How Does a Business Handle Contracts That Were Put in Place Prior to COVID-19?

As the pandemic and economic fallout continue, many businesses are facing questions about their contractual right and obligations. Here are the force majeure remedies, considerations and defenses to consider:

The outbreak of the coronavirus and its related disease, COVID-19, has upended much of our daily lives, from supply chains, to schools, to sports. And as the pandemic and its economic fallout continue, many businesses are facing questions about their contractual rights and obligations.

If your business fails to meet a contract deadline because of the pandemic, are you liable for breach of contract? If you rented space for an event that is now canceled in accordance with CDC guidelines, can you reclaim your down payment? If a supplier fails to deliver due to the virus, can you recover lost profits?

Force Majeure Provisions

One common contract provision that may help determine your contractual rights and obligations is a “force majeure” clause. Often called an “act of god” clause, a force majeure provision allows a party to cancel all or some of their contractual obligations when an unforeseeable and uncontrollable event makes performance of the contract impossible or impractical.

A first step for businesses is to review their contracts to determine if they include force majeure clauses. Because the enforceability of such a clause will depend on the specific language in each contract, the facts at hand, and the applicable state law, business leaders should consult a legal professional to determine their specific rights and obligations under a contract containing a force majeure clause.

Other contractual principals such as impossibility, impracticability of performance and frustration of purpose may also be relevant in evaluating your contracts during the COVID-19 pandemic. (More on these below).

For a force majeure provision to be effective, it must cover the specific type of event that has occurred. Many force majeure clauses cover natural disasters, strikes, government intervention, war, terrorism and the like, but not all force majeure clauses are created equal. Some cover only certain types of events, while other contain a catch-all phrase which generally cover any unforeseen, uncontrollable event that makes performance impracticable.

Force Majeure Clauses in Iowa

The Iowa Supreme Court defines force majeure provision as a clause that “allocate[s] the risk if performance becomes impossible or impracticable as a result of an event or effect that the parties could not have anticipated or controlled.”¹ A force majeure clause, according to the Iowa Supreme Court, is “not intended to shield a party from the normal risks associated with an agreement.”²

Few courts have analyzed the application of force majeure provisions to a human health crisis, like the COVID-19 pandemic, but a federal court in Iowa did rule on the applicability of a force majeure clause during the 2015 avian flu outbreak.³

In Rembrandt Enterprises, Inc. v. Dahmes Stainless, Inc., Rembrandt, an egg producer, wanted to ramp up egg production and contracted with Dahmes to build an industrial egg dryer for $9 million.

When the 2015 avian flu broke out, Rembrandt was forced to destroy more than a million birds, eliminating the need for the new equipment. Rembrandt told Dahmes that it was terminating the contract pursuant to its force majeure clause, which stated: “Neither party shall be liable to the other for failure or delay in performance of the Work caused by war, riots, insurrections, proclamations, floods, fires, explosions, acts of any governmental body, terrorism, or other similar events beyond the reasonable control and without the fault of such party.”⁴

The court held that the force majeure clause, while broadly written, only applied to events that prevented the “Work” (i.e. the construction of the equipment), and did not apply to events that eliminated the need for the equipment.⁵ Accordingly, the force majeure clause did not excuse the breach.

The Rembrandt case illustrates how businesses must be careful in drafting and analyzing their contracts to ensure force majeure clauses are both enforceable and applicable. A legal professional can advise businesses on the applicability of their force majeure clauses and analyze other potential contract defenses and remedies.

Other Force Majeure Considerations

Notice

Time may be of the essence when seeking to enforce a contract’s force majeure clause. Some such clauses require a party to provide notice within a certain amount of time of the occurrence of the force majeure event if it intends to cancel a contract pursuant to a force majeure clause.

Causation

Additionally, canceling a contract under a force majeure clause requires a showing of causation. That is, the party seeking to get out of the contract must show that the unforeseen event — the pandemic, in this case — actually caused the need to cancel the contract.⁶

Mitigation

A party invoking a force majeure clause also has a duty to mitigate damages caused by nonperformance. This means that a party generally cannot invoke force majeure if the potential nonperformance is foreseeable and could have been mitigated or prevented.

