How Might the Government's "Stay at Home" Declaration Impact Contractual Relationships and Performance Obligations?

Fennemore Craig Client Alert

How Might the Government’s “Stay at Home” Declaration Impact Contractual Relationships and Performance Obligations?

With the disruptions caused by the COVID-19 pandemic, some State Governors, following medical recommendations intended to slow the spread of the virus, issued “Stay at Home” orders for all “non-essential” businesses and employees. Arizona’s Governor issued a “Stay at Home” executive order on March 30, 2020, and it is to remain in effect through April 30, with the possibility that it may be extended.

The Stay at Home executive order makes some contracts difficult or nearly impossible to perform. Therefore, questions abound as to how courts might interpret contract disputes that are likely to arise as a result of the disruption caused by the pandemic and related government actions. The purpose of this paper is to identify potentially applicable legal arguments that may excuse performance under a contract in the current circumstances. 

The primary legal arguments that may justify suspension of performance include: (1) Impracticability; (2) Force Majeure; (3) Frustration of Purpose; and (4) Impossibility. Because of the unique circumstances created by the Governor’s executive order to stay at home, there is little analogous case law directly on point. It is likely in the months to follow that many courts will be asked to apply these legal principles to the current events and will give greater clarity. This paper provides a general overview of the elements of each legal concept and how that may apply here. 

Of course, each contract is unique and both the language of the individual contract and the surrounding circumstances will impact how or whether these arguments apply.

A. IMPRACTICABILITY

Arizona recognizes the doctrine of impracticability as a basis to excuse contract performance. Impracticability looks to the industry as a whole to determine whether the contract has become commercially futile. Arizona courts follow the Restatement of Contracts regarding the doctrine of impracticability. See, e.g., 7200 Scottsdale Rd. Gen. Partners v. Kuhn Farm Mach., Inc., 184 Ariz. 341, 345, 909 P.2d 408, 412 (Ariz. App. 1995). The Restatement 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, unless the language or the circumstances indicate the contrary.” Restatement (Second) of Contracts § 261 (1981)¹. The doctrine of impracticability only applies where the party did not assume the risk. Thoracic Cardiovascular Associates, Ltd. v. St. Paul Fire & Marine Ins. Co., 181 Ariz. 449, 456, 891 P.2d 916, 923 (Ariz. App. 1994).

The standard applicable to a claim for impracticability “is whether performance was objectively unreasonable, i.e., whether ‘the industry as a whole found the specifications impossible.’” And that “[c]ompletion of the job must require so much beyond the parties’ contemplation that it becomes an exercise in commercial futility.” Willamette Crushing Co. v. State By & Through Dep’t of Transp., 188 Ariz. 79, 83, 932 P.2d 1350, 1354 (Ariz. App. 1997).

In Williamette Crushing Co., the plaintiff contractor won a state highway contract and completed the project on time, but with a cost overrun of $2.9 million, i.e., a 13% increase over the bid price. Id. at 81, 932 P.2d at 1352. The contractor attributed the overrun to inefficiencies with the Arizona Department of Transportation’s specified Traffic Control Patterns (“TCP”). Id. The parties submitted conflicting affidavits regarding whether another contractor could deliver on time and within budget. Id. at 84, 932 P.2d at 1355. The trial court found no application of impracticability where it was undisputed that the total cost of the project was within the bids received by the State from all but one of the contractor’s competitors, the contractor was allowed to deviate from the TCP, and the contractor performed on time. Id. Courts are generally reluctant to excuse performance based on economic hardship. The Arizona courts have not addressed impracticability in an analogous situation, but those in other jurisdictions have and these cases are instructive. Gulf Oil Corp. v. Fed. Power Comm., 563 F.2d 588, 599 (3d. Cir. 1977), cert. denied, 434 U.S. 1062, 98 S. Ct. 1235, 55 L. Ed. 2d 762 (1978) (impracticability is inapplicable where oil company will realize smaller profits or even suffer a loss, but not a “severe and unreasonable” loss); N. Ind. Pub. Serv. Co. v. Carbon Cty. Coal Co., 799 F.2d 265, 267 (7th Cir. 1986) (public utility was not excused from performing under a fixed price contract to buy coal under a theory of impracticability because the fixed price term is an explicit assignment of risk that a change in market price will disadvantage one party to the agreement).

