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Contract Disputes and COVID-19

"Do you think this is an act of God?"" That was the question I posed to a colleague in my office after getting off the phone with a client on March 12, 2020. The next day, San Mateo County reduced the permissible size of public gatherings to 250 people. On March 9th, the Dow Jones Industrial Average had lost more than 2,000 points and the S&P 500 fell by 7.6%. By March 16th, the markets had their three worst point drops in history. My question was not mere hyperbole - if COVID-19 were considered such an act, or a similarly significant event, how was it and the events that followed going to affect my client's contract? Was my client still obligated to perform? This is a knotty question that our Court and hundreds of others will be wrestling with for a long while.

On March 16th, Dr. Scott Morrow, the San Mateo County Health Officer, issued the county's Shelter-in-Place (SIP) order, and similar orders were issued throughout the Bay Area. Also that day, Gov. Gavin Newsom ordered the suspension of residential evictions for failure to pay rent to May 31st, and gave local governments further discretion in the enforcement of unlawful detainer actions for the same period to, among other things, promote housing security and stability (Executive Order ("EO") N-28-20). On March 19th, Gov. Newsom issued a state-wide shelter-in-place order, EO N-33-20. On April 7th, the San Mateo County Board of Supervisors adopted Urgency Ordinance No. 4826 ("UO 4826"). As it relates to commercial property, the order is a moratorium on the eviction of commercial tenants with gross receipts of $2.5 million or less for the non-payment of rent. The moratorium was originally in effect until at least May 31, 2020, and, as of this writing, was extended until June 30, 2020.

Generally, under the moratorium, an owner of commercial real property cannot recover possession from a tenant for failure to pay rent when it is due if the tenant can demonstrate the failure to pay was directly related to a decrease in net business income resulting from the pandemic or any federal, state, or local government response. UO 4826 has specific steps that the owner and the tenant must comply with, including each putting the other on notice regarding their respective qualifications and applicability under the notice. There are very specific notice requirements and timelines, especially those that are triggered after the state SIP is lifted.

Contract Defenses

For businesses the world over, this leads to at least 3 areas of law that may apply in disputes regarding commercial leases and contracts:

  • force majeure,
  • impossibility/impracticability, and
  • frustration of purpose.

It is necessary to look at what the lease or contract says, if anything, regarding these areas of the law. It is also necessary to look for a provision regarding what jurisdiction's law applies. In California, and more specifically in San Mateo County, as of this writing, a revised SIP is still in effect regarding certain activities. Such activities have included the operation of "Essential" and "Non-Essential" businesses, and related restrictions on their respective activities. What is considered Essential or Non-Essential, and what those businesses can do, has been in a state of flux - or interpretation - since the original SIP was issued.

In California, the defense of force majeure is referenced at Civil Code Section 1511. Civil Code Section 3526 also provides guidance. Some see these two provisions as California taking a more liberal view of what is a force majeure, and that courts may interpret such provisions accordingly. Typically, when a force majeure provision is in a contract, there is often a list of conceived events to which it may apply, e.g., war, terrorist attacks, or natural disasters. However, many do not include a pandemic, and that type of exclusion has been strictly enforced. On the other hand, many such provisions do include governmental regulations, like orders to shelter-in-place or travel restrictions. It is also important to discern if there are any time issues related to the event, for instance, whether performance can be delayed for 60 to 90 days, or whether the contract can be terminated outright. To some, COVID-19 and the governmental responses qualify as a force majeure event, however, there are significant foreseeability and causation questions that need to be considered.

Related issues include impossibility and impracticability. Impossibility is a common law defense referenced in Civil Code section 1441. Originally, it was based on a literal or physical impossibility to perform, however, it has been broadened to include when performance is impracticable. Performance is impracticable when it can be done only at excessive and unreasonable difficulty or expense. However, it is not based on a party's inability to perform. Unusual or unexpected expenses do not establish legal impossibility. Legal impossibility is more than an occurrence that makes performance more difficult or costly than originally anticipated. The question is the degree to which the expense is unreasonable or excessive. City of Vernon v. City of Los Angeles, 45 Cal.2d 710 (1955). Generally, an objective test is applied. If what is agreed to be done is possible and lawful, it must be done. If a party can perform and, in consideration of all circumstances performance is possible, the party is in breach for failure to perform. Selby v. Battley, 149 Cal.App.2d 659 (1st Dist. 1957).

Finally, commercial frustration of purpose may arise where a not reasonably foreseeable supervening event totally or nearly totally destroys the value of performance in a contract or lease. Again, generally, substantial frustration is not sufficient - there must a complete or near complete destruction for the purpose of the contract. Many attorneys may recall first learning about the concept in reference to the coronation of Kind Edward VII. Krell v. Henry, 2 K.B. 740 (1903).

Though codified in California, these theories are largely based on precedent, and much of the case law was decided at times that we have seen only in a limited context, such as World Wars I and II or other profound events in history. In the commercial disputes that will arise from COVID-19, there will be trillions of dollars and millions of jobs at stake, and all of these conflicts are fact-intensive. How does the revision of SIP orders affect the analyses? If a store or restaurant can provide delivery or curbside service, or limited seating, can they still claim a force majeure? If gatherings are increased to 250 people, is it still impracticable to hold a conference? Should cargo restrictions which impact supply chains be considered? As of this writing, Simon Property Group, the largest mall operator in the U.S. had already sued The Gap for nearly $66 million for failure to pay rent. In that case and thousands of others, there will be many factors to sort through.

The Courts and Mediation

On March 23rd, Chief Justice Tani Cantil-Sakauye, ordered that all jury trials automatically be continued for 60 days. On April 1st, the honorable Judge Jonathan E. Karesh, the presiding judge of our San Mateo County Superior Court, ordered that all trials, with certain exceptions, be suspended until at least May 21st. Since those orders, courts around the Bay Area and country have been gradually re-opening and hearing matters. They are prioritizing matters and, much like local rules, courts are issuing their own respective policies regarding the restoration of services. These include potentially excusing members of the public from jury service that provide proof of illness, symptoms, or are at a high risk of contracting the coronavirus.

One consequence of the above events and legal issues, parties should anticipate that it will be a long while before courts hear their current commercial lease and contract disputes at trial. To address this, parties should consider mediating these disputes if they cannot negotiate a resolution informally. Mediations can now be conducted efficiently over a video platform, especially where there are multiple parties, for example, owners, contractors, and insurance adjusters at different locations around the country. Documents can be shared and settlement agreements can be signed electronically. With genuine intention and preparation, lease and contract disputes can be resolved expeditiously.

The city of San Francisco projects losing $1.7 billion in revenue over the next 2 years, and 1 out of every 6 people will be unemployed. At the end of April, more than 3.6 million homeowners were past due on their mortgages, and California's unemployment rate was 15.5%. Neiman Marcus, J. Crew, J.C. Penney and other major retailers have already filed for bankruptcy.

For individuals and businesses, the sooner these conflicts can be resolved the quicker they can focus on being economically productive. Addressing health and safety issues will demand considerable time and effort, as will other significant conflicts requiring redress. Another step towards "meeting the moment" will be in creating solutions to these disputes, genuinely working together to solve problems, and finding compromises. In time, as Abraham Lincoln offered while a practicing attorney, there will be business enough.

Article originally appeared in the San Mateo County Bar Association publication, Heresay.


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