Insights / Financial Services Law Advisor

COVID-19 and Contractual Force Majeure Provisions

By William Schuerman, Filipp Koffman, and Michael J. Detro

03.20.20

For weeks, COVID-19 has had an incredible and devastating global impact. On March 11, 2020, the World Health Organization officially declared the virus a pandemic. In response, the United States declared a national emergency, announced travel restrictions on incoming European travelers, and at least 40 state governments have declared their own states of emergencies. Municipal, state, and foreign governments have imposed additional significant restrictions including city lockdowns, office and business closures, and travel bans.

Similarly, airlines are reducing flights by as much as 50 percent and businesses of all sizes in all industries are recommending or requiring that employees work remotely and many have prohibited travel of any kind.

However one views these events – as an act of God, act of government, circumstance unforeseen by the contracting parties, or other circumstance beyond the reasonable control of the impacted party – such events may be included within the definition of “force majeure” in a typical commercial contract that may excuse one or both parties’ performance obligations. Black’s Law Dictionary defines “force majeure” as “[a]n event or effect that can be neither anticipated nor controlled.”

Effects of COVID-19 on Business Operations

While the world attempts to contain the spread of COVID-19 through quarantines, travel restrictions, and other means, these actions have caused labor disruptions, office and business closures, and supply chain disruptions (to name a few). As a result, many commercial relationships are stressed - parties to financial services, technology, procurement, outsourcing, and other commercial agreements are (or should be) evaluating their respective rights, obligations, and remedies (and whether one or both parties are excused from performing).

Service providers and vendors are analyzing their performance obligations and service level commitments, potential liability for non-performance, and whether non-performance or a delay in performance may be excused pursuant to force majeure provisions in the relevant agreements. Conversely, service recipients are considering what rights they have if their service providers fail to perform or, alternatively, whether COVID-19 provides an opportunity to suspend payment or terminate the agreements (e.g., to eliminate a significant expenditure in light of current economic uncertainty).

In addition to managing the personnel, operational, and financial issues presented by the COVID-19 crisis, financial institutions and other businesses should review their material agreements to evaluate obligations, rights, remedies, and risks. This is especially important where financial institutions have engaged third parties to perform critical/significant activities and core business functions in order to satisfy regulatory risk management obligations (e.g., FIL-44-2008, and Supervisory Letter SR 13-19).

Below are some considerations financial institutions and other businesses should keep in mind when considering whether force majeure provisions in their agreements could be triggered to excuse either party from performing its obligations.

Force Majeure Provisions in Contracts

Whether a party may invoke force majeure, and be excused from performing under the agreement, will depend on two critical factors: (i) the scope/wording of the force majeure provision itself; and (ii) the performance obligations of the party seeking to invoke force majeure.

Scope

Force majeure provisions vary from agreement to agreement, but generally fit within two categories:

A broad provision that excuses a party’s performance upon the occurrence of any event beyond a party’s reasonable control. This provision may list examples, but such examples are often not limiting and provide substantial flexibility for a party to claim force majeure. A party performing services will generally be excused from performance if the agreement contains a broad provision.

An example of a broad force majeure provision is the following:

Neither party will be liable for, or be considered to be in breach of or default under this Agreement for any delay or failure to perform as a result of any cause or condition beyond such party’s reasonable control (including, but not limited to: fire, explosion, earthquake, storm, flood, wind, drought or act of God; court order; act, delay or failure to act by civil, military or other governmental authority; national emergency, strike, lockout, riot, insurrection, or war).

A narrower provision that excuses a party’s performance only upon the occurrence of specific enumerated events. This type of provision may include a general/broad example at the end; however, courts generally (and particularly those in New York and California) narrowly construe such provisions and rely instead on just the specified events. A party performing services will be excused from performance if the underlying event is listed (e.g., a pandemic) and any additional conditions/requirements of the applicable force majeure provision are satisfied.

An example of such a narrow force majeure provision is the following:

Neither party will be liable for, or be considered to be in breach of or default under this Agreement for any delay or failure to perform as a result of any fire, explosion, earthquake, storm, flood, wind, drought or act of God, court order, act, delay or failure to act by civil, military or other governmental authority, strike, lockout, riot, insurrection, war, or other similar causes or conditions beyond such party’s reasonable control.

