Your client's business has been ordered shutdown as not "essential" during the coronavirus crisis, and the business has no funds to pay rent on its lease for at least the next several months. Or, your client's clothing factory has switched from producing shirts to manufacturing face masks, and now cannot fill open orders for shirts. What does the law say about these clients' contractual obligations?

Businesses impacted by the coronavirus shutdown are turning to legal counsel to deal with the fallout. Many want to know how the crisis affects their contractual obligations and whether the crisis might afford them a way out.

Other clients who are parties to contracts may be facing requests or demands to renegotiate obligations due to them, and need to understand their legal position when they negotiate these arrangements.

What are the legal principles of contractual obligations when a crisis makes performance difficult or impossible? What should counsel advising clients review, and what questions should be asked of the client? How should counsel analyze the likelihood that a court would excuse or not excuse any particular breach?

Our discussion of the law here is intended to assist counsel in advising business clients about their legal position on such questions. Understanding the applicable legal principles should assist counsel to frame the analysis and advise the client. (This article focuses on New York law, which governs many commercial and other business contracts. What law may govern any given contract is, of course, something that counsel must consider in each situation.)

Unless an Excuse Is Shown Contractual Obligations Are Binding. The starting point for any analysis is that there is a strong legal presumption that contracts are binding, even when circumstances change. "Generally, once a party to a contract has made a promise, that party must perform or respond in damages for its failure, even when unforeseen circumstances make performance burdensome." Kel Kim v. Central Markets, 70 N.Y.2d 900, 902 (1987).

Contracts are understood to deal with risks and uncertainties. As the New York Court of Appeals has explained, "the purpose of contract law is to allocate the risks that might affect performance and that performance should be excused only in extreme circumstances." Id.

In extreme circumstances the law does recognize three exceptions that do excuse contractual obligations: force majeure clauses, impossibility/impracticability, and frustration of purpose. We examine each and how they might apply to different client situations.

Force Majeure Clauses. "Force majeure," a French term meaning "superior force," is an independent basis, in some civil law countries, to avoid contractual obligations, which operates independently of the contractual term.

In American jurisdictions, however, force majeure refers to express contractual provisions that excuse performance under certain specified circumstances. So the sole focus is on the stated force majeure terms and how they apply to particular situations.

The purpose of a force majeure clause "is to limit damages in a case where the reasonable expectation of the parties and the performance of the contract have been frustrated by circumstances beyond the control of the parties." Constellation Energy Servs. of N.Y. v. New Water St., 146 A.D.3d 557, 558 (1st Dept. 2017).

While such provisions vary, a typical clause might provide that performance is excused where it is prevented by

(1) Acts of God, such as severe acts of nature or weather events including floods, fires, earthquakes, hurricanes, or explosions;

(2) War, acts of terrorism, and epidemics;

(3) Acts of governmental authorities, such as expropriation, condemnation, and changes in laws and regulations; and

(4) Strikes and labor disputes.

Thus the first step requires examination of the language of any force majeure clause and determining what enumerated excuses may be applicable.

The most obvious excuse applicable to the current crisis is an epidemic (or pandemic), since the coronavirus has been declared as such by several governmental and international authorities.

Acts of government are another frequently listed event that would apply in the current situation. Executive orders in many states have required many non-essential businesses to shut down for a period of time.

Counsel must carefully examine the applicable orders, as there are many exceptions that would allow businesses to continue to operate. New York's Executive Order 202.6 issued March 20 listed eleven categories of "essential" businesses that were permitted to continue to operate, including many types of retail, manufacturing, service and construction businesses. So before claiming that government acts prevented performance, it is crucial that counsel examine such orders (and any subsequent modifications) to determine how the business is affected.

Assuming that one of the events listed in the force majeure clause applies, a party seeking to be excused must also show causation, meaning that the relied upon act was the reason that performance was prevented. This, of course, is an intensely factual question; counsel should carefully discuss with the client how and why the force majeure event affected the business and rendered performance impossible.

Counsel should be aware of several other legal principles:

Force Majeure Clauses Are Interpreted Narrowly. Force majeure clauses are generally narrowly interpreted, Reade v. Stoneybrook Realty, 63 A.D.3d 433, 434 (1st Dept. 2009), and "only if the force majeure clause specifically includes the event that actually prevents a party's performance will that party be excused." Kel Kim, 70 N.Y.2d at 902-03.

