In construction contracts, the parties often create their contracts using templates offered by the American Institute of Architects. The AIA documents are widely recognized forms and contracts that define the relationships and terms involved in design and construction projects. This article is going to review the standard Terms and Conditions that are part of construction contracts, and analyze what could happen during the pandemic caused by COVID-19.
Note, though, that owners and contractors often make changes to the various AIA templates. Any analysis of a specific situation must begin, and end, with the actual contract language.
General Conditions of the Contract for Construction, A201-2017. In most construction contracts using the AIA documents, the key document of the Conventional family of documents (A201) is the General Conditions providing terms and conditions between the Owner, Contractor, and the Architect.
Force Majeure Clause Not a Standard Clause. In general, a force majeure clause assigns the risk of nonperformance for certain events that are unforeseeable, and outside the contractor’s control. The General Conditions of an AIA contract does not typically contain a force majeure clause.
Section 8.3: Delays and Extensions of Time. The standard clause grants the contractor a reasonable time extension, but does not excuse performance. The standard clause provides that a delay “in the commencement or progress of the Work” caused by, e.g., labor disputes, fire, unusual delay in delivery, unavoidable casualties, “other causes beyond the Contractor’s control…”, or “other causes that the Contractor asserts, and the Architect determines, justify delay….”
This clause could be used by a contractor to obtain an extension of time if, for example, the various government directives makes delivery of supplies impossible, or makes labor unavailable. The clause also grants a catch-all that allows the Contractor to assert these, or other causes, which convinces the Architect that delay is justified.
Section 22.214.171.124: Termination by the Contractor. When work is delayed, or performance becomes unnecessarily difficult to complete, the AIA provides a method for the Contractor to terminate the Contract. The Contractor may terminate if Work is stopped for a period of 30 consecutive days through no act of fault of the Contractor, a Subcontractor, a sub-subcontractor, for any of the following reasons (among others likely not relevant):
(1) Issuance of an order of a court or other public authority requires all Work to be stopped; or
(2) An act of government (e.g., a declaration of a national emergency) requires all Work to be stopped.
Arguably, the stay-at-home orders could be considered an act of Government that requires Work to be stopped. However, many stay-at-home orders allows that Construction is an essential business and need not be stopped.
If a Contractor determines that it can terminate the Contract, the Contractor would be entitled to recover payment for Work already performed, and reasonable overhead and profit on Work not yet performed.
Section 14.3: Suspension by the Owner for Convenience. Section 14.4 Termination by the Owner for Convenience. The Owner may suspend, delay, interrupt, or terminate the Contract for its own convenience. The decision to suspend, delay, interrupt, or terminate must be done in writing.
If the Owner delays performance, the Contractor would be entitled to an adjustment of the contract sum, including profit, caused by the delay. If the Owner terminates the contract, the Contractor is entitled to payment for the work properly completed, costs incurred because of the termination (including costs to terminate subcontracts), and a termination fee (if required by contract).
Conclusion. Because many stay-at-home orders provide that construction is an essential service and, therefore, allowed to continue to work, the need for relief due to COVID-19 may not be a significant problem. However, there have been some reports that these stay-at-home orders have made it difficult to secure labor and to purchase materials. In such cases, the standard AIA contract will typically allow for the Contractor to obtain a reasonable extension of time for performance. As always, particular care should be paid to review the terms of the Contract.
If you would like to discuss issues regarding COVID-19s impact on construction contracts, please contact Bert Andia at 336.273.1600 or firstname.lastname@example.org
A number of lawsuits have been filed across the Country by businesses seeking to obtain insurance coverage for lost business through a “business interruption “policy. This article attempts to explain what is covered by these policies; and, the positions being taken by the insurer and the insured.
Business Interruption Insurance. Most commercial property insurance policies contain clauses that protect an insured against reduced earnings and increased expenses because of damage to the property they use to conduct business or damage to the property of others on whom they may depend.
The severity of the loss typically depends on the length of the interruption in normal business operations. The coverages include:
Business Income. This insurance covers actual loss sustained by the insured as a result of “direct physical loss or damage” from a covered cause of loss (i.e. by a cause not otherwise excluded from the policy). Business income includes net income (before taxes) that would have been earned by the insured and the continuing normal operating expenses incurred.
