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COVID-19 Contract Performance Defenses under New York Law Part I

April 9th, 2020 Commercial Impracticability, COVID-19 Contract Defenses, Uniform Commercial Code Article 2 1 Comment » By Philip J. Loree Jr.
performance | contract | excuse | defense

These are trying times, to say the least. Businesses have been shuttered or their operations substantially curtailed, millions of persons are out-of-work, and the economic future is uncertain. Those with performance obligations under business contracts may not be able to carry them out as agreed.

One economic result of this disruption is breach of contract and claims to recover for breach of contract. Generally, a breach is a breach, irrespective of the breaching party’s fault or best intentions.

But what happens when circumstances, like the unprecedented ones we’re experiencing today, intervene, leaving a business with no choice but to cease performance under a contract? Does that, under New York law, provide a business a defense to contract performance that can be asserted in litigation or arbitration?

The answer is that New York law can, depending on the circumstances of a given case, provide a defense to nonperformance, provided that: (a) the facts support an impossibility of performance defense; (b) performance is excused by a force majeure clause (or a similar contractual provision); or (c) as respects contracts for the sale of goods, performance 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 or by compliance in good faith with any applicable. . . domestic governmental regulation or order . . .” N.Y. U.C.C. 2-615(a).

Two other contractual doctrines might also be relevant to a COVID-19-precipitated breach of contract claim: (a) frustration of purpose; and (b) illegality of performance.

This post discusses the doctrine of impossibility, force majeure, and commercial impracticability, leaving frustration of purpose and illegality of performance to a later post.

Contract Performance Defense: Impossibility

Impossibility will excuse “performance only when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible.” Kel Kim Corp. v. Central Mkts., 70 N.Y.2d 900, 902 (1987). Impossibility must result from “an unanticipated event that could not have been foreseen or guarded against in the contract.” 70 N.Y.2d at 902.

Generally, the “excuse of impossibility is limited to the destruction of the means of performance by an act of God, vis major, or by law.” 407 E. 61st Garage v. Savoy Fifth Ave. Corp., 23 N.Y.2d 275, 281 (1968). The doctrine does not excuse an inability to perform “occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy. . . .” 23 N.Y.2d at 281-82.

A hurricane or other natural disaster would be a classic “act of God” or “vis major” event that could destroy the means of performance, thereby excusing performance of a contract, but impossibility can also be caused “by law.” For example, in Kolodin v. Valenti, 115 A.D.3d 197 (1st Dep’t 2014), parties A and B were both romantically involved and involved in music-business dealings—A, a Jazz singer, and B, president and sole owner of an artist-management agency, C.  

A had two contracts with C, B’s artist-management agency. A obtained a protective order against B, which resulted in the parties entering into a stipulation, so-ordered by the Family Court, under which A and B agreed to have no contact, even through third parties, except through their respective counsel.

A sued on the contracts but C claimed that it was excused from performance because the stipulation rendered performance impossible. The stipulation prohibited the A and B from communicating with one another, even through third-parties, such as employees of C. And B oversaw the daily operations of C’s 40 employees.

The Appellate Division, First Department upheld the defense of impossibility because the stipulation rendered performance of the artist-management contracts impossible, a stipulation preventing all contact between A and B (including through third parties other than counsel) was not foreseeable, and therefore not something the parties could contract around. Kolodin, 115 A.D.3d at 200-01.

Kolodin is, of course, an unusual case, and New York courts rarely find that a party’s performance is excused by impossibility. That is so because “the purpose of contract law is to allocate the risks that might affect performance and that performance should be excused only in extreme circumstances.” Kel Kim, 70 N.Y.2d at 902.

But the idea that impossibility may, in appropriate circumstances, provide a defense to post-COVID-19 performance of a pre-COVID-19 contract is hardly novel. Whether or not a Court could consider the COVID-19 pandemic to be a “vis major” event comparable to a natural disaster is debatable, and the possibility of a viral epidemic affecting performance of a contract is not entirely unforeseeable.

But the efficient or proximate cause of a business-operations impairment (or shutdown) is more likely to be the government-imposed shelter-in-place orders that have been entered in New York and so many other states. Depending on the circumstances, those orders could render a contract impossible to perform without the breaching party subjecting itself to civil and possibly criminal sanctions.

The shelter-in-place orders are for the most part unprecedented in this country, and were made to address a viral pandemic, an event that last occurred in the U.S. about 100 years ago. Especially, in the context of a relatively short-term contract, a decent argument can be made that the COVID-19 outbreak and the resulting governmental actions were not reasonably foreseeable. 

But whether parties could have “contracted around” the risk of nonperformance by government-imposed, public-health shutdown is a question that may vary from case to case. In some cases the answer could be “yes,” because the parties could, in theory, have included in their contract a so-called “force majeure” clause contract that addressed delays in performance attributable to compliance with laws, regulations, and governmental orders.  

Force Majeure Clauses

“Force majeure” clauses come in many forms but their purpose is to allocate risk upon the occurrence of “an event beyond the control of the parties that prevents performance under a contract. . . .” Beardslee v. Inflection Energy, LLC, 25 N.Y.3d 150, 154 (2015) (citation omitted). Typically, that is done by excusing performance for the period of delay.

One can find numerous examples of force majeure clauses online and in the cases. Here’s the “force majeure” clause at issue Kel Kim:  

If either party to this Lease shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes beyond the control of such party, the performance of such obligation shall be excused for the period of the delay.

Kel Kim Corp., 70 N.Y.2d at 902.

