The Effect of Unforeseen Trade Disturbances Caused by Coronavirus (COVID-19) On a Party’s Performance Obligations Under a Contract Where There is No Force Majeure Clause

Categories : Coronavirus

Types : Alerts

Many people may be parties to contracts that are, or could be, affected by coronavirus (COVID-19). The scenarios run the gamut. In the manufacturing sector alone, it is estimated that the COVID-19 outbreak has caused supply chain disruptions for nearly three quarters of U.S. companies. According to a recent Institute of Supply Management survey, data shows that global production out of China fell to an all-time low last month, with freight and shipping slowing dramatically.

As a result of calls for responsible social distancing, events that are likely to draw crowds such as concerts, competitions, tournaments, games, classes, and on a more personal level, weddings, engagement parties, anniversary celebrations, and birthday parties, have been postponed or cancelled. Social distancing and working remotely will also decrease the demand for many products associated with a mobile society such as gasoline, airline flights, and public transportation.

These disruptions will affect suppliers, vendors, manufacturers, shippers, customers, employees, and unions. What are the contractual ramifications of unanticipated trade disturbances caused by COVID-19 where there is no force majeure clause?[1]

To start with, contract liability is strict liability. This means that contracts are generally meant to be kept and the party who breaches the contract is liable for damages even if that party is without fault and even if circumstances have made the contract more burdensome or less desirable than it had anticipated. If, for example, your primary supplier with whom you have favorable pricing, has shuttered or slowed down, you probably are not excused from your obligations even though your supply costs have increased, if there are alternative sources.

If the circumstance is that there is only one supply source, and that source is in China or Italy and that source has closed because of the pandemic, common law recognizes an excuse to performance based on “impractibility” (not to be confused with “impracticality”). Under this doctrine, generally, if the event in question (here the supply source shutting down) makes performance impossible, as opposed to more costly or “impractical”, performance could be excused.

For contracts governed by the Uniform Commercial Code (“UCC”), the standard for an excuse not to perform is less demanding. Under UCC section 2-615(1) performance is excused 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 or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid”. The comment to section 2-615 clarifies that performance could be excused due to events which cause “a marked increase in cost” otherwise known as  “commercial impractibility”.

No matter which rule applies, the party seeking an excuse to performance will have the burden to prove impractibility. Typically, the nonperforming party will also be required to show what efforts it took to perform the contract regardless of the occurrence of the excuse. If the consequences of a default are severe, a party faced with the prospect of such a default should seek counsel to (and?) ask a court for a declaratory judgment to resolve the uncertainty before committing to a course of action.

Montgomery McCracken attorneys are available to assist clients with numerous issues related to COVID-19.  Montgomery McCracken’s COVID-19 Resource Center is available here.

[1]  Contractual Considerations in the Wake of the Coronavirus (COVID-19) Pandemic.