In a previous client alert, we described the contractual issues that companies should assess under force majeure clauses in their existing contracts in light of the COVID-19 pandemic caused by the novel coronavirus and government measures taken in response.1 In this client alert, we focus on the issues that parties should consider going forward in drafting new agreements, or in amending existing agreements, in light of the COVID-19 pandemic and related governmental responses.
The COVID-19 pandemic has already led to a terrible human toll worldwide. In addition, the global economy is experiencing a significant downturn, as governmental authorities worldwide take actions to save lives and “flatten the curve”—that is, to reduce the growth rate of new COVID-19 infections. Goldman Sachs has recently estimated that the US economy will decline by 34% in the second quarter.2
The pandemic and related governmental responses have disrupted business activities in general and supply chains in particular. Virtually no sector of the economy has been spared. Faced with these massive disruptions, many businesses are reviewing their contracts to determine their rights and obligations, including whether the contracts themselves, or doctrines available under the governing law, could excuse the performance obligations of either themselves or their counterparties.
For most contracts, the analysis of whether a party may be excused from performance of an obligation should begin with a review of the contract’s force majeure clause, if any. Generally speaking, a force majeure clause excuses a party from a contractual obligation in light of an unexpected event beyond its control in specified circumstances. A typical force majeure clause defines or lists the events that excuse performance; specifies the standard that must be established to excuse performance; sets forth additional requirements such as notice and mitigation obligations; and specifies the consequences of a force majeure event, such as termination.
This client alert provides general guidance regarding several key issues to consider in drafting new contracts or amending existing agreements in light of the COVID-19 pandemic and related governmental responses. It should be noted at the outset, however, that a party’s specific approach to a force majeure clause will vary greatly depending on the nature of the contract, whether the party has performance obligations or is the beneficiary of the performance obligations of the other party—or both—under the contract, the particular industry, the relative bargaining leverage, the applicable governing law of the contract and other considerations.
II. Covered Force Majeure Events and Foreseeability
In many jurisdictions, courts will construe a force majeure clause narrowly, meaning that the grounds for relief from performance may be limited as a matter of law. This is the case, for example, in New York.3 Under a contract governed by New York law, generally speaking, only if the force majeure clause specifically includes the event that actually prevents a party’s performance will that party be excused,4 and if the clause contains an expansive catchall phrase in addition to specified events, only events that are the same kind as those listed in the contract are covered.5 Another important legal principle to consider in light of the COVID-19 pandemic is that courts in many jurisdictions often do not allow a party to claim force majeure if an event was foreseeable or known at the time of entering into a contract, especially if the event is not expressly identified in the force majeure clause.6
If a party wants to increase the likelihood that the force majeure clause would excuse performance in light of the current COVID-19 pandemic, or any future recurrence of the pandemic—events that are arguably foreseeable at this time—that party should consider including a specific reference to “pandemics” or “diseases” among the list of specific force majeure events. In addition, a party with that objective should consider including a specific reference to “measures of any governmental authority,” such as those taken in response to a pandemic, because the effect on a party’s ability to perform could be caused by governmental orders, laws, regulations or other actions rather than by the COVID-19 pandemic itself. In addition, a party with the objective of seeking broad coverage to excuse performance through its force majeure clause should consider adding language providing that the performing party is relieved from performance whether or not the underlying applicable event is foreseeable at the time of execution of the contract. The precise language of the clause, however, should be carefully drafted to consider the potential ramifications of broadening the scope in the event of other unexpected events in the future.
III. Standard for Relief
A party entering into a new contract should also consider the appropriate standard for relief that must be established to excuse performance under the force majeure clause. Force majeure provisions employ various standards for relief, ranging from the applicable force majeure event “preventing” performance, on the one hand, to standards that require only that the applicable event have some lesser effect on performance, such as “delaying,” “hindering,” or “adversely affecting” the applicable contractual obligation. For a contracting party that has the obligation to perform, a “prevent” performance standard may pose too high of a contractual proof burden in light of its negotiating objective. And if the burden of proof is not met, particularly in light of the current pandemic, the performing party could have to incur substantial costs to meet its contractual performance obligations or, alternatively, if it could not perform, face the prospect of substantial liability for contractual breach. Conversely, for a contracting party that is relying on its counterparty’s performance, a “prevent” performance standard may be preferable. As we note above, the choice of the appropriate standard for relief will depend on the particular contract, the performance obligations of the party and other relevant factors.
IV. Notice Requirements
Under many force majeure clauses, the party invoking force majeure must provide notice to its counterparty, including (under some contracts) a commitment to identify in the notice the expected duration and effects of the force majeure event excusing performance. In the context of the COVID-19 pandemic, as with some other severe force majeure events, a party may not be able to determine with any degree of certainty the duration of nonperformance or its ultimate effects. As a result, a party that has the notification obligation should consider qualifying the clause in future contracts to make explicit that only good faith estimates need to be provided, and that the estimates have no binding contractual effect and are provided for informational purposes only.
