How the Courts Are Reacting to COVID-19 Contract Cases

How the Courts Are Reacting to COVID-19 Contract Cases

Breach of contract cases arising out of the COVID-19 pandemic are slowly making their way through the court system...

Breach of contract cases arising out of the coronavirus (COVID-19) pandemic are slowly making their way through the court system. The early decisions shed light on how courts are handling force majeure provisions and contract defenses like impossibility of performance and frustration of purpose.

Contractual Defenses to COVID-19 Contract Claims

As discussed in prior posts, a .  Allowed circumstances can include those deemed beyond the party’s control that make performance inadvisable, commercially impracticable, illegal, or impossible. Examples include natural disasters like hurricanes, floods, earthquakes, and other “acts of God.” However, the defense may also apply to manmade disasters, such as war, terrorism, civil disorder, supply shortages, and labor strikes.

Without an enforceable force majeure provision, businesses may look to common law contractual remedies, such as impracticability and frustration of purpose. Frustration of purpose applies when performance of a contract becomes worthless to a contracting party. Meanwhile, impossibility – or impracticability – of performance applies when the actual performance of the contract is impossible

NY Courts Begin Deciding COVID-19 Cases

In recent weeks, New York courts have begun rendering early decisions in COVID-19 cases. In E2W LLC v. KidZania Operations S.a.r.l., a New York federal district court issued a preliminary injunction preventing a franchisor from terminating a franchise agreement with a franchisee.

According to court documents, KidZania Operations, S.a.r.l. owns and licenses the rights to operate KidZania facilities, which are children-based amusement parks consisting of a themed replica of a realistic city environment. Pursuant to the Franchise Agreement, E2W LLC was granted the rights to open and operate KZ Facilities in the United States. After Kidzania sought to terminate the agreement, citing E2W’s failure to make certain royalty payments under the agreement, E2W filed suit. The company maintains that COVID-19 disrupted E2W’s business at its operational Frisco, Texas amusement park facility and its development efforts in Illinois, California, and New Jersey.  It further asserts that the Franchise Agreement’s Force Majeure clause, as well as the doctrines of supervening impossibility and frustration of purpose, excuse contractual performance. According to the complaint:

E2W cannot operate the Frisco Facility, or make any payments to Franchisor while the Frisco Facility is not in operation and it is without the financing it had been negotiating, all due to the COVID-19 pandemic. Further, due to the COVID-19 pandemic, E2W cannot continue Development Activities. The non-occurrence of a worldwide pandemic necessitating the indefinite closure of the Frisco Facility and the cessation of Development Activities was a basic assumption of the Franchise Agreement. Therefore, E2W is discharged from any duty to perform under the Franchise Agreement for the foreseeable future due to the COVID-19 pandemic.

On May 11, U.S. District Judge Andrew L. Carter Jr. granted a preliminary injunction restraining KidZania from terminating its franchise agreement with E2W while the parties arbitrate the dispute pursuant to the agreement’s mandatory arbitration clause, which calls for arbitration before the International Chamber of Commerce (ICC). Judge Carter’s order specifically states:

Defendant KidZania and its agents, employees, and affiliated companies under its control are enjoined from terminating the Franchise Agreement and taking any actions that would interfere with the continued operations of Plaintiff, including indicating or disclosing to any third party that the Franchise Agreement has been terminated. The Parties are ORDERED to otherwise maintain the status quo of their operating relationship pending a decision in the ICC arbitration regarding the termination of the Franchise Agreement.

While the case will be decided outside the court, in granting the injunction, Judge Carter was required to find that E2W had demonstrated a likelihood of success on the merits. The decision is good news for businesses hoping that COVID-19 will be covered under force majeure provisions that include “government actions” and similar occurrences.

In Lantino v. Clay LLC,  the defendants, the owners of several New York-area gyms, sought to prevent the entry of a consent judgment, claiming that their performance under a settlement agreement that permits entry of the judgment was rendered impossible by the COVID-19 pandemic and the resultant “New York State on PAUSE” Executive Order signed by New York Governor Andrew M. Cuomo that became effective on March 22, 2020 (the “PAUSE Executive Order”). 

According to court documents, the plaintiffs, Michael Lantino and Joanne Cabello (collectively, the “plaintiffs”) entered into a settlement with the defendants in 2019 under which they were to be paid $300,000 in monthly installments. In April, the plaintiffs sought entry of judgment, citing that the Defendants were in default under the settlement agreement. In response, the defendants argued that “their performance should be excused based upon the doctrine of impossibility because of their inability to pay, ostensibly as a result of the COVID-19 pandemic and Governor Cuomo’s PAUSE Executive Order.”

U.S. Magistrate Judge Stewart D. Aaron ruled that the defendants’ non-payment was not excused. In support of his decision, Judge Aaron cited 407 E. 61st Garage, Inc. v. Savoy Fifth Ave. Corp., 23 N.Y.2d 275, 281 (1968), which held that “where impossibility or difficulty of performance is occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy, performance of a contract is not excused.” Based on the well-established precedent, Judge Aaron concluded:

At best, Defendants have established financial difficulties arising out of the COVID-19 pandemic and the PAUSE Executive Order that adversely affected their ability to make the payments called for under the Settlement Agreement. As such, Defendants’ performance under the Settlement Agreement is not excused.

Key Takeaway

The court’s decision in E2W LLC v. KidZania Operations SARL suggests that government actions, such as COVID-19 mandated closures, may fall under the force majeure clauses of certain contracts. Conversely, because courts tend to narrowly interpret the common law defenses of impossibility and frustration of purpose, they may be less likely to excuse performance in breach-of-contract cases related to the COVID-19 pandemic. Of course, each case is decided based on its unique facts and contractual provisions, and the skill with which it is presented.

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.