Checklist and Compendium of COVID-19 Force Majeure Issues [Gaille Energy Blog Issue 88]

Checklist and Compendium of COVID-19 Force Majeure Issues [Gaille Energy Blog Issue 88]

  • Posted by scottgaille
  • On May 19, 2020

Over the course of the last few months, lawyers have been deluged with articles about COVID-19 and force majeure, much of them containing quite similar content and analysis.  My Research Assistant at The University of Chicago Law School, Tanner Harris, has been reading and tracking these articles over the last few months.  In this issue of the Gaille Energy Blog, we seek to provide a CliffsNotes-esque summary of the principal topics covered by them, saving our readers the tedium of searching for novel insights in this haystack of articles:

  1. Are diseases, epidemics, and pandemics events of force majeure?
    • Express listing of disease, epidemic, pandemic
    • COVID-19 as an “act of God”
    • COVID-19 as “any other event beyond a party’s reasonable control”
    • COVID-19 as foreseeable or unforeseeable
  2. Do governmental actions, changes of law, and national emergencies (designed to minimize the spread of COVID-19) constitute force majeure?
  3. To what extent must a party have been affected by COVID-19 in order to invoke force majeure?
  4. Did the party mitigate COVID-19?
  5. When must a notice be provided for a COVID-19 force majeure claim?
  6. What are the risks of invoking force majeure for COVID-19?
  7. How do jurisdictional differences affect a COVID-19 force majeure claim?
  8. Are there alternative forms of relief for COVID-19 that could be used in the absence of force majeure?
    • Change in Law
    • Impracticability
    • Impossibility
    • Frustration of Purpose
    • Business Interruption Insurance
    • Suspension Agreements
  9. Special Situations: COVID-19 Force Majeure & Energy Construction/Services
    • Time-No-Money for Force Majeure
    • Dangers of Standby Compensation Clauses
    • Delay Liquidated Damages
    • Quarantine-Related Shut-Downs
  10. Special Situations: COVID-19 Force Majeure & Wind Projects
  11. Special Situations: COVID-19 Force Majeure & Solar Projects
  1. Are epidemics, pandemics, and diseases events of force majeure?
  • Express listing of disease, epidemic, pandemic

Force majeure, which is French for “superior force,” is generally understood to be an event that is beyond the parties’ reasonable control.  Most energy agreements contain some version of a force majeure clause, which lists a parade of horribles (storms, fires, wars, etc.), along with a “catch-all” for other events – for example, “other events beyond the reasonable control of a party.” In most American jurisdictions, force majeure relief arises only from this text itself; there is no implied “force majeure” clause if the contract does not contain one.

If the terms “disease,” “epidemic,” or “pandemic” are specifically enumerated, COVID-19 is likely a covered event.  There could be issues, however, if some (but not all) of “epidemic,” “pandemic,” and “disease” are specifically listed. Each of these terms has a different meaning. Epidemic typically refers to a disease that affects a large number of people within a community, population or region; pandemic typically refers to an epidemic that has spread over multiple countries or continents; and disease refers to epidemics, pandemics, and other sicknesses. In the context of COVID-19, if only the word “pandemic” was used in a force majeure clause, it would raise questions about whether force majeure could be invoked for events prior to March 11, 2020 (when the World Health Organization declared COVID-19 a pandemic).  In any event, from and after March 11, 2020, COVID-19 should qualify as a disease, epidemic, and pandemic.

  • COVID-19 as an “act of God”

If a force majeure clause neglects to mention diseases, epidemics, or pandemics, the parties may need to turn to another item in the list.  For example, does COVID-19 constitute an “act of God”?  That may depend on whether or not COVID-19 originated in a wild animal market or a Wuhan laboratory.  If the contract is governed by the laws of the State of Texas, an “act of God” must not have contributed to or been caused by human intervention.  A laboratory accident likely would preclude COVID-19 being an act of God.  Even if the disease arose in the Wuhan animal market, one could argue that human intervention—capturing wild animals and transporting them to Wuhan—contributed to the release of the virus.

