By Joe Lincoln

Law360 (July 16, 2020, 2:57 PM EDT) --

Joe Lincoln

The COVID-19 crisis has had more than a few recipients of services take hard looks at what is a force majeure and what happens when one occurs. Those reviews may result in more nuanced contract clauses as well as some other changes in sourcing agreements to address future events.

Some may dismiss elaboration of the clauses as too little, too late. Epidemiologists and other risk managers, however, do not rule out the emergence of similar or worse crises in the not-too-distant future.[1]

In approaching force majeure clauses, the commercial service recipient may recognize that its relationship with a service provider, be it a complex business process outsourcer or maintenance service, is asymmetrical, and certain provisions should not be reciprocal in most cases. The service provider's main concern is receiving payment and covering its expenses; the recipient's concern is keeping its business going, from continuing a major business process to picking up the trash.

While this article focuses on force majeure clauses, a similar issue crops up in clauses for termination for convenience. Quite often, the recipient of services, for business or regulatory reasons,[2] will ask for the ability to terminate a relationship for convenience. The provider may try to counter that request by a request for a similar right.

While there may be valid negotiations by the service provider to ask for prior notice, sharing of costs of unwinding the relationship and the like, a service provider's reciprocal right may prove dangerous. A service provider's termination for convenience may well leave a recipient in the middle of the river without a paddle or even a life raft.

Force majeure clauses may create a similar problem for the recipient.

From the recipient's point of view, a well-constructed force majeure clause should deal with several issues: the definition of the force majeure itself; the responsibilities of the service provider during the force majeure and even after a termination; the ability of the recipient to avoid having, without the recipient's consent, the service provider's dismantling systems that were delivering the service; the ability of the recipient to seek an alternative source of the service; and the obligation of the service provider even during a force majeure event to provide as seamless a transition as possible to a new provider.

The definitions of force majeure are getting longer and longer in this age of COVID-19, especially where, as in New York, the parties may be held to exercising force majeure clauses only for those conditions that are expressly enumerated.[3] Thus, perhaps presciently, pandemics have been included in numerous clauses, and it is hard to object to that.

In this time of COVID-19, it may be necessary to be even more specific.[4] Typically war, terrorism, natural disasters and other "acts of God" are also often included, but all events and circumstances should be covered only to the extent they affect the service and be subject to solutions the service provider has promised. (An earthquake at a provider's location should not excuse it when it is supposed to have a fallback location elsewhere.)

Other items, even though seemingly out of control of the service provider, may be too broad. Government regulation governing the provider's business (unless it arises from another force majeure such as a lockdown in a pandemic) should be the responsibility of the service provider in most cases.

Similarly, the service provider should be managing its workforce so a labor shortage or disruption not arising from a specific force majeure should not in itself be deemed a force majeure; a question may be whether an employer's voluntary decision to have workers stay at home is arising from a pandemic.

Issues at the subcontractor level, even those arising from a force majeure, may be more difficult to handle. The service provider probably should be building alternative sources into its supply chain. If it is just a middleperson between the subcontractor and the recipient, what value is the service provider adding? On the other hand, if all its reasonably available sources go down, should it have a respite?

The effect of the event or circumstance should also be considered: Need it prevent or could it just delay performance? Was it the proximate cause of the inability to perform?

An issue that might be addressed is the length of the force majeure. If the event lasts only a few days, should that lead to a suspension of the obligations or be a failure under a service level agreement? The definition should also, where applicable, expressly disclaim any statutory definition.[5]

The occurrence of even a well-defined force majeure should not release the service provider from all of its obligations and liabilities. The first surviving obligation should be to give prompt notice of the occurrence.

Relief should generally be given only with respect to obligations that are actually affected by the force majeure. Certain obligations should not be suspended even should there be a termination for force majeure: indemnification (which is in effect an obligation to pay) and confidentiality in particular.

Rather than just throw up its hands and say sorry, the service provider should be required in many circumstances to find a workaround to mitigate the effect of the force majeure. Often, the recipient will have required a service provider to provide or at least have strong business continuity and disaster recovery plans.

Implementing those plans in force majeure situations, or requiring the provider to produce an alternative plan to meet the specifics of the event, can be built into the contract. If it is necessary to go beyond those initial plans, there may be a question of how increased costs are absorbed.

