When Things Are Not “Business as Usual”: COVID-19 and Contract Defenses

Michael R. Darbee, Jonathan M. Korn, and Adrienne C. Rogove

The coronavirus COVID-19 health crisis has interfered with ongoing and future business arrangements throughout New Jersey. As a result, New Jersey businesses that are parties to existing contracts may have rights in the event that they, or their counterparty, are unable to meet their obligations due to COVID-19. There are several legal doctrines that New Jersey businesses may look to in these situations, including impossibility, impracticability, frustration of purpose, and force majeure.

Generally, contract liability is strict liability. This means that a party who breaches a contract is liable for damages even without fault. See Restatement (Second) of Contracts, ch. 11, Introductory Note. However, a party may be able to invoke impossibility, impracticability, frustration of purpose, or force majeure to excuse its failure to perform its contract obligations based on an unforeseen supervening event.

Impossibility, Impracticability, and Frustration

These related doctrines rely on the principle that parties make contracts with certain fundamental conditions in mind. See JB Pool Mgmt, LLC v. Four Seasons at Smithville Homeowners Ass’n, Inc., 431 N.J. Super. 233, 245 (App. Div. 2013). The fundamental conditions must be reasonably within the parties’ minds when the contract was made but need not be expressed in the contract. See Petrozzi v. City of Ocean City, 433 N.J. Super. 290, 302 (App. Div. 2013).

A party can invoke the doctrines of impossibility, impracticability, or frustration to excuse or mitigate non-performance because of a supervening event, “the non-occurrence of which was a basic assumption on which the contract was made.” M.J. Paquet, Inc. v. N.J. Dep’t of Transp., 171 N.J. 378, 391 (2002). The supervening event must be unexpected when the contract was created, and it must fundamentally alter the parties’ relationship. See JB Pool Mgmt, 431 N.J. Super. at 233.

The difference between impossibility, impracticability, and frustration is a matter of degree. A party can invoke impossibility when the supervening event makes performance objectively impossible. See Duff v. Trenton Bev. Co., 4 N.J. 595 (1950). The impracticability defense arises when performance is not impossible but becomes inordinately more difficult because of the supervening event. JB Pool Mgmt, 431 N.J. Super. at 246.

Frustration of purpose occurs if performance can still occur but the supervening event “fundamentally has changed the nature of the parties’ overall bargain.” JB Pool Mgmt, 431 N.J. Super. at 246. The disruption must be significant; it cannot be a risk reasonably assumed under the contract. Capparelli v. Lopatin, 459 N.J. Super. 584, 606-07 (App. Div. 2019). In Tilcon N.Y., Inc. v. Morris Cnty. Cooperative Pricing Council, for example, the court concluded that an increase in the price of raw materials did not allow the plaintiff to increase the price of a fixed-price contract for asphalt and paving services, under a frustration of purpose theory. The court explained than an increase in the price of raw materials is “the sort of risk that a fixed-price contract is intended to cover.” 2014 N.J. Super. Unpub. LEXIS 449, **51-53 (N.J. App. Div. Mar. 5, 2014) (quoting Restatement (Second) of Contracts § 261, cmt. d)).

Importantly, being forced to comply with a government order may provide a basis for the defenses of impossibility or impracticability. According to Section 264 of the Restatement (Second) of Contracts:

If the performance of a duty is made impracticable by having to comply with a domestic or foreign governmental regulation or order, that regulation or order is an event the non-occurrence of which was a basic assumption on which the contract was made.

Thus, in M.J. Paquet, Inc., the parties entered into a contract for highway rehabilitation services, which included bridge painting. After the contract was made, OSHA revised its regulations on painting bridges containing lead-based paint. As a result, the contractor was required to perform a set of entirely new tasks to comply with the law. The parties attempted to negotiate a price for these new tasks but were unsuccessful. Ultimately, the New Jersey Department of Transportation (“NJDOT”) deleted the bridge painting services from the contract. The original contractor sued and the NJDOT successfully asserted the defense of impracticability based on the supervening OSHA regulations. 171 N.J. 378, 391 (2002).

