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The global financial crisis resulting from the COVID-19 pandemic will undoubtedly raise issues related to the economic viability of countless contracts. Parties will invariably look to enforce force majeure clauses, which have become commonplace in standard form contracts in numerous industries, and may allow parties to either suspend performance or terminate the contract as a result of unforeseen circumstances. The types of unforeseen circumstances covered by force majeure clauses vary significantly depending on state law and the contract at issue, but often include natural disasters, commencement of a war or act of terrorism, political upheaval, significant labor disputes, or serious accidents.

In the bankruptcy context, disputes related to force majeure clauses (or the related common law doctrine of impossibility) will likely arise in two contexts: (1) offensive objections by debtors to claims filed by contract counterparties, which seek to disallow or reduce a claim pursuant to a force majeure clause, or (2) defensive responses by debtors against parties claiming that a contract terminated prepetition as a result of a force majeure event and therefore is not subject to the automatic stay (which generally prevents contract counterparties from exercising remedies against a debtor that would otherwise be available as a result of the Chapter 11 filing or other defaults under the contract). In this article, we discuss some existing guidance from bankruptcy courts addressing force majeure clauses in these contexts, including a number of cases from the last financial crisis.

Do Changes in Economic Circumstances Constitute a 'Force Majeure'?

Two bankruptcy court decisions from the 2008 fiscal crisis offer important guidance on whether recessions and the resulting changes in the economic realities of contracting parties can constitute a force majeure event.

Following Chrysler's historic Chapter 11 cases, the liquidation trust established under the plan, as post-confirmation successor in interest to Chrysler, sought to disallow certain tax claims based on the alleged breach of a prepetition tax exemption agreement. See In re Old Carco, 452 B.R. 100, 104 (Bankr. S.D.N.Y. 2011). The liquidation trust argued that Chrysler never breached the agreement at issue, which included a force majeure clause that provided that neither party could be in default "as a result of circumstances beyond their reasonable control, including specifically changes to economic conditions." Id. at 112. Applying state law, the U.S. Bankruptcy Court for the Southern District of New York stressed that adverse economic conditions typically do not excuse performance. See id. at 119. However, it held that because the parties had negotiated for a broader force majeure definition that included changes to economic circumstances, the force majeure clause would be enforced if the debtor could establish that the alleged breach was caused by a change in economic conditions beyond its reasonable control. See id. at 119-20.

Unlike Chrysler, the U.S. Bankruptcy Court for the Eastern District of Kentucky declined to enforce a generic force majeure clause in In re Clearwater, 421 B.R. 392, 398 (Bankr. E.D. Ky. 2009). Clearwater involved a debtor that had entered into a prepetition contract to mine coal on a coal producer's property for a fixed price. Id. The debtor was ultimately forced to initiate an adversary proceeding against the coal producer after it declared a force majeure under the parties' coal mining agreement. Id. at 397. The coal producer contended that a significant softening in the coal markets in the year following entry into the contract and the resulting absence of demand from customers constituted a "force majeure" under the contract, which was defined as "any event or circumstance that is beyond the reasonable control of the party asserting force majeure, and not due to the fault or negligence of the party asserting force majeure." Id. at 396. In ruling in favor of the debtor, the bankruptcy court held that under Kentucky law, a counterparty to a fixed rate contract assumes the risk that changes in related markets may render the contract uneconomic and that a force majeure clause does not shield the counterparty from such risks. See id. at 397-98; see also In re the Containership Company, 2016 WL 2341363 (Bankr. S.D. N.Y. 2016) (finding that it is well established under New York law that changes in commercial conditions do not excuse performance through a force majeure clause).

