A systematic review of contracts can help businesses determine how the pandemic has affected their … [+]
As America hunkers down in an effort to slow the spread of the coronavirus and ensure the safety of their families and their communities, many businesses are wrestling with tough decisions about how to keep their operations afloat. For many companies, this means poring over stacks of contracts to see how—if at all—the pandemic impacts longstanding business agreements. It is a tense time as businesses seek to understand their options and determine how to proceed. What happens if your suppliers cannot deliver goods on time? What happens if your biggest customer tries to cancel its order? The process of determining your legal obligations—and others’ obligations to you—can go more smoothly if you know what to look for in your contracts. Here are a few key issues to spot and analyze when reviewing your contracts in this unprecedented time.
Force majeure clause
Many contracts include a force majeure or Act of God clause that allows one or both parties not to perform its obligations under the contract if certain events occur. It may specifically include pandemics, or it may include more general language that would encompass a pandemic. Other factors to consider include whether it is impossible to perform under the contract because of a government order and whether the pandemic was foreseeable at the time of the contract was made. It is also important to determine what governing law applies to the contact. For example, there are vast differences in how the principle of force majeure is applied in the U.S. versus other countries.
Contingency and extension of time clauses
If the success of the contract is contingent upon a third party’s performance, there may be language in the contract regarding how the parties’ obligations are impacted if that third party fails to perform. Also, look for contract provisions that may give the parties extensions of time due to a superseding event. Even if there is not a specific extension of time clause, consider whether a reasonable extension of time would make it possible for the parties to perform.
Indemnity agreements and limitation of liability
Is there an indemnity clause that requires one party to compensate the other for losses that result from commercial disruptions or a breach? Also, as you are weighing your options, look for clauses that might put a limit on that liability (either with respect to the type of available damages or the maximum dollar amount at risk). If nonperformance results in a breach of the contract, understand if your company is obligated to indemnify the other party for resulting claims or losses.
Some contracts include a clause requiring a party to carry insurance that could cover one or both parties’ losses if contract performance becomes impossible. Review your existing insurance policies to see if they could apply here, however, in recent years many insurers have taken steps to exclude pandemics from general business interruption coverage.
If the pandemic does not excuse performance, it is important to understand how the contract’s termination provisions work so that you can determine if you, or the other party, have a right to terminate. A material breach typically allows the other party to terminate a contract and, in some contracts, a party can terminate even without a breach. Often there are notice requirements and requirements to give the breaching party an opportunity to fix the breach before a contract can be terminated.
The contract as a whole
It is important to evaluate each contract in its entirety, because many clauses could contain important, relevant obligations and prerequisites, such as “change in law” and dispute resolution provisions. Understanding the contract as a whole will help you prepare to defend yourself, or exercise your rights, if a dispute arises from nonperformance.
It can get complicated, but as a general rule, parties are required to act in good faith and take steps to minimize the losses associated with a breach of contract. This type of more extensive checklist can help those going through the contract review process in response to the pandemic. To be sure, all businesses are finding themselves in uncharted territory. But by taking reasonable actions now based on clear-headed guidance and counsel, businesses can make the best decisions for employees, customers, partners and themselves.
Read more about legal issues related to the COVID-19 outbreak.