Resources for Contracts & Insurance Coverage That May Be Impacted By the COVID-19 Outbreak
In the wake of the current COVID-19 crisis, businesses have invariably begun to wonder what kind of recourse they might have if they suffer losses or are unable to perform certain contract obligations because of the virus and resulting government mandates impacting access, supply chains and/or customers. While the best course of action will be largely dependent on the specific situation of each individual business, the following are some avenues that may provide protection.
Business Interruption Insurance
Most businesses carry Business Interruption insurance to protect them from economic losses resulting from natural or other disasters. Such insurance is designed to cover income lost as the result of a need to partly or completely close down. However, coverage under most such policies is not triggered unless the insured business has suffered some direct physical loss or damage to insured property. The question which will undoubtedly come to a head as the COVID-19 situation unfolds is whether some of the many circumstances created by this pandemic will qualify as “direct physical loss or damage” to property. Plausible arguments include contamination to physical property caused by COVID-19, perhaps even the entry of an infected individual onto the property. Keep in mind that potential policy exclusions could apply, such as contaminant/pollutant, mold/bacteria, and communicable diseases. Given the wide-ranging impacts of finding coverage under these types of policies, insurers will likely push back vigorously; but the ultimate determination of coverage depends on each policy and each situation and should be analyzed for possible recoveries.
Another component of most Business Interruption policies is “Civil Authority” coverage, which is triggered when business is interrupted because the orders of the “civil authority” (e.g., the government) prohibit access to, or operation of, the insured’s business premises. This coverage also typically requires physical loss or damage to property (although not necessarily to the insured’s own property).
Many policies will provide lower sub-limits for Civil Authority coverage or other “extensions” of basic property insurance coverage, as well as other industry-specific endorsements (such as communicable disease or event cancellation coverage, which are common in restaurant policies). The specific wording of each policy will impact the availability of coverage, and we encourage you to review your policy to see if there are any viable options that may help mitigate the negative impacts caused by COVID-19.
In addition to possible insurance coverage, a number of remedies and defenses may be available if the performance of contract obligations is disrupted due to the virus.
“Force majeure” literally means “superior force,” in French. It is generally defined in the law as an event or effect that the parties could not have anticipated or controlled that makes performance of a party’s contract obligations impossible or impracticable. Standard examples include war, civil unrest, natural disaster, and the unavailability of labor, and can sometimes include pandemic. However, the particular force majeure provision in the parties’ contract is what will ultimately be applied by a court. To the extent such a provision exists in a given contract and can be read to deal with the current situation, a court will look at that specific language to see how the parties agreed to allocate such a risk. Even if a given event is covered by a force majeure provision however, certain obligations may be excluded. For instance, in a commercial lease context it is common for the Force Majeure clause to exclude payments of rents. Again, the contract language will need to be thoroughly reviewed to determine if a defense exists.
Frustration of Purpose
If a force majeure clause is not included in a contract, or if the provision cannot be interpreted to cover the COVID-19 outbreak, the doctrine of frustration of purpose may provide a defense to enforcement. Frustration of purpose may apply where unexpected circumstances arise which undermine the purpose for which the parties entered into the contract. It is not enough that the transaction has simply become less profitable to the affected party or that the affected party has sustained a loss.
An example of the application of this doctrine is Weyerhaeuser Real Estate Company v. Stoneway Concrete, Inc., in which the court excused performance of a mining contract due to frustration of purpose where unforeseen legislation passed after the contract was formed which made it impossible for the mining company to receive permits for the project, undermining the purpose for which the parties entered into the contract. No two fact scenarios are identical, and careful consideration of both the contract and the facts are required to determine if frustration of purpose applies.
Impossibility and Impracticability
An additional potential defense to performance is the doctrine of impossibility or impracticability. Similar to frustration of purpose, this doctrine can relieve a party from contractual obligations when the basic purpose of the contract has been destroyed and such destruction makes performance impossible or impractical. An example of the application of this doctrine is Oneal v. Colton Consol. School Dist. No. 306, where the court found impossibility of performance when a teacher entered into a teaching contract with the school district but was unable to perform his duties due to the deterioration of his eyesight.
In summary, the COVID-19 crisis raises a number of issues relating to continued contract performance, insurance coverage, and recovery of potential lost income. The availability of these potential remedies and defenses will be dependent on the specific contracts and facts under which each business operates, and the first step in formulating an approach is a careful review of any applicable contracts or insurance policies.