What If You Can’t Fulfill Your Contract Obligations?by Michelle Bomberger | April 2, 2020
As COVID-19 continues to dictate workplace culture and operations, business owners struggle with fulfilling their contractual commitments to customers. With limited staff, facility closures, and constant uncertainty, you may find yourself asking, “What if I can’t fulfill my contract obligations?” It all comes down to prioritization – In challenging times, we need to prioritize contract compliance based on risk and relationships. Below, we’ll be discussing contract obligations, the right to amend or terminate contracts, and if Force Majeure is applicable.
Contract Basics & Risk Considerations
What is a contract? Simply put, a contract is a mutually agreed promise to do something in exchange for something of value. This promise is essential because it defines the obligations – what guarantees are made by each party. And all contracts will have different terms as to what your rights and obligations are. For example, some contracts, like the purchase of goods, are governed by the Uniform Commercial Code (UCC), which can provide additional context if there are no stated terms.
What contract risks should you consider? Your exposure and relationships can help guide how you prioritize contract compliance in challenging circumstances. Consider what the potential implications are in the decision to terminate or breach the contract (as that is always an option on the table). A breach feels wrong because it’s like breaking a promise, but in difficult times it can be the right thing to do. What should you look for in terms of exposure?
- Personal guarantees: Often leases and bank loans have guarantees, putting your personal assets on the hook. You want to avoid defaulting or breaching these contracts.
- Security interests: Basically, liens. Often, these are used to secure loans with a bank, other owners, or vendors of equipment.
- Liquidated or “special” damages: Specific damages called out in the contract to compensate a party upon breach.
- Dispute resolution procedures: May include mediation, arbitration and/or litigation. Consider what it will cost you to duke it out.
- Relationships: Don’t forget relationships! You want to take care of critical relationships.
What Contract Obligations Will You Be Unable To Meet?
With those contract basics and risk considerations, what ‘promises’ in the contract do you anticipate WON’T be fulfilled? Some examples include:
- Payment terms: Can you simply not make payments on time?
- Fulfillment quantities/timelines: Are there issues with supply chain, workforce availability, or shutdown?
- Other impacts on obligations: Will you fail to comply with other obligations such as reporting, registrations, security, or inspection?
If breaching the contract comes into play, consider the damages caused by the breach. BOTH parties have an obligation to mitigate damages, so one side can’t just sit back and let the damages accrue. Think about a Landlord – They must try to relet the space, not allow it to sit while pursuing the renter for payments. For each contract, understand how your actions impact others in the supply chain, determine in advance if there are alternatives to present as part of your discussions, and assist in minimizing damage to those other parties.
Amending or Terminating A Contract
What rights do you have to modify or terminate a contract?
Unless otherwise specified and agreed, amendments typically require mutual
agreement to change the contract. If you agree with a vendor or someone you’ve
contracted with to amend the terms, be sure you have written down those
changes and had both parties explicitly agree. An email with “Yes, I
accept/agree” is acceptable (although not ideal) if you do not formally execute
an amendment to the agreement.
The basis for termination is in contract’s specific termination terms.
Some examples may include:
- Specific term: Details about closing the
contract once the deal between parties has ended.
- Notice by either party: Formal statement
of termination from one party member to another. Be sure you satisfy the
specific requirements of legal Notice under the contract terms.
- For cause: Takes place if one party
cannot completely fulfill their contractual duties or cannot perform work in
accordance to the timeline in the contract.
- Fulfillment of the obligations: The
termination of a contract occurs at the completion of obligations addressed in
- If you can terminate based on the terms agreed
A contract is a mutually agreed promise. Thus, unilateral violation or modification of a contract is a breach since it’s one-sided. Specific unilateral or discretionary actions may be allowed under the contract but generally not for any material terms, such as termination, unless explicitly stated in the agreement.
What About Force Majeure?
A party’s failure to perform per contract specifications can be excused
by Force Majeure (or “Excusable Delay”), which is often described as Acts of
God but generally tries to cover events beyond your control. You’ve
probably seen a Force Majeure term in your contracts many times; however, the
specific words matter here. There isn’t standard Force Majeure language because
each situation is different. Because they are tailored to unique circumstances,
some may be clear while others are ambiguous. The declaration of a National
Emergency, specific bans on certain business activities, quarantine directives,
and stay at home/essential business only orders will likely trigger most Force
Majeure clauses. Legally speaking, to effectively trigger these provisions,
you’ll need to:
- Show the event has materially impacted or
rendered impossible the performance of the contract;
- Show the event falls within the definition of
Force Majeure or Excusable Delay; and
- Comply with any notice provisions or
pre-conditions (e.g., taking steps to mitigate its losses) specified by the
Force Majeure or Excusable Delay clause.
You need to look at the specific Force Majeure language in each
contract to evaluate it under the specific circumstances. Review each Force
Majeure provision for the following elements:
- Failures protected by Force Majeure
provisions: What failures are covered by the Force Majeure provision? And
whose failures – one side or both? Some Force Majeure provisions only include one
side of the equation, like protecting the Landlord but not the tenant from
default. Consider payment, fulfillment, and any/all obligations.
- Rights granted by Force Majeure provision:
What rights are you granted if you trigger Force Majeure? Some provisions call
out specific details, like a workforce shutdown. Often, it’s only an extension
of time and likely not monetary damages, unless you can explicitly show that
each party bears its costs associated with excusable delays.
- Notice Requirements: If Notice is
required, be sure you comply with the legal notice requirements in the
contract. Washington law strictly construes contractual notice requirements and,
if not done correctly, can threaten your rights if you fail to follow the
notice provisions precisely.
It’s important to understand that Force Majeure is a limited remedy, and there are many other factors that you need to consider.
If Force Majeure language is not written into the contract, there are additional legal doctrines that may be available, including the “Frustration” doctrine and the doctrine of impossibility. The Frustration doctrine is only available where the performance of the contract is truly impossible or commercially impractical, or whether there has been a change of circumstances so fundamental that it would be unjust to hold the parties to their original bargain. An extreme example would be if a construction site fell into the ocean, or a mineral required for a manufacturing project ceased to exist in the world. In these cases, performance is impossible and termination of the contract and release from all future obligations for the parties would occur.
What Should You Do About Contract Obligations?
Review the rights and obligations of each party under the contract, as this will help you identify risks in terminating or breaching the contract. Once you understand the risks, proactively take steps to mitigate those risks and reduce damages to the parties involved. Take action in full compliance with the contract terms and consider the impact of those actions on critical relationships. Keep open lines of communication and negotiate with open dialogue – remember, the carrot is often more effective than the stick.
We understand that business owners are facing many challenging decisions. We’re happy to help you with a risk assessment and a review of what rights you have. Contact us at 425-250-0205 or firstname.lastname@example.org.
Legal Disclaimer: This article contains general information and should not be viewed as legal advice. You should talk with counsel familiar with your unique business needs before taking or refraining from any action.