Type: Law Bulletins
Date: 03/24/2020

Failure to Pay: Does COVID-19 Excuse a Party's Contractual Obligations?

While there are many unknowns during the current coronavirus pandemic, one certainty is that market disruptions have caused financial distress for many companies. For example, because borrowers and lessees have struggled to stay current on payment obligations, they are defending collection and enforcement actions by referring to the coronavirus pandemic. Even if ultimately unsuccessful, however, some contracting parties will deploy these defenses to either delay until business gets back to normal or to leverage some forbearance or contractual modification.

To help you plan, here are some of the more likely legal theories that may be raised by a party to excuse contractual performance:

(1) Force Majeure. Also called an “act of God” or “vis major,” whether this coronavirus pandemic qualifies as a force majeure event will depend on the precise wording of a contract’s force majeure provision. Although the law varies by jurisdiction, courts will generally analyze four force majeure elements: (1) whether it is external, that is not caused by a party to the contract; (2) whether it is unforeseeable; (3) whether it is irresistible and (4) whether it results in an absolute impossibility for a party to perform its legal obligations. Borrowers, lenders and counterparties to leases should review their agreements for any force majeure clauses and, if such a clause exists, examine the language to determine whether the provision could be reasonably interpreted to apply to the coronavirus pandemic. Finally, lenders, borrowers and counterparties to leases should review and monitor any contractual prerequisites for invoking force majeure, including notice and mitigation requirements.

(2) Impossibility. Even if a contact does not include a force majeure clause, a party may argue that the common law doctrine of impossibility excuses nonpayment due to some previously unknown and unforeseeable change in circumstance that renders performance impossible. Under the doctrine of impossibility, merely making performance more difficult or more expensive generally will not excuse the promisor from its obligations. But, regardless of whether impossibility is a winning argument, it could in many cases buy a contracting party more time while the issue is litigated.

(3) Frustration of Purpose. Even if performance would not be objectively impossible, borrowers and lessees may argue that performance should be excused because the purpose of the loan or lease has been substantially frustrated. Under the doctrine of frustration of purpose, performance may, under some circumstances, be excused because some event occurs, the non-occurrence of which was an underlying assumption of the contract at the time it was made. Borrowers and lessees may argue that loans were taken or leases entered into based on the assumption that there would not be a pandemic and that the borrower or lessee would be able to conduct business.

(4) Illegality Due to Governmental Exercise of Authority. A governing authority’s proper exercise of police power may render a party’s performance of a contractual obligation unlawful. Under those circumstances, the party’s contractual performance is excused based on the doctrine of impossibility. This legal theory may have little applicability for payment obligations, but many other contractual obligations may be rendered illegal or impossible by shelter-at-home orders that are being issued across the country.

(5) Commercial Impracticability. Although the common law doctrine of impossibility is relatively strict, the Uniform Commercial Code (UCC) created a less stringent “commercial impracticability” standard for the sale of goods where an unforeseen occurrence makes performance impracticable. Generally, a party’s performance will be excused under the doctrine of commercial impracticability if (1) a contingency has occurred which has made performance impracticable; (2) the non-occurrence of that contingency was a basic assumption on which the contract was made; (3) the seller has not assumed a greater obligation and (4) the seller has reasonably notified the buyer that there will be a delay or non-delivery. 

Although the UCC applies only to the sale of goods, the Restatement (Second) of Contracts applies the UCC doctrine of commercial impracticability to situations outside the context of the sale of goods and has been followed by some courts.

The above-described legal defenses are complex and vary from jurisdiction to jurisdiction. Taft stands ready to analyze applicability in the context of specific facts and circumstances.

Please visit our COVID-19 Toolkit for all of Taft’s updates on the coronavirus.

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