Extra Expense. This coverage is typically an additional coverage for many policies. Extra expense is defined as the expense needed for arranging for temporary quarters due to property damage at the insured’s location. This coverage also typically requires “physical damage” to the covered property.
Contingent Business Income. Coverage may be obtained for interruption of an insured’s business due to property damage suffered by a supplier or customer. This coverage typically requires direct property damage to the supplier/customer resulting from a covered cause of loss.
Civil Authority. Losses resulting from interruption of business caused by actions taken by governmental/civil authorities can be covered when access to the insured’s property is prohibited because of damage to other property.
State Legislatures Try to Respond. Pennsylvania, Louisiana, New York, Ohio, Massachusetts, and New Jersey lawmakers – and perhaps others — have introduced bills that would force insurers to retroactively cover business interruption claims due to COVID-19.
The bills generally attempt to require coverage for “loss or damage to property, which includes the loss of use and occupancy and business interruption [to include] coverage for business interruption due to global virus transmission or pandemic.” In many cases, insurers that pay out business interruption claims under these proposals would apply to their State’s insurance commissioner for reimbursement; the proposal would allow the insurance commissioner to collect a special assessment against all insurers doing business in the state.
Lawsuits Across the Country. Individual and class actions suits have been filed by businesses across the country seeking coverage for financial losses resulting from the pandemic. A New Orleans-based restaurant filed a petition in Louisiana state court seeking a declaratory judgment that their business interruption coverage would cover contamination by the coronavirus as a “direct physical loss” requiring remediation to clean the surfaces of the establishment; and, that a Civil Authority Order by the Louisiana Governor banning large gatherings in a single space and by the New Orleans Mayor restricting restaurants trigger the civil authority provision of the policy. Cajun Conti LLC et al. v. Certain Underwriters at Lloyd’s, London et al., No. 2020-02558 (La. Dist. Ct., Orleans Parish, Mar. 16, 2020).
Two Miami-based restaurants filed a putative national class action complaint, seeking a declaratory judgment and alleging an anticipatory breach of contract claim. The plaintiffs seek a declaration that “the COVID-19 pandemic and the corresponding response by civil authorities to stop the spread of the outbreak triggers coverage, has caused physical property loss and damage to the insured property, provides coverage for future civil authority orders that result in future suspensions or curtailments of business operations.” El Novillo Restaurant, et al. v. Certain Underwriters at Lloyd’s, London et al., No. 1:20-cv-21525-UU (S.D. Fla. Apr. 9, 2020).
Insurance Companies Worrying about Financial Resources. On May 8, 2020, the United States Treasury Department issued a letter to members of Congress which argued that the insurance industry’s ability to serve policyholders would be threatened if Congress were to pass any of the various proposals that seek to force insurers to retroactively change business interruption policies to pay losses arising from the COVID-19 pandemic. The letter is shown below:
In the letter, the Treasury Department official writes that the proposals “fundamentally conflict with the contractual nature of insurance obligations and could introduce stability risks to the industry.” The letter tells federal lawmakers that Treasury will collaborate with insurer groups on “addressing losses attributable to the current and potential future pandemics.”
North Carolina Department of Insurance. In North Carolina, the Insurance Commissioner sent a letter to “Business Owner[s]” that said in pertinent part:
Standard business interruption policies are not designed to provide coverage for viruses, diseases, or pandemic-related losses because of the magnitude of the potential losses. Insurability requires that loss events are due to chance and that potential losses are not too heavily concentrated or catastrophic….Consider the difference…between losses suffered from a hurricane and the losses resulting from COVID-19. The hurricane losses affect certain areas on the coast…but the losses from this pandemic cover the entire nation. Therefore, mandating coverage for this size and type of loss while canceling existing exclusions in the policies would end the very existence of the business interruption insurance market….We can’t legally force insurers to cover a risk which they didn’t intend to cover and which, in some instances, was specifically excluded in the policy.
Insurance Companies’ Position. The American Property Casualty Insurance Association has stated that most insurance policies – including those with business interruption coverage – do not cover shut downs caused by COVID-19 or other viruses. Some policies specifically exclude losses resulting from a virus or bacteria. Insurers also take the position that coverage requires “physical damage to adjacent or nearby property” and the pandemic did not physically damage any property.
Legal Basis for the Insured’s Claim.