Contractual Remedies and Considerations

Frustration of Purpose

Frustration of purpose is a defense to a contract due to an event occurring after the contract was formed. In effect, when the parties enter into a contract for a specific purpose and an event occurs that undercuts that purpose, a party may assert frustration of purpose to defend against a breach of contract claim, as long as the party did not cause the event.⁷ Additionally, the language or circumstances of the contract may preclude the use of a frustration of purpose defense.⁸

Impossibility

Another defense that may excuse performance of a contract is the doctrine of impossibility. In Iowa, courts hold that contracts contain an implied condition that performance shall be excused when performance has been “rendered impossible by the intervention of unforeseen, accidental, and uncontrollable superior” occurrences.⁹

Impracticability of Performance

Contracts for the sale of goods are governed by the Uniform Commercial Code, which, in some instances, allows a party to be excused from a contract when performance is impracticable. To invoke an impracticability defense, an event must have occurred that makes performance impracticable, and the contract must have been based on the assumption that such an event would not occur.¹⁰

Re-Negotiation

While litigation may be unavoidable for some contracting parties impacted by the COVID-19 pandemic, in many cases it may be advantageous for businesses to negotiate contract amendments rather than pursing costly litigation.

The Big Picture

Whether seeking to enforce a force majeure clause or invoking a defense such as impracticability, businesses should consult a legal counsel when evaluating their contractual rights and obligations. The contractual remedies and defenses discussed in this article often depend on fact-intensive inquiries and turn on state-specific contract law and analysis, meaning no single remedy or defense fits every contract. Consulting with legal counsel about your contracts can help limit your risk and more accurately evaluate your rights during the ever-changing COVID-19 pandemic.

Third-year Drake Law student Joel Aschbrenner assisted with research and drafting this blog post.

You can count on The Partnership to continue to share accurate and fact-based updates as well. See more on COVID-19 here.

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¹ Pillsbury Co., Inc. v. Wells Dairy, Inc., 752 N.W.2d 430, 440 (Iowa 2008).
² Id.
³ See Rembrandt Enterprises, Inc. v. Dahmes Stainless, Inc., No. C15-4248-LTS, 2017 WL 3929308, at *13 (N.D. Iowa Sept. 7, 2017).
⁴ Id.
⁵ Rembrandt Enterprises, Inc. v. Dahmes Stainless, Inc., No. C15-4248-LTS, 2017 WL 3929308, at *13 (N.D. Iowa Sept. 7, 2017)
⁶  § 77:31.Force Majeure clauses, 30 Williston on Contracts § 77:31 (4th ed.) (“An express force majeure clause in a contract must be accompanied by proof that the failure to perform was proximately caused by a contingency and that, in spite of skill, diligence, and good faith on the promisor's part, performance remains impossible or unreasonably expensive”).
⁷ Water Dev. Co. v. Lankford, 506 N.W.2d 763, 766 (Iowa 1993); Restatement (Second) of Contracts § 265 (1981); see also Hubbell Homes, L.C. v. Key, 786 N.W.2d 519 (Iowa Ct. App. 2010) (Where a homebuyer enter into a purchase agreement from a homebuilder, the buyer losing his job did not constitute frustration of purpose.)
⁸ Restatement (Second) of Contracts § 265 (1981).
⁹ Yost v. City of Council Bluffs, 471 N.W.2d 836, 839 (Iowa 1991).
¹⁰ Iowa Code § 554.2615.

Authors

Corrin Hatala

Corrin Hatala is a business attorney at the Davis Brown Law Firm. She advises businesses in their mergers and acquisitions as well as in matters of equity, debt financing, and securities compliance. Corrin also serves on the Board of Eat Greater Des Moines.

Laura Wasson

Laura Wasson is a business attorney at the Davis Brown Law Firm. In addition to working with emerging businesses, Laura advises many small and mid-size banks in Iowa on regulatory compliance. Laura serves on the Board of the Polk County Juvenile Drug Court Collaborative.

Courtney Strutt Todd

Courtney Strutt Todd is a tax, employee benefits, and public finance attorney at the Davis Brown Law Firm. She advises businesses on their pension, profit-sharing, employee stock ownership, and other retirement plans. She is Vice-President of the Davis Brown Board of Directors.