by Tom Moran
Any business finding itself in a contract that it cannot complete due to COVID-19 should consider asserting an impossibility defense. Unlike a force majeure defense, which relies on the particular language of the contract, and specific case law interpreting the clause, impossibility is a common law defense. This means that even if notice provisions or other conditions precedent for relying on force majeure were not complied with, an impossibility defense may still be available.
The rationale behind the impossibility defense is that one party should not bear the entire risk of nonperformance when an unexpected event renders performance impossible. In other words, when the parties make a basic assumption when forming a contract, and that assumption falls through, the law will not punish the nonperforming party if it was not at fault. In this situation, performance will be excused.
The impossibility defense typically sets a high bar for a company that wants to avoid its performance under a contract. Most jurisdictions put an emphasis on upholding the bargains made between private parties. You should expect that without compelling circumstances, courts will uphold the terms of the contract wherever possible.
A classic example is a contractor that agrees to provide security services at a particular building. If that building burns down due to an accident that was not the fault of the owner or the contractor, the contract is impossible to perform and can be cancelled without penalty to either party. Over time, this principle has evolved to include situations where performance is not just physically impossible, but commercially impracticable. So, if the security system provided by the contractor requires the use of a particular rare metal, and a global shortage of that metal occurs such that it can only be obtained from one particular mine on the other side of the world, at 1,000 times the price, performance may also be excused.
The elements of a successful impossibility defense are:
- An unexpected occurrence of an intervening act
- The occurrence was of such a character that non-occurrence was a basic assumption of the agreement; and
- The occurrence made performance impracticable
For contracts that were in existence before approximately February 2020, the COVID-19 pandemic will almost certainly be considered “unexpected”. However, new contracts will need to specifically address who bears the risk of nonperformance in the event of a pandemic. If a contract is entered into with the knowledge we have now and it can’t be performed later due to virus-related issues, it may be at the risk of the party who can’t perform if they did not address the virus in the contract.
As for the “intervening act,” simply stating that you are having problems fulfilling your obligations because of the virus is not going to satisfy this requirement. To be “intervening” an event has to specifically hinder the performance of a duty arising under the contract in some way. For example, if a government-ordered lockdown prevents employees from going to a jobsite where presence on the premises is necessary (such as in construction or factory work), that would qualify as an intervening event. A contract cannot compel you to do something illegal, or violate a government order, even if it is later found unconstitutional. If half of your workforce gets sick with COVID-19 and you experience a slowdown in productivity as a result, that may constitute an intervening event, depending on your company’s ability to work with a reduced workforce, remote work, and other potential factors.
The second factor asks whether, given the nature of the contract, the parties could have been expected to account for it at the time they signed it. Some jurisdictions refer to this as “foreseeability,” but in the Fourth Circuit, where I practice, it has moved away from this language because the human imagination can make just about any far-fetched scenario foreseeable. For most contracts, a world-altering pandemic would have been outside the reasonable scope of the parties’ anticipation prior to this year, so for most claims at this time this requirement will be met.
The last factor is impracticability of performance. This is going to be the most contested factor in the vast majority of COVID-19 claims. It is heavily fact- and contract-specific. Again, mere impossibility is not the only situation that will satisfy this factor. It can include changed circumstances where the costs of performance due to the unforeseen event would be excessive and unreasonable. If you are relying on increased costs to claim impossibility, the costs need to have increased to such a degree that they defeat the purpose of the contract.
An important point tying into this concept is the duty to exhaust all alternatives. If there is an indication that you may not be able to perform a contract, you should not simply rest on your laurels. The best practice is to give notice to the other party of the issue as soon as possible, and begin exploring your alternatives. In a construction contract, this may mean looking into alternative suppliers or replacement materials. In commercial contracts, you may need to adjust quantities, prices, or times of delivery. Always document your efforts to investigate these alternative means of performance, even if they don’t end up bearing fruit. Proof of these efforts may persuade a court that you did everything you could to avoid terminating the contract, but you had no choice.
Finally, when terminating a contract with the eye toward asserting an impossibility defense, you should decide whether your situation involves permanent impossibility or temporary impossibility. Where the purpose of the contract is only temporarily frustrated, then a delay equal to that period of time is preferable to a full termination. Unless it would be materially more burdensome to resume performance of the contract than it would have been had there been no frustration, then you will be expected to perform once the situation is resolved. Someday, hopefully soon, the COVID-19 crisis will be behind us and businesses will open back up. Where possible, you should assume that the inability to perform is temporary and that the contract will resume when that occurs.
If you are in Virginia, West Virginia, or the District of Columbia and have questions on whether your duty to perform under a contract can continue in the face of COVID-19, please contact Tom Moran at (804) 362-9434 or firstname.lastname@example.org.
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