This particular clause excuses delayed performance “by reason of” “restrictive governmental laws or regulations. . . .” Delay caused by a government-ordered shutdown of a place of business would seem to fall within the terms of this particular clause, although clearer, more specific language could have been used.  

The general “catch-all” phrase “other similar causes beyond the control of such party” will not operate to bring any other type or kind of delay within the scope of the clause. As Kel Kim explained, “only if the force majeure clause specifically includes the event that actually prevents a party’s performance will that party be excused.” 70 N.Y.2d at 902-03.

Under the contract interpretation principle ejusdem generis, “general words are not to be given expansive meaning; they are confined to things of the same kind or nature as the particular matters mentioned.” 70 N.Y.2d at 903 (citation omitted).

Thus, in Kel Kim, the Court held that the lessee’s inability to procure contractually-required liability insurance was not excused by the force majeure clause because “the events” listed in it “are different in kind and nature from [the lessee’s] inability to procure and maintain” such insurance.

A force majeure clause could have a kind of “double edged sword” effect in a close case. If an event does not fall within in its scope, then there is little or no chance that a Court would find the event to justify non-performance under the impossibility of performance doctrine. But there might be a slightly higher chance that a court would recognize the same event as justifying non-performance if the parties’ contract contained no force majeure clause.

That said, and all else equal, a carefully drafted, and sufficiently inclusive force majeure clause is a better solution to the problems concerning excuse from performance than simply relying on the doctrine of impossibility of performance. 

Contract Performance Defense: Commercial Impracticability

The doctrine of “commercial impractibility,” as it is known under the Uniform Commercial Code in cases involving the sale of goods, evolved from common law contract law. It is derived from early English case under which defendant was to permit plaintiff to use a music hall on day X, but prior to day X, a fire destroyed the hall.

Plaintiff sued but the Court in Taylor v. Caldwell, 32 L.J.Q.B. 164, explained that even though impossibility of performance was not a defense to enforcement of a contract (that was true for much of the 19th century), there was an exception in cases where the parties must have “contemplated” the “continued existence of” “some particular specified thing” “as the foundation of what was to be done” under the contract.

In such cases, explained the Court, the law implied a condition that the “perishing” of that thing excused performance under the contract: “where, from the nature of the contract, it appears that the parties must from the beginning have known that it could not be fulfilled unless, when the time for the fulfillment of the contract arrived, some particular specified thing continued to exist, so that when entering into the contract they must have contemplated such continued existence as the foundation of what was to be done, there, in the absence of any express or implied warranty that the thing shall exist, the contract is not to be construed as a positive contract, but as subject to an implied condition that the parties shall be excused in case, before breach, performance becomes impossible from the perishing of the thing, without default of the contractor.” Dolan v. Rodgers, 149 N.Y. 489, 492 (1896) (quoting Taylor v. Caldwell, 32 L.J.Q.B. 164) (quotations omitted).

This common-law rule—which has become to be known as the doctrine of “commercial impracticability”—was codified in Article 2 of the Commercial Code, which governs contracts for the sale of goods.

N.Y. U.C.C. 2-615(a), entitled “Excuse by Failure of Presupposed Conditions,” excuses “delay in delivery or non-delivery” of goods if agreed performance “has been made impracticable”—i.e., impossible or at least unreasonably difficult — when a “contingency” occurs and “the non-occurrence” of that “contingency” “was a basic assumption on which the contract was made. . . .” N.Y. U.C.C. § 2-615(a). In much the same vein UCC 2-615(a) also excuses performance “made impracticable” “by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid:” 

Except so far as a seller may have assumed a greater obligation and subject to the preceding section on substituted performance:

(a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a contract for sale 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 or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.

.  .  .  . 

N.Y. U.C.C. § 2-615(a).

UCC 2-615(a)’s commercial impracticability doctrine can provide a seller with a breach of contract defense against a claim that the seller did not make delivery as agreed because of its good faith compliance with a government-ordered shutdown.

Complying with such a shutdown would constitute “compliance. . . with [an] applicable. . . domestic governmental regulation or order. . . .” The seller’s ability to lawfully conduct business at full (or reasonably full) capacity might also be “a basic assumption on which the contract was made,” the non-occurrence of which as a result of the COVID-19 pandemic, could provide an excuse for nonperformance under UCC 2-615(a).

Want to learn about the frustration of purpose doctrine and illegality of performance? Read Part II of this post here.

About the Author

Philip J. Loree Jr. is a partner and founding member of Loree & Loree. He has nearly 30 years of experience handling matters arising under the Federal Arbitration Act and in representing a wide variety of clients in arbitration, litigation, and arbitration-related litigation. He is a former partner of the litigation departments of the New York City firms of Rosenman & Colin LLP (now known as Katten Munchin Rosenman LLP ) and Cadwalader, Wickersham & Taft LLP.

Loree & Loree focuses its practice on solving arbitration problems for small businesses and professional practices, usually by representing them in arbitration proceedings and in arbitration-related litigation.

It represents private and government-owned-or-controlled business organizations, and persons acting in their individual or representative capacities, and often serves as co-counsel, local counsel or legal adviser to other domestic and international law firms requiring assistance or support.

Loree & Loree was recently selected by Expertise.com out of a group of 1,763 persons or firms reviewed as one of Expertise.com’s top 18 “Arbitrators & Mediators” in New York City for 2019, and now for 2020. (See here and here.)

You can contact Phil Loree Jr. at (516) 941-6094 or at PJL1@LoreeLawFirm.com.

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