By Ari MacKinnon, Martha Vega-Gonzalez and Leila Mgaloblishvili

Law360 (March 4, 2020, 4:52 PM EST) --

Ari MacKinnon

Martha Vega-Gonzalez

Leila Mgaloblishvili

On Feb. 15, at least 760 million people in China were subject to residential lockdowns as part of the Chinese government's response to the COVID-19 novel coronavirus outbreak; at that point, while seemingly contained to China, the virus already presented clear systemic risks and managing those risks was certain to entail significant economic costs that would not be localized to China.

Thus, much attention was paid to the possibility that Chinese firms would not be able (or in some cases, willing) to perform contractual obligations due to, inter alia, interruptions to the tightly integrated logistics chain, government quarantines and worker protections.

Since then, however, the virus has spread to dozens of countries, further complicating the risk management calculus for businesses without significant operations in China who must now consider not only the potential inability to rely on performance by Chinese counterparties but how to manage the broader risks posed to their portfolios, employees and customers by both the virus itself and efforts to limit its spread.

In some cases, companies may find themselves presented with tough decisions, including how to protect their employees (which may implicate any number of labor and liability issues) while endeavoring to perform contractual obligations that require travel or onsite employees.

The scope and scale of the health and economic risks posed by the coronavirus outbreak thus raise significant issues of risk allocation in preexisting business relationships. This article addresses three related New York law concepts that allocate contractual risk by excusing performance in the face of unforeseeable and unavoidable circumstances: contractual force majeure provisions and the legal principles of impossibility/impracticability and frustration of purpose.

In each case, whether a party to a contract will be able to avoid or will bear the cost of nonperformance attributable to the outbreak (including governmental and nongovernmental responses to the outbreak) will depend on a number of factors, including the governing law, the contractual language, and the specific facts underlying the claimed inability to perform.

What Is Force Majeure?

Broadly speaking, the concept of force majeure provides that a party's contractual performance will be excused when an event beyond that party's control inhibits performance. The term has its origin in the Napoleonic Code, which served as the basis for civil codes throughout Europe and Latin America and thus embedded the concept as a background principle in most civil law jurisdictions, where the hallmark of a force majeure is traditionally an unforeseeable, unavoidable, external event.

However, in common law systems, force majeure ordinarily refers to specific contractual clauses. Thus, under New York law, what constitutes a force majeure event and what its effect will be on a party's contractual rights and obligations, will depend on the specific force majeure clause — if any — in the relevant contract.

While force majeure clauses are highly customizable, they often contain common elements, including: (1) what events constitute force majeure; (2) what causal nexus must be established between the event and the invoking party's nonperformance; (3) what steps a party must take to invoke force majeure, including notice requirements; (4) the scope of relief afforded to the invoking party; and (5) any additional rights and remedies available under the contract.

Broad force majeure provisions may maximize the circumstances that give rise to force majeure through open-ended descriptions or exhaustive lists of qualifying events and may excuse performance that is substantially more onerous or different from what the parties originally agreed upon, even if performance is not impossible.

By contrast, narrow clauses may tightly cabin qualifying events through the use of precise and limited lists and may only grant one party the right to invoke force majeure. Narrow clauses may also require that performance be impossible, rather than merely infeasible, before nonperformance can be excused.

Under New York law, force majeure clauses tend to be interpreted narrowly, in recognition of the fact that contracting parties generally intend to allocate risk among themselves and prefer for their contractual obligations to be enforced. Thus, New York law excuses nonperformance based on a force majeure clause only if it "specifically includes the event that actually prevents a party's performance."[1]

For open-ended clauses that, in addition to specifically listed circumstances, contemplate other similar events, New York courts apply the ejusdem generis principle narrowly: "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."[2]

Notably, unless the agreement expressly provides otherwise, mere financial hardship does not excuse performance.[3] Additionally, New York courts will require the party invoking force majeure to prove that it has made reasonable efforts to exhaust alternatives to non-performance.[4]

Assessing Coronavirus-Related Force Majeure Claims

Whether a party affected by the coronavirus outbreak will be able to successfully invoke force majeure to suspend its obligations will depend on the specific text of the contract and the specific facts that are causing it to invoke force majeure. If the alleged force majeure event is covered by the relevant clause, then New York courts may excuse the invoking party's performance if it complied with contractual conditions, fulfilled its duty to mitigate and did not independently breach the agreement prior to the force majeure event.[5]

Given the broad impact of the outbreak, and depending on the specific language of the relevant clause, a firm affected by a coronavirus-related situation could potentially seek to invoke force majeure as a result of various conditions that are frequently included as a qualifying event:

• Quarantine;
• Epidemic;
• Pandemic;
• National or regional emergency;
• Labor stoppages;
• Breakdown of the logistics chain; or
• Government action, etc.