The events surrounding the COVID-19 pandemic, including the Governor’s executive order, may serve as a rare example when impracticability can be successfully used to excuse contract performance because, in most instances, the resulting challenges to performance apply to industries as a whole. In most instances, the parties would not be assumed to have anticipated the events unfolding over the last several weeks and, to the extent contractual duties were impaired, an argument for impracticability may justify excused performance.

B. FRUSTRATION OF PURPOSE
Frustration of purpose exists if the reason for, rather than the duties in, a contract becomes nullified due to no fault of either party. Unlike impracticability, which may excuse a party’s duty of performance under certain circumstances, frustration of purpose, or “frustration of contract,” looks to the intent of the parties that entered the agreement and whether the purpose of the agreement has been impeded by some unforeseeable event. This doctrine “deals with the problem that arises when a change in circumstances makes one party’s performance virtually worthless to the other, frustrating his purpose in making the contract.” Kuhn Farm, 184 Ariz. at 345, 909 P.2d at 412 (quoting Restatement § 265 cmt. a). “Performance remains possible but the expected value of performance to the party seeking to be excused has been destroyed by a fortuitous event, which supervenes to cause an actual but not literal failure of consideration.” Id.

Frustration of purpose is an equitable doctrine, which “has been severely limited to cases of extreme hardship so as not to diminish the power of parties to contract, and . . . require[s] proof from the party seeking to excuse himself that the supervening frustrating event was not reasonably foreseeable.” Next Gen Capital, L.L.C. v. Consumer Lending Assocs., L.L.C., 234 Ariz. 9, 11, 316 P.3d 598, 600 (Ariz. App. 2013) (holding the doctrine was inapplicable to excuse a tenant payday loan establishment from rent obligations to the landlord after the expiration of the payday lending authorizing statute because it was reasonably foreseeable that the statute might not be extended and the parties could have contracted around this contingency).

Arizona courts also look to the Restatement with regard to frustration of purpose, which enumerates the following four requirements before relief may be granted:

First, the frustrated purpose must have been a principal purpose of that party and must have been so within the understanding of both parties. Second, the frustration must be so severe that it is not to be regarded as within the risks assumed [] under the contract. Third, the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made. And, finally, relief will not be granted if it may be inferred from either the language of the contract or the circumstances that the risk of the frustrating occurrence, or the loss caused thereby, should properly be placed on the party seeking relief.

Id. at 11, 316 P.3d at 600 (internal citations and quotations omitted). Moreover, “[p]roper application of the doctrine requires proof from the party seeking to excuse themselves from performance that the supervening frustrating event was not reasonably foreseeable.” B.F. Goodrich Co. v. Vinyltech Corp., 711 F. Supp. 1513, 1519 (D. Ariz. 1989) (citing Garner v. Ellingson, 18 Ariz. App. 181, 183, 501 P.2d 22, 24 (Ariz. App. 1972))². In B.F. Goodrich, the Court, applying Arizona law, held that frustration of contract was inapplicable because the take-or-pay provision within an agreement for the ongoing supply of resin to fabricate PVC pipe apportioned the risk of price fluctuations and changed market conditions between the parties. Id. at 1519–20. The inclusion of such a provision in the contract indicated that the parties understood market fluctuations as normal commercial risks that were reasonably foreseeable and took steps to apportion those risks. Id. Accordingly, one party “cannot now contend for purposes of its commercial frustration argument that a change in prices or market conditions was not a reasonably foreseeable event.”  Id.

1. A CLOSER LOOK AT THE KUHN FARM CASE

Although 7200 Scottsdale Rd. Gen. Partners v. Kuhn Farm Mach., Inc., 184 Ariz. 341, 909 P.2d 408 (Ariz. App. 1995) is not entirely analogous, it is factually similar in material respects so as to provide guidance here. In Kuhn Farm, a convention organizer contracted with a resort to use the resort’s facilities for a convention at which Kuhn’s European personnel were to present new products to Kuhn’s dealers and employees. The agreement contained remedies protecting the resort if Kuhn canceled the meeting. Id. at 343, 909 P.2d at 412. The resort filed suit against the convention organizer for failure to make payment for reserved facilities after the organizer cancelled the convention due to the Gulf War in Iraq. Id. Kuhn alleged that its performance was discharged pursuant to, among others, the doctrine of frustration of purpose, and the trial court granted summary judgment for Kuhn Farm. Id.