Notice Pursuant to Force Majeure Clauses

The contract will determine whether notice is required, and the standard for such notice may vary from jurisdiction to jurisdiction. There are a number of bankruptcy court decisions, however, recognizing that even where a well drafted force majeure clause explicitly references the type of event at issue, proper notice must be provided in order for the force majeure clause to be enforceable if the contract requires notice. For example, in In re Magna Entertainment, 475 B.R. 411, 416 (Bankr. D. Del. 2017), the U.S. Bankruptcy Court for the District of Delaware found that a force majeure clause would have been enforceable against a debtor had the contract counterparty followed the notice provisions under the contract. These provisions required the counterparty to provide timely notice of the force majeure event and a good faith estimate of the resulting delays in performance otherwise required under the contract. See id.

Common Law Doctrines

Where a contract lacks a force majeure clause, contract parties may seek to invoke common law doctrines. The availability of such doctrines varies from jurisdiction to jurisdiction and depends on the specific factual scenario at issue. The most commonly invoked common law defense is impossibility, which dates back to a 19th century decision from the Court of the Queen's Bench in England. Taylor v. Caldwell, 122 Eng. Rep. 309 (1863). In Taylor, the owner of a music hall was excused of his liability for failure to make the hall available due to an accidental fire that destroyed the building. The court concluded that the "parties when framing their agreement evidently had not present to their minds the possibility of such a disaster, and have made no express stipulation with reference to it … ." Id. at 314. Following this decision, a number of U.S. cases further delineated the common law doctrine of impossibility, which generally recognizes that after execution of a contract an unforeseen event that renders performance impossible should terminate the parties' respective obligations "unless the language or the circumstances indicate the contrary." Restatement (Second) of Contracts §263.

Two recent bankruptcy court decisions highlight issues related to invoking the doctrine of impossibility. For example, in In re Conneaut Lake Park, 564 B.R. 495, 507 (Bankr. W.D. Pa. 2017), the manager of a beach club under a long term management contract sought to invoke the doctrine of impossibility after a fire. In finding that the doctrine was inapplicable, the U.S. Bankruptcy Court for the District of Pennsylvania relied heavily on a contractual provision requiring the manager to return the property "free from any damage" and the fact that it had purchased property insurance in concluding that the contract had allocated the risk of unforeseen events to the manager. See id. at 510. More generally, the court concluded that the manager could have negotiated a force majeure clause and that courts should be hesitant to write such a clause into a contract where sophisticated parties failed to do so. See id.

More recently, the U.S. Bankruptcy Court for the District of Puerto Rico reached a similar conclusion in ruling in favor of a commercial landlord that filed an urgent motion for immediate surrender of a leased premises (the landlord had terminated the lease prior to commencement of the Chapter 11 case for failure to pay rent). See In re Chase Monarch Int'l, 581 B.R. 715, 723  (Bankr. D.P.R. 2018). The debtor claimed that its default should be excused under the Puerto Rico law equivalent of the doctrine of impossibility (rebus sic stantibus) following Hurricane Maria, a Category 5 hurricane that struck Puerto Rico in the fall of 2017. See id. at 721. While the leased property was not destroyed by the hurricane, the debtor contended that the hurricane was a monumental event that should excuse its obligation to make the rent payments due for the month following the hurricane within the grace period provided under the contract. See id. at 722. In ruling in favor of the landlord, the court observed that while Hurricane Maria was a "remarkable meteorological phenomena … severe in its scope" a hurricane was not "altogether unexpected given Puerto Rico's geographic location." Id.

Conclusion

As noted above, this article is limited to recent bankruptcy case law on force majeure clauses, and the applicability of such clauses and related common law defenses is specific to the individual contract, jurisdiction, and facts at issue. However, given that the issue is likely to arise in future Chapter 11 cases in the wake of the COVID-19 pandemic, it is important to note the existing guidance from bankruptcy courts addressing (1) the significance of the specific scope articulated in a force majeure clause, (2) whether notice provisions in a force majeure clause are required, and (3) other related common law theories where parties have failed to include a force majeure clause in a contract.

John J. Rapisardi is a partner and chair of the corporate restructuring practice of O'Melveny & Myers. Joseph Zujkowski is a partner in the restructuring practice. T.J. Li, a restructuring associate, assisted in preparation of this article.