Covid-19 & Common Law Impossibility – Perfect Backup Partner?

COVID-19 and the ensuing economic fallout continues to ravage across the landscape as weeks of shutdowns and shelter in place orders have turned into months. While there is some glimmer that more economic activity is starting to resume, it is undeniable that the economic fervor and general sense of consumer and institutional confidence present at the beginning of 2020 has given way to tepid skepticism and paralyzing reticence. Such restraint, while arguably may have helped temper viral spread, has irrefutably been decimating on the world economy.

According to the United States Department of Labor, as of May 9, 2020, total unemployment claims filed in the U.S. since the beginning of the pandemic have risen to an unprecedented 36.5 million, not seen since the Great Depression of the 1930’s.[1] Indicative of the magnitude of the economic despair, once pillar business entities have been plunged into insolvency. In recent weeks, widely known names including: Gold’s Gym; J. Crew; Neiman Marcus; and Stage Stores (Gordmans, Bealls and Goodys) have all been left with no recourse other than to file for bankruptcy protection. Even telecom providers including: internet provider Frontier Communications and satellite operator Intersat have not been able to avert bankruptcy. [2] Many lauded analysts predict the pain will get worse before it gets any better, with an expected peak unemployment of some 25%. in the U.S.[3]

Given the current, and likely continuing lackluster business climate, invariably parties are going to be faced with the dilemma of being unable to fulfil contractual commitments once thought to be immutable. Even if parties can manage to still perform, the desirability and practicality of such performance may no longer be advantageous or reasonable. In our last blog article, we discussed how exercising of certain force majeure clause provisions of contractual agreements can provide a mechanism for parties to excuse performance in situations including the current pandemic. But what if the contract does not include such a force majeure clause? Are parties without recourse to discharge their obligations despite pandemic related externalities?

In fact, parties may have an alternate judicially recognized means to excuse their contractual duties. Contracts interpreted under Texas law, and many other jurisdictions, recognize and will generally excuse a party’s duties arising under a contract if the party seeking relief can establish impossibility of performance. This mechanism is referred to as the common law doctrine of impossibility. The application of impossibility of performance has been codified in Section 261 of the Restatement (Second) of Contracts which provides: “Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged…”[4] Essentially, the Restatement holds that a party does not have to perform if their performance is now unfeasible because of an ensuing event or non-event, not assumed at the time of the contract execution.

Texas courts have referred to the common law doctrine of impossibility as all of the following: impossibility of performance, commercial impracticability, and frustration of purpose.[5] Texas courts have traditionally applied impossibility defenses in three instances: (1) the death or incapacity of a person necessary for performance, (2) the destruction or deterioration of a thing necessary for performance, and (3) prevention by governmental regulation.[6] When examining applicability of the impossibility doctrine to COVID-19 induced concerns, clearly the third instance is the most applicable, which in effect “allows courts to read into a contract an escape clause that does not otherwise exist”[7]

The timing of the negotiation and execution of the contract in question will have key implications on applicability of an impossibility defense. The following key inflection dates in the pandemic must be considered. On Jan. 31, 2020, The United States Department of Health and Human Services declared a public health emergency for the United States before The World Health Organization classified COVID-19 as a pandemic on March 11, 2020. Beginning in mid-March 2020, much of the United States, if not the developed world, was subject to varying lock-down measures and most commercial activity was severely curtailed by government restrictions affecting most individuals and businesses. The above serving as a basis for potentially arguing prevention of contract fulfilment due to government regulation.

The most dispositive of the requisite factors to successful application of impossibility of performance can readily be satisfied for many, if not most, contracted obligations negotiated and executed before 2020. The most critical factor being that the party seeking relief is without fault by occurrence of an event that was unknown at the time of the contract execution. To the contrary, contracts negotiated and executed in early 2020, before the classification of COVID-19 as a pandemic but after its declaration as a public health emergency, are on less certain footing with respect to the required lack of foreseeability component to establishing impossibility. Contracts negotiated and executed after mid-March 2020 likely cannot be reasonably found to have been entered into without foreknowledge or foreseeability of COVID-19 related impediments to performance.

Some examples of situations where Texas courts have found events sufficient to excuse performance under common law impossibility include: excusing of a party’s obligation to pay a finder’s fee when a new government regulation promulgated prohibited such a payment[8] and excusing of a party’s contractual obligation to operate a nightclub or bar when the county in which the business was to be located later prohibited the sale of alcohol in the said county. [9]

Additional factors that will influence a court’s ruling on impossibility due to COVID-19 include:

• When the contract was negotiated;
• The facts and circumstances pertaining to the conditions and duties arising under the contract as known at the time of the contract’s negotiation and execution;
• When the event causing impossibility arose in relation to the above (the pandemic);
• Foreseeability of the impossibility event (the pandemic);
• Nature of the impossibility caused by the event (objective versus subjective, only objective impossibility is excusable, see explanation below);
• Whether the event (the pandemic), or its lack thereof, was an underlying assumption in the contract; and
• If the party seeking relief made a reasonable effort to still perform.

