By: William K. Flynn
State and local governments are taking aggressive actions to contain the spread of the COVID-19 virus, including official and unofficial quarantines, “social distancing,” stay at home requirements, and cancellation of public events. I wrote the other day addressing the potential implications of a pandemic relative to negotiated force majeure provisions commonly found in all manner of commercial contracts. In that alert, I also referenced existing common (“judge made”) law principles that may provide another avenue for impacted businesses to find relief, namely the doctrines of impracticability or impossibility of contract performance. Over time, courts have merged these related concepts into a common doctrine characterized as a “frustration of contractual purpose.”
The underpinnings of a frustration defense to contractual performance are articulated by the Restatement 2d of Contracts § 261, “Discharge by Supervening Impracticability.” For readers not steeped in nuance of different legal authorities, the Restatement is a compilation of developed common law principles prevailing in courts across the United States. Although Restatement principles are not necessarily binding on all state courts, many have adopted Restatement principles as the guiding law of the land. Ohio courts, for instance, follow and apply selected Restatement addressing principles of frustration and excused performance, while at the same time characterizing the doctrine as “disfavored.”
What businesses caught up in the current coronavirus maelstrom should understand, is that frustration of purpose is not a means for obtaining affirmative relief in the form of money damages, but rather is a defense that may excuse the obligation of continued performance of an existing contract. The fundamental elements supporting a frustration defense are: a condition arising after the contract is made; the occurrence or non-occurrence of which was a basic assumption on which the contract was made; the party seeking relief is not at fault; and the contract does not otherwise address what happens should the condition occur. Analogous principles apply specifically to contracts involving a sale and purchase of goods, reflected by the Uniform Commercial Code (UCC §2-615), adopted specifically in Ohio as Revised Code § 1302.73.
Particularly relevant today, is that both the Restatement (§ 264) and the UCC (R.C. § 1302.73(A) and K.R.S. § 355.2-615), specify that contractual duties may be excused (or deferred temporarily) where compliance with a governmental order or regulation make performance “impracticable.” Ohio and Kentucky for instance, have ordered all dine-in restaurants and non-essential businesses to close. Under these exigent circumstances, the defense of excused performance would seem to fall squarely within the frustration of fundamental purposes contemplated by courts and by the legislature by adopting the UCC principles. It can be argued easily that businesses enter into real estate leases, longer term equipment or supply contracts, and even lender financings, having the basic assumption that operating the business is not contrary to law. Stated differently, if the business itself was illegal, neither party would have, in good faith, entered into the agreement in the first instance.
What To Do Now.
As I wrote in the earlier alert, the first thing to do is open a dialogue with your counter party. But failing that, take stock of your written agreements. Real estate leases are required to be in writing, and most sophisticated documents will include a force majeure provision requiring the tenant to continue payments, even in the event of business disruption. The same caution would apply to any lender financing agreement. These requirements are enforceable, regardless of frustration principles, because courts reason that this kind of language evidences that the parties contemplated the possibility of severe financial disruption. But the actual language is always going to be the determinative fact. If frustration is not addressed in your agreements, it is also important to note that the courts almost uniformly reject a frustration defense grounded on arguments that wide spread financial decline or changing market conditions made contract performance impracticable or impossible, whether stated in the contract or not, reasoning that changed financial conditions is a contingency implicit in the operation of almost any business. But with those cautions, the doctrine of frustration of purpose, particularly in the case of a governmental order shuttering entire industries, may provide another tool for business trying to navigate through unprecedented economic uncertainty.
William K. Flynn is a Strauss Troy Shareholder who advises businesses on operations and commercial dispute resolution.