During the suspension and even when the contract is terminated, the recipient provider may need the original service provider to support a transition to the new provider or to the recipient itself. The recipient's data will need to be transferred, although there may be concern about the format in which it comes. The cost of converting data to a useful format for the successor may be at issue.

Also, the service provider may claim it needs to protect trade secret rights in certain of its internal processes in using that data. Finally there may be a discussion of who bears the cost of the transition, which may be colored by the fact that the transition has been triggered by the inability of the service provider to perform, not merely by the recipient's desire to find a cheaper or better successor.

If the workaround or return to normalcy cannot be done within a number of days, often a force majeure clause will allow either party to walk away without further liability or obligation. The service provider's right to do so may create a significant issue for the recipient.

If the service provider exercises such a right to terminate upon its own inability to perform, the recipient may lose a valuable process when the force majeure passes or the recipient may face an unwelcomed renegotiation of price since the existing contract has terminated. Therefore, the service provider should not have a right to terminate (although retaining a right to suspend) as the result of a force majeure affecting its ability to perform.

On the other hand, where the service provider cannot perform, the recipient, after the passage of a defined reasonable time, may have to find an alternative either temporarily or permanently. It therefore should have the right to terminate and contract with an alternative supplier or even bring the process in-house.

A recipient may also need to replace the provider's services temporarily even though the intention is to revert to the initial provider when the circumstances allow, so the use of the alternative source should not constitute repudiation by or other liability for the recipient.

A force majeure affecting the ability of the recipient to perform requires a different perspective. The most significant performance by the recipient is payment, and most force majeure clauses exclude the inability to pay from the definition of force majeure.

In some cases, a contract provides other recipient obligations. For example, the recipient must provide personnel to work with the service provider to establish the services or to give the service provider access to the recipient's facilities for support or maintenance services.

At some point the service provider may want to redeploy its resources to a paying customer. The answer might be a fee negotiated upfront for significant delays caused by a recipient force majeure (one not applicable to service provider delays as well) payable by the recipient as an option to avoid termination by the service provider.

Thought should also be given to whether the suspension under a force majeure should lead to an extension of deadlines in a contract and of the term of the contract itself. Determining factors may be whether the provider is developing a system or providing an ongoing service. For ongoing services, the interplay of force majeure and service level agreements should be addressed.

Even with a pro-recipient force majeure clause, will the recipient be protected if the service provider simply says it is in its best interest, in the time of an event, to walk away from the contract, that it is more efficient to breach than to perform? What will the damages be? Many a service contract provides for a waiver of consequential damages, subject to certain exceptions. The exception that a recipient might look to is for a willful wrongful act or omission of the other party or its gross negligence. Is that enough?

The concept of "efficient breach" has been supported, in dicta, by the Delaware Chancery Court, which even suggested that it may be a breach of fiduciary duty to a company not to consider exercising that contractual alternative. Although dicta, the language of the court suggests that the breach would be far from a wrongful act.[6]

In Freund v. Washington Square Press Inc., in which there was no discussion of waivers of consequential damages, the New York Court of Appeals stated, "Damages are not measured, however, by what the defaulting party saved by the breach, but by the natural and probable consequences of the breach to the plaintiff."[7]

The Delaware Supreme Court in its 2019 decision in Leaf Invenergy Co. v. Invenergy Renewables LLC discussed with seeming approval the efficient breach concept, but reversed the Court of Chancery that had attempted to reduce damages on the basis of the concept, stating that "efficient breach does not bar recovery or modify damages calculations in any way."[8]

To make a possible breach less efficient, a recipient may consider carving out — from the waiver of consequential, lost profits and related types of damages — a termination of the agreement, or a cessation of performance, not otherwise contemplated by the express terms of the contract.[9] The recipient should lay out the possible consequences of the breach by the time of contracting.

On the other hand, with such a change in the carveouts, the recipient may be undertaking a risk should it attempt to terminate on the basis of what it thought was a material default and be held to have repudiated a valid contract. An argument may be made for nonmutual carveouts: As direct damages, the provider would arguably be entitled to the price forgone less the costs it has saved, so it would have neither a windfall nor a loss. The recipient, on the other hand, may suffer the consequences of the sudden absence of an important business process.[10]

An alternative approach is to rely on strong provisions with respect to the necessity of specific performance and a right to injunctive relief (not merely the right to seek relief), including waivers of claims of adequate remedies at law, waiver of bonds, and admission that failure to perform material provisions of the contract would cause irreparable harm to the recipient. Such a right, to obtain performance after what might be lengthy litigation, might be less daunting to an efficient breacher than the threat of consequential damages.

