Preparing for the Litigation Storm
Only the imprudent would fail to prepare for what comes after the pandemic. When commerce returns to “normal” one can reasonably expect a flood of litigation as parties to contracts and related commercial activities endeavor to allocate legal responsibility for circumstances the likes of which none of us have ever experienced. But careful preparation now, along with analysis of your own company’s financial pressure points and jeopardized contracts, is critical to maximizing results in the litigation aftermath. Anticipation and preparation should be the watchwords for any general counsel. In the Elizabethan words of the common subpoena: “Fail Not At Your Peril.”
One question facing many companies is whether contractual obligations remain valid and enforceable. To assess your own exposure, identify the sectors or business divisions in your company in which contractual performance is more likely at risk and review potential arguments for enforcement or avoidance of contracts. Five likely candidates include: (1) force majeure; (2) impossibility or “impracticability” of performance; (3) if you are covered by a business interruption (“BI”) insurance policy, whether coverage applies only to “direct physical loss;” (4) if you are covered by a BI policy, whether there is there a “contagion exception;” and (5) if you are covered by such a BI policy, whether it covers interruptions caused by the edicts of civil authorities -- in today’s parlance, the so-called “stay at home orders.” Of course, the specific wording of your contract or policy will control under the particular factual circumstances of your case. Exploring the applicability of these theories and defenses now, however, can only enhance the eventual outcome of any litigated dispute. Indeed, preparation now may avert litigation later entirely.
1. Force Majeure.
Whether your supply chain spans the globe, or you buy from the reliable component manufacturer down the road, the pandemic and measures to contain it have erected massive roadblocks to obtaining critical goods and services. Imagine your supplier fails to deliver essential components or raw materials necessary for your company to manufacture or deliver its finished product. This could occur in the defense industry where downstream blockages precluded your supplier from performing, in industrial processes where a certain essential chemical or chemical mix became unavailable, or even in commercial or multi-family construction projects in which needed materials or labor could not be obtained. Consider the restaurant chain that cannot obtain essential food resources. The party seeking to avoid performance of the contract may invoke the force majeure clause arguing that the virus constituted an “act of God” or “superior force.” The wording of the clause is, of course, paramount. Some clauses are defined to include only specific events: acts of war, terrorism, floods, etc. In contrast, some force majeure clauses are defined so broadly that they encompass virtually all events the parties could not reasonably anticipate. For example: “the occurrence of an event which is beyond the reasonable control of Seller or Buyer and which by the exercise of due diligence and foresight could not reasonably have been avoided.” The contract wording will define the legal parameters of the dispute. But then the circumstances of your transaction become critical: was the pandemic spread of Covid 19 reasonably foreseeable in late January? In mid-February? By early March?
2. Impossibility or “Impracticability” of Performance.
In most states, “impossibility of performance” is an affirmative defense to performance of a contract and the defense is commonly limited to intervening events. In other words, impossibility of performance occurs when an unforeseen event arises after the contract is executed that renders performance by one of the contracting parties “impossible.” The doctrine does not excuse performance in circumstances where performance is difficult, burdensome, or even dangerous. See, e.g., Truetried Serv. Co. v. Hager (Ohio Ct. App. 1997). And courts have distinguished between objective and subjective impossibility: “there is a distinction between objective impossibility -- ‘the thing cannot be done,’ which may discharge the contractual duty and subjective impossibility -- ‘I cannot do it’ which does not discharge the contractual duty.” J.J.O. Constr. Inc. v. Baljak (Ohio Ct. App. 2007). Impossibility of performance has afforded relief in cases involving destruction of the subject matter of the contract, a change in law that makes performance illegal (but see Part 5 below), or the death of an essential person. It frequently is invoked in supply contracts.
A related doctrine -- impracticability of performance as defined by the U.C.C. § 2-615(a) for contracts for the sale of goods -- arises from “the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.” Though “impracticability” is a lower threshold than impossibility, the fact that performance is simply more difficult or costly is not sufficient.
3. Business Interruption Insurance Requiring “Direct Physical Loss.”
Business interruption coverage is most often a feature of first-party property insurance. Traditionally, this property insurance responds in situations in which a policyholder’s property sustains “direct physical loss.” In simplest terms, coverage applies when some damaging event (e.g., a fire) alters the physical characteristics of the property in a way that necessitates repair, keeps the property from being used as intended, and/or causes “business interruption” losses of various sorts. This has proven to be a hurdle to coverage for business interruption losses. For example, the Eighth Circuit denied coverage to the insured when the USDA ordered an embargo of Canadian beef during the “mad cow disease” scare because the insured failed to prove the property was damaged, to wit, that the beef from the particular herd in question was contaminated. Source Food Tech. v. USF&G (8 th Cir. 2006).
