How to Escape Contracts That Are Killing Your Company During Coronavirus

Preston Byrne, a columnist for CoinDesk’s Opinion section, is a partner in Anderson Kill’s Technology, Media and Distributed Systems Group. He advises software, internet and fintech companies. His biweekly column, “Not Legal Advice,” is a roundup of pertinent legal topics in the crypto space. It is most definitely not legal advice.

In my last column two weeks ago – “How to Survive the Coronavirus and Keep Your Startup Alive” – I suggested that companies take steps to position themselves for the coming storm. Chief among these was sending their employees home (which is now law in New York), cutting their burn rate, reviewing their insurance policies and re-structuring their contracts where appropriate. 

Businesses in the hospitality industry in particular have put such emergency plans into effect. If you are a restaurant owner in New York City, extreme measures are necessary to deal with a truly unprecedented 100 percent, near-instantaneous drop in demand. “Social distancing” emergency orders continue to be handed down by governors all over the U.S. including in New York, Connecticut, New Jersey and Pennsylvania. 

Even if you’re not a restaurant, the ban on utilizing office space will almost certainly take a hunk out of your business – see, for example, New York and its statewide edict that businesses must keep at least 50 percent of their workforces at home. Of course, the U.S. is much larger than just New York, but New York may be where the rest of the country is headed if we don’t get this outbreak under control. 

Businesses affected by local, state or federal emergency orders have a variety of mechanisms available to them if this emergency materially interferes with their contracts. Businesses that are suffering disastrous losses as a result of the virus have an obligation to take swift action to work with their contracting parties – for example, landlords or event organizers – to stanch the bleeding and reduce their burn rate in the face of what could be the single most disastrous macroeconomic event in history. 

Consensual modification

The first thing any business should do in this (extremely stressful) period is talk to your commercial counter parties and try to cut a deal. If you operate a popular restaurant with a beautiful view in New York City, chances are pretty good that the executive orders from the Mayor’s and Governor’s offices have wiped out 100 percent of your business. 

Under the circumstances, your landlord ought to be sympathetic to your position and recognize your business is under strain. What one ought to do, however, is not necessarily the same thing as what one has agreed to do. 

Last week, I was staying in an Airbnb in Washington, D.C., when that city’s first coronavirus outbreak was discovered at a church… two blocks from the apartment on a Sunday night. 

I packed up and moved out the following morning. I tried to get a refund from the owner of the unit, who refused. Eventually, I managed to twist Airbnb’s arm enough to get the job done. The contract left that call within the discretion of Airbnb. By communicating with them and demonstrating a willingness to start a fight, I negotiated a better outcome. 

In a relationship that is a little cozier than that – for example, between your startup and a co-working space landlord that isn’t WeWork – negotiation is to be expected even in good times and especially in disasters. A tenant with a temporary abatement is better than a tenant that goes out of business. 

Contracts are agreements, not straitjackets. Parties are free to breach them provided they are also prepared to face the consequences for doing so.

It bears mentioning that virtually everyone, everywhere is under strain right now: your landlord is and other suppliers are, likely feeling the same pain as you are, and have their own contractual, commercial and financial obligations (including paying lenders) and questions as to where they will find the cash to meet those obligations. 

It is the role of government, in this instance, to lean on regulated businesses like utility firms and banks to enact repayment moratoriums wherever possible on these base-level contracts, and then to act as a backstop to the systemically important institutions like the banks to ensure that a liquidity crisis doesn’t transmogrify into a solvency crisis (as happened in the wake of Lehman Brothers’ collapse back in 2008). 

But what happens if things go bad? 

Force majeure

The first, and best, option is if your contract contains a force majeure clause and the event in discussion is covered by it. 

“Force majeure” is French for holy s***. Kidding. It’s actually French for “superior force” and the long and short of it is that if some massive supervening event prevents the parties from performing an obligation, the performance of that obligation is excused. See, for example: 

In no event will either Party be liable or responsible to the other Party, or be deemed to have defaulted under or breached this Agreement, for any failure or delay in fulfilling or performing any term of this Agreement (except for any confidentiality or payment obligations), when and to the extent such failure or delay is caused by any circumstances beyond such Party’s reasonable control (a “Force Majeure Event”), acts of God, invasion of interstellar groundhogs from the faraway planet Marmota Prime, flood, fire, earthquake or explosion, war, terrorism, invasion, riot or other civil unrest, embargoes or blockades in effect on or after the date of this Agreement, national or regional emergency, strikes, labor stoppages or slowdowns or other industrial disturbances, passage of Law or any action taken by a governmental or public authority, including imposing an embargo, export or import restriction, quota, or other restriction or prohibition or any complete or partial government shutdown, or national or regional shortage of adequate power or telecommunications or transportation.

Sounds great, right? There’s a list of really bad things, and coronavirus is a bad thing, so surely can wiggle out of the contract, because that’s what Force Majeure clauses do. Right?