  • COVID-19 as “any other event beyond a party’s reasonable control”

If the enumerated force majeure list does not include the words “disease,” “epidemic,” or “pandemic,” but contains a catch-all (e.g., any event beyond the reasonable control of a party), the party attempting to invoke force majeure should anticipate the following counterparty argument:

Viruses like SARS, H1N1 influenza, and Ebola have been widely publicized.  Had the parties intended the force majeure clause to cover diseases, epidemics, and pandemics, they would have expressly listed them.

This argument has merit because courts generally construe force majeure “catch-all” clauses narrowly under the doctrine of ejusdem generis, which is Latin for “of the same kind” and means that only events like those specifically mentioned in the force majeure provision would be included in the catch-all. If parties broaden the scope of a catch-all by using language such as “any event beyond the reasonable control of the affected party, whether similar or dissimilar to the foregoing,” then the catch-all is more likely to capture COVID-19.

  • COVID-19 as foreseeable or unforeseeable

Some force majeure clauses expressly require that force majeure be unforeseeable.  Courts also have found that, in order for an event to qualify as force majeure under a catch-all, the event must have been unforeseeable.  The issue of foreseeability becomes particularly challenging for contracts entered into during 2020, when the parties are aware of the outbreak. To avoid such issues, new contracts should expressly state to what extent COVID-19 issues qualify as force majeure (or not).

  1. Do governmental actions, changes of law, and national emergencies (designed to minimize the spread of COVID-19) constitute force majeure?

Even in the absence of terms such as “disease,” “epidemic,” or “pandemic” in the enumerated list, the parties may nevertheless be able to invoke force majeure if the force majeure provision includes governmental actions, changes of law, or national emergencies.  Following the outbreak of COVID-19, national, state, and local governments placed restrictions on movement between and within jurisdictions. In addition, COVID-19 resulted in many new laws, orders, and regulations (as well as changes in existing laws) that have affected parties’ ability to perform contractual obligations. If applicable law actually prevents the performance of a party’s contractual obligations (as opposed to merely making such performance more economically unfavorable), then such provisions could be a basis for invoking force majeure.

One issue with COVID-19 governmental orders is the question of whether their content was binding law or merely recommendation/guidance.  Federal guidelines, for example, were not binding on states.  Similarly, cities and counties may have issued more restrictive guidance than the binding orders of state governors.  Compliance with guidance likely does not qualify as force majeure.

  1. To what extent must a party have been affected by COVID-19 in order to invoke force majeure?

In order to invoke force majeure, an affected party must demonstrate that (a) it could have performed its contractual obligations but for the triggering event and (b) the triggering event actually prevented it from performing those obligations. With respect to (a), if a party was not going to meet a deadline regardless of the occurrence of the triggering event (e.g., the triggering event coincided with unplanned downtime resulting from the invoking party’s failure to inspect its equipment pursuant to the contract), then that party would be unable to successfully invoke force majeure because the triggering event would not have been the “but for” cause of that party’s inability to perform its contractual obligations.  With respect to (b), taking precautionary measures or making voluntary decisions to withhold performance in light of the triggering event would generally not be viewed as actually preventing performance. Contracts may allow some level of lenience, however, by including language such as “hindered,” “impeded,” or “interfered with” in addition to “prevented.”

  1. Did the party mitigate COVID-19?

Most force majeure clauses (and courts interpreting them) require the party invoking the clause to have adequately planned for events of force majeure and mitigated the event to the extent commercially reasonable. A party’s failure to engage in adequate planning or mitigation efforts could reduce the relief it seeks—or even prevent it from invoking force majeure altogether.  In the case of COVID-19, we are aware of the many ways in which the threat can be mitigated, including social distancing, working from home, face masks, and frequent testing.  The failure of a party to take such steps may compromise its force majeure claim.