Requirement for “Physical Loss.” Courts have been split as to whether this coverage may apply where buildings have become uninhabitable or nonoperational because of contamination, including from airborne contaminants. Coronavirus can physically affect property – it can survive for days on plastic and stainless steel.
Here is a sampling of cases addressing the question of “physical loss” (note that some interpret that phrase, but not in the context of business interruption insurance) include:
Universal Image Productions, Inc. v. Chubb Corp., 703 F. Supp. 2d 705 (E.D. Mich. 2010) (intangible harms, such as pervasive odor, mold and bacterial contamination did not constitute physical loss), aff’d sub nom. Universal Image Prod. v. Federal Ins. Co., 475 Fed. Appx. 569 (6th Cir. 2012)
Great Northern Ins. v. Benjamin Franklin Fed. S & L, 793 F. Supp. 259 (D. Or. 1990) (finding no direct physical loss from discovery of asbestos insulating material because building “remained physically intact and undamaged”), aff’d, 953 F.2d 1387 (9th Cir. 1992)
Yale University v. Cigna Ins. Co., 224 F. Supp. 2d 402 (D. Conn. 2002) (citing cases and concluding that insured suffered physical loss of or damage to property by alleging presence of asbestos and lead contamination in buildings)
Gregory Packaging, Inc. v. Travelers Prop. Cas. Co. of America, Civ. No. 2:12-cv-04418 (WHW), 2014 U.S. Dist. LEXIS 165232 (D.N.J. Nov. 25, 2014)(rejecting argument that physical loss or damage requires physical change or alteration to insured property, but can cover loss when ammonia spill incapacitated facility rendering it unfit for occupancy; the spill changed the facility’s condition to an unsatisfactory state needing repair)
In North Carolina, in the case of Harry’s Cadillac-Pontiac-GMC Truck Co. v. Motor Ins. Corp., 126 N.C. App. 698, 486 S.E.2d 249 (1997), plaintiff’s car dealership was insured by defendant-insurer for protection against loss of income resulting from the suspension of business due to property repairs. After a snowstorm struck the area, plaintiff filed a claim under its basic coverage for damage to its roof sustained as a result of the storm, and for lost profits because of the interruption of its business due to the snowstorm. The insurer paid for the damages to the roof but denied business interruption loss because the roof damage did not cause an interruption of the insured’s business. The business interruption clause provided coverage for loss of business income due to the “necessary suspension of your operations…caused by direct physical loss of or damage to property….” The period of restoration was defined to begin on the date of the direct physical loss, and ending on the date when the property is “repaired, rebuilt, or replaced….” The Court of Appeals pointed out that insurance policies are to be strictly construed against the insurance company. The Court of Appeals found for the insurance company; the insured-business did not allege that it lost business income was due to damage to the property, but instead only offered evidence that the business income was lost due to the inability to access the dealership due to the snowstorm. Under the language of the policy, coverage is only provided when loss results from damage to or destruction of business property.
A subsequent case involved a policy that provided coverage when a business loss occurred during a period of time when ingress to or egress from the property was prevented. Fountain Powerboat Indus. v. Reliance Ins. Co., 119 F. Supp. 2d 552, 556 (E.D.N.C. 2000). In this case, Hurricane Floyd caused a dramatic fall in production at Plaintiff’s manufacturing facility. The ingress-egress clause did not require physical damage, but required only the reduction of business operations caused by “loss, damage, or destruction….” Flooding made the property inaccessible, and the route to the facility was also inaccessible. The court concluded that physical loss to the insured property was not required to trigger coverage under the ingress-egress clause.
Looking for some guidance regarding other “airborne” pathogens, an insured may look at cases where mold or contamination losses resulted from an event covered by an insurance policy. In HoneyBaked Foods, Inc. v. Affiliated FM Ins. Co., 757 F. Supp. 2d 738 (N.D. Ohio 2010), the discovery of listeria caused the plaintiff to suspend production. The policy excluded coverage for “fungus, mold, or mildew” (defined to include bacteria), but an extension of coverage provided coverage for the “direct physical loss or damage to insured property caused by or resulting from fungus, mold, or mildew when fungus, mold, or mildew is the direct result of direct physical loss or damage….” The court found that the policy would only provide coverage when the bacteria resulted from property damage and therefore would not apply in this case since there was no property damage that caused the listeria. See, also, Liristis v. Am. Family Mut. Ins. Co., 204 Ariz. 140, 61 P.3d 22, 25 (Ariz. App. Ct. 2002) (“[M]old damage caused by a covered event is covered . . . . On the other hand, losses caused by mold may be excluded.”); Simonetti v. Selective Ins. Co., 372 N.J. Super. 421, 859 A.2d 694, 699 (N.J. 2004) (mold damage covered despite policy exclusion for “loss caused by mold” where plaintiff could prove mold resulted from rainstorm, a covered peril); Graff v. Allstate Ins. Co., 113 Wn. App. 799, 54 P.3d 1266, 1268-69 (Wash. App. Ct. 2002) (contamination exclusion did not bar coverage where vandalism, a covered peril, resulted in the contamination).