This is consistent with the Court of Appeals' view that one of the purposes of the contract is to allocate risks, so only those events specified in the contract will be a basis for an excuse.

The Event Must Not Be Foreseeable. Foreseeable events as a matter of law will not qualify as force majeure events. That was the holding of the Court of Appeals in Kel Kim, 70 N.Y.2d at 902-03, where the lessor of commercial space to be used for a roller-skating rink was unable to obtain liability insurance as required by the lease. "Kel Kim's inability to procure and maintain requisite coverage could have been foreseen and guarded against when it specifically undertook that obligation in the lease, and therefore the obligation cannot be excused on this basis."

Choice of law is important here—some other jurisdictions do not have a legal requirement of non-foreseeability, so counsel should carefully consider which state's law applies.

For many contracts, the coronavirus crisis is likely to be considered unforeseeable. Timing is, however, a crucial consideration. For a contract entered before 2020, a court would likely conclude that the crisis was not foreseeable, as hardly anyone at the time foresaw the current economic shutdown. But by March 2020, for example, the current situation was much more likely, and thus might not be held unforeseeable.

Catch-all Clauses. Some force majeure clauses contain catch-all provisions; in one case the provision listed some typical events and then added "or other similar causes beyond the control of such party." Here again, such clauses are narrowly interpreted. "[T]he general words are not to be given expansive meaning; they are confined to things of the same kind or nature as the particular matters mentioned." Kel Kim, 70 N.Y.2d at 903.

So if a party wishes to rely on such a catch-all provision, the event should be similar to those specifically listed. In Kel Kim, the Court of Appeals noted that the listed events "pertain[ed] to a party's ability to conduct day-to-day commercial operations on the premises," while the proffered excuse, inability to obtain liability insurance, was completely different in kind.

For similar reasons, financial hardship due to business downturns or changes in regulatory environment will generally not constitute a force majeure event (see Macalloy v. Metallurg, 284 A.D.2d 227, 228 (1st Dept. 2001)), and many force majeure clauses expressly exclude financial hardship.

Reliance on force majeure clauses requires careful study and consideration by counsel: (1) What are the force majeure events listed, (2) how did the event affect the business' ability to perform, and (3) what other contractual provisions might come into play. Some contracts require notice to the other party that it is suspending performance based on a force majeure event.

Impossibility and Impracticability. Apart from agreed-to force majeure events, the law does recognize that events beyond a party's control may render contractual performance impossible. But, consistent with the Court of Appeals' theme that contracts involve allocation of risks, this is a very narrow defense. Kel Kim, 70 N.Y.2d at 902.

"Impossibility excuses a party's performance only when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible. Moreover, the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract." Id.

Not surprisingly, the impossibility defense is rarely successful. In one reported case, an individual entered into a recording and management contract regarding jazz music. At the same time, the singer became romantically involved with the principal of the recording/management company.

After their relationship soured, the parties entered into a stipulated order with the Family Court that barred personal contact between the singer and the company's principal. That order rendered performance impossible, as performance would have required close personal contact between the singer and the principal, which was now barred by court order. See Kolodin v. Valenti, 115 A.D.3d 197, 200-01 (1st Dept. 2014).

Businesses shut down by an executive order or other governmental act are good candidates for raising the impossibility defense, since, it should be argued, as in the Kolodin case, where performance violates a government order, that renders it impossible.

UCC and Impracticability. The strict standard of impossibility is applicable to contracts governed by common law. But for those governed by the UCC, such as contracts for sales of goods, a somewhat looser standard of "impractability" applies. New York U.C.C. §2-615(a) excuses performance where it has been "made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made."

The comments to the UCC make clear that this is a more lenient standard than common law impossibility (id., cmt. 3), and applies where "performance has become commercially impracticable because of unforeseen supervening circumstances not within the contemplation of the parties at the time of contracting" (id., cmt. 1).

