Contracts and COVID-19 in North Carolina

April 3, 2020 by

Thinking COVID-19 might excuse a contractual obligation in NC?

The impact of the coronavirus pandemic on North Carolina becomes greater each day. The economic implications of social distancing have taken hold. Local businesses and individuals are increasingly concerned about their ability to fulfill various contractual obligations.

Interruptions in the workforce, global supply chain, and financial markets are just a few of the areas COVID-19 will impact. There is every reason to believe most sectors of the economy will experience challenges for an indefinite amount of time, jeopardizing contractual obligations across the board.

Proceed with Caution (and a good understanding of the facts and law)

Many law firms have written about the potential for COVID-19 to qualify as a “force majeure” event under the terms of a contract. They suggest COVID-19 might allow a contracting party to avoid liability based on the theories of impossibility, impracticability or frustration of purpose.

While these are valid defenses to consider, anyone thinking these defenses will excuse their contractual obligations in North Carolina would be well-advised to consider their options very carefully.

The fact is, even if your contract contains a force majeure clause, it may not provide the relief you are seeking. And the defenses of impossibility, impracticability and frustration of purpose may not be as widely available as one might think.

Impossibility. Impracticability. Frustration of Purpose.

In North Carolina especially, the defense of impossibility has been applied in very limited circumstances, and the defense of impracticability has only been expressly recognized in the sale of goods arising under the Uniform Commercial Code (UCC). It is difficult to find any case in which the defense of frustration of purpose has been successfully applied in North Carolina (perhaps because of its misapplication).

This is not to say that these defenses are not subject to a greater degree of application, they may be. Especially given the dire circumstances now faced by so many. However, it is important to note that the mere indication that a party to a contract might not perform its obligation could be considered a breach by anticipatory repudiation. Therefore, you will want to be sure you stand on firm ground before dipping your toes in the waters of non-performance.

What Should You Be Prepared to Discuss With Your Attorney?

The following questions are intended to assist you and your attorney in discussing your options at a high level. We believe the following questions will give you a better understanding of the contractual theories that may apply and provide a framework for thinking through the issues.

Do you have a written agreement that addresses your obligations in any way?

The starting point for any contractual issue is the language of the contract itself, as the express terms of the contract are generally controlling. As mentioned above, many contracts contain a force majeure clause that set forth the obligations of the parties under extraordinary circumstances that are beyond the parties’ control. These include, for example, labor strikes, war, riots, “acts of God”, and governmental regulations or controls. The language of your contract may or may not specifically list a pandemic or epidemic as a force majeure event. However, it is far more likely if your contract contains a force majeure clause, it includes some general “catch-all” provision that includes any cause beyond the reasonable control of the parties as a force majeure event. A global pandemic could arguably fall into this category.

Of course, the question then remains whether any force majeure provision will provide the relief you need. Many force majeure clauses (especially those contained in commercial leases) state that they do not apply to obligations for the payment of money. Therefore, even if you have been significantly impacted by COVID-19, and your contract contains a force majeure provision, you may not be relieved of your obligation to timely pay rent under the terms of your lease.

Even if your contract does not contain a force majeure clause, it remains essential to carefully review the terms of the contract. Application of the doctrines of impossibility, impracticability and frustration of purpose all include an assessment of whether you assumed the risk of any given condition that may occur. For example, in a recent North Carolina Business Court decision, a commercial tenant argued it should not be liable for breach of a commercial lease because it could no longer use the building for the tenant’s intended purpose. However, the court held the tenant assumed the risk this would occur by agreeing in the lease that the premises could be used for any lawful purpose, and that the lease could be assigned, or the premises subleased.

Is your obligation the mere payment of money?

If there is nothing in your contract that expressly addresses the relevant circumstances (or if you do not have a written agreement at all), you may be entitled to relief under the doctrine of impossibility, impracticability or frustration of purpose. However, if the obligation you seek to avoid is the mere payment of money, you may be fighting an uphill battle in seeking relief under any of these defenses.