Even if a coronavirus-related hardship constitutes such a qualifying event, however, that does not automatically mean that a party is entitled to invoke force majeure. Rather, parties evaluating the likelihood of success on a force majeure claim should consider:

Force Majeure Definition

A threshold question will be whether any relevant aspect of the outbreak (including responses to the outbreak) is covered by the force majeure clause. Even if the claimed condition appears to be listed as a force majeure event, parties should consider the overall purpose and structure of the force majeure clause, as well as any facts that may be relevant to understanding the intent of the parties at the time of contracting and their potential relevance in interpreting any contractual ambiguities.

Causal Nexus

Close attention must be paid to whether the party invoking force majeure is able to establish the requisite causal nexus between the coronavirus outbreak and the invoking party's performance.

If the relevant force majeure clause requires that the coronavirus have caused the party's nonperformance, is the party invoking force majeure able to show that the coronavirus has actually prevented its performance? If the clause excuses performance that has been rendered substantially more onerous than contemplated by the parties, is the party invoking force majeure able to provide sufficient evidence of the increased onus?

Relatedly, parties evaluating a claim of force majeure should consider whether any additional facts, including contemporaneous actions taken by the parties, bolster the claim that performance has been rendered impossible or has been substantially impeded, or whether to the contrary, there are facts that suggest that performance has merely become more expensive or less attractive.

Notice and Mitigation Requirements

In addition to confirming that notice is proper, a party evaluating a force majeure claim should understand what steps the invoking party has taken, or reasonably could have taken, to mitigate the impact of the purported force majeure event.

Other Contractual Provisions

Other provisions, including any dictating when the purchaser assumes risk over the property, can inform the scope of the force majeure clause. Notably, the U.S. Court of Appeals for the Second Circuit has rejected a force majeure claim under New York law where the alleged force majeure event related to a shipping problem that occurred after the buyer of raw materials had assumed the risk.

In Phillips Puerto Rico Core Inc. v. Tradax Petroleum Ltd., the seller shipped naptha from Algeria to the buyer in Puerto Rico. However, shortly after the ship carrying the naptha left Algeria, it was detained by the Coast Guard off of Gibraltar. The purchaser argued that this constituted force majeure under the sales contract.

The court side-stepped the question of whether the ship's detention constituted force majeure, and held that the "detention did not frustrate the purpose of the contract or prevent [the buyer] from carrying out its obligation under the terms of the parties' contract to make payment." [6] In so holding, the court relied on the contract's cost-and-freight provision, which provided that title and risk of loss passed to the buyer once the product was loaded onto the vessel.[7]

Ultimately, whether coronavirus-related hardships constitute force majeure is a fact-intensive inquiry that must be evaluated on a case-by-case basis.

Alternatives to Force Majeure Under New York Law

Even where the coronavirus outbreak does not give rise to a force majeure condition as defined by the parties' agreement, a party seeking to excuse its performance obligation may seek to rely on impossibility, impracticability or frustration of purpose.

Under New York common law, "[i]mpossibility excuses a party's performance only when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible."[8] The New York Court of Appeals has held that in order to excuse performance, "the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract."[9]

Similarly, the Uniform Commercial Code will excuse a seller's obligation to deliver goods where "performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation."[10]

Where the issue relates specifically to the impracticability of the agreed-upon delivery mechanism, however, performance will not be excused and must be accepted if there is a commercially reasonable substitute delivery method.[11]

Frustration of purpose arises when performance is possible, but performance by the affected party would no longer provide it with the benefit that induced it to make the bargain.[12] The triggering event must be unforeseeable and render the contract wholly valueless to the affected party; additionally, the parties must have understood that the frustrated purpose was the sole reason for entering into the agreement.[13]

New York courts tend to apply these doctrines narrowly in keeping with the courts' recognition that the purpose of contract law is to allocate the risks that might affect performance and that performance should be excused only in extreme circumstances. Moreover, increased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency that alters the essential nature of the performance.

As with contractual force majeure clauses, whether a court or tribunal would conclude that a condition resulting from or related to the coronavirus outbreak gives rise to impracticability or frustration so as to excuse performance is likely to be a fact-intensive question that turns on the wording of the contract, the parties' expectations and the exact facts that the invoking party claims give rise to impracticality or frustration.

Therefore, parties analyzing claims of impracticability and frustration should evaluate the exact circumstances that allegedly give rise to impracticability or frustration, the causal nexus between the relevant event and the claimed impracticability or frustration, and the availability of mitigation.

Foreseeability is key, because New York courts will typically excuse performance under these doctrines only when the intervening event is truly unforeseeable. Thus, for example, New York courts have refused to excuse performance where the possibility of regulatory changes was foreseeable,[14] or caused by a contracting party's business decision to suspend operations.[15]

It will also be important to carefully understand the way in which the parties' agreement will interact with these background common law principles, as the parties may have agreed to shift the risk of a particular unforeseen event to one party, even where the common law would ordinarily absolve that party.

