The spread of COVID-19, and accompanying steps taken by state governments, has created a situation in which many businesses will, out of necessity, find themselves breaching contracts or suffering from a breached contract. While the breaching parties may not wish to breach these contracts, difficult financial straits may present no other option.
Two legal doctrines I expect will be invoked in any litigation that arises from the COVID-19 crisis are frustration of purpose and impossibility. Parties should be aware of the limitations of these defenses, as well as their required elements.
Frustration of purpose refers to situations in which performance of a contract becomes worthless to a contracting party. The classic law school example of this is a British case, Krell v. Henry, in which an individual purchases the right to use another individual’s apartment to view a parade. The parade was canceled, and the purchaser refused to pay for use of the apartment, as the purpose of using the apartment was frustrated. The court agreed and refused to uphold the contract.
The frustration of purpose defense has three required elements: (1) “the purpose that is frustrated must have been a principal purpose of that party in making the contract”; (2) “the frustration must be substantial”; and (3) “the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made.” Restatement 2d of Contracts § 265.
New Jersey courts have adopted the Restatement’s definition of frustration of purpose and have taken a rather strict approach to frustration of purpose. The Appellate Division, in JB Pool Mgmt., LLC v. Four Seasons at Smithville Homeowners Ass’n, Inc., 431 N.J. Super. 233 (App. Div. 2013) wrote that “[a] key facet of the frustration of purpose doctrine, as it is applied in this state, is that ‘relief from performance of contractual obligations on this theory will not be lightly granted.’” Id. at 248 (quoting A-Leet Leasing Corp. v. Kingshead Corp., 150 N.J. Super. 384, 397 (App. Div. 1977)). In JB Pool, a pool management company had agreed with a condominium association to provide lifeguarding and maintenance services. However, the pool ended up being closed for seven months due to a mold infestation. The association refused to pay service fees and the pool company sought those fees.
At the trial court, the trial judge instructed to jury on frustration of purpose, which the jury found did apply. The Appellate Division reversed for two reasons. First, it observed that frustration of purpose is an affirmative defense that had not been pled and that discovery had not been conducted with this defense in mind. Second, the trial judge, in instructing the jury, had failed to note language in the contract stating that “[t]here will be no reduction in charges of the contract amount for any closing.” Id. at 253. In other words, even if all the elements of frustration of purpose seem to have been met, the parties are still free to contract around the doctrine.
One can imagine ways in which frustration of purpose will arise in contractual disputes resulting from the COVID-19 outbreak. For example, just as in that classic law school example Krell, there is sure to be a deluge of dishonored contracts for halls, event spaces, food catering and the like that are simply not going forward due to restrictions on gatherings. These parties will assuredly argue frustration of purpose in refusing to pay for services that ultimately could not be rendered due to the ongoing state of emergency.
Impossibility—or impracticability—is essentially the inverse of frustration of purpose; instead of the purpose of the contract being made impossible, it is the actual performance of the contract that is impossible. Much like frustration of purpose, there are strict requirements that must be met to invoke this defense, namely the occurrence of a supervening event, the non-occurrence of which was a basic assumption on which both parties made the contract. Interestingly enough, the first example of impossibility or impracticability found in the Restatement involves the closing of a port due to a quarantine. Restatement 2d of Contracts § 261, Ill. 1. Clearly the Restatement contemplates the use of the defense of impossibility where delivery of goods has been made impossible by quarantine restrictions.
New Jersey courts have adopted this Restatement provision. See Facto v. Pantagis. 390 N.J. Super. 227 (App. Div. 2007). In Facto, a restaurant suffered a power failure in the middle of a wedding reception, making the performance of the contract impossible. However, as the Appellate Division noted, “[w]here one party to a contract is excused from performance as a result of an unforeseen events that makes performance impracticable, the other party is also generally excused from performance.” Id. at 233-34. In other words, because the restaurant could not provide the wedding reception for no fault of its own, the reception did not have to be paid for. Impossibility cuts both ways as a defense.
The impossibility defense is often embodied in contracts in what is known as a force majeure clause. While often these are open-ended, and cover any unforeseen events, sometimes they are tailored to a specific list of excusable events. What if quarantine or disease are not among those listed events? Indeed, the extremely unique nature of the instant public health crisis is unlikely to have been foreseeable to most drafters. However, New Jersey courts have held that the impossibility defense is still available, but the rule of ejusdem generis applies. Seitz v. Mark-Lite Sign Contractors, 210 N.J. Super. 646, 649-50 (Law Div. 1986). What this means is that courts will look to the other specified events in the force majeure clause—such as a reference to a state of emergency, for example—in determining its limits.
Finally, it should be noted that financial impracticability is not a defense. As the Restatement notes, “[t]he 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[.]” Performance is not impossible simply because the money to perform is no longer there. That said, there must necessarily be a limit to this principle—at some point extreme market conditions must be said to have exceeded “mere market shifts,” and it remains to be seen the financial fallout of our current condition.
These are indeed difficult times for individuals and businesses, and we are already seeing business disagreements on the rise. If you anticipate litigation related to business dealings, or are faced with contracting parties who are refusing to pay on their contracts, please contact us for a free consultation.
The above is general information only and not to be relied upon as legal advice. It does not create an attorney client relationship nor should it be relied upon as advice in lieu of consultation with an attorney.