When should the Covid-19 pandemic — or the restrictions imposed in its wake — excuse you from a contract? The courts have been struggling with this issue for months now, and the answer until recently has been ... almost never.
That’s in keeping with a long US tradition under which each party to a contract essentially bears the risk of its own promises. But there have been calls for change, and some judges may be listening.
Which might cause problems of its own.
Let’s start with a bit of history. This fall, like many other law professors who teach contracts, I added to my course a 1918 decision called Hanford v. Public Fair Association, which arose during the 1916 polio pandemic that would eventually kill 6,000 people, mostly children, across the US. An entrepreneur who had planned to put on a “baby show” canceled the event and was sued by the property owner who’d expected to make money from the lease. The court ruled for the entrepreneur on the ground that putting on the show would have been dangerous to public health.
That was then; this is now.
In the explosion of litigation related to Covid-19, cases on breach of contract have gone poorly for parties pleading the pandemic as an excuse. Unlike courts in many other developed countries, the US judicial system tends to enforce contracts as written when the excuse for breach boils down to: "Things have changed, and the deal is less profitable than I expected."
Consider, for example, the flood of lawsuits challenging clauses in business interruption insurance that exclude losses due to virus. So far, courts have ruled for the insurers against claimants as diverse as mattress stores, medical practices, restaurants, and day spas. The message is that it’s up to the businesses that want insurance against pandemic losses to make sure their contracts provide it. Otherwise, they’re demanding reimbursement for risks they’ve never paid the insurers to assume. This is particularly true given that, as I’ve noted before, insurers have long offered policies specifically designed to deal with pandemics; there just haven’t been many takers.
For similar reasons, retailers feuding with their corporate landlords have fared poorly. Courts across the country have held that the pandemic does not excuse commercial tenants from paying rent. Nor is the pandemic a justification for escaping a retail lease entirely. On the day before Thanksgiving, the Court of Appeals of Indiana upheld an injunction preventing Abercrombie & Fitch from permanently closing its locations in malls owned by Simon Property Group. Abercrombie had tried to escape its leases, citing “the current uncertainty regarding the impact of COVID-19,” but the panel required the stores to stay open as the parties worked through their dispute.
Even in notably pro-tenant New York City, the courts have expressed concerns about the pandemic defense. In another Thanksgiving eve decision, Federal District Judge Ronnie Abrams dismissed a lawsuit by landlords who claimed that new rules protecting residential and commercial tenants against “harassment” during the pandemic caused “severe economic harm by impeding their ability to profit from their properties” and therefore violated the Contract Clause of the US Constitution. But the decision was less pro-regulation than it might seem. Judge Abrams agreed that landlords have a right to make money, and cautioned that her decision rested on an interpretation of the rules as in no way interfering with the right of landlords to make “routine demands for rent.” In other words, for Covid-19 rules to survive constitutional scrutiny, they can’t become a sword used to prevent all efforts by landlords to get tenants to pay what they owe.
But change may be on the horizon. On November 30, the Delaware Court of Chancery handed down what is believed to be the first major decision allowing a business to back out of a deal because of Covid-19. South Korea’s Mirae Asset Global Investments Co. was excused from its $5.8 billion agreement to purchase 15 hotels from China’s Dajia Insurance Group on several grounds, among them that the pandemic had led Daija to make significant changes to operations, violating a clause requiring continuation of the “ordinary course of business” until the transaction closed.
The decision isn’t necessarily a bellwether, but the outcome suggests that the courts might be starting to pay attention to a growing, thoughtful literature arguing for a more sympathetic approach to pandemic-based claims in contract cases.
Whether that would be a problem depends on how one thinks about risk. Consider the 1918 Hanford case with which we began. Although a polio pandemic would certainly justify cancelling a “baby show,” the court still had to decide which party should bear the risk of loss. The dissent argued that the risk should rest on the party who promised to pay, unless that party specifically guarded against the possibility in the contract.
This traditional approach often seems unfair, but it possesses the singular virtue of clarity. The parties generally know going into the deal who will have to pay should an unanticipated risk arise. They also know that they should negotiate to cover as many contingencies as possible.
Perhaps it’s time to alter those rules. Let’s just be careful not to leave matters so unpredictable that only litigation can sort them out.
Bloomberg