  1. When must a notice be provided for a COVID-19 force majeure claim?

Most contracts require that a party invoking force majeure provide written notice to its counterparty. These provisions generally also require the invoking party to provide details as to the time, location, personnel, and equipment affected by the event, and they may further require the submission of supporting documentation.  In the context of a pandemic such as COVID-19, there may be uncertainty regarding when to submit a notice of a force majeure. Force majeure events are generally discrete events such as fires and tornadoes that last only for a short period of time. COVID-19, on the other hand, has lasted for months. In such situations, at what point is notice required?  Is it when a party anticipates that COVID-19 may disrupt its performance—or only when the performance has actually been prevented by COVID-19?  Law firms have been erring on the side of caution by sending out “protective” force majeure notices that generally allege the existence of the pandemic and the possibility that it may prevent future performance.  Such notices likely fail on their face to allege force majeure if they do not assert any specific impact to performance.  Moreover, as described below, they may unintentionally trigger the right of the other party to terminate the contract altogether.

  1. What are the risks of invoking force majeure for COVID-19?

There are several risks that a party must account for when deciding whether to invoke force majeure. One major risk is the improper invocation of force majeure (e.g., a party ceases its performance of its contractual obligations but fails to give timely notice or was not actually prevented from performing its obligations as a result of the triggering event). Improper invocation may result in contractual termination, loss of entitlement to relief, and liquidated and other general damages.

Even if a party properly invokes force majeure, it may still have unintended adverse consequences. For example, many force majeure provisions allow the non-affected party to terminate the contract if nonperformance lasts for an extended period (typically over 30 days). Accordingly, the invoking party may inadvertently create a termination right for the counterparty that was otherwise unavailable.

Another risk of invoking force majeure is the potential loss of exclusivity. Both goods and services contracts (e.g., gathering agreements) may contain exclusivity provisions which restrict the ability of one or more parties to transact with other suppliers or buyers for the duration of the contract. Invoking force majeure may trigger language in an exclusivity provision that temporarily or permanently removes such restrictions. Accordingly, before invoking force majeure, parties should evaluate any exclusivity provisions in their contracts to determine whether loss of exclusivity will be triggered.

  1. How do jurisdictional differences affect a COVID-19 force majeure claim?

The governing law of a contract may be outcome-determinative in a force majeure dispute because there are many differences between states with respect to force majeure and related common law doctrines. Thus, choice of law provisions (or lack thereof) matter a great deal in force majeure disputes. Differences in force majeure treatment between states include whether the affected party must show unforeseeability, whether certain mitigation requirements apply, and whether the enumerated force majeure list will be interpreted broadly or narrowly.

A party evaluating options for invoking force majeure or responding to a notice of force majeure should ensure thorough evaluation of the claim and any potential defenses under the proper applicable law. This analysis may become complex when multiple contracts govern a relationship between parties, a choice of law provision is absent from the contract, a party has many contracts governed by laws of different jurisdictions, or when a party prefers the law of one state when invoking force majeure and prefers the law of a different state when responding to counterparty notices of force majeure.

  1. Are there alternative forms of relief for COVID-19 that could be used in the absence of force majeure?
  • Change in Law

Although “change in law” is sometimes included as one of the enumerated items in a force majeure provision, it may be addressed in a standalone provision.  It is important to consider whether “change in law” may offer a different remedy than force majeure.

  • Impracticability

Impracticability may be used as an alternative defense when the contract lacks a force majeure provision or where the enumerated force majeure list does not include terms sufficient to encapsulate a given event.  Impracticability is available under common law, which provides that if a party’s performance is made impracticable by the occurrence of an event—the non-occurrence of which was a basic assumption on which the contract was made—the duty to render that performance may be discharged.  However, some jurisdictions bar a claim based on the common law defense of impracticability if the contract contains a force majeure provision, even if such force majeure provision is not found to apply to the relevant triggering event.

