By Phillips Murrah Director, Clayton D. Ketter
The continuing uncertainty surrounding the COVID-19 global pandemic is causing significant disruption to business operations. In addition, recent restrictions on operations is likely to further cause various businesses to lack the financial capabilities to meet ongoing obligations. Such business may have various contractual and legal rights that may serve to ease their financial pain. Several of these are analyzed below.
Clayton D. Ketter is a Director and the Firm’s Litigation Practice Group Leader. Clay has extensive experience in financial restructurings and bankruptcy matters.
A. Business Interruption Insurance
The first place many businesses may look for relief when forced to temporarily close due to the COVID-19 pandemic and related government restrictions is a business interruption insurance policy. Business interruption insurance generally compensates a business for lost income suffered in the event the business is forced to temporarily cease operations due to an unforeseen event such as a fire or natural disaster. Some policies also provide coverage for issues with a business’s supply chain that are outside of the business’s control.
Every business interruption insurance policy will contain various exclusions from coverage. After the SARS outbreak in 2003, it became common for insurance companies to seek to exclude from coverage losses sustained from communicable disease outbreaks, such as the current COVID-19 pandemic. Such exclusions may prevent coverage in the current situation.
Many business interruption policies also require that covered losses be tied to physical damage to a business. A typical example would be a business that was forced to close because its building was damaged by a fire or natural disaster. A general slowdown in business related to a broad disaster is unlikely to meet this requirement, because there is no corresponding physical damage to the specific business. Some policies also provide coverage when ingress or egress to a business is limited or prohibited by a governmental authority. Those too, though, often require some specific physical damage to have been suffered.
However, the precise wording of the insurance policy, which will vary from policy to policy, is critical to determining coverage. Even small variations in policy language can have large impacts, particularly in an unprecedented situation such as the one we are currently facing. Thus, business owners should carefully review their specific policy and seek legal counsel for any potential issues.
B. Force Majeure Clauses
Another potential source of relief for specific contractual obligations is a contractual provision known as a force majeure clause. The term force majeure covers a broad range of provisions that generally excuse a party’s performance under a contract when external events, such as an act of god, have rendered such performance impossible. While there is no single standard force majeure clause and they can take many forms, a common example would be a provision providing:
In the event either party is unable to perform its obligations under the terms of this Contract because of acts of god or other causes reasonably beyond its control, such party shall not be liable for damages to the other for any damages resulting from such failure to perform or otherwise from such causes.
Specific clauses may explicitly set out circumstances that constitute a force majeure event, such as strikes, wars, and natural disasters. It is also common for provisions to set out certain obligations that are not excused by a force majeure event. For example, commercial real property leases often provide that a tenant’s obligation to pay rent is not excused by a force majeure event.
While force majeure clauses are common, most do not explicitly provide that a global pandemic will constitute a force majeure event. Without a specific reference, parties seeking to invoke such a provision will have to rely on general terms such as act of god. Such general terms are subject to differing interpretation by courts. For instance, the Oklahoma Supreme Court has defined an act of god as “some inevitable accident that could not have been prevented by human care, skill and foresight, but which results exclusively from nature’s cause, such as lightning, tempest and flood.” City of Purcell v. Subblefield, 139 P. 290 (Okla. 1914). Whether a global pandemic such as COVID-19 would fit within that definition remains to be seen.
Another issue with the applicability of a force majeure clause is the extent that performance was affected. Specific clauses will use a variety of standards to excuse performance, such as impracticability, impossibility, or illegality. These differences will have a significant impact on whether a force majeure clause applies. For example, restrictions on how businesses are permitted to operate in the current environment continue to evolve. Those restrictions may make performance of a contractual obligation impracticable, but not necessarily impossible or illegal. Thus, a business that has been statutorily restricted from operating would likely have a stronger argument that a force majeure clause applies than one whose operations have been impaired by the restrictions.
Ultimately, whether a party’s performance under a contract will be excused due to the COVID-19 pandemic is going to largely depend on the terms of the specific contract coupled with the facts of each party’s individual situation. Thus, it is recommended that a contracting party carefully review the language of the contract at issue with a legal professional.
C. Governmental Taking
There may be other contractual provisions that could also provide relief. For instance, it is common for commercial real property leases to excuse performance when the underlying property has been taken by condemnation or eminent domain. An enterprising tenant could attempt to argue that governmental restrictions on the business’s operations constitute a condemnation because the tenant’s rights have been “taken” for the greater good of the public. Such arguments appear to be completely untested. However, as with the other issues raised herein, the ability to utilize such arguments is going to heavily depend on the specific terms of the agreement at issue.
D. Chapter 11 Bankruptcy
While the forced closure of a business may result in a general reduction in certain contingent expenses, fixed costs such as rent and loan payments are likely to continue. Upon reopening, many business, despite being profitable, are likely to face liquidity issues due to the temporary cessation in income. For such businesses, the first step should be to attempt to reach a consensual resolution whereby the outstanding obligations are restructured by agreement. However, when an out of court workout cannot be reached, a bankruptcy under Chapter 11 may present a viable option.
Chapter 11 is designed to allow a debtor to restructure its debts so that it can repay creditors in an orderly manner. Often, this involves extending the period for repayment. For instance, a business that is facing a large amount of debts currently due, might be able through a Chapter 11 bankruptcy to repay those debts over time through a series of payments. Thus, Chapter 11 may provide an otherwise profitable businesses that has incurred substantial debts as a result of the current crisis a path to continue operating and repay its debts in a structured manner.
E. Conclusion
Ultimately, a party’s rights and obligations will depend on the specific facts and circumstances at issue, including the language of the parties’ agreement. To the extent a business is facing such issues due to the current pandemic and associated response, it is advisable to discuss the specific situation with a qualified legal professional.