COVID-19 and Commercial Frustration

With the COVID-19 wreaking havoc on California’s economy, many of the adversely affected businesses increasingly find themselves unable to perform their contractual obligations.  Hardest hit are businesses declared non-essential and ordered to shut down, including movie theaters, cruise liners, sport stadiums, restaurants, convention centers, clothing outlets, barbers and beauty salons, etc.  Other businesses such as airlines, hotels, and travel services are operating at severely reduced capacity.

The centuries old doctrine of “Commercial Frustration” or “Impossibility of Performance” can help alleviate the consequences of non-performance for California businesses in certain situations by allowing an adversely affected party to a contract to be excused from performance of its obligations. In addition to its potential application in legal proceedings, the doctrine can also be used as leverage for such businesses to re-negotiate their contracts.

In California, Commercial Frustration can be invoked where: 1) a main purpose of the contract is frustrated by an event; 2) the frustrating event was not reasonably foreseeable; and 3)  the party seeking to be excused from performance did not assume the risk of the frustrating event. Waegemann v. Montgomery Ward & Co., 713 F.2d 452, 454 (9th Cir.1983).

Advantageously for California contracts impacted by the COVID-19, courts in California have generally been more expansive in their interpretation and application of the rule compared with many other states.  While many jurisdictions interpret Commercial Frustration as requiring impossibility of performance, California courts have excused performance where performance is still possible but can only be done with excessive and unreasonable cost. Habitat Tr. for Wildlife, Inc. v. City of Rancho Cucamonga, 175 Cal. App. 4th 1306, 1336 (2009).  An additional angle on California’s commercial frustration precedent is that courts have been more receptive to the doctrine in times of national calamities, such as wars, pandemics and severe economic downturns.  In such circumstances, courts have shown increased willingness to excuse performance under the doctrine where performance would be possible, but only at excessive and unreasonable costs. Lloyd v. Murphy (1944) 25 Cal.2d 48, 53, 153 P.2d 47.

The following are examples of application of the doctrine by courts in California to excuse performance.

Hackfeld & Co. v. Castle, 186 Cal. 53 (1921) concerned a contract entered into shortly before outbreak of WWI, for shipment of honey from Hawaii to Germany through a specified route, which became inaccessible following the start of the war due to an embargo on shipments to Germany.  The seller brought suit to enforce the contract after buyer refused to accept delivery of the unshipped portion of the goods.  The California Supreme Court found that continued existence of the shipment route was a condition of the contract and was essential to its performance, and that unavailability of the specified shipping route had excused the buyers purchase obligations.

LaCumbre G. & C. Club v. Santa Barbara Hotel Co., 205 Cal. 422 (1928) dealt with a contract between a golf club and a hotel company under which hotel guests would enjoy membership privileges in the club in exchange for monthly payments by the hotel to the club.  After the hotel burned down it stopped making payments to the golf club and the club filed suit to enforce the contract. The California Supreme Court excused the hotel’s performance obligations, finding that both sides understood that having guests at the hotel was an essential purpose of the contact, which had been frustrated by destruction of the hotel by the fire.

20th Century Lites v. Goodman, 64 Cal.App.2d 938 (1944), a dispute which arose during WWII, involved a neon sign manufacturing company which had contracted with a business to provide it with lighted signs.  After the local government passed an ordinance prohibiting outdoor neon signs to be lighted at nighttime, the business refused to honor the contract, claiming frustration of the purpose of the contract.  The neon light supplier argued that the contract did not specify the hours of day or night that the sign would be used, and that it was still possible to illuminate the display with electricity in the daytime.  The court found that lighting the signs at night was a main purpose of the contract, which had been frustrated by the city ordinance banning nighttime lighting.  Importantly, the court of appeal found that parol evidence was properly admitted to show that illumination of the signs at night was the desired object to be obtained by the parties.

 

The Spanish Flu pandemic of 1918, which many have compared to COVID-19, was the backdrop of the dispute in Citrus Soap Co. v. Peet Bros. Mfg. Co., 50 Cal. App. 246 (Cal. Ct. App. 1920).  The case involved a contract for purchase of crude glycerine, which plaintiff had failed to timely deliver as provided by the contract.  After buyer refused to accept the late delivered glycerine, seller filed suit for the unpaid amount arguing that its late delivery was excused by the city ordinance which had closed local businesses for four days. The court agreed, finding that the delay was caused by the quarantine due to the pandemic.

A case decided in arbitration during the economic downturn of 2008/2009 is attracting attention for its potential application to the COVID-19 affected businesses.  In Gateway & 4th LLC and Itracrop Los Angles LLC v. Pacific Cityhomes LLC, Cityhome Managers, (JAMS Arbitration No. 1200027669, 2009), a real estate condo developer breached its payment obligations to its creditor, arguing that the credit market conditions at the time made it impracticable for it to sell the condos and pay its creditor from the proceeds.  The arbitrator, a former California State court judge, found that both sides had understood that reasonably available credit to potential buyers of the condos was a main basis of the contract, and that the drastically deteriorated credit market condition excused the developer from performance of its contractual obligation to its creditor.

There is no doubt that COVID-19 pandemic has and will cause severe hardship to many California businesses.  The doctrine of Commercial Frustration may provide some of the affected businesses with an opportunity to excuse their contractual obligations.  Attorneys representing such businesses can use California precedent applying this doctrine as leverage to re-negotiate these contracts.