Impracticability also is available under the Uniform Commercial Code (the “UCC”).  Although the UCC doctrine of commercial impracticability is rarely applied, it has been used successfully when extreme weather events or supervening governmental regulations prevent performance.  The unanticipated closing of borders and similar events arising from government responses to COVID-19 may fall within the common law and UCC requirements for impracticability. However, proving that performance is impracticable is a high bar—unprofitable or inconvenient performance is not enough.  The event also must be unforeseeable and not caused by the invoking party.

  • Impossibility

Impossibility may be used as an alternative defense when the contract lacks a force majeure provision or where the enumerated force majeure list does not include terms sufficient to encapsulate a given event. In addition, some jurisdictions bar a claim based on impossibility if the contract contains a force majeure provision, even if such provision is not found to apply to the relevant triggering event.

Impossibility is construed more narrowly than impracticability and requires clearing the high bar of objective impossibility. Subjective impossibility is not enough (i.e., if another party could step into the shoes of the affected party and perform, even at an extremely high cost, performance is not objectively impossible). Because of its stringent requirements, invoking impossibility as an alternative to force majeure should only be attempted in a narrow set of circumstances.  That being said, government decrees such as COVID-19 border closures may be found to create objective impossibility—if the movement of employees or materials is entirely restricted.

  • Frustration of Purpose

Frustration of purpose may excuse nonperformance when contractual performance remains possible, but such performance would produce a dramatically different result from what the parties anticipated (when the contract was signed).  Commentators have argued, for example, that this defense could be applicable to advertising contracts for basketball or baseball games that were canceled by COVID-19.  Although the advertisements could technically still be displayed in the stadium, there would be no fans to see them.

  • Business Interruption Insurance

Business interruption insurance is intended to cover losses resulting from direct interruptions to a company’s operations and generally covers lost revenue, fixed expenses (e.g., rent), or expenses incurred while operating from a temporary location. Contingent business interruption insurance covers lost profits and costs resulting indirectly from supply chain disruptions (e.g., failures of suppliers or downstream customers).

While claims under these policies usually relate to physical property damage, businesses have submitted claims for COVID-19-related business interruptions.  For example, some precedent exists for claiming physical loss or damage if the property or building cannot be used for its intended purpose, and contaminants at a property (including pathogens like COVID-19) arguably constitute “physical” damage.  Still, policy exclusions should be carefully checked before pursuing claims.  Most business interruption policies expressly exclude epidemics and pandemics—because these events affect large swaths of businesses in a short period of time and are not geographically isolated.  In the absence of such exclusions, large-scale pandemics like COVID-19 would cause claims to rapidly exceed insurance company assets.

  • Suspension Agreements

Rather than wait for force majeure to actually prevent performance, parties can voluntarily suspend their obligations in a controlled manner with a suspension agreement.  Under a suspension agreement, performance is mutually suspended until the threat subsides.  Suspension agreements work well in situations such as COVID-19, where the duration of a threat and its impacts are uncertain.

Suspension agreements also work well for large enterprises facing a threat of force majeure to many different agreements at the same time.  Rather than individually dealing with force majeure across many contracts with varying terms, the enterprise can propose that all of its affected counterparties enter into the same suspension agreement. This can reduce the administrative burden and related legal costs of widespread force majeure claims.

  1. Special Situations: Special Situations: COVID-19 Force Majeure & Energy Construction/Services
  • Time-No-Money for Force Majeure

Most construction and services contracts contain “time-no-money” clauses for force majeure.  This means that even if a force majeure event has occurred, the contractor only receives additional time to complete the work—and no additional compensation due to force majeure.  In Pernix Serka Joint Venture v. Department of State, decided on April 22, 2020 by the Civilian Board of Contract Appeals, the U.S. State Department had engaged a contractor (Pernix) to construct a rainwater capture and storage system in Sierra Leone in 2013. During the project, the Ebola epidemic caused Pernix to suspend construction to protect the health and safety of its workers. Because the fixed-price contract allowed only for a time extension in the event of an epidemic, the court held that the State Department had no contractual obligation to reimburse Pernix for additional costs incurred related to the Ebola outbreak. The court rejected arguments that the circumstances constituted cardinal change or constructive change, reasoning that requiring performance exactly as stipulated in the contract could not fall into either category.

