Analysis

Beyond Force Majeure: What Real Estate Attys Should Know

By Andrew McIntyre
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Law360 (May 7, 2020, 10:53 AM EDT) -- The COVID-19 pandemic has brought an unprecedented level of attention in the real estate community to force majeure, and while the contract clause will excuse some parties from certain obligations, lawyers say parties are increasingly looking beyond force majeure for other ways out of their obligations.

Force majeure clauses excuse a party from its obligations if certain circumstances — something largely unexpected or unpredictable — arise that make its participation impossible. Force majeure has its limits, particularly when it comes to disputes over payment of rent, but there are various aspects of common law that could help parties who are seeking to avoid an obligation.

"All is not lost if you are a party to a contract that doesn't have a force majeure provision," said Emil Petrossian, a partner at Manatt Phelps & Phillips LLP.

And lawyers also say contracts are now starting to include more extensive provisions to address some of the issues that COVID-19 has caused or brought to the surface.

Here, Law360 looks at three ways parties may achieve the relief that force majeure provides for without actually invoking force majeure.

Frustration of Purpose

Parties that are looking for relief amid the pandemic could find help with frustration of purpose, a part of common law, although lawyers say there is a high bar to proving that in court.

Andrew Raines, a partner at Raines Feldman LLP, said case law on frustration of purpose dates back to Prohibition era. The law generally applies when an event upends the core purpose of a contract, and lawyers say the law may apply in the pandemic.

"I signed the lease to open up a bar, Prohibition came in and I had no idea it would happen. I need to get out of the contract," Raines said. With many courts closed, "what we're seeing now are a lot of demand letters. Prelitigation arming and strategy," he said

As parties consider whether to seek relief under frustration of purpose, lawyers caution that the circumstances must be extreme.

"For contract frustration, the common law test is very clear," said Simon Adams, a partner at Nossaman LLP. He said significant case law was developed after the Second World War.

Adams said that a California court found in 1966 in Kennedy v. Reece that the defendant could not use frustration of purpose to get out of an obligation to drill a 400-foot well after hitting rocks at 270 feet.

But in 1916 in Mineral Park Land v. Howard , the California Supreme Court found that a defendant contractor was excused from an obligation to build a bridge after a flood put the gravel pit the defendant was drawing from under water.

"Frustration of purpose is less about the ability to perform and more about the value of the performance. The value of that contract to a particular party," Petrossian said. "If there's very little value moving forward ... the law will potentially allow that party to forgo performance."

Conditions Precedent

Language in contracts is also changing during the pandemic, and one area that's seeing change is the conditions precedent aspect of contracts, experts say.

One way this is playing out is in the area of occupancy. Before COVID-19, parties would sign their purchase and sale agreement knowing the occupancy at the time, and changes in occupancy between the signing and closing would not affect the closing.

Now, some parties are putting in a conditions precedent clause to address the liability of falling occupancy. The idea is, if occupancy of a property drops below a specified rate before the closing date, the buyer can pull out of the deal and get the deposit back.

Since deals often take several months to close, that could be key, since occupancy can drop quickly, as COVID-19 has shown, and such buildings become far less attractive if they don't have the built-in rental income stream the buyer was expecting when the purchase and sale agreement was signed.

"In normal times, you would never have that. These are uncertain times," said Joel Rothstein, a shareholder at Greenberg Traurig LLP. "In other times, people wouldn't have had these provisions. For a purchase and sale agreement for an office building ... in a seller's marker, you never had a provision that said if the occupancy goes below a certain percent between time you sign and close, you don't have to close."

Petrossian said that if conditions precedent clauses are unambiguous and clearly worded, courts generally recognize and uphold them.

These clauses have been changing in response to the sheer speed with which COVID-19 rattled markets, and are part of a broader effort of economic underwriting.

"It's all about risk allocation, and who's responsible for the economic risk," Rothstein said. "You could walk away and lose your deposit. People don't want to lose their deposit."

Impracticability and Impossibility

Impracticability and impossibility, other common law doctrines with approaches similar to frustration of purpose, could also help when conditions change, experts say. Both can provide the same kind of relief force majeure provisions in contracts might have provided.

"Impossibility is typically contrasted as objective impossibility. A hurricane comes in and wipes out the facility that was supposed to produce the widgets, and that's no longer possible," Petrossian said.

"Impracticability is one small notch below impossibility. It's not objectively impossible but the perception is that it is so extremely burdensome or expensive ... the court is going to treat that as essentially impossible," Petrossian said. "That's a high bar to meet."

And while frustration of purpose had a high bar, impracticability and impossibility require even more extreme events, Raines said.

"It's more like, I signed an agreement to make these machines and World War II started, and there's an embargo on being able to use tin, and I cannot use these machines," Raines said. "Case law back then turned on whether you signed the contract in 1939 or 1941, if you had foreseeability that there would be a restriction on material."

In Autry v. Republic Productions , a California court found under the impossibility doctrine that actor Gene Autry no longer had contractual obligations with that movie studio after he enlisted during the Second World War.

And Petrossian also stressed that the situation needs to be extreme for impracticability and impossibility to come into play.

"The way the law has evolved, if you're a party to a contract and have assumed the risk ... you have to undergo some measure of economic pain," Petrossian said. "It's not enough to say, 'This is really inconvenient. I'm going to lose some money on this.' It's got to be something extreme."

--Editing by Brian Baresch and Rebecca Flanagan.

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

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