Subjective impossibility, which will not excuse an obligation under Texas law, refers solely to the inability of a party to perform.[10] Whereas objective impossibility arises “if the thing cannot be done,” i.e., inability to “perform the promise…”[11] For example, it would be objectively impossible to deliver a shipment of specified goods if someone else intervened and already delivered the said goods to the specified location. But it would be subjectively impossible to deliver a shipment of goods if the vehicle that was to deliver the goods broke down but alternate transportation was available. Critically, even if increased costs would make the deal unprofitable for the party charged with delivery of the goods, performance would still only be subjectively impossible and hence not excused.

Given the above underlying framework, how receptive will a court likely be to a party attempting to excuse their performance under a contract on the basis of the common law doctrine of impossibility caused by COVID-19? The crux of the matter is that we are navigating unchartered legal waters with respect to the current pandemic and its related fallout. However, we can reasonably deduce the following given the state of the common law impossibility doctrine as it currently stands. Assuming that the contract in question was negotiated and executed before 2020, it would be reasonable to expect a finding that the COVID-19 pandemic, ensuing economic fallout, and government-imposed shutdowns, were unforeseeable events by parties to the contract. Further, pertinent parties to the contract would reasonably be found faultless for the arising of the pandemic.

Finally, the establishing of impracticability of performance, will be a fact intensive inquiry specific and unique to the nature of the contract, and its contemplated duties and conditions giving rise to those duties. Texas courts require more than hardship or expense to establish impracticability. Performance must be foreclosed due to the unforeseeable event and well – impossible. Clearly some contracts will meet this definition of impracticability and some will not. For example, a contract to deliver food to a restaurant is not rendered impossible due to the pandemic, even though it may now be undesirable or more expensive due to extra safety measures, particularly if the said restaurant was not allowed to open for business due to government shutdown orders. The restaurant may not be able to sell the food to customers dining in the restaurant but the food could still be delivered. Hence, a party would not reasonably be able to argue impossibility of performance.

On the other hand, a contract to hold a convention at a local hotel in an area under quarantine and social distancing orders is now literally impossible to discharge as government regulation prevents the contracted act from occurring. Courts must also be satisfied that a party seeking relief has engaged in all reasonable efforts to abate the impediment to performance. In the given convention example, even the most proactive and diligent good faith efforts on the part of a party cannot overcome the regulations preventing the occurrence of the contracted event, serving to reasonably satisfy the obligation to reasonably remediate.

The coming months and years will see many COVID-19 based common law impossibility doctrine claims asserted as defenses to performance of contracted obligations. This area of the law and legal precedent will quite likely be greatly influenced, if not reformed, by recent events as these cases are adjudicated. We can expect precedent to evolve and expand to provide a more explicit legal framework for successfully invoking common law impossibility for pandemics. Until such time, parties seeking to discharge their obligations by way of common law impossibility should focus on tailoring their defense to establish lack of foreseeability, lack of fault, and preclusion from performance over and above added expense or difficulty in performing; all as a direct result of COVID-19.

[1] https://fortune.com/2020/05/14/us-unemployment-rate-numbers-claims-this-week-total-job-losses-may-14-2020-benefits-claims/.

[2] https://www.cnbc.com/2020/05/15/these-companies-have-filed-for-bankruptcy-since-the-coronavirus-pandemic.html.

[3] https://www.cbsnews.com/news/unemployment-rate-could-hit-25-percent-goldman-sachs-predicts/.

[4] RESTATEMENT (SECOND) OF CONTRACTS § 261 (1981).

[5] Tractebel Energy Mktg., Inc. v. E.I. Du Pont de Nemours & Co., 118 S.W.3d 60, 64 n. 6 (Tex. App.-Houston [14th Dist.] 2003, pet. denied).

[6] Id. at 65.

[7] Key Energy Services, Inc. v. Eustace, 290 S.W.3d 332, 340 (Tex. App. – Eastland 2009, reh’g.denied).

[8] Centex Corp v. Dalton, 840 S.W.2d 952, 955–56 (Tex. 1992).

[9] Merry Homes v. Chi Hung Luu, 312 S.W.3d 938, 947 (Tex. App.—Houston [1st Dist.] 2010, no pet.).

[10] See Grayson v. Grayson Armature Large Motor Div., Inc., No. 14–09–00748–CV, 2010 WL 2361432, at *5 (Tex. App.—Houston [14th Dist.] June 15, 2010, pet. denied) (mem. op.).

[11] Id.