Force Majeure, MAC Clauses & COVID-19: A Court Speaks to Every Commercial Tenant in the United States

Why You Should Include a Force Majeure Clause in Lease Agreements

 

 

The Northern District of Illinois delivered a victory last month for a tenant who could not operate its leased space as contemplated at the time it entered into the lease (and as it had been operating up until COVID-19), because continuing to operate normally would have violated an order issued by the Governor of the State of Illinois. The case in which this ruling was issued is In re Hitz Restaurant Group, 20 B 05012 (June 20, 2020), and the presiding judge is Bankruptcy Judge Donald Cassling. 

Hitz received a lot of press, because it broke new ground as we discuss here. However, our focus is to: 

• Provide you with an easily understood overview of how to view force majeure clauses when negotiating for rent relief for obligations already in default; 
• Explain how to negotiate these force majeure clauses in lease agreements and other contracts; and
• Briefly compare force majeure clauses with the legal concept of material adverse change. 

Force Majeure in Plain English

If you are a commercial tenant whose business has been hurt by COVID-19, then you have likely become acquainted with the legal doctrine of force majeure. If not, then you should be. The executive summary of what force majeure is, in short:

• It is originally a French term that literally translates as “greater force.”
• As a legal concept, it first developed in France.
• The term “act of God” is often used to mean the same thing.
• In essence, the doctrine means that a party to a contract should not be held to its obligations under that contract if the party cannot perform those obligations due to unavoidable circumstances that have nothing to do with the parties to that contract.
• The doctrine is not, by any means, limited to leases. It can apply to any contract.¹

Material Adverse Change and Material Adverse Effect Provisions

As discussed in the earlier article,² some agreements contain provisions that permit a party to an agreement to not perform or to terminate the agreement altogether upon the occurrence of certain events that can reasonably be expected to result in a material adverse change (“MAC”) or material adverse effect (“MAE”) on the business or its prospects.³ 

The analysis and considerations around MAC and MAE clauses are almost identical to those with respect to force majeure clauses. It’s the context that is different. That is, one usually sees MAC and MAE provisions in the M&A and financing contexts (and they are commonly relevant only between the time between the signing of a transaction agreement and the closing of the transaction), whereas force majeure provisions are commonly seen in most other contexts. But don’t let this general rule fool you; the names of provisions don’t matter nearly as much as their actual terms (“a rose by any other name,” you know?). In any event, because they have different names and arise in different contexts, two distinct bodies of case law developed—one for MACs and MAEs and another for force majeure. But if one actually delves into both bodies, one can readily see that their similarities far outweigh their differences (so much so that much of each body of law makes frequent mention of the other).

Need for a Force Majeure Clause

The legal doctrine of force majeure is just that—a legal doctrine. A theory. A concept. To be used, force majeure clauses must be included as contractual provision within the applicable contract at issue.⁴ Your right to invoke force majeure as a defense for not performing your duties under a contract (including, of course, a commercial lease) in 49 of the 50 United States only exists if that right is explicitly provided for in your contract. (Under Louisiana law, always the outlier, force majeure can be invoked whether or not your contract provides for it.)

Drafting a Force Majeure Clause

Force majeure clauses, until COVID-19 hit, were often relegated to “generic boilerplate” status. What we mean is this: whether a contract included a force majeure clause and the terms used for such provision were largely dependent on the precedent document or template used to create such agreement, without much thought, review, or negotiation.⁵

We looked back at a number of contracts we have litigated over in the past, so we could provide a couple of “typical” force majeure clauses we have seen other attorneys draft (we intentionally are not sharing examples of force majeure clauses we have drafted, because ours are far more detailed and often bespoke). Here are a couple that are quite common:

• “Neither party shall be liable to the other for any failure or delay caused by events beyond their reasonable control, including sabotage, war, terrorist activities, or labor disputes.” (This is an example of a broadly drafted provision.)
• “Notwithstanding anything to the contrary herein, neither Party will be liable for any failure or delay in performing an obligation under this Agreement that is due to any of the following causes, to the extent beyond its reasonable control: acts of God, accident, riots, war, terrorist act, national strikes, fire, explosion, and generalized lack of availability of raw materials or energy. (This is an example of a narrowly drafted provision.)

Broad or Narrow?

As explained in the earlier article, “force majeure clauses may be written broadly (i.e., stating that anything affecting performance that is out of control of a party is a force majeure) or more narrowly (i.e., by listing specific events which constitute force majeure, for example ‘war,’ ‘acts of government’’ or ‘disease’)…” 

As you can see, the first example is drafted broadly, and the second is drafted narrowly. A fundamental problem (or benefit, depending on your perspective) with drafting broadly is that it kicks the can down the road in terms of whether a specific event will be considered as triggering force majeure. In other words, the vagueness means more uncertainty about whether a court will later deem an event a force majeure if the parties to a contract later litigate over the question.