Application of these doctrines depends on whether it was a basic assumption of the parties’ agreement that the relevant intervening circumstances would not occur. It is the failure of this basic assumption that allows one party to avoid its obligation. However, it is rarely a basic assumption that a party’s financial condition will remain the same. It is generally anticipated that market conditions will change, businesses will experience periods of decline, and individuals will experience financial difficulty.

Moreover, it may not make a difference that the cause of your financial difficulty is a global pandemic. While the exact cause of the intervening circumstances may not have been a basic assumption, the focus is largely on the circumstances themselves, and not the cause. For example, in a case where a father asserted frustration as a defense to his obligation to pay private school tuition after his ex-wife refused to permit their child to attend the school, the North Carolina Supreme Court held that although the ex-wife’s exact actions were not foreseeable, it was foreseeable that the child might be unable to attend school.

This is not to say that one of these defenses would not apply in any case in which the obligation at issue is the mere payment of money. Each of these defenses are fact specific. (For more on this, see below.)

There are a lot of businesses and individuals that will not be able to pay their rent this month (and possibly for months to come). Unfortunately, in most cases, the law will provide little relief; despite the unforeseen circumstances that have resulted in their economic situation. Most of these individuals and businesses will be better served by working out a payment plan amongst themselves or seeking legislative relief.

Would anyone be prohibited from completing your obligation due to a recent governmental order or other restriction?

The law is fairly well-settled that a party is entitled to relief from a contractual obligation that becomes impossible to perform due to an intervening change in the law.

In North Carolina, the majority of cases have dealt with the defense of impossibility where the subject matter of the contract has been destroyed, and it is for this reason that the contract becomes impossible to perform. As a result, the law of impossibility is usually defined in North Carolina as requiring such destruction of the subject matter.

However, our courts have also expressly recognized that the defense of impossibility applies where an obligation is rendered impossible “by act of the law”. Therefore, there should be little difficulty in applying this defense where a contractual obligation has been directly prohibited by a “Stay at Home” Order or other similar ordinance or regulation. In fact, this is perhaps the simplest and most direct manner in which a contractual obligation could be rendered impossible as a result of COVID-19.

Consider, as an example, if a hotel was contracted to host a convention in late March. Executive Order No. 117 expressly prohibited all “mass gatherings” (at that time defined as any gathering of 100 people, and most recently defined as any gathering of ten people). Therefore, hosting such a gathering would be in direct contravention of the law. Contractual parties are not required to break the law to comply with their obligations, and the defense of impossibility should apply under these circumstances.

Close attention should be paid to the terms of the relevant orders or other regulations. There are many businesses that are considered “essential” or are otherwise exempt under the various “Stay at Home” orders that have been issued. You should be sure that anyone in your position would be prohibited from performing your obligation before declaring as much.

If you are not directly prohibited from performing your obligations, have the current circumstances otherwise made performance unsafe relative to the benefit to be obtained?

If it would not be “impossible” for anyone to perform the relevant contractual obligation, you may still be able to argue that your obligation should be excused on the basis of impracticability.

The first thing to note here is that North Carolina has only expressly recognized the defense of impracticability in cases involving the sale of goods. Section 2-615 of the UCC (which applies to contracts for the sale of goods) states that a delay in delivery, or non-delivery, of goods is not a breach “if performance as agreed 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 . . . .” This contemplates, for example, “a severe shortage of raw materials or of supplies due to a contingency such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or altogether prevents the seller from securing supplies necessary to his performance[.]”

While North Carolina has not formally recognized the defense of impracticability outside of the UCC, the North Carolina comment to Section 2-615 states that it is in accord with present North Carolina contracts principles regarding the defense of impossibility. Under the Restatement (Second) of Contracts, the defense of impossibility is treated under the larger umbrella of the defense of impracticability, and North Carolina courts would do well to formally recognize the same.

The Restatement notes that performance of an obligation may be impracticable “because extreme and unreasonable difficulty, expense, injury, or loss to one of the parties will be involved” or “it will involve a risk of injury to person or to property, of one of the parties or of others, that is disproportionate to the ends to be attained by performance.”