Performance Obligations

A properly drafted force majeure provision should only excuse the impacted party’s performance under the agreement to the extent of the impact. For example, a party whose only obligation is to pay for services, would unlikely be able to rely on force majeure to terminate the agreement or suspend payments under the agreement, particularly if the services continue to be provided .

Moreover, force majeure provisions commonly exclude a party’s payment obligations from being excused even if such party is impacted by a force majeure event. Similarly, a program manager responsible for providing all aspects of a card program should remain obligated to perform marketing, distribution, and processing services (and satisfy corresponding service levels), provided that such services provided by the service provider (or its subcontractor(s)) are not impacted by a qualifying force majeure event.

Additionally, the force majeure provision should not excuse the impacted party if the party’s failure to perform could have been prevented through reasonable precautions or workaround plans. Finally, the force majeure provision should also require the impacted party to mobilize its disaster recovery and business continuity plans (and take other reasonable mitigation steps) as a condition to seeking relief under such provision.

Other Considerations

Service recipients should determine which third party service providers are providing critical or other core or important functions and activities for the service recipient’s business, engage in discussions with those service providers regarding the impact or potential impact of COVID-19 on their ability to perform, and evaluate potential non-performance and force majeure risks under their contractual arrangements.

An impacted party should carefully analyze all related factors before invoking force majeure. Depending on how the force majeure provision is drafted, if the force majeure event is not removed within a certain period of time, or the impacted party is not able to cure its inability to perform, the impacted party may inadvertently (or unknowingly) provide the non-impacted party a termination right. Instead of providing formal notice of force majeure, an impacted party could consider using the dispute resolution/program governance mechanisms in the agreement (if any) to communicate and resolve performance issues.

Other items to take into consideration when evaluating a party’s rights, obligations, remedies, and risks:

Does the force majeure provision contain any notice requirements (e.g., the impacted party must immediately notify the non-impacted party of the force majeure event)? If so, an impacted party wanting to invoke force majeure should provide prompt notice to the non-impacted party in the event that force majeure is going to be invoked.
Parties to agreements, particularly in connection with critical services, should frequently communicate and provide updates regarding the performance or restoration of services, satisfaction of service levels, mitigation efforts, and disaster recovery/business continuity plans.
The impacted party generally cannot be at fault in any way in order to invoke force majeure.
Parties should exercise audit rights throughout term of the agreement to ensure proper and adequate testing of disaster recovery/business continuity plans.
Parties should review if their agreements provide the ability to suspend or terminate in part (as opposed to only a termination right in full).
An impacted party may be able to rely on other legal theories (e.g., frustration of purpose or impossibility) to discharge performance obligations in the event that the underlying agreement does not contain a force majeure provision or the force majeure provision does not otherwise excuse the impacted party’s performance obligations.
If the non-impacted party needs or wants to terminate the agreement, it should closely review other provisions for a termination right (e.g., material adverse effect on the underlying services or program).
Prior to asserting termination rights, non-impacted service recipients should also consider whether there are viable, alternative service providers or vendors.
Parties should review the agreement’s dispute mechanism procedures and provisions. Are informal/relational dispute resolutions required to be followed before exercising a termination right? Does the agreement provide for binding arbitration or are the parties permitted to pursue litigation? If litigation is permitted, does the agreement mandate a certain governing law and venue?
Disputes over the applicability of force majeure terms often require a court, arbitrator, or mediator to conduct a fact intensive analysis with respect to both the event(s) triggering the assertion of force majeure and the parties’ behavior. It is important for a party to act in good faith during this process and document the circumstances as much as possible.

Often, a force majeure provision is thought of as legal boilerplate language and is not even discussed, let alone negotiated. However, all contracting parties should be mindful of these provisions going forward in connection with negotiating new or renewal agreements.

The facts, laws, and regulations regarding COVID-19 are developing rapidly. Since the date of publication, there may be new or additional information not referenced in this advisory. Please consult with your legal counsel for guidance.