By: Ryan M.T. Allen and R. Anderson Sessions
The last several weeks have confirmed what most knew was never myth: the U.S. economy is tied hand-in-hand with the state of global affairs in countries that, though far beyond our borders, directly impact the daily business operations for regional, state, and local businesses. From a bird’s eye view, COVID-19 has caused an economic deluge for Fortune 500 companies and small businesses alike in virtually all major industries of trade and commerce. With supply chains failing, personnel shortages, and governmental restrictions in place, now is a crucial time for Texas business owners (and their lawyers) to review an all-too-often overlooked provision within their standard contracts: the Force Majeure clause.
What is a Force Majeure Clause and Why is it Important
Texas courts generally recognize the function of a “force majeure” clause is to excuse a party’s failure to perform a contractual obligation when that non-performance was caused by circumstances beyond the party’s reasonable control, or by an event that was unforeseeable at the time the parties entered into the contract . See TEC Olmos, LLC v. ConocoPhillips Co., 555 S.W.3d 176 (Tex.App.—Houston [1st Dist.] 2018, pet. denied).
Although similar in purpose to other common law doctrines and defenses (e.g., “impossibility of performance” and “frustration of purpose”), the force majeure clause is unique in allowing parties to customize and define certain scenarios that may jeopardize the underlying transaction, or series of transactions, during the course of performance. If carefully vetted, this boilerplate provision can be molded to protect against unique problems triggered by (inter)national catastrophes such as COVID-19 and other business disruption categories that will continue to produce ripple effects throughout our global economy. Business owners should be asking what can be done now to anticipate a future national or regional crisis that could disrupt your particular business industry or practice.
Defining the Parameters
Three basic questions should frame the content for a force majeure provision: (1) what is the scope and standard for invoking this clause, (2) who has the authority to invoke, or to create, an event triggering the force majeure, and (3) what are the notice requirements to avail oneself of a force majeure provision.
First, the provision’s scope should include specific events, conditions or occurrences that can be reasonably predicted to interrupt the flow of business in that industry if to happen. For example, with health care providers and medical vendors, a global pandemic causing short and long-term scarcities of essential medical equipment should certainly be included post-COVID-19. More strategically, businesses should carefully tailor the “catch-all” phrase capping off that list (e.g. “Act of God”, “any other cause or occurrence beyond … control”, etc.) by ensuring that it describes an unforeseeable act or occurrence that generally falls within the same or similar class of events. In the Information Age, however, Texas courts may begin to question whether wide-spread media coverage on catastrophes such as COVID-19 render foreseeable what some practitioners would otherwise argue is clearly an unforeseeable “Act of God.”
The provision should also clearly define the standard connecting the event, condition or occurrence to the non-performance. The three (3) most common standards used in commercial business and insurance contracts include i) impracticality, ii) impossibility, and/or iii) illegality. In other words, the question to be asked is whether a specified event renders a party’s performance impractical, impossible, or, in the case of violating a federal, state, or local law, even illegal. Prudent business owners should also consider the advantages and consequences of using less stringent standards growing in common use such as “reasonably prevented from performing”, “prevented or hindered from complying”, or “not reasonably practicable in the event of […].”
Next, for similar reasons, some industries should take measures to define who can trigger a force majeure provision. Tying together the identity of specific governmental, or quasi-governmental, regulatory authorities to the standard and scope needed to invoke the force majeure could make the difference in enforcing a party’s obligation to deliver goods or services. In Texas, the incremental emergency orders promulgated throughout various counties could reveal an “accordian effect” when those measures decrease as COVID-19 becomes more controlled and the event triggering the force majeure vanishes.
Last, many contracts containing force majeure clauses have notice requirements. The issue arises whether a party has complied with a prescribed timeframe to provide notice that an event of force majeure has, in fact, occurred. A generic example may state: “A Party is required to provide written notice within 5 days of an event of force majeure.” Thus, a party’s ability to provide timely notice hinges on their same ability to accurately classify and identify when such an event happened. Failing to have a well-drafted provision in place may risk exposure to liability for preemptively exercising the force majeure provision. In short, parties should make sure to operate in good faith when electing to invoke an event of force majeure and not simply to gain an unfair commercial advantage in the marketplace.
Business Disruption Claims
As we know, businesses are experiencing critical interruptions to their daily business operations due to COVID-19. Many businesses will look to their insurance policies to see if they can get relief or file a claim as most policies have business interruption clauses. Although these policies are used to cover things such as hurricanes, tornados or floods, a significant number of these policies exclude or are silent on pandemic diseases. Depending on the type of policy your business holds, coverage is sometimes limited also to certain types of disruptions and exclusions.
For business interruption coverage to trigger, physical loss or damage must generally occur on the insured’s premises. Business interruption extensions like contingent business income, loss of attraction and even civil authority claims all require physical loss or damage in order to be covered. The question becomes: does the coronavirus constitute physical damage to insured property?
Most, if not all, normal insurance policies will not (as of right now) allow claims that come from business slowdowns or shutdowns due to a pandemic, unless the policyholder has a specific rider covering such claims. As the coronavirus continues to spread across the United States and abroad, so do the concerns of business owners who are being forced to let go of employees or close its doors. The pandemic threatens everything from the supply, manufacture, retail and consumer supply chains. Most importantly, the pandemic is affecting businesses revenue.
But many existing business disruption coverages pay only for quantifiable physical losses, like repairing and replacement of damaged property. Moreover, many business disruption coverages pay only for quantifiable physical losses.
What happens if the business disruption does not cause any type of damage to the property but only a business slowdown or shutdown which results in a lack of revenue. This question boils down to whether the insurance policy has any type of coverage for communicable disease coverage. A business would need to look at its insurance policy and contact its insurance broker to look at the aspects of its policy to determine if it has any exclusions or potential contingencies in the insurance policy, e.g. closures ordered by a Civil Authority. Ordered closures could trigger certain insurance clauses, which may cover a business’s lost earnings resulting from the closure of a property that attracts customers to the business.
It is important to remember that whether insurance claims are covered will depend on the language of the insurance policy and the facts surrounding the loss. As many businesses most likely have insurance coverage which only affects general liability coverage, these types of policies would normally not cover losses due to a virus or global pandemic. It’s most certain that a plethora of litigation will stem from small businesses to large businesses filing claims for business disruption on their policies or seek claims against their brokers for Errors and Omissions.
Because of the complexity in these areas, all of these are distinct issues that require each policy and endorsement to be reviewed and evaluated by counsel experienced in insurance coverage litigation. If you have a loss, check your policy for this coverage and consult with a lawyer who is knowledgeable in this area.