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Joe Lincoln is a solo practitioner. He was a partner at Pepper Hamilton & Scheetz (now Troutman Pepper) for more than 10 years and worked at GE Capital for nearly 19 years in several senior counsel positions. More recently, he served as counsel at Reed Smith LLP and Holland & Knight 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] For a discussion of what pandemic planning should look like, see Michael T. Osterholm & Mark Olshaker, Chronicle of a Pandemic Foretold: Learning From the COVID-19 Failure—Before the Next Outbreak Arrives, July-August, 2020, at 10.

[2] See, e.g., Office of the Comptroller of the Currency ("OCC") Bulletin 2013-29 (Oct. 30, 2013) at 12, supplemented, OCC Bulletin 2020-10 (March 5, 2020): "Ensure the contract permits the bank to terminate the relationship in a timely manner without prohibitive expense." Many government procurement contracts contain rights to terminate for convenience "in whole" or "in part" if the Contracting Officer determines that "termination is in the Government's interest." See Federal Acquisition Regulations, 48 C.F.R. §8.406-5 (2019).

[3] See, e.g., Kel Kim Corp. v. Cent. Mkts. Inc. , 519 N.E.2d 295, 70 N.Y.2d 900, 902 (N.Y. 1987) The court held the force majeure defense is narrow and excuses nonperformance "only if the force majeure clause specifically includes the event that actually prevents a party's performance". The plaintiff had been unable for a period to maintain required insurance because of the public liability insurance crisis in 1986. The clause read: "If either party to this Lease shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes beyond the control of such party, the performance of such obligation shall be excused for the period of the delay" The "other similar causes" clause, the court said, did not save the plaintiff.

[4] It may be very difficult to argue that, in a contract executed today, the inclusion of the term "pandemic" means a force majeure is immediately operative. One might address with precision a "surge", "flare" or second or subsequent wave of the current pandemic. Cf. In re: Republican Party , No. 20-0525 (Tex. July 13, 2020)(Devine, J., dissenting).

[5] In California, a statute provides:


Cal. Civ. Code § 1511. Legal impediments to performance are covered by a different framework.

Many jurisdictions outside the U.S. provide for incidents of force majeure in their codes. Care should be taken in cross-border transactions even if the law of a U.S. jurisdiction is expressly selected as governing.

[6] Frederick Hsu Living Trust v. ODN Holding Corp. , C.A. No. 12108-VCL (Del. Ch. April 14, 2017, corrected April 24, 2017) (denying a motion to dismiss most counts under Rule 12(b)(6)). The court noted that in most cases a claim of breach of fiduciary duty in not breaching a contract with an unrelated party would probably not survive in light of the business judgment rule. The same court after trial ultimately gave judgment to the defendants based on the entire fairness of the questioned acts and omissions. Frederick Hsu Living Trust v. Oak Hill Capital Partners III , C.A. No. 12108-VCL (Del. Ch. May 4, 2020).

[7] Freund v. Washington Square Press Inc. , 314 N.E.2d 419, 34 N.Y.2d 279, 357 N.Y.S.2d 857 (N.Y. 1974)

[8] Leaf Invenergy Co. v. Invenergy Renewables LLC , 210 A.3d 688 (Del. 2019), reargument denied May 20, 2019

[9] Frustration of purpose and impossibility of performance have often been described as alternative theories to relieve a party of its obligations. It should be argued that well-crafted force majeure and related provisions should render these concepts inapplicable, and stating expressly such inapplicability might be considered.

[10] Judge Richard Posner discussed in some detail efficient and inefficient breaches in striking down liquidated damages provision as an unenforceable penalty clause. Lake River Corp. v. Carborundum Co. , 769 F.2d 1284 (7th Cir. 1985). For a critique of the absolute ban on penalty provisions and the creation of inefficiencies in "efficient breach", see Robert E. Scott & Charles J. Goetz, Liquidated Damages, Penalties And The Just Compensation Principle, Some Notes on An Enforcement Model and a Theory of Efficient Breach, 77 Col. L. Rev. 554 (1977).

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