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. If those contracts do not contain such a clause, Big Daddy can assert an impossibility-of-performance defense, which is addressed here.
Force Majeure Clauses
Force majeure literally means “a superior force” and historically referred to events beyond the parties’ anticipation or control that intervened to make contract performance impossible – including acts of nature, such as hurricanes and fires, and acts of people, such as strikes, riots and wars. Force majeure clauses are not uniform, but they typically list specific events relieving contract performance and end with a broad “catch all” such as:
Neither party shall be liable to the other for failure to perform an obligation to the extent such failure was caused by acts of God, terrorism, riots, civil disorder, strikes (except those caused by a party’s employees or agents), war, or any other act outside the parties’ control which could not be avoided by the exercise of due care.
Texas courts have held that specifically listed events need not be unforeseeable at contract commencement (although foreseeability may affect whether the party could reasonably control the event). The catch-all provision, however, can only apply to events unforeseeable at time of contract. Because market fluctuations are foreseeable, economic hardship, standing alone, is usually not enough to fall within the force majeure clause.
Moreover, under Texas law, parties seeking to invoke a force majeure clause are not required to exercise reasonable diligence to perform or overcome the force majeure event unless the clause expressly so requires. If it does, “such diligence as an ordinarily prudent and diligent person would exercise under similar circumstances” must be exercised—a very fact-intensive question for the jury.
Whether a force majeure clause will excuse COVID-19-caused non-performance depends upon the clause’s language and the connection between the virus and non-performance. The clause may list “disease”, “pandemic” or “quarantine ” as events constituting force majeure. If it does not, the party will have to rely on the catch-all provision, which raises difficult questions of foreseeability. COVID-19 was probably not foreseeable itself, but some will argue that epidemics and diseases are generally foreseeable, especially in light of the outbreaks of H1N1, SARS and swine flu, and the parties should have specifically provided for that contingency in the contract. Additionally, parties who entered into contracts after January 2020, when the virus began to attract worldwide attention, will have a more difficult argument that COVID-19 was unforeseeable than those who entered into the contracts earlier.
Finally, the force majeure clause more likely applies if there is a strong and direct link between COVID-19 and non-performance. Inability to perform due to loss of key, affected employees is a stronger argument than economic inability to pay the rent.
If you want to “go legal,” invoking a contract’s force majeure clause can be risky at any time because, if done improperly, it could itself amount to a breach of the contract, entitling the other party to terminate and sue for damages. Additionally, some force majeure clauses require the invoking party to give timely notice of the occurrence to use it as a defense for non-performance. Consult with an attorney to assess the specific applicability of the force majeure clause in your agreement to ensure compliance with it. 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, 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.