The onset of the COVID-19 pandemic has created a new normal in a multitude of economic sectors, including commercial transactions. From commercial leases to loan agreements to construction and supply contracts, questions are surfacing about the rights, liabilities, and defenses available to parties to a contract in view of the pandemic. While force majeure provisions, which set forth reasons that can excuse a party’s performance under a contract, must be evaluated, these provisions often do no excuse monetary obligations. Thus, parties must also consider longstanding contract principles that are likely to generate a considerable amount of discussion and ultimately litigation. Contractual principles of particular significance, and may be of consideration during the COVID-19 pandemic, are impracticability of performance and frustration of purpose. While these principles can be defenses to breach of contract claims, the availability of these defenses is highly dependent upon the language of the contract and the facts and circumstances of each particular situation.
Restatement (Second) of Contracts
Notably, Pennsylvania law recognizes several sections of the Restatement (Second) of Contracts including Sections 261, 264, and 265.
- Section 261 covers discharges by a supervening impracticability. This section provides that when, after a contract is made, a party’s performance is made impracticable without its fault by the occurrence of an event and the non-occurrence of this event was a basic assumption on which the contract was made, its duty to render that performance is discharged unless the language or the circumstances indicate the contrary.
- Section 264 covers the prevention of performance by governmental regulation or order. This section provides that if a party’s performance of a duty is made impracticable by having to comply with a domestic or foreign governmental regulation or order, and the non-occurrence of the regulation or order was a basic assumption on which the contract was made, its duty to render that performance is discharged unless the language or the circumstances indicate the contrary.
- Section 265 covers the discharge of performance by supervening frustration. This section provides that where, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event and the non-occurrence of this event was a basic assumption on which the contract was made, its remaining duties to render performance are discharged unless the language or the circumstances indicate the contrary.
COVID-19 Impracticability and Frustration of Purpose
In analyzing the applicability of the defense of impracticability of performance, the focus of the inquiry is whether the non-occurrence of the circumstance was a basic assumption on which the contract was made. If a party’s performance under the contract remains practicable but is merely beyond the party’s capacity to perform it, the party is not ordinarily discharged from its obligations under the contract. If the impediment to performance is a government regulation or order, the regulation or order must make it impracticable for the party to comply with the regulation or order and to perform under the contract.
To establish a defense of frustration of purpose, the purpose that is frustrated must have been the principal purpose of the party in making the contract such that, without this purpose, entering into the contract would make little sense. In addition, the frustration must be substantial, and the non-occurrence of the event must have been a basic assumption on which the contract was made.
With respect to the defenses of both impracticability and frustration of purpose, a party has an obligation to make reasonable efforts to overcome the impediment to performance. In addition, if impracticability of performance or frustration of purpose is only temporary, the duty to perform may only be suspended temporarily and, when the impracticability or frustration ceases to exist, the party may then again be required to perform under the contract.
The foregoing clearly will give rise to various issues and questions, such as:
- Did the owner of an essential business assume that he would not have to close because the level of clients or patients decreased substantially, leaving it without sufficient revenues to pay debt service on a sizeable loan?
- Did the owner of a non-essential business in a commercial shopping complex lease assume that it would not be shut down by a government order that was imposed through no fault of the tenant, leaving it without the revenues to cover its payments under a lease?
- Did a governmental order require a commercial landlord to close all common areas serving non-essential businesses, leaving its tenants without the ability to access their premises?
- If contract obligations are secured by a guarantor, must the guarantor continue to perform under the guaranty agreement even if the party whose obligations are guaranteed is excused from performing?
- Is a construction contractor that must cease operations because one of its employees tested positive for the COVID-19 virus liable for delay damages?
The contract and the surrounding circumstances in each case are unique. As a result, whether COVID-19 and, in particular, any governmental orders occasioned by it give rise to a defense under the principles of impracticability of performance or frustration of purpose requires a thorough analysis of the wording contained in a contract.
Norris McLaughlin is prepared to assist existing and new clients with a review of their leases, purchase and sale agreements, construction contracts, and other contractual commitments in light of these principles.
If you have any questions about this post or any related matters, please feel free to contact John at firstname.lastname@example.org or 484-765-2211. For more information related to COVID-19, visit our Coronavirus Thought Leadership Connection.
The information contained in this post may not reflect the most current developments, as the subject matter is extremely fluid and constantly changing. Please continue to monitor this site for ongoing developments. Readers are also cautioned against taking any action based on information contained herein without first seeking advice from professional legal counsel.