On the other hand, narrow drafting (i.e., defining what events qualify by reference to an exhaustive list) can result in an event not constituting a force majeure even if that event may appear objectively as a force majeure.

As a party to a contract, should you prefer a broadly or narrowly tailored force majeure clause? As the expression goes, where you stand depends on where you sit. So, if you are the party who benefits from the continued performance of the contract by both parties no matter what may happen, then you ought to prefer, in the following order:

1. No force majeure clause at all (unless the contract is governed by Louisiana law, in which case you will want to include an explicit waiver of the right to call a force majeure, to the extent permitted by law).
2. A narrow force majeure clause, particularly, one that lists the smallest number of events that will be deemed to constitute force majeure.
3. A broad force majeure clause (but only if the other party insists and the contract otherwise would not be executed), to kick the can down the road as touched on above.

 

On the other hand, if you are the party who is more likely to find it difficult to perform should circumstances beyond your control change, then you should try to negotiate a force majeure clause that is as broad as possible and which includes a non-exclusive (i.e., you need “Including but not limited” to language) list of specific events that will be deemed to constitute a force majeure. The following is drafted in a way that is very favorable to a party who is concerned about being unable to perform in the event of circumstances beyond its control:

“Neither party shall be liable to the other for any failure caused by events beyond its reasonable control. Such events are deemed to include but not limited to the following circumstances: sabotage, war, terrorist activities, labor disputes, civil unrest, government action (i.e. any law, regulation, or order), pandemic, or epidemic.” 

Whether you can get the other side to agree to this is another question, though as with so many contract terms, it will come down to who needs whom more, right?

“Including but Not Limited to” is Not a Cure-All

This “including but not limited to the following” language, to be clear, is not a cure-all for those who would seek to use it to include anything and everything that might render performance outside a party’s control. Courts often reject such an attempt by applying a doctrine known as ejusdem generis. 

Under this doctrine (which is Latin for “of the same kind”), courts will limit a force majeure clause to events or things of the same general nature or class as those specifically enumerated. In such instances, the catch-all provision is often neutered, thus excusing performance only for the types of hardships expressly delineated.⁶

Regarding specific examples, needless to say, the more examples of events you include as being deemed force majeure events, the better. We’re not suggesting you engage in an exercise of creative writing in which you try to list every conceivable event under the sun. Rather, think situationally specific.

If, for example, your company is negotiating a supply agreement for the delivery of chemicals in Canada over a period that would include the winter, you may want to include as a specific force majeure event, akin to “snow in excess of 20 inches in a period of less than 48 hours” or “the issuance of a snow advisory alert by any radio or television station for any of the following counties…”. 

Notice here, two things: 

• We didn’t suggest you simply include “bad weather” as the force majeure event. 
• We made a point of not stating in this example whether you are the supplier or the recipient of the chemicals. This is because, generally speaking, clarity is generally better than ambiguity, regardless of your position.

Force Majeure & Today’s Commercial Tenant

A problem from the perspective of the commercial tenant seeking to invoke force majeure is that many commercial leases have narrow force majeure clauses in the lease agreement, with only specifically listed events constituting a force majeure. And, it is (or at least was, prior to COVID-19) quite uncommon for a force majeure clause to list a global health emergency, pandemic, epidemic, government lockdown or quarantine as a force majeure event. 

In re Hitz Restaurant Group

With the foregoing as background, let’s discuss In re Hitz Restaurant Group. 

Hitz Restaurant Group (“Hitz”) operated a restaurant, from a leased location in Chicago. Hitz did not pay its rent for February 2020, and on February 24, 2020, Hitz filed for chapter 11 bankruptcy. Hitz then did not pay any of its post-petition rent for March, April, May, or June, relying on the force majeure provision of its lease. In pertinent part, the force majeure clause stated:

“Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by . . . laws, governmental action or inaction, orders of government. . . . Lack of money shall not be grounds for Force Majeure.”

Judge Cassling found that the force majeure clause was unambiguously triggered on March 16, 2020 by Ill. Exec. Order 2020-7⁷ §1 issued that day by Governor Pritzker (which suspended the ability of restaurants and bars to provide on-premises services or consumption, but allowed for take-out, curbside pick-up, and delivery), because the Executive Order was both a “governmental action” and an “order of government” as contemplated by the lease’s force majeure clause. Judge Cassling wrote that the restrictions under the Executive Order were the proximate cause for Hitz’s nonpayment of rent, “at least in part, because it prevented Debtor from operating normally and restricted its business to take-out, curbside pick-up, and delivery.” 