The Court of Appeals reversed after providing a substantive analysis of the doctrine of frustration of purpose, holding that: (1) both parties did not have a common understanding that the principal purposes of Kuhn Farm entering the contract was the assumption that European personnel would attend; (2) any risk of lack of attendance was expressly assigned to Kuhn Farm; and (3) the risk of perceived terrorism threats to air travel were not so severe as to not fairly be regarded as within the risks assumed under the contract.  Id. at 346–7, 909 P.2d at 415–17. 

Decisions from other jurisdictions generally have rejected a party’s attempt to avoid payment or other obligations based on changed market or economic conditions. See, e.g., Fargo Mgmt., LLC v. City of Worcester, No. 2012-1028C, 2014 WL 7466746, at *3 (Mass. Super. Nov. 21, 2014) (a near doubling in the market price of steel did not frustrate the principal purpose of a contract to build a bridge as price fluctuations are not beyond the contemplation of the parties); Drummond Coal Sales, Inc. v. Norfolk S. Ry. Co., No. 7:16CV00489, 2018 WL 4008993, at *14 (W.D. Va. Aug. 22, 2018) (finding no frustration of purpose where the “market for imported coal . . . ceased to exist” as a result of environmental regulations, holding that governmental regulations are foreseeable as a matter of law); Sabine Corp. v. ONG W., Inc., 725 F. Supp. 1157, 1179 (W.D. Okla. 1989) (holding that “the disparity between the contract price and the market value of [natural] gas [is not an] event or occurrence which frustrated the purpose of the contract” because the take-or-pay contract term assumed the risk of a change in price).

Although there are cases where government regulation is deemed to be an assumed risk of contracting, the circumstances surrounding the COVID-19 outbreak may not clearly fall into that category given that many states and the federal government issued executive orders and other regulations after declaring a state of emergency. Frustration of purpose may be particularly applicable where, for example, the issuance of the stay at home executive order and directives regarding social distancing resulted in the cancellation of large public events (e.g. sporting or entertainment events).  The availability and efficacy of this argument to excuse performance will depend on the language of the contract and the factual circumstances.

C. FORCE MAJEURE

Many contracts contain a “force majeure” clause that will address under what circumstances performance may be suspended or excused. “The concept of force majeure is an equitable legal principle pursuant to which a party to a contract whose performance has been made physically and/or economically impossible (or at least impracticable) due to circumstances totally beyond his control, can be given certain types of relief.” Russo v. Barger, 239 Ariz. 100, 102, 366 P.3d 577, 579 (Ariz. App. 2016). A force majeure clause serves as “insulat[ion] from damages based upon an act of God.” Tech. Const., Inc. v. City of Kingman, 229 Ariz. 564, 567, 278 P.3d 906, 909 (Ariz. App. 2012).

Again, courts generally hold that economic hardship does not equal inability to perform. “A force majeure clause is not intended to buffer a party against the normal risks of a contract. The normal risk of a fixed-price contract is that the market price will change.” N. Ind. Pub. Serv. Co. v. Carbon Cty. Coal Co., 799 F.2d 265, 275 (7th Cir. 1986) (holding that public utility was not excused from performing under a fixed price contract to buy coal under a force majeure term because the fixed price term is an explicit assignment of risk that a change in market price will disadvantage one party to the agreement). In Kyocera Corp. v. Hemlock Semiconductor, LLC, Kyocera, a producer of solar panels, contracted under a take-or-pay arrangement to purchase from Hemlock polysilicon that was used to manufacture solar panels. 886 N.W.2d 445, 447 (Mich. App. 2015). The Chinese government later provided illegal subsidies to Chinese companies and successfully aided those companies in obtaining 75% of the solar panel market, which precipitated a significant price decline for solar panels. Id. at 450. The United States government responded with a tariff on Chinese-manufactured solar panel components and the price of polysilicon increased dramatically, which created liabilities for Kyocera of nearly $2 billion. Id. The Court held that the force majeure clause did not relieve Kyocera of its obligations because Kyocera assumed the risk of market price shifts under the take-or-pay price term and the force majeure clause does not “excuse[] contractual performance resulting from unprofitability due to governmental market manipulation.” Id. at 453; see also Int’l Minerals & Chem. Corp. v. Llano, Inc., 770 F.2d 879, 885 (10th Cir. 1985) (government regulation did not prevent party from paying under the contract and, thus, force majeure clause did not excuse performance); Sabine Corp. v. ONG W., Inc., 725 F. Supp. 1157, 1172 (W.D. Okla. 1989) (holding there was no excuse for purchase of natural gas at the take-or-pay contract price because the force majeure clause contains an “unable to perform” clause, not an “unable to perform except at a loss” clause).