Indeed, litigation is already underway involving the efforts of businesses to establish that business closures and business losses flowing from the Covid 19 pandemic arise from “direct physical loss” (or words of similar effect) under their property insurance policies. Additionally, the New York State Department of Financial Services recently issued a letter to all authorized property and casualty insurers in New York, demanding that they provide information concerning their policies issued in New York, particularly as they pertain to business interruption coverage in the face of the Covid 19 pandemic. The “physical loss” issue is front and center among the concerns that the insurers have been directed to address. Thus, any business interruption coverage your business may have should be reviewed carefully to determine whether it affords coverage only in situations of “direct physical loss,” whether a case could be made that your property did suffer such a “physical loss,” and whether there are any other extensions of coverage for business interruption losses in your policy that do not depend on a “physical loss” to the insured property to trigger coverage.
4. Business Interruption Insurance with a Pollution/Contamination Clause.
The wars are also already underway between insurers and insureds with respect to the scope of business interruption coverage. For example, many such policies include a “pollution / contamination” exclusion that declares coverage does not apply to damages caused by the dispersal or release of “contaminants.” Depending on the language of the contract, a court may interpret this exclusion as applying only to losses stemming from “traditional environmental pollution.” The court so held in Marshall v. Selective Ins. Co. of Am. (Va. Cir. 1995), for example, in which the policy defined “pollution” as the escape of pollutants “upon the land, the atmosphere or any … body of water.” See also PBM Nutritionals, LLC v. Lexington Ins. Co. (Va. Cir. 2011). On the other end of the spectrum, the policy may include coverage for “bacteria, fungi, [or] virus . . .” One such policy form expressly covers and defines a “Pandemic Event.” Within such a covered Pandemic Event, the policy enumerates as “Covered Diseases” 27 separate maladies ranging from Leprosy to Ebola. We have even seen a policy that expressly covered, among other diseases, “Severe Acute Respiratory Syndrome-associated Coronavirus (SARs-CoV) disease” and its variants and mutations. In a federal court case in the Southern District of Texas, Certain Underwriters at Lloyd’s denied coverage because they argued Covid 19 “is not a named disease on that endorsement.” The best advice if you have a business interruption policy that includes a Pandemic endorsement, “contamination” exclusion, or other similar provision is to parse the clause assiduously to determine if it applies under the facts and circumstances of your case.
5. Business Interruption Insurance and Shelter In Place Directives.
Another common provision of business interruption policies entails circumstances in which the business cessation arises from civil authority orders. As discussed above, policies affording such business interruption coverage frequently provide coverage only in the event of direct physical loss or damage to the property. For example, the Fifth Circuit affirmed summary judgment denying coverage to the insured restaurant chain when it closed (business interruption to be sure) during a mandatory evacuation for Hurricane Gustav. Dickie Brennan & Co., Inc. v. Lexington Ins. Co. (5th Cir 2011). The policy wording seemed straightforward: “We will pay for the actual loss of Business Income you sustain and necessary extra Expense caused by action of civil authority that prohibits access to the described premises due to direct physical loss of or damage to property, other than at the described premises, caused by or resulting from any Covered Cause of Loss.” The Court of Appeals affirmed the district court’s grant of summary judgment in favor of the insurer holding that the evidence failed to prove the required link between the evacuation order and damage to the property.
A similar result occurred in United Air Lines, Inc. v. Ins. Co. of State of Pa. (2d Cir. 2006), in which the Second Circuit held that losses incurred due to closure of Reagan National Airport on September 11, 2001 were not covered because the airport was closed before the nearby Pentagon was hit: the civil authority order closing the airport was “based on fears of future attacks” and not on prior physical damage. Given the fact that poultry and pork producers are now considering euthanizing hundreds of thousands of animals, and Tyson Foods has taken out full-page ads arguing the American “food chain” is broken, restaurants and grocery chains alike face massive uncertainty. Dead animals may be damaged property, but is the “damage” due to a government stay-at-home order? Are euthanized animals covered within the meaning of “damage to property?” How the “damage to property” element will play out in Covid 19 cases will necessarily be a fact-intensive inquiry depending on the particular circumstances of your case.
Given the magnitude of actual and potential commercial losses due to Covid 19, the stakes are too high for general counsel to ignore, dismiss, or defer consideration of the coming litigation flood. Indeed, the drip of early cases has already become a stream of litigation presaging the inevitable deluge. Prudent counsel suggests that commercial actors prepare now. The five theories or defenses to contracts and insurance claims outlined above constitute merely the tip of the proverbial iceberg, but should comprise an analytical framework within which to initiate your own litigation risk assessment, including evaluation of potential insurance recoveries. We would be glad to help.