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Law360 (July 1, 2020, 4:21 PM EDT) --
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| Stephanie Denker |
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| Christie McGuinness |
New York has already started to see lawsuits concerning whether contractual performance can be excused. In these suits, courts will be tasked with interpreting the contract's force majeure provision (to the extent one exists) and applying common law contractual defenses, such as impossibility of performance and frustration of purpose, to determine whether performance can be excused in these unprecedented circumstances.
Force Majeure
Force majeure is a contractual doctrine that is typically invoked by a party seeking to excuse performance under a particular contract by claiming that an unforeseen, unpredictable event (such as an "act of God") prevented performance. When thinking of force majeure in the traditional context, images of hurricanes, tornadoes and other natural disasters come to mind.
While COVID-19 was not a natural disaster, in the traditional sense, the effects of COVID-19 were similar. Specifically, states enacted executive orders that prohibited in-office operations of nonessential businesses and required people to stay at home. These orders undoubtedly hindered the ability of certain businesses to perform under their contracts.
New York courts interpret force majeure provisions narrowly, and the party seeking to excuse its performance has the burden of establishing that the force majeure provision is applicable to the specific event that prevented performance under the contract.[1]
Common Law Contractual Defenses That May Be Applicable
In addition to force majeure, New York recognizes the defenses of impossibility of performance and frustration of purpose to excuse contractual performance.
Impossibility of performance is applicable where the contract does not allocate risk of the specific occurrence causing performance to be impossible, and the unanticipated event could not have been foreseen or guarded against in the contract.[2] For the doctrine to apply, performance must be objectively impossible, and the party claiming impossibility must "make every effort to perform" and could not have "contributed to the circumstances that caused the impossibility."[3] The doctrine will not apply "where performance is possible, albeit unprofitable."[4]
Unlike the defense of impossibility, the doctrine of frustration of performance is applicable when the parties can perform under the contract; however, "as a result of the unforeseeable events, performance by one party would no longer give the other party what induced him to make the bargain in the first place."[5]
The key is whether the contract was based upon an assumption that a specific event or contingency would not occur.[6] Courts have applied the doctrine in limited instances, "where a virtually cataclysmic, wholly unforeseeable event renders the contract valueless to one party."[7]
Recent New York Cases
In May, the U.S. District Court for the Southern District of New York issued rulings in two cases concerning performance under contracts during the COVID-19 pandemic.
In E2W LLC v. KidZania Operations SARL,[8] E2W sued KidZania for allegedly breaching the parties' franchise agreement by terminating the agreement for failure to pay certain royalties. In response to the termination notice, E2W invoked the force majeure provision contained in the franchise agreement because it could not lawfully operate its facility — an amusement park — in the midst of the pandemic.
The operative clause excused nonperformance due to enumerated events, including "governmental orders," "actions by government or by political sector(s) of their respective counties," and acts of God. The provision made no specific reference to pandemics or national emergencies.
As a result, E2W also raised the common law doctrines of impossibility and frustration of purpose, arguing that COVID-19 — requiring the indefinite closure of E2W's facility and termination of its development activities — was an event whose nonoccurrence was a basic assumption upon which the franchise agreement was made.
U.S. District Judge Andrew L. Carter Jr. granted a preliminary injunction preventing KidZania from terminating its franchise agreement with E2W while the parties arbitrate the case before the International Chamber of Commerce, or ICC, pursuant to a mandatory arbitration clause.[9] The order granting the preliminary injunction specifically stated that KidZania is:
enjoined from terminating the Franchise Agreement and taking any actions that would interfere with the continued operations of [E2W], including indicating or disclosing to any third party that the Franchise Agreement has been terminated. The Parties are ORDERED to otherwise maintain the status quo of their operating relationship pending a decision in the ICC arbitration regarding the termination of the Franchise Agreement.[10]
Judge Carter found that E2W had demonstrated a likelihood of success on the merits, a necessary element for granting a preliminary injunction, that COVID-19 excused E2W's performance under the franchise agreement.[11]
In Latino v. Clay LLC,[12] the parties entered into a class action settlement agreement whereby the defendants (gym owners) were required to pay $300,000 over a period of 23 months and, if they failed to do so, plaintiffs would be permitted to file a consent judgment.
On April 29, the plaintiffs filed a motion for entry of the consent judgment. The defendants opposed the motion, arguing "that their performance should be excused based upon the doctrine of impossibility because of their inability to pay, ostensibly as a result of the COVID-19 pandemic and Governor [Andrew] Cuomo's PAUSE Executive Order."[13]
U.S. Magistrate Judge Stewart D. Aaron held that performance was not excused. He stated that "[a]t best, Defendants have established financial difficulties arising out of the COVID-19 pandemic and the PAUSE Executive Order that adversely affected their ability to make the payments called for under the Settlement Agreement," but that "where impossibility or difficulty of performance is occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy, performance of a contract is not excused."[14]
New York state courts are seeing similar lawsuits. One such action was filed by Victoria's Secret seeking rescission of the commercial lease for its Herald Square location under the doctrines of frustration of purpose and impossibility of performance.[15]
The complaint alleges that "[b]ecause of the COVID-19 Pandemic, VS cannot operate its retail store at the Premises consistent with the parties' fundamental understanding, purpose, and expectation at the time the lease was entered." It is worthwhile to note that the complaint does not invoke force majeure in an effort to excuse performance under the commercial lease.