Force Majeure

Unlike impossibility, impracticability, and frustration of purpose, which are created by common law, the defense of force majeure is created by contract. A force majeure provision “provides a means by which the parties may anticipate in advance a condition that will make performance impracticable.” Facto v. Pantagis, 390 N.J. Super. 227, 231 (App. Div. 2007).

However, case law shows that courts interpret force majeure clauses narrowly. Therefore, acts constituting force majeure should be explicitly set forth in the contract. In Facto, the parties contracted to host a wedding at a banquet hall. The contract contained a force majeure clause, which stated:

Snuffy’s will be excused from performance under this contract if it is prevented from doing so by an act of God (e.g., flood, power failure, etc.), or other unforeseen events or circumstances.

The banquet hall experienced a power failure 45 minutes into the wedding. Although the parties attempted to perform the contract, the wedding did not go as intended (e.g., there was no air conditioning in 90-degree humid weather; the band refused to play; and the police were called). The host sued the banquet hall for breach of contract and the banquet hall asserted a force majeure defense. The Appellate Division agreed with the banquet hall. It concluded that the power failure fell within the force majeure provision as either an “act of God” or “other unforeseen event.” Indeed, the court observed that the force majeure provision referenced “power failure” as an example of an “act of God.” Although the banquet hall was required to refund the host’s deposit for the wedding, the host was required to pay for the reasonable value of services that were actually provided. 390 N.J. Super. at 229-34.

By contrast, in Seitz v. Mark-O-Lite Sign Contractors, Inc., the contract was not as explicit. In that case, the parties made a contract to restore a theater’s neon sign. The contract stated:

The Company shall not be liable for any failure in the performance of its obligation under this agreement which may result from strikes or acts of labor union, fires, floods, earthquakes, or acts of God, or other conditions or contingencies beyond its control.

The company’s only worker capable of doing the work was admitted to the hospital, causing the company to breach its obligation to restore the sign. The theater hired a new contractor, who charged a higher price. The theater then sued the company for the difference between its contract price and the new contract price. The company asserted a defense based on the force majeure clause. The court rejected this defense. It observed that the worker’s hospitalization did not meet the definition of the defined acts of “force majeure.” The court also refused to interpret “other conditions or contingencies beyond its control” broadly to include the hospitalization. 210 N.J. Super. 646, 648-50 (Law Div. 1986).

To avoid litigating whether an issue is within the scope of a force majeure clause, parties may contract for an absolute obligation to perform. In 476 Grand, LLC v. Dodge of Englewood, Inc., the parties contracted to lease a car showroom for five years. At the time of contracting, the tenant had a dealership agreement with Chrysler, LLC. During the lease term, the tenant’s dealership agreement was terminated as part of Chrysler’s bankruptcy proceedings. After the dealership agreement was terminated, the tenant purported to terminate the lease and vacated the premises. The landlord declared the tenant in default and sued for unpaid rent. The tenant asserted a force majeure defense based on the lease. The Appellate Division rejected that defense, however, because the force majeure clause stated: “Nothing herein shall be deemed to relieve Tenant of its obligation to pay rent when due.” The court concluded that “defendant agreed to pay rent regardless of circumstances beyond its control.” Thus, the parties negotiated an absolute obligation for the tenant to pay rent, and the court upheld that provision. 2012 WL 670020, at **1-2, 4 (N.J. App. Div. Mar. 2, 2012).

Conclusion

The COVID-19 crisis is a unique event that is affecting business and public life in many unforeseen ways. It is critical for New Jersey businesses to understand their rights and obligations during these uncertain times, as the defenses of impossibility, impracticability, frustration, and force majeure may impact how those businesses respond to, and recover from, the COVID-19 crisis.

Blank Rome’s Princeton office and Coronavirus (“COVID-19”) Task Force are monitoring this ever-changing situation and are here to help. Please contact us if you have any questions about contract compliance during the COVID-19 crisis or any other related commercial issues.

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