Analysis

Coronavirus Disputes May Turn On Little-Known Clause

By Caroline Simson
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Law360 (March 27, 2020, 8:47 PM EDT) -- As the economy reels from the effects of the coronavirus pandemic, an often overlooked clause included in boilerplate contractual language that may excuse businesses from their obligations due to "acts of God" or other events beyond their control has been getting a lot more attention.

The unprecedented worldwide shutdowns and widespread shelter-in-place orders issued as a result of COVID-19 mean that in the coming months, many businesses — particularly those that rely on global supply chains, which are likely to be severely impacted — can expect to face disputes with business partners accusing them of not holding up their end of a contract.

Still, the outcome of such disputes may not be so bad for businesses that have included a little-known contractual provision known as a force majeure clause in their contracts. Such clauses may give companies latitude to suspend or even terminate their contractual obligations in certain circumstances.

As a result, many disputes lawyers and general counsel have been scrambling in recent weeks to check not only whether their clients' contracts include such clauses, but also how they're written and whether tribunals and judges might be inclined to interpret a global pandemic like COVID-19 as force majeure.

"It's clearly a hot topic because it's unlike any situation we've seen in our lifetimes," Kobre & Kim LLP attorney Martin De Luca said, noting that previous disruptive events, such as the H1N1 outbreak in Asia, didn't affect entire countries or, indeed, the entire world, simultaneously.

Generally speaking, force majeure clauses may allow a business to suspend or terminate the performance of its obligations under a contract because of circumstances beyond its control. These clauses often refer to "acts of God" like natural disasters or acts of terrorism, or they may spell out other specific examples.

Outside of Asia, where businesses have become familiar with the challenges caused by the recent SARS and H1N1 outbreaks, it's fairly unusual for businesses to refer specifically to pandemics in their force majeure clauses.

But that doesn't mean that businesses that haven't specifically included pandemics in their force majeure clauses should despair. In fact, it's expected that many judges and arbitrators in the coming months and years will have to consider for the first time whether a global pandemic like the novel coronavirus outbreak will qualify under a more general force majeure clause.

Still, while this pandemic is unprecedented in its scale, that doesn't mean the tribunal would be breaking entirely new ground.

"In many ways, from a commercial perspective, this is also not dissimilar to what occurred in 2008 and 2009," Reed Smith LLP partner James P. "JP" Duffy IV said. "The current situation is clearly different in that there is an immediate human component, but it is also similar in that some companies will be unable to perform because of global events that impact everyone. Tribunals will therefore have a playbook to draw from, even if they still be on completely new ground."

And in some cases, businesses could be on relatively strong footing to declare force majeure.

In the absence of a specific reference to global pandemics in a force majeure clause, courts and tribunals will question whether the pandemic was reasonably foreseeable, and whether it made a company's performance impossible.

"Most people would argue that this was unforeseeable," said the global co-head of Sidley Austin LLP's international arbitration and trade practice, Tai-Heng Cheng. "If governments themselves were unprepared, I think a company is on pretty strong grounds to [question], 'How could we have ever been expected to foresee it?'"

Moreover, companies facing a government shutdown order would also have a strong argument that they had no way of performing under a contract, he said. Those not facing a government shutdown, meanwhile, are likely to face a steeper climb, though.

"If you're just relying on the fact that everyone's falling sick and can't perform, or that people are staying away out of fear, it's going to be much tougher to win than in a situation where the government issued a forced shutdown — where it's simply impossible to perform," Cheng noted.

As a result, the exact wording of the clause — along with the governing law and the specific fact pattern of a dispute — is going to prove critically important as these disputes begin to arise.

"In practice, international arbitral tribunals have a tendency to construe force majeure provisions narrowly, which highlights why it is important for parties to tailor a force majeure clause to their specific situation to reduce uncertainty and allocate risk," said Lisa Houssiere, a principal with McKool Smith PC.

As an example, many international business contracts are governed by New York law, which requires judges and arbitrators to interpret force majeure provisions very strictly. Even if a contract governed by New York law includes a force majeure clause, it may not help a business impacted by the coronavirus if the clause doesn't specifically refer to a global pandemic, or if the force majeure events covered under the clause are poorly defined.

It's therefore important not to think of a force majeure clause as a panacea for any business dealing with the effects of COVID-19, according to De Luca. In fact, businesses declaring force majeure are in many instances going to have to work hard to prove that there was simply no way they could perform their contractual obligations — not that it was merely difficult to do so, or that it would have been financially burdensome.

"Was there a pandemic? Yes. But that's not the end of the analysis," De Luca said. "It may drive you into bankruptcy, but under a force majeure analysis a court may find that you still have to perform."

He gave the example of a company that designs and manufactures a product. One possible example of a force majeure event would be if the government shut down the factory after workers tested positive for the novel coronavirus and one-fifth of the manufacturer's suppliers went out of business.

But even in that instance, the company may face an uphill battle in convincing a court or tribunal that it exhausted every option under the contract to try to perform. For the manufacturer, that could mean trying to move operations to another plant or seeking an exemption from the government.

"If you raise force majeure, you become the defendant," he said. "You're going to have to prepackage your defense by documenting the facts very carefully."

--Editing by Breda Lund.

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

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