No Force Majeure Clause? Other Defenses to Contractual Performance
April 23, 2020
By: Colin A. Walker
Introduction
One of the most fundamental rules of contract law is pacta sunt servanda-"a contract must be observed.” However, the current outbreak of COVID-19 has caused unprecedented business disruptions and has already had a significant effect on the ability to perform existing contractual obligations.
As discussed in our March 20, 2020 Client Alert, Force Majeure: Contractual Performance and Commercial Agreements in a COVID-19 World (available here), force majeure clauses may excuse certain types of contractual performance.
However, what happens when a force majeure clause cannot provide the desired relief? In that situation, businesses may be forced to rely on the seldom-used legal doctrines of “frustration of purpose” and “impracticability” as defenses against pre-COVID-19 contractual obligations.
These two doctrines both operate to excuse a party for whom the anticipated value of a contract is destroyed by an unexpected event. While both doctrines are closely related, they have some important differences.
Frustration of Purpose Doctrine
The frustration of purpose doctrine serves to excuse a contracting party from performing not because it has become more difficult or impossible to perform (as in the case of impracticability), but rather because the other party's counter-performance has become worthless.
Under Colorado law, a party seeking to invoke the frustration of purpose doctrine must meet the three following elements:
- the frustrated purpose must have been so completely the basis of the contract that, as both parties understand, without it the transaction would make little sense;
- the intervening event cannot fairly be regarded as within the risks the frustrated party assumed under the contract; and
- the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made.{1}
Whether complications from COVID-19 will allow a party to be excused from performing under a contract will likely depend on whether the party seeking relief can persuade a fact-finder that its principal purpose for entering into the contract has been frustrated by such complications, through no fault of its own, and that the complications were unforeseeable. Therefore, if the purpose for which you entered into the contract is so frustrated that the overall transaction contemplated by the contract makes little sense, then you may be able to claim frustration of purpose.{2}
Impossibility and Impracticality
The doctrine of impracticability of performance excuses nonperformance of a contractual obligation if a party's performance is made impracticable by the occurrence of an event, the nonoccurrence of which was a basic assumption upon which the contract was made, that party may be relieved of the obligation.{3}
Under Colorado law, the following three conditions must be met to establish impracticability:
- An occurrence of an unforeseen circumstance or condition has occurred;
- The unforeseen condition has render the duty unreasonably difficult or expensive to perform; and
- The extreme expense or difficulty could not have been anticipated by either party to the contract.
Impracticability can be difficult to show. Interpretation of the contract in the light of accompanying circumstances and usages may show that the risk of impracticability has clearly been assumed by the party claiming impracticability. This is the case if the event giving to rise the impracticability is deemed a “reasonably foreseeable” event.{4}
Traditionally, changes in economic conditions do not provide a basis for excusing a contractual obligation.{5} However, if the performance of a duty is made impracticable by having to comply with a domestic or foreign governmental regulation or order, then courts tend to find that impracticability can be invoked.{6}
Whether complications from COVID-19 will entitle a party to relief under the impracticability doctrine will likely depend not only on whether the complications were reasonably foreseeable but also on whether their impact results in extreme hardship that the parties did not anticipate or could not have reasonably anticipated.
Note that courts have a reticence towards discharging parties from their contractual obligations because the general public policy is that parties should be held to their promises under a contract. Therefore, these two doctrines should be viewed as narrow equitable doctrines reserved for situations of extreme hardship.
Other Considerations
Businesses should carefully examine their contracts and determine the purpose of the contract and whether or not the contract contains a force majeure clause that addresses unforeseen events.
Additionally, businesses should determine the exact timing of when the parties engaged in discussions to enter into the contract, and assess whether frustration or impracticability due to COVID-19 was a possibility at the time the contract was executed. For example, those parties who entered into contracts before December 2019 may have an easier time proving either doctrine because they had no reason to anticipate a pandemic occurring just three months later. By contrast, if parties enter into a contract after the likelihood of a pandemic became apparent, then it will be much more challenging for either party to argue that the impacts of the pandemic could not have been reasonably anticipated at the time of executing the contract. In other words, given the escalating news and other reports surrounding the potential for a COVID-19 pandemic, at what point did a pandemic become reasonably foreseeable? That question may become the subject of significant debate and case law in the near future.
{1} United States v. Chaidez-Guerrero, 665 F. App'x 723, 724 (10th Cir. 2016); United States v. Bunner, 134 F.3d 1000, 1004 (10th Cir. 1998).
{2} Chaidez-Guerrero, 665 F. App'x 723, 724 (10th Cir. 2016).
{3} Martinez v. Rocky Mt. Bank, 540 F. App'x 846, 848 (10th Cir. 2013); Cent. Kan. Credit Union v. Mut. Guar. Corp., 102 F.3d 1097, 1102 (10th Cir. 1996); Fraser v. Davis, 644 P.2d 100, 101 (Colo. App. 1982).
{4} See Magnetic Copy Servs., Inc. v. Seismic Specialists, Inc., 805 P.2d 1161, 1162 (Colo. App. 1990) (stating “If the occurrence is reasonably foreseeable, the courts typically take the position that the promisor has assumed the risk of impossibility or frustration”); Littleton v. Emp'rs Fire Ins. Co., 169 Colo. 104, 113, 453 P.2d 810, 814 (1969)
{5} Magnetic Copy Servs., Inc. v. Seismic Specialists, Inc., 805 P.2d 1161, 1162 (Colo. App. 1990).
{6} Martinez v. Rocky Mt. Bank, 540 F. App'x 846, 848 (10th Cir. 2013) Cent. Kan. Credit Union v. Mut. Guar. Corp., 102 F.3d 1097, 1102 (10th Cir. 1996).