COVID-19: Why is Force Majeure the Topic Du Jour?

During this pandemic, you are likely to see, and I have already seen, a major slow-down of the payment cycle for your obligors and the outright cessation of many businesses. New pipelines of business are on pause as well. Many factors and lenders have corresponding lines of credit or refactoring agreements, so this crunch cuts both ways. 

So, what is a financier to do? A number of mass emails, online articles and webinars have been published recently on this topic, and they mainly focus on the impact of the “force majeure” clause in your contracts. For an extremely in-depth analysis of that legal doctrine, see “So What’s Your Excuse? An Analysis of Force Majeure Claims,” by Jay D. Kelley; 2 Tex. J. Oil Gas & Energy L. 91 (2007).

After 20 years of representing the commercial finance industry through various natural disasters, in my opinion, 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 do). Regardless of what is in a contract, or whether the force majeure clause fails to refer to pandemics or government mandates, there is still an alternative common law and statutory defense of ‘impossibility,’ ‘impracticability,’ or ‘frustration of purpose,’ depending on the particular state law at issue (see e.g. Section 261 of the Restatement (Second) of Contracts; Centex Corp. v. Dalton, 840 S.W.2d 952, 954 (Tex. 1992); Article 2.615 of the UCC (applying to sales of goods); Article 79 of the United Nations Convention on Contracts for the International Sale of Goods).[1]   

“And to everything, there is an exception … except for some things.” This exception to performance, as the name implies, 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 defaulting party has exhausted all reasonable alternatives. The defense is also 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 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 cause of the breach.   

Regardless, you 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 walk into court and seek emergency injunctive relief is basically nil. 

Additionally, you would be hard pressed to evict someone during this time, or even hold a public foreclosure at the courthouse. It is true that most courts are still accepting electronic filings, with some exception, so lawsuits can be initiated, but there is a suspension of jury trials and most 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).  And process servers may find it difficult to pick up and hand deliver citations notifying defendants that you have sued them.  So, even where courts are available, this pandemic will likely cause a backlog to already slow dockets. 

Now, that doesn’t mean you should not initiate the process and get your case in the queue. It also does not mean you cannot effectuate self-help remedies and repossess equipment (absent bankruptcy, a court order or other government mandate to the contrary). And most of your contracts provide for the free ability to notify and renotify account debtors of the assignment of invoices.  They are your invoices, so you have the ability to seek collection and communicate with account debtors accordingly. This recent crisis simply means you should not expect immediate relief from the court system. 

Along those same lines, judges and juries have discretion, and they are likely to be sympathetic to companies that can tie, directly or indirectly, their non-performance to the economic impact of COVID-19.  And there is a reputational risk to consider. We have legal rights to enforce, but you are still vying for new business and when this event subsides (hopefully soon), those finance companies that were adding salt to wounds may find it difficult to get new business once the machinery of capitalism ramps back up.   

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 (not unlike landlords that are seeking rent while having to pay a mortgage). But if taking legal action is not going to help in the immediate sense, and if it could actually bring you disrepute and hurt you in the long run, you should proceed with caution. 

All of these principles apply only with respect to simple non-payment due to economic circumstances. They do not excuse other disputes and do not apply to a breach of warranty. Selling false invoices and dummy paper cannot be forgiven because there is a pandemic — lying is never protected by the defense of force majeure. And 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. 

On a related note, if your agreement has an early termination fee or a minimum volume requirement or utilization fee, as long as it can be reasonably tied to the pandemic, these defenses can hinder the ability to pursue collection of such fees. There are limitations to being able to capture these types of exit fees anyway, if they are viewed as overly punitive. See e.g. JMD Holding Corp. v. Cong. Fin. Corp., 4 N.Y.3d 373, 379–80, 828 N.E.2d 604, 609 (2005); see also UCC Section 2-718, and the IFA Code of Ethics Nos. 6 and 7, on dealing with incoming factors and obeying legal mandates).

While unreasonable termination fees may be viewed as unenforceable, there is some support for the position that minimum volume requirements are different, and therefore more readily enforceable (although still subject perhaps to the defenses discussed herein). See e.g. Am. Teleconferencing Services, Ltd. v. Network Billing Sys., LLC, 293 Ga. App. 772, 775, 668 S.E.2d 259, 262 (2008).

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 may trigger an anticipatory breach argument by the creditor. Instead, at least initially, you should therefore attempt to negotiate informally for an abatement, extension and/or reduced payments during this crisis (but only after discussing your specific situation with your attorney). 

While the defenses raised during this crisis are not unlimited and are not “get out of jail free cards,” they do allow the customer and account debtor an opportunity to hang their hat on a viable excuse. And regardless of the legal arguments that can be raised by both sides, factors would be wise to negotiate such matters as much as possible but would be equally wise to show little fear in vetting these defenses thoroughly and making the customer or account debtor prove it sufficiently. 

In short, factors and lenders 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). And what’s good for the goose isn’t always good for the gander. So, 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 would be prudent to remember that 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 clients I have spoken to have reported positive collections but are starting to see a decline and are expecting 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 and renotify and to 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 and government mandates, you should evaluate those defenses from both a practical and legal perspective.

And we should not ignore the human element at play here, nor should we ignore the fact that even during hard times, we all still have an obligation to fulfill our promises, unless circumstances are so far beyond our control that it is impossible to do so. And even then, the obligation returns once the crises end — and this too shall pass.

Wishing you optimal health, both physically and financially,

Jason M. Medley, Attorney

Clark Hill PLC

[1] The defense of ‘illegality’ is a different matter and not addressed here; the “Severability” clause in your factoring agreements (which states that if a provision in the contract is illegal, invalid or unenforceable, the remainder of the contract is not rendered void) should not be imparted in this situation; most “Material Adverse Event” clauses would not be imparted either, depending on how they are drafted; this is not to say defaulting parties won’t try to use these provisions to escape liability.