forms of doing things. Before jumping to the conclusion that contract cancellation is the best option, consider the possibility of renegotiating your contracts. This can be the opportunity to build or strengthen business relationships.
On the other hand, if contract cancellation is in fact the best option, consider that once you advise a party that you intend to cancel the contract, there is usually no going back. Once a party is notified, she may request a money refund or payment of damages. Thus, you may end up in litigation if the amount of damages is at issue. Finally, pay close attention to the language of your contract and establish with clarity whether the non-performing party has the duty to refund any amount already paid.
Giselle Ayala Mateus is a Colombian lawyer qualified to practice law in the United States and Colombia. Giselle has served as counsel in reviewing and drafting commercial contracts, creative developments, transfer of intangible rights and business formation in the United States.