Given the UCC's emphasis on commercial realities, §2-615 might excuse performance in situations that the common-law impossibility standard does not. Consider the following hypotheticals:

• A factory is still operating, as it is considered an essential business. But because of the emergency situation, it switches to making product needed for the crisis, and that use of manufacturing capacity precludes production of contracted-for goods. Is that an excuse under the UCC?
• Same question, but company is commandeered by government, such as through the Defense Production Act of 1950, which the President invoked to force manufacture of N95 masks.
• A factory is unable to obtain raw materials or components needed to manufacture contracted-for goods. Comment 4 to U.C.C. §2-615 states that increased costs or normal market scarcities will not excuse performance, but a "severe shortage of raw materials or of supplies due to a contingency such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like" would be an excuse.

Frustration of Purpose. Another doctrine that will likely be invoked in many contract disputes is "frustration of purpose." This is the mirror image of impossibility—not that an unexpected event made performance very difficult, but that it made the contract worthless.

Generally frustration of purpose is invoked by a party seeking to avoid payment under a contract. Payment is generally not rendered impossible or impracticable by outside events, so those defenses do not work. Rather, the party argues, the consideration it was supposed to receive for the payment was rendered worthless by unforeseen circumstances.

The doctrine originated in the "coronation cases" in England. The coronation of Edward VII in 1902 had to be postponed when he contracted appendicitis. Parties who had rented rooms along the parade route were excused from payment, since the whole purpose of the rental was to have a convenient location to watch the parade. See Krell v. Henry, 2 KB 740 (1903).

New York law, however, is more stringent. As one court opined, the defense "is limited to instances where a virtually cataclysmic, unforeseeable event renders the contract valueless to one party." Noble Americas v. CIT Group/Equip. Fin., 2009 N.Y. Misc. LEXIS 6780, *6 (Sup.Ct. 2009). The coronavirus crisis, and the attendant virtual shutdown of large parts of the economy, certainly lends itself to this description.

Courts focus on what the parties' understanding was at the time of the contract. "In order to invoke this defense, the frustrated purpose must be so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense." Crown IT Servs. v. Koval-Olsen, 11 A.D.3d 263, 265 (1st Dept. 2004) (citing Restatement (Second) of Contracts §265 (1981)).

Frustration of purpose can be a strong argument where outside legal realities frustrate the purpose of the contract. One reported decision involved a lease for premises intended to maintain an office, as expressly stated in the lease. The Department of Buildings, however, issued a Certificate of Occupancy which specifically forbade that use. In reversing summary judgment for the landlord, the First Department held that frustration of purpose could well be a valid defense for the tenant and a basis to terminate the lease. Jack Kelly Partners v. Zegelstein, 140 A.D.3d 79 (1st Dept. 2016).

As the Jack Kelly Partners case shows, examining the terms of the contract, including the recitations of its purposes, is an indispensable part of raising the frustration defense. The court is asked to examine whether the parties would have entered into the contract had they known about the unexpected event. What they actually expressed about the contract's purpose is critical to such an analysis.

If the contract is clear about its purpose, then courts will often refuse to look beyond their terms. See PPF Safeguard v. BCR Safeguard Holding, 85 A.D.3d 506, 508 (1st Dept. 2011) ("Since the parties' intent was clearly expressed within the four corners of their writing, [defendant] Roch's self-serving affidavit should not have been considered.")

The coronavirus crisis will create many circumstances that lend themselves to a frustration-of-purpose argument. As large parts of the economy have been shut down, whether by government fiat or economic practicalities, many contracts will have been rendered valueless. For example:

• Commercial leases for a business, where the business has been shut down by Executive Order as "non-essential."
• Supply contracts for components for a "non-essential" manufacturing business that does not continue to operate.
• Supply contracts for completed items that are not being sold, for example, clothing and other non-essential consumer goods.

One unusual, and perhaps novel, aspect of the coronavirus crisis may be its relatively short duration compared to the duration of a contract. For example, a business with a two-year commercial lease may be shut down for only four months. The lease certainly has value for most of the lease period. Can the tenant invoke frustration of purpose for only part of the lease? Such questions will no doubt be litigated in the coming months and years.

Conclusion

The current economic shutdown has impacted the ability of thousands of businesses to meet contractual obligations, and many counsel will be called upon to advise clients as to how to deal with these circumstances. Both contractual terms and factual impact of the crisis will vary widely. We have thus attempted to summarize the applicable legal principles that will facilitate individual analysis of each client situation.

Milton Springut is a partner at Springut Law PC. Tal S. Benschar, a partner at the firm, assisted in the preparation of this article.