by Arash Beral
Contracting parties have been aflutter over their duties and obligations in the wake of the coronavirus pandemic. “Help! Can you help us get out of our contract?” has been a common refrain lately as has been (from the other side) “How could they possibly back out of our deal?” The onset of this pandemic has, in other words, thrust commercial contracts into a state of unprecedented uncertainty, forcing all parties to evaluate their options and determine how best to proceed in a suddenly uncertain world.
Indeed, while we field questions like these, we are mindful of the fact that there is no case or commercial precedent analogous to the circumstances surrounding the COVID-19 pandemic specifically. But the country has experienced shocks to the system before, and those historical circumstances can and do shed some light on how California courts may treat coronavirus-related contract cases in the future.
Take actor Gene Autry, for example. On September 22, 1938, Autry entered into an agreement to act in a series of western films. But from July 1942 through July 1945, Autry served in the Army thus affecting his ability to perform. During Autry’s military service, the production company continued to exercise its options for the production of additional films (apparently in an attempt to hold Autry to his contract after his military service concluded). Autry, for his part, disputed that his army service simply suspended the contract; rather, he contended that the contract was terminated altogether. He prosecuted that claim in an action for declaratory relief and, in 1947, the California Supreme Court issued Autry a resounding victory, holding that “there is no duty upon the plaintiff to perform services for the defendant after his discharge from military service.” Autry v. Republic Productions, Inc., 30 Cal.2d 144, 157 (1947).
Just down the road from Autry’s film set, in August 1941, an avid car dealer named William J. Murphy entered into a lease to launch an automobile dealership in Beverly Hills. Beginning in January 1942, however, the federal government began restricting the sale of new automobiles and Murphy’s business tanked. By March 15 of that year, Murphy closed up shop and vacated the premises altogether. The landlord sued for unpaid rent while Murphy contended that the contract should be terminated due to the federal government regulations. The California Supreme Court, however, was not as kind to Murphy as it would be to Autry three years later: “No case has been cited by defendant or disclosed by research in which an appellate court has excused a lessee from performance of his duty to pay rent when the purpose of the lease has not been totally destroyed or its accomplishment rendered extremely impracticable or where it has been shown that the lease remains valuable to the lessee.” Lloyd v. Murphy, 25 Cal.2d 48, 58 (1944).
So how did these cases reach different conclusions? We can derive the answer to that question from a body of law that is rooted in the landmark English law case, Taylor v. Caldwell. Since Taylor (which held for the first time that when a contract becomes impossible or impracticable to perform, the contracting parties are excused from their obligations), California courts generally tend to evaluate these cases in the following manner:
Initially, the courts will begin by determining whether the contract itself addresses the changed circumstances that gave rise to the dispute. Then, if (and only if) the contract is silent, the courts will determine whether the contract has become wholly impossible or impracticable to perform or whether its purpose is frustrated.
WHEN THE CONTRACT ENVISIONS AN UNFORESEEN EVENT
Many of today’s contracts contain “force majeure” (“superior force”) provisions: a clause that excuses performance when certain circumstances arise beyond a party’s control. If your contract contains such a provision, it should be reviewed carefully. Does it address epidemics, pandemics, disease, or “acts of God”? Does it contain other language that would apply to the events facing us today? If the answer is “yes” on any one of the preceding questions, the analysis then generally turns on whether: (a) today’s pandemic is beyond the reasonable control of the affected party; (b) the affected party’s ability to perform is prevented or impeded by the pandemic; and (c) the affected party took all reasonable steps to mitigate the consequences of the pandemic. If a party satisfies these factors, the affected party may be afforded an extension of time to perform, suspension of performance, or termination of the contract altogether depending on the circumstances.
WHEN THE CONTRACT IS SILENT
If the contract does not contain a “force majeure” or similar provision, litigants may still invoke the judicially-crafted doctrines of impossibility of performance or frustration of purpose. Impossibility may be invoked when an unforeseen event makes performing the contract extremely and unreasonably difficult or costly, and frustration may be invoked when an unforeseen event destroys the value of performing the contract.
The key questions in impossibility and frustration cases usually are: (1) was the unforeseen event actually unexpected (e.g., how far along was the pandemic); and (2) is the party claiming frustration or impossibility able to show not just the diminished benefit of performance or increased costs of performance, but complete destruction of the value of performance or an extreme and unreasonable increase in the cost of performance?
In the examples of the two World War II-era cases above, the Court’s differing treatment of Autry and Murphy rested precisely on how the Court analyzed these questions. The key issue for Autry was whether he would suffer sufficient enough hardship by suspending performance of the contract that it should be considered terminated. The Court answered that question in the affirmative, finding that any enforcement of the contract against Autry for an additional period – given an actor’s limited professional lifespan – constituted substantial hardship that, when compounded by the contract consideration being greatly lessened by the inflation that occurred as a result of the intervening event (World War II), warranted the termination of Autry’s obligations under the agreement.
In contrast, the Court determined in Murphy’s case that based on the circumstances at the time the lease was executed in 1941, Murphy could not establish that “the possibility of war and its consequences on the production and sale of new automobiles was an unanticipated circumstance wholly outside the contemplation of the parties.” The Court also held that “if governmental regulation does not entirely prohibit the business to be carried on in the leased premises but only limits or restricts it, thereby making it less profitable and more difficult to continue, the lease is not terminated or the lessee excused from further performance.”
These lessons from the past will help guide our future. Of course, each contract and the circumstances underlying each case is different. The guiding principles of these cases most certainly require, at minimum, a factual analysis into the timing, nature, and circumstances surrounding a specific contract. When was the contract entered into? Did the parties contemplate what would happen during a pandemic? Has the contract become completely impossible or impracticable to perform, or is it simply no longer profitable to perform?
Clients are advised to seek advice of counsel if issues like these are affecting them in light of today’s unfortunate circumstances.
This article is made available for educational purposes and to provide general information on current legal topics, not to provide specific legal advice. The publication of this article does not create any attorney-client relationship and should not be used as a substitute for competent legal advice from a licensed professional attorney.
Please feel free to reach out to any attorney in our Litigation Practice Group with any questions.