As an example of this latter potential scenario, the Restatement indicates that if a shipper were obligated to deliver goods to a war-torn country, it may be relieved of this obligation given the potential danger to persons or property. However, this would be a borderline question if the goods to be delivered were needed medical supplies as this would make the risk more proportionate to the ends to be obtained.

We can relate this example to the current circumstances by considering a contractor obligated to construct a building on a tight schedule. The most recent “Stay at Home” Order suggests that construction tradesmen are considered essential, and therefore not directly prohibited from continuing their work. However, given what we know about the virus, requiring employees to perform construction could unnecessarily expose them to the risk of infection. Safety precautions by the contractor (whether those mean stopping work altogether for a period of time or something less drastic) could result in delays that may or may not be excused based on the defense of impracticability.

Have you otherwise experienced a marked price increase in the cost of performance or an inability to perform altogether due to a severe shortage of raw materials or supplies resulting from the pandemic or related governmental action?

Returning to the notion that mere financial difficulty will rarely be sufficient to justify the defense of impracticability, it is important to note that “impracticability” means more than “impracticality.” As the Restatement indicates, “[a] mere change in the degree of difficulty or expense due to such causes as increased wages, prices of raw materials, or costs of construction, unless well beyond the normal range, does not amount to impracticability since it is this sort of risk that a fixed-price contract is intended to cover.”

However, while “mere market shifts or financial inability do not usually” discharge a contractual duty, the law remains flexible “[i]n borderline cases.” The Restatement further provides, for example, that while a manufacturer generally assumes the risk of increased costs “within the normal range”, if a disaster resulted in “an abrupt tenfold increase in cost,” a court might determine that the non-occurrence of such a disaster was a basic assumption upon which the contract was made.

Many of these “borderline cases” will need to be resolved.

Have the current circumstances essentially rendered the value of the other party’s performance worthless?

Even if your contractual obligations are not impossible—or even impracticable—to perform, there may yet be relief if COVID-19 has somehow rendered the performance of the other party to your contract virtually worthless, thereby frustrating your purpose in making the contract in the first place. This is a distinct defense from impossibility/impracticability but is treated similarly since it also depends upon the occurrence of some fortuitous event that was not anticipated by the parties when they made their agreement.

Returning to the example of a convention cancelled due to COVID-19, assume that the organizer of the convention had a contract with a company to supply audio-visual equipment and support for the entirety of the convention. Under the circumstances, the A-V company was ready, willing and able to deliver, set up, and maintain the equipment as scheduled. The A-V company would like to receive the agreed-upon amount it was to be paid under the contract (especially given the uncertainty it is now facing in the months to come), but the convention was cancelled. There will be no one attending the convention, and no need for the audio-visual equipment.

It was a basic assumption of the parties’ agreement that a global pandemic would not require the convention to be cancelled. While the A-V company remains capable of performing, this performance has no value for the organizer as a result of the intervening circumstances. Therefore, the organizer may assert the defense of frustration to any claim of breach by the A-V company for its refusal to pay the contract amount.

Final Consideration

The examples provided in this article are stripped-down, simplified examples, and things will rarely be this simple and clear-cut in real life. However, these examples reflect that there are always competing perspectives in contractual disputes and parties have a multitude of potential defences if they are unable to fulfill their contractual obligations.

All stakeholders should take care to look at these issues from each perspective to find a workable solution if possible. Delay of performance, payment plans, or mutual amendments of contract are worthwhile options during these unexpected events.

When a global pandemic occurs, neither party is at fault for the unfortunate circumstances that follow. While we certainly hope that all of those involved will show the utmost graciousness in light of these circumstances, disputes will undoubtedly arise that will require court intervention.

A clear understanding of the law surrounding these issues will help you develop a strategy for finding a workable solution while also positioning yourself to use the law in your favor should court intervention become necessary.

Posted in COVID-19, General

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