  • Dangers of Standby Compensation Clauses

COVID-19 presents unique challenges for construction and services contracts with standby compensation clauses.  Owners did not expect to pay standby fees for such a long period when agreeing to bear the risk of force majeure interruptions.  In terms of obtaining relief, an owner can argue that its contractor is required to mitigate force majeure by furloughing and demobilizing personnel and equipment.  Alternatively,  an owner can evaluate whether it is less expensive to terminate the contract altogether.

Going forward, drafters of construction and services agreements should draft delay or standby fee provisions to address prolonged shutdowns. Drafters should consider (i) including a cap on the duration of standby fees, which allows a contractor to be covered for finite periods of time; (ii) having standby fees decline as the event lengthens, which incentivizes contractors to quickly mitigate their exposure via furloughs and demobilizations; and (iii) excluding COVID-19 altogether from standby compensation.

  • Delay Liquidated Damages

Construction and services contracts sometimes include delay liquidated damages provisions, which provide for the payment of liquidated damages if work commences or is completed later than required by the contract. Although force majeure clauses sometimes exclude “payment of money owed,” it is important for parties to understand that such liquidated damages payments are not the same thing as “money owed.” If force majeure enabled, for example, an owner to escape paying for completed work, the owner would be unjustly enriched—it would have received the work and not had to pay for it.  Delay fees, in contrast, are liquidated damages for breaching a contractual covenant.  These delay fees are paid in place of regular damages that would otherwise be owed for breach.  If force majeure would have excused regular damages for delay, then it also should exclude delay-based liquidated damages.  See American Soil Processing, Inc. v. Iowa Comprehensive Petroleum Underground Storage Tank Fund Board, 586 N.W.2d 325 (Iowa 1998) (“we agree with the [defendant] that the district court’s construction of the Agreement renders the force majeure provision a nullity. Under the court’s construction, the force majeure provision would never relieve the Board from paying liquidated damages even though events within the force majeure provision occurred.”).

  • Quarantine-Related Shut-Downs

One of the principal COVID-19 issues facing the construction industry is a work shutdown due to an employee exhibiting COVID-19 symptoms, testing positive for COVID-19, or being exposed to someone who has tested positive for COVID-19.  In such cases, the entire construction crew may be quarantined for several days (a “Quarantine Suspension“).  If the project owner is responsible for paying a contractor’s standby costs for a Quarantine Suspension, the contract creates a moral hazard because it greatly reduces the contractor’s incentive to guard against its personnel being exposed to COVID-19 outside of the work place, including: (a) the nature of housing for its work force; (b) how people are transported to and from the work site; (c) the manner in which personnel take their meals; (d) whether or not curfews are in place to minimize exposure to others in the community; and (d) when and how often COVID-19 testing occurs.

If the project owner is contractually required to pay for a contractor’s COVID-19 standby costs, then the contractor is less incentivized to take such precautions (and is less likely to incur these costs).  Standby compensation for Quarantine Suspensions likely makes the workplace less safe by leading to more COVID-19 cases over the course of the project.  Applying the rule of moral hazard to owner’s personnel similarly would allocate the costs of a Quarantine Suspension to the project owner in cases where its own personnel cause the shutdown.  For example, if an owner’s inspector tested positive for COVID-19 and work was suspended as a result, the owner would be required to pay the contractor standby compensation.  This approach of “your watch, my watch” would allocate the costs of Quarantine Suspensions to the party whose personnel caused the suspension.

  1. Special Situations: COVID-19 Force Majeure & Wind Projects

The production tax credit (the “PTC”) provides a tax credit of 1-2 cents per kilowatt-hour for the first 10 years of electricity generation for utility-scale wind projects. To qualify for the PTC, project owners must either (a) “continuously” progress the project through to completion or (b) place wind farms into service by December 31 of the year four years after construction began. The latter safe harbor route is almost universally preferred due to the difficulty and uncertainty of proving “continuous” progression.  Due to a phase out of the PTC, wind projects commenced in 2016 qualify for 100% of the PTC, while those commenced in 2017 receive 80%, 2018 receive 60%, and so forth. As a result of this phase out, many wind projects were commenced in 2016. To obtain the PTC under the safe harbor, projects commenced in 2016 must be placed into operation by December 31, 2020.

