COVID-19: Why is Force Majeure the Topic Du Jour?
Jason Medley of Clark Hill discusses the recent focus on “force majeure” clauses in contracts and proposes a more important practical reality regarding the state of commercial finance.
BY JASON M. MEDLEY
During the COVID-19 pandemic, we are experiencing a major slowdown of the payment cycle for obligors and the outright cessation of many businesses. Many factors have corresponding lines of credit or refactoring agreements, so this crunch cuts both ways.
What is a financier to do? Much of the focus has centered on the impact of the “force majeure” clause in contracts. This focus is too myopic. Most factoring agreements and commercial loan agreements do not even have specific force majeure clauses like many commercial lease agreements or other performance-based contracts.
Regardless of what is in a contract, or whether the force majeure clause fails to refer to pandemics or government mandates, an alternative common law and statutory defense of “impossibility,” “impracticability” or “frustration of purpose” still exists, depending on the particular state law at issue. This exception to performance can create an excuse for breaching a contract, but only if it is impossible to perform through no fault of the defaulting party, and after the exhaustion of all reasonable alternatives.
The defense also is limited if the event was something that could have been reasonably anticipated. The defense of impracticability and frustration of purpose are easier to prove, in theory, but they are not available in every state, and in some states, they are just interchangeable terms with no real distinction. Importantly, these defenses are not always available if the parties anticipated certain events and therefore added a force majeure clause. In other words, these catch-all defenses may not even be available if there is a force majeure clause in the contract, or if there are other reasons for the breach.
Regardless, factoring companies can’t ignore the practical reality that courts are temporarily ineffective or, in some cases, entirely unavailable. For example, during this event, while electronic recording of financing statements seems unaffected (as of the time of this writing), the ability to seek emergency injunctive relief in court is basically nil. Additionally, you would be hard pressed to evict someone, or even hold a public foreclosure at the courthouse.
Most courts are accepting electronic filings, with some exception, so lawsuits can be initiated, but jury trials are suspended and oral hearings are shifted to submission dockets, meaning the judge will take it under advisement with written briefs instead of listening to oral arguments, unless they offer telephonic or video hearings. Plus, process servers may find it difficult to pick up and hand deliver citations notifying defendants. Even where courts are available, this pandemic will likely cause a backlog to already slow dockets.
PROCEED WITH CAUTION
Now, that doesn’t mean you should not initiate the process and get your case in the queue. It also doesn’t mean you are barred from effectuating self-help remedies and repossessing equipment. Most contracts provide the free ability to notify and renotify account debtors of the assignment of invoices. They are your invoices, so you can seek collection and communicate with account debtors accordingly. This recent crisis simply means you should not expect immediate relief from the court system.
Similarly, judges and juries have discretion, and they are likely to be sympathetic to companies able to tie their non-performance to COVID-19’s economic impact. There is a reputational risk to consider as well. We have legal rights to enforce, but you are still vying for new business, and when this event subsides, finance companies that added salt to wounds may find it difficult to get new business.
This is not to say we should disregard our rights and convert to being charitable entities. We are in business to make money, and we have our own lines of credit and refactors that will likewise be demanding payment. But if taking legal action is not going to help in the immediate sense, and if it could bring you disrepute and hurt you in the long run, you should proceed with caution.
These principles apply with respect to simple nonpayment due to economic circumstances. They do not excuse disputes based on the failure to provide goods and services as promised. These defenses do not apply to a breach of warranty. Selling false invoices and dummy paper cannot be forgiven because of a pandemic — lying is never protected by the defense of force majeure. If the reason for nonpayment precedes the pandemic, that will certainly help negate the defense. In most cases, failing to provide quality goods and services cannot be blamed on the government mandate to engage in social distancing.
The defense not only applies to the account debtor’s inability to pay but also may be asserted by the factoring customer with respect to its ability to satisfy the recourse obligations. Additionally, if the factoring agreement has an early termination, minimum volume or utilization fee, as long as it can be reasonably tied to the pandemic, the defense of impossibility or force majeure can hinder the ability to pursue collection of these fees. There are limitations to capturing these types of exit fees if they are seen as overly punitive.
If your company is the borrower under a line of credit or subject to a refactoring agreement, and if you anticipate a potential inability to pay as a result of downstream economic issues, you should seek counsel promptly and review your credit agreement for any applicable provision. You and your counsel should discuss putting your own creditor on notice of the above defenses, being mindful that it will trigger an anticipatory breach argument by the creditor. Therefore, at least initially, you should attempt to negotiate informally for an abatement, extension and/or reduced payment during this crisis instead.
NEGOTIATE & VERIFY
While the defenses raised during this crisis are not unlimited and are not “get out of jail free cards,” they do allow customers and account debtors an opportunity to hang their hat on a viable excuse. Regardless of the legal arguments that can be raised by both sides, factors would be wise to negotiate such matters as much as possible. They would be equally wise to show little fear in vetting these defenses thoroughly to make the customer or account debtor prove them sufficiently. Factors should still pursue their rights and claims for payment, just with the reduced expectation of seeing swift or sweeping relief from the court system and being mindful of the reputational risk of being too unforgiving. Be careful about the arguments you assert in writing to defeat these defenses against your customers and account debtors; your own lenders and financiers may say the same to you.
While the topic du jour is force majeure, creditors should remember debtors will be tempted to cut corners or even commit fraud when they find themselves in a tight spot such as this. Most of the factors I have spoken to reported positive collections but expected a severe decline to begin shortly. Your customers may find it too easy to accept a merchant cash advance, or they may doctor up an invoice or intercept account debtor payments. Now is the time to reverify, renotify and implement strict controls.
In closing, there is no doubt that the health and well-being of our nation is of utmost importance, but our physical vitality is dependent in large part on our economic viability. A crisis is often misused by defaulting parties. As those parties who are responsible for payment start to raise defenses based on the coronavirus pandemic, factors should evaluate those defenses from practical and legal perspectives. We should not ignore the human element at play here, nor should we ignore the fact that even during hard times, we still have an obligation to fulfill promises, unless circumstances make that impossible. Even then, the obligation returns once the crisis ends, and this too shall pass.
Jason M. Medley is an attorney at Clark Hill.