Judge Cassling addressed the force majeure clause’s specific exclusion of a “lack of money” from constituting a force majeure by noting that the exclusion conflicted with the categories of “order of Government” and “Governmental action.” He explained that since the latter were more specific, they should control. In other words, he concluded that since the lack of money to pay rent was caused by governmental action, the fact that “lack of money” was explicitly excluded as a force majeure was irrelevant based on standard contractual interpretation grounds.⁸

Because Hitz was not prevented from operating entirely, Judge Cassling went on to consider what percentage of the rent Hitz should be responsible for paying. He determined that since the kitchen occupied about 25% of the leased premises and the dining area the rest, and since the restaurant could have continued to provide carryout from the usable kitchen, Judge Cassling held that 75% of rent should be excused under the force majeure clause, with the remaining 25% of rent payable to the landlord.

While this decision on its face appears to be a panacea to the blight of restaurants, our view is that its effect will likely be more muted and have limited precedential value. First, the landlord missed two key arguments that certainly would have helped its case and may have affected Judge Cassling’s ruling. Namely, the landlord could have and should have pointed out that the Executive Order in question specifically stated that it did not excuse rent payments. The landlord also should have emphasized that the lease itself provided that the payment of rent was an independent covenant. Second, the holding of a partial force majeure in this case was tied not to the overall pandemic itself, but to the specific terms contained within the force majeure clause dealing with government actions and government orders. In our experience, it is uncommon for commercial leases to include such actions as force majeure events. 

As of the date of this article, the ruling in Hitz has not been appealed and may never be, given that the amount at issue may not be substantial enough to justify the cost.

Cases Subsequent to Hitz

Many courts throughout the United States are being asked to address the issue of whether the current pandemic and related government orders should trigger the force majeure clauses in commercial leases. 

For example, the United States District Court for the Eastern District of Louisiana, in Richards Clearview, LLC v. Bed Bath & Beyond, Inc., is currently reviewing whether the Governor of Louisiana’s executive order in response to COVID-19 constituted a force majeure event that justified the withholding of rent. CV 20-1709, 2020 WL 3960372 (E.D. La. July 13, 2020). 

The substantially equivalent argument is being made by the debtor in the case of In re Alamo Chandler, LLC, et. al. 2:20-bk-05017-DPC in the United States Bankruptcy Court for the District of Arizona, where the debtor has argued that the Executive Orders in State of Arizona trigger a force majeure under its lease thereby providing the tenant the right to withhold rent for a movie theater it is not currently able to operate.

As another example, in In Re Republican Party of Texas, Relator, 20-0525, 2020 WL 4001050 (Tex. July 13, 2020), the Supreme Court of Texas held that Houston First Corporation could terminate its contract with the Republican Party of Texas to hold its convention at the George R. Brown Convention Center by invoking the force majeure clause of the contract due to coronavirus concerns. 

The force majeure clause at issue In In Re Republican Party of Texas contemplated that either party could terminate its obligations under the agreement “due to Force Majeure to the extent that such occurrence is beyond the reasonable control of the party whose performance is effected [sic],” “[p]andemics affecting Houston or preventing use and occupancy of the [Convention Center],” and “orders materially and substantially restricting the size of the gatherings at the Facility.” The Republican Party attempted to argue that it had a constitutional right to hold a convention, but the court nevertheless ruled in favor of Houston First Corporation by relying on the force majeure clause holding that the “use of the Center for its Convention is under the terms of the parties’ Agreement, not a constitution.” Therefore, while the Republican Party did have the right to engage in electoral activities, “those rights do not allow it to simply commandeer use of the Center.” 

Force Majeure and Personal Guarantees

A very important question is whether a force majeure event will relieve obligations under a personal guarantee (or, for that matter, under a guarantee issued by a parent company or anyone else). The answer may depend on whether the guarantee is absolute or conditional. To clarify the point, assume that you have an agreement with Barney, and Fred agrees to guarantee Barney’s obligations under that agreement:

1. If Fred guarantees that you will be paid no matter what, you may call that an “absolute guarantee.” Sometimes this is called a “payment guarantee.” If Fred gives you one, then you can demand that Fred pays you immediately upon Barney’s default; you do not need to first try to collect from the Barney. 
2. On the other hand, if you get a “conditional guarantee” from Fred then he is guaranteeing that if Barney defaults, if you sue Barney, if you win, and if you try to collect- and Barney still doesn’t pay you, then Fred will. Sometimes this is called a “collection guarantee.”

