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Coronavirus and the Law of Contracts

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The international reaction to the COVID-19 virus (otherwise known as the “Coronavirus”) has been unprecedented, as nations around the globe rush to stem the spread of the disease.  Aside from serious public health issues, the virus will likely have a staggering economic impact on business in the United States.  Already, many companies that rely on the international supply chain are beginning to feel the effects of the disease in the form of manufacturing delays, inventory shortages, travel restrictions, and other business interruptions caused by quarantines in major production centers overseas.

 The virus first appeared late last year in the city of Wuhan, China, a metropolis of more than 11 million people and a major manufacturing and transportation hub in central China.  Within a month the virus had exploded into an epidemic, prompting Chinese authorities to quarantine the city.  Factories around Wuhan were shuttered as the city’s population was kept on lockdown for two months.  Still, the disease quickly spread to other neighboring countries, and by mid-February Japan had closed its entire school system to 16 million students.  Soon thereafter, the virus appeared on European shores where it swept through northern Italy, culminating on March 10th when the Italian government took the extraordinary step of quarantining its entire population of 60 million citizens, instituting travel restrictions, and banning all public gatherings, including postponement of the country’s beloved professional soccer league.  It is almost unfathomable to think that such seismic interruptions to global life were caused by a virus that was unknown to the world only five months ago, and it is not beyond belief that a similar scenario could unfold in the United States.  Indeed, to a degree it has already begun, with several school districts closing, businesses ordering their employees to work remotely from home, and postponement of the NBA season. 

Begging the question, what happens when a company is unable to fulfill its contractual obligations because its employees are quarantined, or key products and components do not arrive from foreign suppliers?  Who bears the risk of business losses from a contractual delay or failure to perform caused by an unexpected pandemic that extensively interrupts everyday commerce as we know it?  The answer depends largely on whether such a contingency is addressed in the contract and the risk allocated accordingly.

Generally speaking, the law allows parties to freely negotiate the terms of their contract (including risk of delay or failure to perform), and the most common method of allocating risk for an unexpected event such as a global pandemic is the incorporation of a “force majeure clause” into the contract.  Force Majeure (French for “greater force”) is a legal doctrine whereby a party may be relieved of its contractual obligations when certain extraordinary conditions are met.  The doctrine can be successfully asserted as a defense to a claim for breach of contract when (1) an event is unexpected by all parties; (2) not caused by any party; and (3) limits the ability of either party to perform a contractual duty.  Contracting parties may use a “force majeure clause” to indicate that a party owes no liability to the other when a force majeure event makes performance of the contract impossible.

A boilerplate “force majeure clause” common in many contracts might read as follows:

Neither party shall be liable to the other for failure to perform its obligations under this contract if prevented from doing so because of an act of God (including flood, earthquake, storm, hurricane or other natural disaster), acts of war or terrorism, strikes, lockouts, or other labor disturbances, civil commotions or riots, embargos, quarantines, interference by princes, rulers, civil or military authority, or any other causes beyond the reasonable control of the party (“Force Majeure”).

By way of example, when Hurricane Sandy struck New York City in October of 2012, causing extensive flooding and closing the seaport, many ocean cargo shipments that were contractually required to be delivered there were diverted instead to the Port of Norfolk.  After the cargo receivers sued the shipping company for breach of contract, seeking as damages the additional costs to transport the cargo from Norfolk to New York, the shipping company successfully raised the “force majeure clause” in the parties’ contract to relieve itself of liability.

By contrast, however, a “force majeure clause” is not intended to buffer a party against the normal risks of a contract.  For instance, the recent impact of the virus on the airline and cruise ship industries precipitated a drop in the demand for fuel oil which resulted in a sharp fall in oil prices.  Obviously, an American fuel supplier that entered into a fixed price contract last year to purchase oil will be faced with the prospect of massive financial losses if it must pay more for the oil than what it can reasonably charge to its customers.  Nevertheless, the fuel supplier will probably not be permitted to rely upon the “force majeure clause” in the contract to escape its obligations because the clause was never intended to guard against price fluctuations.  Shortage of cash or inability to buy at a remunerative price cannot be regarded as a force majeure contingency beyond the seller’s control.  On the other hand, if the virus caused oil producing nations to quarantine themselves, thereby stopping all oil exports, the chances are much greater that the American oil supplier could rely upon the “force majeure clause” to avoid its contractual obligation to sell oil to its customers.  In such a scenario, the issue is not that the virus caused oil prices to drop, but that the virus caused the cessation of oil production, which would likely be a force majeure event.

 If the parties have not specifically addressed excusable delay or force majeure events in the contact, the issues still might be covered in applicable statutes or regulations.  For example, if the contract is for the sale of goods, the Uniform Commercial Code (UCC) includes provisions that address the failure of presupposed conditions and commercial impracticability.  Nevertheless, as the virus begins to infiltrate the United States, companies would do well to begin planning for the inevitable difficulties they will face in meeting contractual obligations caused by production delays, inventory shortages, or a quarantined work force.  Critical to this planning, is knowing whether contracts with suppliers and customers contain a “force majeure clause” that addresses an unforeseen pandemic such as the Covid-19 virus. 

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