Wanting to diversify his investments, Ernest “Big Daddy” Bux signed a franchise agreement with GA Fitness last year. Construction by Big Daddy’s contractor Bill Toosuit is scheduled to be completed for in time for an early May grand opening in the new strip center owned and managed by Mawl & Mawl. Last week, in response to the COVID-19 pandemic, the town’s mayor and the state governor prohibited any gathering of more than 10 people and directed that all bars, restaurants and gymnasiums close. Now that gymnasiums are prohibited from opening, Big Daddy’s business is almost certain to fail, and Mawl & Mawl loses a tenant. If Big Daddy stops construction and buys out his current lease obligation, Bill Toosuit loses his construction project and Mawl & Mawl loses a long-term tenant. Can Big Daddy get out of his lease obligations? And his construction contract? Are there other options to get to a win-win?
Maybe and probably. If Big Daddy is looking to set aside or suspend his obligations under the lease and construction contracts, he should first examine them for a force majeure clause, which is addressed here. If Big Daddy’s contracts do not contain a force majeure clause or the clause does not cover pandemics like COVID-19, hope is not lost.
The Texas Supreme Court recognizes an impossibility-of-performance defense – upon an event occurring that the contracting parties assumed would not occur. Unlike force majeure clauses, a successful impossibility defense must also demonstrate reasonable efforts to surmount the obstacle to performance and, only then, performance is excused if it is impracticable in spite of such efforts.
Texas courts have applied the impossibility defense narrowly and upheld it in three scenarios: (i) a person necessary for performance dies or becomes incapacitated; (ii) the thing necessary for performance is destroyed or deteriorates; and (iii) the law changes making performance illegal. Consistent with force majeure clauses, the impossibility defense is not satisfied simply because performance is more inconvenient or economically burdensome than anticipated – increased difficulty or expense is judicially regarded as being covered within a fixed-price contract.
The COVID-19 pandemic could cause the first and third scenarios—a person who entered into a contract to provide services could become infected or governmental decrees or regulations issued to combat the virus could prevent parties from performing their contractual obligations. For instance, the recent order banning gatherings of more than 50 people in Dallas County would “make performance illegal” of a contract to host a large party or concert.
Businesses affected by COVID-19 might also argue for expansion of the impossibility defense beyond these three recognized scenarios. Some authority excuses performance if there is either a risk of injury to persons disproportionate to the purpose of performance or a severe shortage of raw materials or supplies. And courts may be receptive to expanding the defense, given that a pandemic causing a broad economic shutdown is a rare and devastating event.
For those sellers and lessors of goods, the Universal Commercial Code (UCC) may offer some COVID-19 relief. In Texas’s version, delays in delivery by sellers, lessors or suppliers of goods is not a breach “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 good faith compliance with a governmental order or regulation. Notably, these only protect sellers and lessors of goods from one type of breach—delay in delivering the sold or lease goods.
As with invoking a contract’s force majeure clause, stopping performance based on the impossibility defense is risky because, if done improperly, it could itself amount to a breach of the contract – entitling the other party to terminate and sue for damages. Consult with an attorney to assess whether the defense applies to your case. Bottom line: it’s risky and there will be a cost—win or lose.
Tilting the Scales in Your Favor
If you believe that this COVID-19 pandemic is permanent and terminal, abandon all hope! Big Daddy’s business will fail. Bill Toosuit will lose his construction contract (likely only one among many). Mawl & Mawl will lose a long term tenant. The local citizens will lose the positive economic impact of a new business – and a gym!
If, on the other hand, you believe that by working together we can beat this short-term challenge – nearing a panic – consider these: Collaborate. Share the short-term risk. Find common grounds of trust. Then, get creative and flexible. For Big Daddy, almost everyone would agree that the scheduled grand opening of his new business in early May is a bad idea – probably terminal for his business. The closure would significantly impact his landlord Mawl & Mawl, who would probably prefer a multiple-year tenant to a short-term cash settlement, Bill Toosuit would lose the rest of his construction project and cash flow for his workers and subcontractors.
This is just one of many legal issues the pandemic is raising. For Gray Reed resources on additional issues, check out our firm’s COVID-19 Resource Center.