 

Can you see why a force majeure event is far more likely to protect a party who gives a conditional guarantee than one who gives an absolute guarantee?

Business Interruption Insurance

If you are looking to invoke a force majeure provision as your company’s possible salvation, then you also want to review your insurance policies.  

Closing Thoughts

Your bottom-line take-aways from this article should be:

• If you need out from a lease or other contract because of COVID-19 (or for any other reason), consider whether force majeure can help. 
• Going forward, make sure your attorney discusses force majeure with you when you are negotiating a new lease or contract.
• More detailed force majeure provisions are generally better than less detailed ones.
• Keep in mind that force majeure may relieve your company of liability under a contract but even when that is the case, it may or may not help relieve a personal guarantor of that contract of personal liability.
• Don’t forget about insurance you may have that may help.

 

Finally, if all else fails, a corporate restructuring attorney may be your best bet. 

 

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Insider Lease Agreements and The Commercial Tenant’s Perspective.]

 

1. It is sometimes stated that an event must be unforeseeable for it to be a force majeure. This is simply not the case unless the force majeure provision at issue states it must be. This is only logical, given that when a party lists events that would constitute a force majeure, that party has obviously foreseen the possibility that they may occur.

2. Financial Poise, the sister website of this publication, published one of the first articles written by any attorney in the United States to analyze the likely application of force majeure clauses by courts on commercial leases and other contracts in the context of COVID-19. We refer to it herein as the “earlier article.” Co-author Waitzman is the author of the earlier article. At the time, not a single court in the country had yet been called upon to rule on the issue. This update of the earlier article is necessary, because cases have started to work their way through the court system.

3. MACs and MAEs are not different. Think of them as you do “sofa” and “couch.” Regardless of which name is used, the following is an example of one pulled from a random asset purchase agreement in our files: “’Material Adverse Change’” means any event, occurrence, fact, condition or change that is, or could reasonably be expected to become, individually or in the aggregate, materially adverse to (a) the business, results of operations, financial condition, assets, liabilities, or prospects, or (b) the ability of the Seller to consummate the transactions contemplated in an agreement on a timely basis.” We won’t get into whether this is “good” clause (which, by the way, is a meaningless question); the question would be, “good for whom?”

4. Note this is different that an implied legal doctrine such as the implied duty of good faith. As an example, in the United States, when two parties enter into a contract with each other, there generally is an implied duty of good faith (English law is different, by the way). In other words, a party to a contract (in the United States—and many other counties—but not the United Kingdom) generally has a duty to perform its contractual obligations in good faith whether or not the contract at issue explicitly provides for that. Other implied doctrines- such as impossibility, impracticability, frustration of purpose- are often plead as alternatives to invoking force majeure.

5. Your authors, of course, were not guilty of this sin. We are quite the thoughtful chaps.

6. Some courts apply a more encompassing view of force majeure clauses. First, some hold that ejusdem generis is not a rule of mandatory application, but a rule of construction which should not be applied to defeat the unambiguous intent of the parties to an agreement. Accordingly, if catch-all language contained in a force majeure clause (i.e., “including but not limited to the following”) does not render other specifically bargained-for provisions of an agreement meaningless, then events not similar to those enumerated in the clause have been found to be within the scope of intent of the contracting parties and therefore entitled to protection as instances of force majeure. Second, some courts have found that certain terms within force majeure clauses are broad enough to delay or excuse performance even though the actual event that led to nonperformance was not specifically listed. For example, the term “governmental prohibition” has in certain instances been construed broadly to include temporary restraining orders that prevented a party from full performance.

7. Note that the order originally expired on March 30, 2020, but was extended twice, first, to April 30, 2020 via Ill. Exec. Order 2020-18 and then again to May 29, 2020 via Ill. Exec. Order 2020-33.

8. Judge Cassling wrote: “[I]n interpreting an Illinois contract, when there is a conflict between a clause of general application and a clause of specific application, the more specific clause prevails.” “[T]he more specific provision of a contract governs where it arguably conflicts with a more general provision. Aeroground, Inc. v. CenterPoint Props. Trust, 738 F.3d 810, 816 (7th Cir. 2013) (citing Grevas v. U.S. Fidelity and Guar. Co., 152 Ill.2d 407, 411 (1992)). In this case, a lessee’s lack of money could arise from any number of events, including but not limited to the effect of governmental action or orders. By contrast, the Debtor’s failure to pay post-petition rent is the direct and proximate result, at least in part, of Governor Pritzker’s executive order.”

 

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