The applicability of a force majeure clause under the COVID-19 circumstances will be highly dependent on the language of any given contract provision.

D. IMPOSSIBILITY

Often referred to as impossibility of performance, this related contract avoidance doctrine provides that a party may be exonerated of its performance obligation where it “becomes impossible due to circumstances beyond the parties’ control.” Garner v. Ellingson, 18 Ariz.App. 181, 182, 501 P.2d 22, 23 (1972). “The doctrine of impossibility of performance dates back to the celebrated case of Taylor v. Caldwell, 3 Best & S. 826 (1863) wherein Caldwell was relieved of liability in damages for non-delivery of a music hall to Taylor because the hall had been destroyed by fire. Since that case the courts have grown increasingly liberal in their construing of what constitutes ‘impossibility.’” Minderman v. Perry, 103 Ariz. 91, 93–94, 437 P.2d 407, 409–10 (1968). The Supreme Court of Arizona articulated the rule as set forth in the Restatement of Contracts:

[W]here performance of a promise becomes impossible because of facts which the promisor had no reason to anticipate and for the occurrence of which the promisor is not at fault his duty is discharged unless a contrary intention has been manifested; and, more specifically, where the existence of a specific person is essential to the performance of a promise the duty to perform that promise is discharged if the person is not in existence at the time for seasonal performance, unless a contrary intention is manifested or the contributing fault of the promisor causes the nonexistence[].

Id. (quoting Restatement of Contracts §§ 457, 460). Although best invoked where the facts of the case indicate that performance is truly impossible, not just impractical, e.g., a famous musician is set to play a stadium concert, but unexpectedly dies the week before the event, the trend is to extend the doctrine from the truly impossible to cases of “extreme or unreasonable difficulty or expense” in the performance. Id. at 183, 501 P.2d at 24. But just as with frustration of purpose, courts often require “proof … that the supervening frustrating event was not reasonably foreseeable.” Id. Consequently, this doctrine is often pled as a defense in conjunction with impracticability (§ A) and frustration of purpose (§ B).

Thus, it is likely that impossibility will be a relevant theory in contesting contract performance during the coming months of fallout from the pandemic.

E. CONCLUSION

The application of these legal principles will be highly dependent on both the language contained in the contract and the surrounding circumstances. Courts are generally very reluctant to allow parties to cancel their performance obligations under a contract. The current circumstances, however, may present an opportunity for these principles to be applied in a way to mitigate the fallout caused by the unprecedented government actions.

If you have questions or would like to discuss your situation, please contact Doug Northup or Chris Gooch at Fennemore Craig.

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[1] But see id. at cmt. b (“The continuation of existing market conditions and of the financial situation of the parties are ordinarily not such assumptions, so that mere market shifts or financial inability do not usually effect discharge under the rule stated in this Section.”) (emphasis added).
[2] See also Mohave County v. Mohave–Kingman Estates, 120 Ariz. 417, 422, 586 P.2d 978, 983 (Ariz. App. 1978) (“[W]hile Arizona recognizes the doctrine of commercial frustration, . . . we do not see fit to interpret it as a general absolution whenever performance under the contract becomes difficult or expensive.”) (holding that frustration of purpose is inapplicable to a risk in the change of zoning ordinances because such changes are foreseeable).