Memo on Force Majeure and COVID-19

COVID-19: Excuse of Contractual Performance under California Civil Code Section 1511

The pandemic related to COVID-19 and the economic impact resulting from various stay-at-home orders raises concerns of whether such circumstances can justify non-performance of certain contractual obligations including under leases, loans or commercial contracts. This memorandum addresses two possible defenses to excuse performance under California Civil Code Section 1511.

I. Operation of Law 

California law excuses performance when it is “prevented or delayed by [. . .] the operation of law.” Cal. Civ. Code § 1511(1). After Govern Gavin Newsom declared a state of emergency in California, he issued an executive order mandating the closure of “non-essential” businesses. Even though a governmental order may constitute an “operation of law”, such factor alone will not be dispositive in determining whether contractual obligations are excused.  Courts will look at different factors to determine if the governmental order will excuse contractual performance, including whether such governmental order makes it impossible to conduct the business at issue, if the event was unforeseeable and if the purpose of a contract is frustrated.

Case law interpreting CC Section 1511 is sparse.  In Lloyd v. Murphy, a governmental order restricting the sale of new automobiles during World War II did not excuse a party’s contractual obligations under a lease, even though 90% of the gross volume of the business was derived from new car sales. Lloyd v. Murphy, 25 Cal. 2d 48 (1944). The California Supreme Court reasoned that the sale of automobiles was not made impossible and that if a governmental regulation does not entirely prohibit a business, but merely restricts it, a lessee is not excused from performance. Id. (emphasis supplied). Further, the Court weighed on the fact that the lessee was an experienced automobile dealer and at the time the lease was executed, risk of war was reasonably foreseeable. Id.

By contrast, in 20th Century Lites, Inc. v. Goodman, an emergency war measure during World War II which ordered cessation of all outside lighting at night, including neon signs, excused performance under a lease. 20th Century Lites, Inc. v. Goodman, 64 Cal. App. 2d Supp. 938 (1944). Here, the lessee entered into the lease with the purpose of illuminating the exterior of his business and of advertising it by means of electrically illuminated signs during the nighttime. Id. The lessor claimed that because it remained possible to illuminate the signs during the day, it should not excuse the lessee’s performance. Id. However, the Court rejected this claim because, even though it remained possible to light the signs during the daytime, it was not the “desired object to be obtained by the parties.” Id. The Court held that if a governmental order frustrates the purpose of a contract, without the fault of either party, the parties are excused from further performance. Id.  (emphasis supplied).

II. Force Majeure

Force majeure is a legal principle, either contracted by the parties or imposed by law, that may, in some circumstances, excuse or delay the performance of contractual obligations in whole or in part. This principle is based on the concept that “no man is responsible for that which no man can control.” Cal. Civ. Code § 3526.

Contractual Obligations

Contracts often contain force majeure provisions that define certain events which may excuse performance.  However, absent a contractual provision, California law excuses performance “when it is prevented or delayed by an irresistible, superhuman cause . . . unless the parties have expressly agreed to the contrary.” Cal. Civ. Code § 1511(2). The California Supreme Court held that the words “irresistible superhuman cause” are equivalent to an “act of God.” Fay v. Pacific Improv. Co., 93 Cal. 253, 261 (1892). In a later decision, the Court extended its ruling and established that not only does Civil Code 1511 apply to an act of God, but “the test is whether under the particular circumstances there was such an insuperable interference occurring without the party’s intervention as could not have been prevented by the exercise of prudence, diligence and care.” Pacific Vegetable Oil Corp. v. C. S. T., Ltd., 29 Cal. 2d 228, 238 (1946).

Typically, a court will look at whether the party invoking force majeure used reasonable efforts to avoid the effects. Mere increase in expense does not excuse performance unless there exists “extreme and unreasonable difficulty, expense, injury, or loss involved.” Butler v. Nepple, 54 Cal. 2d 589, 599 (1960). In Butler, the Court found that force majeure did not excuse a party from its contractual obligations where, due to a steel strike, the defendant was unable to obtain the required casing to drill an oil well. Id. The evidence showed that there was a list of other possible suppliers that could provide the needed casing to defendant, even though it would involve a greater expense to the company. Id.

On the other hand, a party is compelled to perform only so far as it is possible to do so, and “is not liable for failure to perform which results from vis major [force majeure] not attributable to any fault on its part.” Squillante v. California Lands, Inc., 5 Cal. App. 2d 89 (1935). In Squillante, the parties agreed to the sale and purchase of ten carloads of grapes of a particular quality, grown in defendant’s vineyards. Id. Defendant delivered five carloads of grapes with the quality agreed upon in the contract but was unable to produce the rest due to extraordinary heat conditions. Id. The Court held that defendant cannot be compelled to perform impossibilities and was excused from performance. Id.

Leases

California courts are reluctant to excuse a lessee’s duty to pay rent if the purpose of the lease has not been totally destroyed or its accomplishment rendered extremely impracticable, or where it has been shown that the lease remains valuable to the lessee.

See Lloyd v. Murphy, 25 Cal. 2d 48 (1944). Therefore, even if COVID-19 qualifies as force majeure, a court may find that rent is due.

In this regard, Governor Gavin Newsom issued an executive order allowing local governments to impose eviction protection for residential and commercial tenants who are unable to pay their rent due to the effects of COVID-19. Governor Newsom’s order, however, makes clear that such local ordinances should state that rental payment obligations of the tenant are deferred for a reasonable period but not waived.[1]  Given the California Supreme Court’s holding in Lloyd v Murphy, coupled with the express language of Governor Newsome’s order, tenants would be challenged in asserting that the non-payment of rent under a lease is excused because of the effects of COVID-19.

Mortgage Payments

California courts have not yet ruled on the application of force majeure under loan documents. However, it is likely that the same principles that apply to leases will also apply to whether payment obligations under mortgage loans are excused.

On March 25, 2020, Governor Newsom announced that the state reached an agreement with several financial institutions including Citigroup, JP Morgan Chase, US Bank, Wells Fargo, and nearly 200 state-chartered banks to provide a 90-day grace period for mortgage payments for those impacted by COVID-19. During this period, financial institutions will waive or refund mortgage-related late fees.[2] Additionally, financial institutions may not initiate foreclosure sales or evictions for at least 60 days.
As the COVID-19 outbreak is rapidly changing, we continue to monitor ongoing developments on business and legal implications.

Juan E. Zúñiga is an international transactions attorney who has worked on cross-border deals throughout the United States, Latin America and in over 60 other countries. His practice is focused on buying and selling real estate, resort and hospitality transactions, mergers & acquisitions, overseas distribution agreements, international joint ventures, foreign trade and commerce, workouts of distressed assets, lending and investment issues. He has been particularly sought out for his handling of cross-border transactions, especially in Latin America. In this work, he represents American clients in their investments in overseas properties and in establishing subsidiary operations internationally. Additionally, he represents foreign clients in their investments in the United States. Read more about Juan here.

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