Prior to COVID-19 disruptions, supply of key components including turbine blades and main bearings was already tight and many wind projects were at risk of delayed completion. Further supply chain disruptions have resulted from COVID-19 and may be compounded by delays due to the unavailability of construction equipment and workers at project sites.  Project owners facing tight schedules prior to COVID-19 now face a threat to project economics if force majeure causes a wind project in-service date to move beyond December 31, 2020.

The American Wind Energy Association is currently lobbying for the PTC safe harbor rule to extend from four years to six years for all projects commenced in 2016 through 2020. However, uncertainty surrounding this issue will likely continue as any change to existing law is more likely to appear in later COVID-19 economic relief packages than in earlier packages (if this change ever appears at all).  Project owners intending to utilize the full PTC for projects commenced in 2016 should review project timelines to determine what impact any COVID-19 related force majeure event will have on the projected in-service date. Owners should recognize that competition for critical components will increase as project teams contend more fiercely for scarce components as the December 31 deadline approaches. Projects with in-service dates beyond the safe harbor deadline may still qualify for the full PTC by establishing that the project has “continuously progressed” (if it has done so).

  1. Special Situations: COVID-19 Force Majeure & Solar Projects

The Investment Tax Credit (the “ITC”) allows owners of solar projects commenced in 2019 to deduct 30% of the cost of the project from future tax liabilities. The ITC declines to 26% for projects commencing in 2020 and 22% for project commencing in 2021.   Guidance from the Internal Revenue Service permits costs associated with an early 2020 delivery to count as incurred in 2019 if the project sponsor made the payment in 2019 and reasonably expected the equipment to be delivered within 3.5 months of the payment date. This exception allows project sponsors to receive the 30% ITC even though project components were only paid for – but not received – in 2019. Some project financiers required sponsors relying on this exception to represent that such equipment would actually be delivered within 3.5 months of the payment date.  Now that COVID-19 has delayed or prevented many shipments of solar components, project sponsors may be in technical breach of a warranty or covenant under their documents, even though tax rules only require the reasonable expectation of timely delivery.

The eventual scope of the COVID-19 outbreak was not a known risk at the end of December 2019. Accordingly, sponsors that made 2019 payments should be able to rely on reasonable expectations to qualify for 2019 ITCs, provided there are no other specific facts suggesting it would have been unreasonable to expect delivery within 3.5 months absent COVID-19. While sponsors making payments in 2019 likely still qualify for the 30% ITC under the 3.5-month rule, they should discuss the ITC qualification with lenders and investors immediately if delivery of components has been delayed beyond 3.5 months of payment.  The Solar Energy Industries Association also is requesting revisions to safe harbor guidance to allow all equipment delivered by the end of 2020 (for payments made in 2019) and 2021 (for payments made in 2020) to qualify as safe harbor equipment. It is unclear whether this proposal will be included in any stimulus package.

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Note that for purposes of brevity (and due to the repetitive nature of many COVID-19 force majeure articles), this compendium does not provide citations to the many articles reviewed.  The above descriptions are meant only to be brief summaries of issues raised by COVID-19, serving as a checklist and starting point for further research.  

About the Gaille Energy Blog. The Gaille Energy Blog (view counter = 144,924) discusses issues in the field of energy law, with periodic posts at Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development), and co-author of the award-winning travel compilation, Strange Tales of World Travel (Bronze Medalist, IPPY Awards for Best 2019 Travel Essay; ForeWord Magazine Finalist for Best Travel Book of 2019; North American Travel Journalists’ Honorable Mention for Best Travel Book of 2019).

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