Civil Authority closure. A South Carolina case,Kelaher, Connell & Conner, P.C. v. Auto-Owners Ins. Co., No. 4:19-cv-00693-SAL, 2020 U.S. Dist. LEXIS 31081 (D.S.C. Feb. 24, 2020), involved a law firm that closed because of a mandatory evacuation ordered by the Governor of South Carolina because of the threat of Hurricane Florence and subsequently made a claim for business interruption loss for the days that it closed during the evacuation order. The policy contained an extension of coverage for actual loss sustained as a direct result of an interruption of business “because access to the … business premises is prohibited by order of civil authority because of damage or destruction of property adjacent to the … premises….” The court found that the policy unambiguously required a link between the civil authority order and property damage. Therefore, the policy would not cover this loss since there was no evidence that the civil authority issued the order because of the existence of property damage or destruction at the time of the order (but, instead, issued the evacuation order because of an expectation of property damage).
The court summarized other cases involving civil authority orders:
Dickie Brennan & Co., Inc. v. Lexington Insurance Co., 636 F.3d 683 (5th Cir. 2011)(noting the “general rule” that “[c]ivil authority coverage is intended to apply to situations where access to an insured’s property is prevented or prohibited by an order of civil authority issued as a direct result of physical damage to other premises in the proximity of the insured’s property”).
Jones, Walker, Waechter, Poitevent, Carrere & Denegre, LLP v. Chubb Corp., No. 09-6057, 2010 U.S. Dist. LEXIS 109055, 2010 WL 4026375 (E.D. La. Oct. 12, 2010)(provision allowed recovery of business income loss incurred “due to the actual impairment of [ ] operations, directly caused by the prohibition of access to [the] premises by a civil authority” and further provided that “prohibition of access by a civil authority must be the direct result of direct physical loss or damage to property away from such premises[.];court found that the provision “does not insure against impairment of operations that occurs simply because a civil authority prohibits access.”)
United Air Lines, Inc. v. Insurance Co. of Pa., 439 F.3d 128 (2d Cir. 2006)(denial of coverage to airline when civil authority order halted flights due to 9/11 terrorist attacks; concluding airport was not shut down “as a direct result of damage to” the Pentagon);
Allen Park Theatre Co., Inc. v. Michigan Millers Mutual Insurance Co., 48 Mich. App. 199, 210 N.W.2d 402 (Mich. Ct. App. 1973)(following the death of Dr. Martin Luther King, Jr., and several riots around Detroit, the Governor of Michigan issued an executive order, closing all “places of amusement” until further notice; theatre owner sought coverage under the civil authority order provision that allowed coverage of actual loss incurred, “[w]hen as a direct result of the peril(s) insured against, access to the premises described is prohibited by order of civil authority”, the court affirmed the trial court’s award to plaintiff).
Conclusion. The question about coverage for a COVID-19 business interruption claim will primarily be based upon the language of the policy. If the policy is not clear, there is legal precedent and moral authority that appears to dictate that an insurer should be required to pay a claim.
If you would like to discuss issues regarding business interruption insurance coverage on your business, please contact Bert Andia at 336.273.1600 or email@example.com
In the last several months, there have been efforts across the globe designed to contain the spread of the coronavirus (COVID-19). Those efforts have resulted in cancellation of events, and the closure (temporarily or permanently) of businesses. As a result, questions have arisen about whether a person’s obligation under a contract – whether it’s a residential lease, a commercial lease, or a sales contract – can be excused because of the unique situation with which we are all dealing.
While there is no one-size-fits-all answer, the North Carolina cases described below have been selected in an attempt to provide information that might assist an analysis for those questions.