In the case of a claim of frustration, understanding the fundamental purpose of the contract will be of paramount importance. Thus, it will be important to understand whether the contract specifies a particular purpose: a party whose main customer has had to stop accepting shipments due to the outbreak may be more successful in claiming frustration of a contract to buy copper if the contract specifies that the copper is being purchased to fabricate phone components for said customer than if the contract merely specifies the terms of purchase and delivery.

Where the contract does not state its purpose, or is ambiguous as to what the purpose of the agreement is, it will be important to understand whether the invoking party communicated its purpose to the other side prior to entering into the agreement.

Considerations for Affected Businesses

In light of the foregoing, businesses concerned about the impact of the outbreak on their contractual arrangements should carefully read their agreements to understand:

• What performance is required under the contract in the absence of force majeure;

• Whether the course of performance has deviated from the explicit requirements of the written agreement;

• The governing law and applicable dispute-resolution provisions;

• The scope of the force majeure clause;

• What the parties foresaw at the time they entered into the agreement;

• The purpose of the contract; and

• Any other risk-allocation mechanisms in the contract.

Additionally, any party unable to perform or receiving a force majeure notice should develop its understanding of the facts as much as possible, exploring:

• The exact condition or conditions that constitute the triggering event and whether the event is covered by the force majeure clause or excused by the doctrines of impracticability or frustration.

• Whether the triggering event has actually caused the invoking party's nonperformance or delay, or whether it has simply rendered performance less attractive or desirable.

• Whether commercially reasonable alternative measures, short of nonperformance, are available to the party seeking to be excused. These could include delivery to an alternative port, reselling of goods or temporarily delaying payment obligations.

• Any duty to mitigate damages.

• The scope of any available damages. Among other things, affected parties should be cognizant of the fact that ordinarily, unforeseeable consequential damages are not available under New York contract law, and should review any applicable indemnification or damages limitation language in their agreements.

Parties faced with potential disputes over the applicability of any of these risk-allocation mechanisms to their own agreements should also be careful to document and preserve evidence that may be relevant to any subsequent litigation or arbitration, and should be mindful of privilege and other evidentiary considerations as they draft and distribute documents.

Regardless of whether a company is currently affected by coronavirus, the scale of the outbreak and its vast economic ramifications underscore the ways in which health crises can have a global effect and is a reminder that force majeure and other risk-allocation provisions should be carefully reviewed to ensure that they accurately reflect the parties' desired risk allocation.

---

Ari D. MacKinnon is a partner, Martha E. Vega-Gonzalez is an associate and Leila Mgaloblishvili is a law clerk at Cleary Gottlieb Steen & Hamilton LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Kel Kim Corp. v. Cent. Mkts. , 70 N.Y.2d 900, 902 (1987).

[2] Id. at 903.

[3] See Macalloy Corp. v. Metallurg, Inc. , 284 A.D.2d 227, 227 (2001).

[4] See Rochester Gas & Elec. Corp. v. Delta Star, Inc. , No. 06-CV-6155-CJS-MWP, 2009 WL 368508, at *7 (W.D.N.Y. Feb. 13, 2009) ("The burden of demonstrating force majeure is on the party seeking to have its performance excused, ... and the non-performing party must demonstrate its efforts to perform its contractual duties despite the occurrence of the event that it claims constituted force majeure." (citation omitted).

[5] See, e.g., Toyomenka Pac. Petroleum, Inc. v. Hess Oil Virgin Islands Corp. , 771 F. Supp. 63, 67 (S.D.N.Y. 1991).

[6] See Phillips Puerto Rico Core, Inc. v. Tradax Petroleum Ltd. , 782 F.2d 314, 319 (2d Cir. 1985).

[7] Id. at 319-20.

[8] Kel Kim Corp., 70 N.Y.2d at 902.

[9] Id.

[10] N.Y. U.C.C. § 2-615(a). N.Y. U.C.C. § 2-615(b) addresses a seller's ability to allocate stock among different buyers if performance becomes only partially impracticable, such as where only part of the seller's inventory is destroyed.

[11] N.Y. U.C.C. § 2-614(1).

[12] Glen Banks, 28A N.Y. Prac., Contract Law § 20:19 (2020).

[13] Id.

[14] See, e.g., Beardslee v. Inflection Energy, LLC , 904 F. Supp. 2d 213, 217, 221 (N.D.N.Y. 2012), aff'd, 798 F.3d 90 (2d Cir. 2015) (directive that allegedly "brought natural gas development in New York State to a screeching halt" was foreseeable because prior regulation clearly "failed to adequately consider the environmental impacts posed by" hydrofracking).

[15] See, e.g., Rivas Paniagua, Inc. v. World Airways, Inc. , 673 F. Supp. 708, 710 (S.D.N.Y. 1987) (airline's suspension of all commercial flights was a business decision and did not excuse airline's obligations under contract for the provision of an in-flight magazine).

For a reprint of this article, please contact reprints@law360.com.