V. Mitigation/Remediation Efforts
Force majeure clauses typically require a party to exert a certain level of effort to attempt to prevent a failure to perform as a result of a force majeure event, to mitigate the effects of the force majeure event once it has occurred, and/or to resume performance as soon as possible or practicable thereafter. As with other force majeure contract provisions, the standards that parties use vary a great deal, depending on the subject matter of the contract, negotiating leverage, industry, and other factors. The clause will often include standards such as “good faith efforts” or “commercially reasonable efforts” and in some cases a “best efforts” standard that applies to the performing party’s obligations, with the “best efforts” standard generally viewed as creating a higher standard for the required level of efforts than the others. While impossible to predict with any certainty at this time, the efforts required to recover from the ongoing COVID-19 pandemic and related governmental measures could very well be substantial for many parties under their existing contracts. As a result, the performing party entering into a new contract should consider carefully what level of efforts it would be prepared to undertake when negotiating its recovery obligation commitments.
VI. Consequences of Force Majeure
The parties to any new contract should also consider whether one or both of the parties should have the right to terminate the agreement in the event of a prolonged force majeure event, whether caused by the COVID-19 pandemic, governmental response measures, or other factors. A termination right may be appropriate for certain contracts, such as contracts regarding products with short shelf lives or time-sensitive services, or regarding products or services that have readily available substitutes, among other areas.
VII. COVID-19-Specific or Other Event-Specific Clauses
Another issue that parties should consider in structuring and negotiating a new contract is whether to include a separate, detailed stand-alone provision to address the consequences and performance obligations of the parties in light of the COVID-19 pandemic and governmental measures, or other force majeure events. This type of provision would apply in addition to, or in lieu of, the terms of the force majeure clause, which typically sets forth only the general contract principles that apply in the case of any force majeure event, without any specifics regarding contractual performance obligations on a prospective basis.
The appropriate terms for any stand-alone provision will vary depending on the subject matter of the contract. For example, in a supply agreement, the parties could specify the percentage allocation that a customer would receive of an available product in the event that product shipments were disrupted due to a production shortfall or distribution interruption. A manufacturing contract could identify multiple backup production sites that could be utilized in the event that the primary site was not available. Similarly, the parties to an IT application development agreement could identify alternative sites for performance of code development, or even work-from-home options for developers, assuming confidentiality and data security concerns could be adequately addressed. Numerous other specific provisions could be drafted.
Including specific obligations that apply in the event of a force majeure event or another disaster is an approach that parties to certain other contracts routinely include in their contracts. For example, complex IT services and outsourcing agreements have utilized these provisions for many years to address issues such as outages caused by cyberattacks and other IT software or service disruptions. In these agreements, the parties will typically agree on a framework for the provision of replacement services, alternative performance venues, recovery time objectives, and, in some cases, pricing adjustments that would apply. This type of approach used in complex IT and other outsourcing agreements could be used as a framework and tailored as appropriate in new contracts to develop alternate performance obligation clauses for other industries and contract types to address the consequences of COVID-19 and governmental measures on contract performance.
When drafting new stand-alone provisions, the parties should consider whether the stand-alone clause itself should be subject to the same force majeure excuse provisions that apply to the other terms of the contract, or whether the specific provisions of the stand-alone clause should apply notwithstanding the occurrence of the COVID-19 pandemic or other force majeure events that excuse performance. If the force majeure clause is not intended to apply to the stand-alone clause obligations, the contract should clearly state so in unambiguous terms.
VIII. Other Clauses to Consider
When drafting a force majeure clause in a new contract, the parties should also evaluate how the force majeure clause interacts with other clauses in the contract, including how the contract allocates risks between the parties. The risk allocation provisions are important because they could prevent a party from successfully invoking the force majeure clause if a court (or an arbitral tribunal) were to determine that a party assumed the risk of the occurrence of the unexpected event.
The evaluation of the interaction with other clauses should include consideration of the governing law and the dispute resolution provisions. The choice of the governing law may dramatically impact the interpretation of a force majeure clause, which in turn will influence the scope and operation of the clause, as we discussed in our prior client alert.7 For example, some jurisdictions may read additional elements into force majeure clauses, regarding such issues as foreseeability, control, and fault, even if the contract does not expressly cover these areas. The choice of governing law will also significantly influence the extent to which the parties may be excused from performance of their contractual obligations based on related concepts—under certain statutory provisions or common law—to the extent the force majeure clause itself is not applicable. These concepts may include the doctrines of impossibility, impracticability, and frustration of purpose applicable in some common law jurisdictions as well as other related doctrines applicable in civil law jurisdictions, as noted in our prior client alert.8
The parties should also evaluate the relationship between the dispute resolution clause and the force majeure clause and other related provisions. When a party seeks to excuse performance based on a force majeure clause or a related doctrine, that party generally has two options: either seek to negotiate a resolution of the issue with its counterparty, or alternatively seek to resolve the dispute through formal dispute resolution under the contract. Any formal dispute resolution will largely be determined by the specific terms of the dispute resolution clause, for example, litigation in a specified court or arbitration under specified arbitration rules. When drafting a new contract, it is critical to ensure that there will be an effective and enforceable means to resolve any dispute. In particular, a party should assess whether interim relief or emergency relief may be available under the dispute resolution provisions. In many instances, the parties may be able to seek interim or emergency relief from a court or arbitral tribunal, depending on the language of the dispute resolution clause in the contract.
The COVID-19 pandemic has created enormous challenges for many parties under their contracts. We believe that, by considering the issues set forth in this client alert, the parties negotiating new contracts can create force majeure clauses and other provisions that may better address the consequences of not only the current pandemic and governmental response measures, but also other force majeure events as well.