Force Majeure Clause – Commercial Lease. Crabtree Ave. Inv. Group, LLC v. Steak & Ale of N.C., Inc. 169 N.C.App. 825, 611 S.E.2d 442 (2005)
Steak & Ale operated a restaurant in Raleigh, and leased the building from Crabtree Ave. Inv. Group, LLC. Group (Crabtree). Crabtree filed suit to have Steak & Ale evicted, and was granted possession of the property. The Court of Appeals found that the decision to evict Steak & Ale was proper.
The property that Steak & Ale was leasing was sold to Crabtree Ave. Inv. Group, LLC. Crabtree informed Steak & Ale that its lease payments were to be sent to a new address. Steak & Ale sent a written request to the Crabtree at the new address requesting Crabtree to send them an IRS Form W-9 and a copy of the deed. Steak & Ale’s letter was returned unopened. Thereafter, Crabtree sent a letter to Steak & Ale requesting rent payments; Steak & Ale sent all past due rental payments to Crabtree. Crabtree returned the checks and filed to have Steak & Ale evicted. Crabtree was successful in evicting Steak & Ale.
On appeal, Steak & Ale argued, in part, that Crabtree’s failure to provide the W-9 should have extended Steak & Ale’s obligation to pay rent pursuant to the “force majeure” clause. The Court’s description of the force majeure clause describes the lease provision as providing an extension of time for a party’s performance under the lease when performance was delayed due to a “cause beyond the tenant’s control.” Steak & Ale argued that it could not pay the rent to Crabtree unless and until Crabtree sent the W-9.
The Court disagreed with Steak & Ale: there was no legal requirement for a W-9 before payments were made; the failure to pay rent was merely because of Steak & Ale’s internal company policy; and, therefore, the failure to pay rent was not due to an event beyond Steak & Ale’s control.
Application to COVID-19 Situations: With commercial leases, close attention must be paid to the language of the force majeure clause. The clause in this case appears to allow for an extension of time for the tenant’s performance if the tenant was unable to perform due to a “cause beyond the tenant’s control.” Stay-at-home orders and government orders that restaurants close down certainly makes payment of rent more difficult for certain business such as restaurants. However, whether performance under a contract is excused or not, this case would merely stand for the proposition that the language of the force majeure clause is a determining factor in the analysis.
Force Majeure Clause; Frustration of Performance – Commercial Lease. S. College St., LLC v. Charlotte Sch. Of Law, LLC, 2018 NCBC 80 (18 CVS 787, August 10, 2018)(Judge Michael L. Robinson)
Charlotte School of Law (CSL) was founded in 2006 as a for-profit law school. CSL signed an Office Building Lease Agreement for a 3 year term; the lease lists certain Permitted Uses on the property, including use as an educational institution as well as for general office use, uses ancillary to its business, and other legally permitted uses (with the Landlord’s permission). Plaintiff, S. College St. (Landlord), purchased the property, and the lease was assigned to it as part of the purchase.
CSL’s state license to conduct post-secondary degree activity expired, and CSL ceased operation of the law school. CSL failed to pay its monthly rent in October 1, 2017, and Landlord notified CSL that it was demanding payment of all sums due. CSL abandoned the property.
Landlord filed a Complaint seeking monetary damages for breach of the lease. CSL argued that the doctrine of frustration of purpose excused its obligations to pay rent once it could not use the premises for a law school.
The doctrine of frustration of purpose states that “changed conditions supervening during the term of a contract sometimes operate as a defense excusing further performance on the ground that there was an implied condition in the contract that such a subsequent development should excuse performance or be a defense….”
The Court explained that the doctrine is based upon the “fundamental premise of giving relief in a situation where the parties could not reasonably have protected themselves by the terms of the contract against contingencies which later arose.” The must be an (1) an implied condition that a change would excuse performance; (2) the changed condition caused a failure of consideration or the expected value of performance; and (3) the changed condition was not reasonably foreseeable.
CSL argued that its ability to operate a law school was an implied condition and, due to several regulatory and governmental actions, there was a failure of consideration and an elimination of the value of performance of the Lease. However, since the Lease specifically provided that the “Permitted Uses” for the property included “other legally permitted uses”, the Court determined that CSL’s position was not an implied condition that would excuse performance.