Takeaway
While the COVID-19 pandemic is a unique circumstance under which force majeure provisions are beginning to be tested, past New York cases are illustrative of New York courts' attitude regarding force majeure in general. Some examples include:
- A court relieved a tenant "of its obligation to pay rent due to government action prohibiting the intended use of the premises" where the force majeure clause included "governmental action or inaction" as a force majeure event.[16] In this case, after the parties executed the lease for the premises where the tenant intended to operate a betting parlor, the town passed a resolution that prohibited the premises from being used as a betting parlor and a court issued an injunction to the tenant.
- A court found that "government prohibition" as used in the force majeure clause of the lease covered a judicial temporary restraining order that prevented the landlord from performing the necessary construction before the tenant could take possession of the premises.[17]
- A court found that a vacate order issued by the New York City Department of Buildings to a venue fell within the wedding contract's force majeure clause, which permitted refunds if the event was canceled because of "an order of the Federal, State, or City government or for any reason beyond Owner's control," if the venue was able to show that the vacate order was not foreseeable or within its control.[18]
New York courts have thus excused performance based on government actions prohibiting contractual performance when the force majeure provision's enumerated events specifically included "government action," "government prohibition," or government orders.
As the discussion above demonstrates, each case must be evaluated individually in light of the particular contract and facts at issue. As illustrated in E2W and Latino, New York courts appear reluctant to invoke common law defenses to excuse performance under contracts that may have been breached due to the COVID-19 outbreak.
While it remains unclear whether the International Chamber of Commerce or the Southern District of New York will ultimately conclude that the force majeure provision excuses E2W's performance under the franchise agreement, the issuance of a preliminary injunction suggests that the Southern District of New York is inclined to at least entertain the notion that the COVID-19 pandemic may fall within the enumerated events of a contract's force majeure provision. New York precedent likewise demonstrates that government actions can be covered under certain force majeure provisions.
Parties concerned about contractual performance issues should look at whether the contract contains a force majeure provision, and whether the COVID-19 pandemic falls within any of the enumerated events. If the contract does not contain a force majeure provision (or one that is not helpful), it will be necessary for parties to evaluate whether other contractual defenses are applicable to the dispute at hand.
Stephanie L. Denker and Christie R. McGuinness are associates at Saul Ewing Arnstein & Lehr LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] See, e.g. Rochester Gas & Elec. Corp. v. Delta Star Inc.
, No. 06-CV-6155-CJS-MWP, 2009 WL 368508, at *7 (W.D.N.Y. Feb. 13, 2009); Team Marketing USA Corp. v. Power Pact LLC , 41 A.D.3d 939, 942 (3d Dep't 2007) (quoting Williston on Contracts §§ 77:31 (4th ed.)); Kel Kim Corp. v. Cent. Markets Inc. , 70 N.Y.2d 900, 902-903 (1987).[2] 28A N.Y. Prac., Contract Law § 20:2; Kel Kim Corp., 70 N.Y.2d at 902.
[3] 28A N.Y. Prac., Contract Law § 20:3.
[4] Warner v. Kaplan
, 71 A.D.3d 1, 5–6 (1st Dep't 2009).[5] In re: Schenck Tours Inc.
, 69 B.R. 906, 911 (Bankr. E.D.N.Y.).[6] M&M Transp. Co. v. Schuster Express Inc.
, 13 B.R. 861, 869 (S.D.N.Y.1981).[7] United States v. Gen. Douglas MacArthur Senior Vill. Inc.
, 508 F.2d 377, 381 (2d Cir. 1974).[8] No. 1:20-cv-02866-ALC (S.D.N.Y.) (filed on April 6, 2020).
[9] No. 1:20-cv-02866 (S.D.N.Y.) at Doc. 54; see also https://www.law360.com/newyork/articles/1270963/franchisee-stops-kidzania-theme-parks-from-ending-deal?nl_pk=21c21ef5-b149-4058-9b01-f413033cd777&utm_source=newsletter&utm_medium=email&utm_campaign=newyork&read_more=1&attachments=truehttps://www.google.com
[10] No. 1:20-cv-02866 (S.D.N.Y.) at Doc. 54.
[11] For a discussion on the elements for obtaining a preliminary injunction, see, e.g. Citigroup Global Markets Inc. v. VCG Special Opportunities Fund Ltd.
, 598 F. 3d 30, 35 (2d Cir. 2010); Jackson Diary Inc. v. H.P. Hood & Sons, Inc. , 596 F. 2d 70, 72 (2d Cir. 1979); AIM Intl Trading LLC v. Valcucine SpA , 188 F. Supp. 2d 384, 386 (S.D.N.Y. 2002).[12] No. 1:18-cv-12247, 2020 WL 2239957 (S.D.N.Y. May 8, 2020).
[13] Id. at *3.
[14] Id.
[15] Victoria's Secret Stores LLC v. Herald Square Owner LLC, Index No. 651833/2020 (N.Y. Sup. Ct. N.Y. Cnty.).
[16] Burnside 711 LLC v. Nassau Regional Off-Track Betting Corp., No. 08-006169, 2008 WL 8738243 (N.Y. Sup. Ct. Sep. 02, 2008) (affirmed on appeal).
[17] Reade v. Stoneybrook Realty LLC
, 63 A.D.3d 433, 434 (1st Dep't 2009).[18] Goldstein v. Orensanz Events LLC
, 146 A.D.3d 492, 492 (1st Dep't 2017).For a reprint of this article, please contact reprints@law360.com.