Wrong. The problem, of course, is you need to read the clause. This clause, for example, says that a “Force Majeure Event” will excuse performance “except for any confidentiality and payment obligations,” and of course the thing that every business in the world is currently trying to do is excuse payment obligations in the face of an unprecedented demand shock and associated liquidity crunch. 

Even if we presume that payment was captured by the force majeure language (“when and to the extent such failure or delay is caused by any circumstances beyond such party’s reasonable control”) it does not say “when and to the extent such failure or delay is caused by the decision of one of the parties that it would be uneconomical or inconvenient to perform that obligation.” 

If a restaurant is closed and takeout-only, a landlord may argue that the New York ban didn’t ban the payment of rent. It merely made it uneconomical to operate the business in that space. While such a landlord would be behaving, in the view of the tenant, unreasonably, as we mentioned above, the landlord is likely facing stressors of its own, and to the extent the force majeure event didn’t cause the failure to perform, at least with this clause, it isn’t going to excuse a failure to perform. 

Impossibility and Frustration

Force majeure aside, common law defenses to non-performance exist that can, under the right circumstances, be employed to attempt to excuse or modify performance under a contract. 

Before proceeding, it bears mentioning that there is no “magic bullet” which will excuse you from performing under a contract or losing a lawsuit if you breach. I recall a member of my extended family who locked into a winter heating oil contract one year and, after the price of oil fell below the contract price, asked us (plural, as there are many attorneys in our clan) if there were a way out to get the lower price (there wasn’t).

With that said, contracts are agreements, not straitjackets. Parties are free to breach them provided they are also prepared to face the consequences for doing so. In the example of a lease, for example, a tenant who vacates may be on the hook for the rent for the remainder of the term, subject to the landlord’s duty to mitigate his or her losses. 

The common law (in both England and the US) provides escape valves in the event that a contract ceases to make commercial sense. By this I don’t mean the contract simply becomes uneconomical to perform, but rather that the contract ceases to have meaning. 

Being prepared to go to war – and having a credible defense to non-performance in hand – is a useful prerequisite to any successful negotiation.

The way these rules are used, most of the time, is as a basis for negotiation if your counter party decides that they don’t want to play ball and would prefer to hold you to the original contract terms, despite the fact that your business is under stress from some external event. For these negotiations to work, you have to be prepared to go to the mat and fight.

Per Transatlantic Financing three criteria must be satisfied before a claim of impossibility will be sustained: ‘First, a contingency – something unexpected – must have occurred. Second, the risk of the unexpected occurrence must not have been allocated either by agreement or by custom (or, from Drummond Coal, “such occurrence was of a character that its non-occurrence was a basic assumption of the agreement of the parties”). Finally, occurrence of the contingency must have rendered performance commercially impracticable.”

So, for example, a contract to rent a beach house will be impossible to perform if a hurricane sweeps through and the land on which the house once sat is devoured by the sea. The contract has become impossible to perform because its subject matter no longer exists. And while one could argue  it is possible to remediate the land and reconstruct the house, it is likely a court would consider this an excessive and unreasonable expenditure.

The issue with invoking the defense of impossibility is that, in normal times, there are very few situations where performance is truly impossible. If you wanted to host a comedy night at a bar in Kentucky, for example, where there is (as of this writing) no curfew or public meetings ban but everyone is staying off the streets, that would make the show uneconomic, but not impossible. 

Contrast this with the position in Connecticut, where gubernatorial orders have closed all bars, and impossibility would be available. Furthermore, with regard to any contracts concluded after the coronavirus emergency had begun, it cannot be said that the non-occurrence of this plague was not a basic assumption of the agreement, because the emergency is already upon us and the parties may be presumed to have knowledge of it.

Facts and circumstances, and the terms of the agreements governing the relationship, will determine whether impossibility is available, or not. 

The second defense available in the absence of contractual terms is frustration of purpose, or simply “frustration.” Frustration is “a defense to excuse performance on the basis of changed conditions that have rendered the performance worthless to one of the parties.” La Gloria Oil & Gas Co. v. United States, 72 Fed.Cl. 544, 573 (2006) That is to say, the purpose for entering into the contract no longer exists, even if the contract is, theoretically, possible to perform. 

As with impossibility, mere inconvenience is not enough to invoke this particular excuse to performance – “changed conditions have rendered the performance bargained from the promisee worthless, not… different or impracticable.” (Id.)

Of course, these areas are complex, and you can be sure that (1) if a company invokes frustration, (2) its counter party disagrees with your client’s version of reality and (3) the dispute sees the inside of a courtroom, the company’s assertion that the Coronabug/that Executive Order/that space groundhog invasion is going to be picked apart and all manner of  counter-arguments can and will be raised. 

But invoking these defenses was, is, and will continue to be (at least as long as you don’t wait too long) an option. Going down fighting like a berserker honey badger is an option. Ideally, no fighting is necessary. But being prepared to go to war – and having a credible defense to non-performance in hand – is a useful prerequisite to any successful negotiation. Federal and state governments in the US and around the world can make these negotiations easier by doing what they failed to do after 2008: backing up the banks and money markets while debt repayment moratoria are put in place for this once-in-a-century event.