The Lease also included a force majeure clause
When a period of time is herein prescribed for any action, other than the payment of any monetary sums due hereunder, to be taken by [Landlord] or [CSL], [Landlord] or [CSL], as applicable, shall not be liable or responsible for and there shall be excluded from the computation for any such period of time, any delays due to strikes, riots, terrorism, acts of God, shortages of labor or materials, war, laws, regulations or restrictions, inability or delays in obtaining governmental permits, or any other causes of any kind whatsoever which are beyond the reasonable control of [Landlord] or [CSL.]
The language of the force majeure clause specifically allows for additional time to perform any of CSL’s obligations under the lease, except for its payment obligations. The Court found that the parties expressly agreed that a failure to pay sums due under the lease is a breach that is not excused by CSL’s inability to obtain the appropriate government permits to operate a law school.
Application to COVID-19 Situations: As with the above, close attention should be paid to the language of the force majeure clause. The clause in this case did not allow the tenant to avoid its payment obligations for certain force majeure events. The defense of frustration of purpose might provide relief if there is sufficient proof of an “implied condition” (i.e. ability to operate the business on the property), the changed condition caused the party to lose the benefit of its bargain (e.g., stay-at-home order prevented operation of the business), and the cause (the virus) was unforeseeable.
Force Majeure Clause; Contract for Sale of Goods. Certainteed Gypsum NC, Inc. v. Duke Energy Progress, LLC, 2018 NCBC LEXIS 91, 2018 NCBC 90 (August 28, 2018)
CertainTeed manufactured wallboard which, in part, required a supply of synthetic gypsum. Duke Energy’s plants produced gypsum as a byproduct of coal-fired electric power plants. The parties entered into a supply agreement in 2004, in 2008, and again in 2012.
Due to a drop in natural gas prices, Duke Energy decreased the utilization of its coal-fired plants, with a resulting decrease in production of synthetic gypsum. A dispute arose about the quantity term under the Supply Agreements – was Duke Energy required to provide a minimum quantity of gypsum; did Duke meet is contractual obligation to use commercially reasonable efforts to maintain a stockpile of gypsum; and, was Duke Energy excused from performing because performance would be inconsistent with its primary purpose as a regulated public utility.
The supply agreements contained a clause that Duke Energy’s obligations are subject to Duke Energy’s “primary duty to produce economical and reliable electric power for public consumption…” and that the agreement should not be interpreted to obligate Duke Energy to maximize production of synthetic gypsum. The Court found that this clause excused Duke Energy’s obligation to supply synthetic gypsum if future changes in laws or regulations restricted Duke Energy from supplying synthetic gypsum, but did not excuse Duke Energy if it could continue to lawfully supply synthetic gypsum even if the expense of doing so increased to an unanticipated degree.
The Court further noted that the agreements contained a force majeure article that expressly provided that “certain specific events” would excuse either party’s obligations, although the “primary duty” clause did not have similar force majeure language.
The result was that the Court found that the supply agreements excused Duke Energy from its obligations to supply synthetic gypsum only if it could no longer legally supply the product.
Application to COVID-19 Situations: The language of the contract is supremely important. Even though Duke Energy believed that its obligation as a public utility should excuse its performance from supplying synthetic gypsum (which was no longer economically advantageous), the Court determined that the primary purpose clause did not excuse performance and that the failure to provide force majeure events that might excuse performance prevented the use of such defense.
Doctrine of Frustration of Purpose; Doctrine of Impossibility of Performance; Contract. Brenner v. Little Red Sch. House, Ltd., 302 N.C. 207, 274 S.E.2d 206 (1981)
Plaintiff entered into a contract by which Defendant (private school) agreed to enroll Plaintiff’s son in the fourth grade class of Defendant-school. The contract required Plaintiff to pay one year’s tuition in advance, and explicitly provided that the tuition was non-refundable. Plaintiff was divorced, and his former wife received custody of the child. Although Plaintiff paid one year of tuition in advance, his former wife refused to allow the child to attend the school.
The trial court granted summary judgment to Plaintiff; but the Court of Appeals reversed that decision. The Supreme Court of North Carolina found that summary judgment could not be granted to either party.
Plaintiff asserted the doctrine of impossibility of performance arguing that he should be excused from an executory contract (a contract requiring future performance) since the subject matter of the contract (attending the school) was destroyed without fault of Plaintiff. Since it was still possible for the child to attend the school, the doctrine of impossibility of performance was not applicable.
