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November 20, 2020 | Covid-19From the blog

Force Majeure in the Wake of COVID-19

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In the wake of the COVID-19 outbreak, many businesses have found themselves unable to perform their contractual obligations, whether due to changed economic circumstances or actual impossibility.  We have now seen several cases in which force majeure provisions are beginning to be tested as a result of the pandemic.  In these cases, courts are being tasked with interpreting the relevant contract’s force majeure clause (to the extent one exists) and applying common law contractual defenses, such as impossibility of performance of frustration of purpose to determine whether contractual performance can be excused in these unprecedented circumstances.

As we wrote back in March, pandemics such as COVID-19 may provide a valid reason for nonperformance of a contract, but it depends on the circumstances and the language of the force majeure clause.  Several New York courts have made or are preparing to make initial rulings as to how the COVID-19 pandemic interacts with force majeure clauses or other traditional common law contractual defenses, as discussed below.

E2W LLC v. Kidzania Operations, S.A.R.L., No. 1:20-cv-02866 (S.D.N.Y.)

In E2W LLC, plaintiff sued KidZania for breach of the parties’ franchise agreement after KidZania sought to terminate the agreement for failure to pay certain royalties.  In response to KidZania’s termination notice, E2W invoked the force majeure provision contained in the franchise agreement because it could not lawfully operate its facility — an amusement park — during the pandemic.

While the force majeure provision at issue excused nonperformance due to certain events, including “governmental orders,” “actions by government or by political sector(s) of their respective counties,” and acts of God, the provision made no specific reference to pandemics or national emergencies.  As a result, E2W also raised the common law doctrines of impossibility and frustration of purpose, arguing that COVID-19 required the indefinite closure of E2W’s facility and was an event whose nonoccurrence was a basic assumption upon which the franchise agreement was made.

On May 11, 2010, the Court granted a preliminary injunction preventing KidZania from terminating its franchise agreement with E2W while the parties arbitrate the case pursuant to a mandatory arbitration clause.  The Court’s order stated that KidZania is:

[E]njoined from terminating the Franchise Agreement and taking any actions that would interfere with the continued operations of Plaintiff, including indicating or disclosing to any third party that the Franchise Agreement has been terminated. The Parties are ORDERED to otherwise maintain the status quo of their operating relationship pending a decision in the ICC arbitration regarding the termination of the Franchise Agreement.

In granting the preliminary injunction, the Court found that E2W had demonstrated a likelihood of success on the merits, a necessary element for granting a preliminary injunction, that COVID-19 served as a basis to excuse E2W’s performance under the franchise agreement.

Lantino v. Clay LLC, No. 1:18-cv-12247, 2020 WL 2239957 (S.D.N.Y.)

In Lantino, the parties had previously entered into a class action settlement agreement whereby the defendants (gym owners) were required to pay $300,000 over a period of 23 months and, if they failed to do so, plaintiffs would be permitted to seek a consent judgment.

On April 29, 2020, after defendants failed to pay, plaintiffs moved for entry of the consent judgment.  In opposing the motion, defendants argued that their performance should be excused based upon the doctrine of impossibility because of their inability to pay as a result of the COVID-19 pandemic and related government-mandated shutdown.

The Court held that performance was not excused.  Specifically, the court reasoned, “[a]t best, Defendants have established financial difficulties arising out of the COVID-19 pandemic and the PAUSE Executive Order that adversely affected their ability to make the payments called for under the Settlement Agreement,” but that “where impossibility or difficulty of performance is occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy, performance of a contract is not excused.”

Victoria’s Secret Stores, LLC v. Herald Square Owner LLC, Index No. 651833/2020 (Sup. Ct., New York County)

In Victoria’s Secret, plaintiff filed suit seeking rescission of the commercial property lease for its Herald Square location as a result of the COVID-19 Pandemic and related government-mandated shutdowns.  The relevant lease did not include a force majeure provision, and plaintiff’s claims are based on the doctrines of frustration of purpose and impossibility of performance.

Specifically, plaintiff’s alleged:

Because of the COVID-19 Pandemic, VS cannot operate its retail store at the Premises consistent with the parties’ fundamental understanding, purpose, and expectation at the time the lease was entered.

On June 29, 2020, Defendant subsequently moved for summary judgment on the basis that the lease did not include any force majeure provision and that the express terms of the lease negated essential elements of plaintiff’s claims based on the doctrines of frustration of purpose and impossibility of performance.  Specifically, according to defendants, the lease expressly allocated the risk of a closure to the tenant and that the risk of closure was “foreseeable,” even if the precise cause of the closure was not foreseeable.

In response, Plaintiff argues that the terms of the lease do not contemplate the forced closure arising from the COVID-19 pandemic, an event so extraordinary and so unthinkable that it constitutes “a classic case of frustration of purpose.”

A decision on the motion remains pending, but it will have the significant effect of instructing how New York State Courts will analyze the nonperformance of contractual obligations in the absence of a force majeure provision based on traditional common law contractual defenses.  As counsel for defendants noted in this case, the Court’s decision on this matter will likely “have sweeping consequences reaching beyond this action to the many other suits mirroring the allegations of the Complaint.”

We will continue to monitor developments in these cases as well as the legal and business implications related to the COVID-19 pandemic.  With the potential for a “second wave” and additional government-mandated closures in New York, clear guidance from these courts will be instrumental as commercial parties try to navigate these uncertain times.

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