As the COVID-19 pandemic continues to impact businesses throughout the nation, many of our clients are seeking input on basic contract related issues. The effect of force majeure provisions in contracts and the applicability of business interruption insurance are two of the most commonly asked questions.
What is force majeure?
“Force majeure” translates literally as “superior strength,” and refers to unforeseen calamities ranging from natural disasters like hurricanes or avalanches, to man-made emergencies, such as labor strikes or wars. But what about an unpredictable, highly infectious pandemic and virus?
Generally, a force majeure event is an event that is beyond the affected party’s reasonable control, and could not have been foreseen, or, if the event could have been foreseen, is an event that was unavoidable.
A typical “force majeure” provision excuses each party from any delay in performance of that party’s obligation (other than the payment of money) to the extent that the delay is caused by (for example) strikes, riots, acts of God, shortages of labor or materials, war, terrorist acts or activities, governmental laws, regulations, or restrictions, or any other causes of any kind whatsoever which are beyond the control of such party.*
Other theories to keep in mind… Impossibility of Performance and/or Frustration of Purpose.
Impossibility of Performance and/or Frustration of Purpose both act as Affirmative Defenses to a Breach of Contract action. To prove Impossibility, one must prove that: performance became impossible/impracticable due to some extreme or unreasonable difficulty, expense, injury, or loss. The important question is whether an unanticipated circumstance has made performance of the contract impossible or impracticable because of extreme and unreasonable difficulty, expense, injury, or loss.
To prove Frustration of Purpose, one must prove: 1) the contract must be in the midst of being performed; 2) the frustrated party’s purpose in making the contract must have been known to both parties when the contract was made; and 3) the purpose must have been basically frustrated by an event not reasonably foreseeable at the time the contract was made, not due to the fault of the frustrated party and not based on a risk assumed by the frustrated party.
Is COVID-19 included?
COVID-19 is likely included within the scope of most force majeure provisions. Using the sample language above, COVID-19 (and/or the inability to open for business due to COVID-19) falls within one or more of acts of God, governmental laws, regulations, or restrictions, or any other causes of any kind whatsoever which are beyond the control of such party.
An example as it relates to leases
- Does tenant have to pay rent?
Most force majeure clauses carve out from the force majeure definition the payment of money. As a result, under a typical force majeure provision, a tenant who could not be open for business due to governmental restrictions, such as a shelter in place order, would not be in default for breach of a “continuous operations” clause of a lease. However, a typical force majeure provision will not excuse that same tenant from the non-payment of rent (being an obligation that is performable by the payment of money).
- What are landlord’s options if tenant doesn’t pay rent?
If the tenant is not paying rent in accordance with the lease, the landlord has all rights and remedies provided under the lease.
Most leases include, among landlord’s remedies for a tenant default, the right to terminate the lease or terminate the tenant’s right to possess the premises. In electing whether or not to enforce those remedies, a landlord needs to consider whether, at the end of this pandemic, it prefers a leased space (even if it has not collected full rent for some period of time) or vacant, unleased premises. The answer may well differ on a project by project, tenant by tenant basis.
Some people intend to respond to requests for rent abatement, with a proposal to negotiate some deferral of rent in exchange for an extension of term, or a “payback” period, etc. and in connection with that, have prepared a form response to abatement-requesting tenants outlining information that the landlord will require before negotiating with that tenant. A generic version is included below.
- What happens if a Tenant doesn’t pay rent?
Keep in mind that laws may change during this pandemic, and landlords may not have all of the rights and remedies that are set forth in their leases. For example, multiple municipalities and states have enacted moratoriums on eviction (both residential as well as commercial) and there are rumors that similar legislation may be enacted at the federal level (similar to the “freeze” that occurs upon a party filing bankruptcy).
Additionally, the Tenants may raise the Affirmative Defenses of Impossibility and/or Frustration of Purpose.
* Be sure to review each force majeure provision carefully. A recently reviewed a provision in an existing lease did NOT exclude the payment of money. In that case, the tenant (which operated an entertainment venue in the premises) was excused indefinitely from the payment of rent, due to governmental restrictions that prohibited the tenant from being open.
- What about force majeure as it affects Landlord’s obligations?
The landlord lease obligation most likely to be delayed by COVID-19 is the construction/delivery obligation. This is a lease-specific issue, but most premises delivery provisions include a force majeure concept, pursuant to which the landlord is not penalized for late delivery to the extent resulting from force majeure.
Landlords need to confirm whether there is a limit on force majeure delays for construction. Sometimes a tenant will not agree to unlimited delays, and instead the parties negotiate a “cap” on force majeure delay days, after which penalties will kick in.
Be sure to confirm whether the landlord is obligated to notify the tenant of force majeure delays as they occur, at the risk of having waived those delays if it fails to do so.
What does business interruption insurance typically cover?
Business interruption insurance generally covers a company’s actual loss of business income (e.g., lost rent and similar lost revenues) to the extent that the loss of business income directly results from a casualty such as fire, tornado and the like, during the period of reconstruction and restoration. For business interruption coverage to apply, there must be a “direct physical loss” of the premises caused by a covered cause.
Most policies specifically exclude all coverage for damage or loss “resulting from” a virus. These exclusions began being added to policies between 2003 and 2006 in response to the SARS outbreak. To the extent that a policy includes civil authority coverage (e.g., losses resulting from “shelter in place” orders), such coverage typically will still require physical damage or direct loss, either to the insured property or an adjacent property in close proximity and will be limited to 30 days of coverage.
Some who have maintained more expensive policies may have applicable coverage through endorsements and the like. Prudent landlords will want to obtain an expert review of existing insurance policies to confirm whether coverage exists.
Other related issues
The currently existing exclusions of COVID-19 from business interruption coverage are being contested as we speak.:
At least one suit on coverage for business interruption has been filed in Louisiana.
Legislative efforts to ban the virus exclusion are moving to the Senate in New Jersey and are under consideration in multiple other jurisdictions.
Article written by Richard W. Warner