Plaintiff asserted that the doctrine of frustration of purpose should apply to require that the contract be rescinded. The doctrine of frustration of purpose provides that “changed conditions supervening during the term of a contract sometimes operate as a defense excusing further performance on the ground that there was an implied condition…that such a subsequent development should excuse performance or be a defense…even though the subsequent condition that developed was not one rendering performance impossible.” The doctrine of frustration of purpose is not a form of impossibility of performance, but more properly relates to the issue of “consideration.” While performance is possible, performance is excused because an event causes a failure of the consideration or a practically total destruction of the expected value of the performance.
The doctrine of frustration of purpose is not applicable if (a) the frustrating event was reasonably foreseeable; or (b) if the parties allocated the risk involved in the frustrating event.
In this case, (a) there was no substantial destruction of the value of the contract since Defendant-school made preparations to educate the child; reserved a space for the child; and kept a place open for the child; and (b) the possibility of the child not attending was foreseeable, and the contract expressly provided for that event (making tuition nonrefundable) and allocated the risk to the Plaintiff.
Application to COVID-19 Situations: A stay-at-home order may be seen as destroying the consideration that might be received from a contract. A good argument can be made that such a virus, and the subsequent shut down orders, is not reasonably foreseeable. Thus, if the contract does not otherwise allocate the risk of such a shutdown, the doctrine of frustration of performance could provide a basis to rescind the contract.
Doctrine of Frustration of Purpose; Commercial Lease. WRI/Raleigh, L.P. v. Shaikh, 183 N.C. App. 249, 644 S.E.2d 245 (2007)
Plaintiff (Landlord) and Defendant (Tenant) entered into a lease so that Tenant could operate an Italian restaurant on the premises. After signing the lease, Tenant learned that City Ordinance required a 1,000 gallon grease trap. Although Tenant was aware prior to signing the lease that a grease trap was required, Tenant believed the minimum capacity was closer to 200-300 gallons; there was no grease trap on the Premises and no plans to install a grease trap when the lease was signed.
Tenant received estimates for modification of the Premises to add a grease trap, but was informed that any system was likely to clog repeatedly. Tenant decided that he could not open a restaurant on the Premises, and tendered the keys to the Landlord. Plaintiff sued for breach of contract, and a jury found Tenant liable. The jury specifically found that “Defendant’s failure to perform under the terms of the commercial lease” was reasonably foreseeable as a preliminary question before considering the amount of damages to be awarded.
Defendant argued that the doctrine of impossibility (i.e. Tenant could not have operated the restaurant Tenant planned to operate) should excuse his performance. The Court of Appeals noted that the premises existed and were in the same condition as when the contract was signed. Additional evidence demonstrated that subsequent tenants were running a restaurant and had installed a grease trap. Based on those factors, the Court found that someone could have performed under the terms of the lease and, therefore, the doctrine of “impossibility” was inapplicable.
Defendant next asserted that his performance under the lease should be excused under the doctrine of frustration of purpose. Defendant argued that, after the lease was signed, “investigation after the lease was signed revealed conditions that resulted in practically total destruction of the expected value of the performance.” Under the doctrine of frustration of purpose, performance under a contract is excused whenever a fortuitous event supervenes to cause a failure of the consideration or a practically total destruction of the expected value of performance of the contract. The fundamental premise for the doctrine of frustration of purpose is to give relief when the parties could not reasonably have protected themselves by the terms of the contract against contingencies which later arose.
The doctrine of frustration of purpose does not apply when the frustrating event was reasonably foreseeable. The Court of Appeals found that the question of foreseeability was properly submitted to the jury, and therefore the jury’s verdict necessarily meant that the jury had found that performance was “not excused by an event which was reasonably foreseeable.” The jury’s verdict did not allow the Court of Appeals to overturn the verdict.
Application to COVID-19 Situations: This statement of the doctrine of frustration of purpose would seem to allow for excusing performance under a commercial lease since an unforeseeable event (the COVID-19 virus and shut down) supervenes so that there was a failure of consideration (paying rent in return for the right to rent a certain space). Of course, the countervailing argument is that the space was still available for the tenant to use, and that the tenant could have used it for some business purpose.-
If you would like to discuss the impact of the coronavirus or the resulting shutdown of your business, please contact Bert Andia at 336.273.1600 or firstname.lastname@example.org