« "A Bookseller's Worst Nightmare" by Margarita Golden | Main | Letter From The Editor »

"Beyond Boilerplate: Drafting Considerations For The Force Majeure Clause In Real Estate Deals" by Michael Liptrot


Beyond Boilerplate: Drafting Considerations For The Force Majeure Clause In Real Estate Deals

by Michael Liptrot

The Jurisprudential Foundation Of Force Majeure In New York State

Force Majeure is a defense that excuses performance of a contract. TINA L. STARK, NEGOTIATING AND DRAFTING CONTRACT BOILERPLATE 321 (2003). In general, the nonperforming party is "relieve[d]... from its contractual duties when its performance has been prevented by a force beyond its control or when the purpose of the contract has been frustrated." Phillips Puerto Rico Core, Inc. v. Tradax Petroleum Ltd., 782 F.2d 314, 319 (2d Cir. 1985). With respect to lease contracts, New York courts have construed the force majeure defense narrowly, finding relief only in instances where the intervening event was wholly unforeseeable and has made performance objectively impossible. The following cases illustrate New York's narrow interpretation of the common law force majeure doctrine as well as its narrow reading of force majeure contract provisions, and highlight the need for thoughtful, granular drafting of the force majeure contract clause.

A. New York's Narrow Interpretation of the Common Law Doctrine

In Kel Kim Corp. v. Cent. Markets, Inc., Kel Kim Corporation (Kel Kim) entered into a ten-year lease agreement with Central Markets, Inc. (Central Market). 70 N.Y.2d 900 (1987). The lease was for a vacant supermarket, which Kel Kim used as a roller skating rink. The lease required Kel Kim to acquire and maintain a public liability insurance policy in the aggregate amount of not less than $1 million on account of any single incident, which Kel Kim was able to do for six years. After six years, Kel Kim's insurance policy expired, and the insurer would not renew the policy because of the uncertainty of its own financial condition. Thereafter, Kel Kim could not find any insurer who would write a policy in excess of an aggregate amount of $500,000. In response to this failure, Central Market sent a notice of default directing Kel Kim to cure the default within 30 days or vacate the premises. Kel Kim then brought an action for declaratory judgment, arguing that it be excused from performance under the common law doctrine of force majeure or under the lease's force majeure clause.

The court refused to recognize a force majeure defense in this case both under the common law and under the contract. The court held that a force majeure event means "destruction of the subject matter of the contract or [when] the means of performance makes performance objectively impossible." Kel Kim Corp., 70 N.Y.2d at 902. The court further held that even in the event that performance is made impossible or the purpose of the contract is frustrated, "the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract." Id. In this case, the court found that because Kel Kim specifically undertook the obligation to get public liability insurance, it could have foreseen being incapable of acquiring such insurance, and thus could not avail itself of the common law force majeure defense. Id.

Kel Kim Corp. is representative of the current New York jurisprudence regarding the common law doctrine of force majeure. The Northern District of New York recently reaffirmed New York's commitment to recognizing the defense only in extreme circumstances. See Beardslee v. Inflection Energy, LLC, 2012 WL 5522912 (N.D.N.Y. Nov. 15, 2012). In Beardslee, the court reaffirmed the holding in Kel Kim Corp. that the force majeure event must have been unforeseeable or guarded against in the contract, and that with respect to frustration of purpose, performance is only excused if a "virtually cataclysmic, wholly unforeseeable event renders the contract valueless to one party." Id. (internal quotations omitted). In the case, an oil drilling company claimed a force majeure event occurred when former Governor David Patterson signed a directive that required the company to use a drilling method other than the one they originally contemplated using. The court found that because the drilling method the company originally wanted to use was not contemplated by the existing governing regulation, they could have foreseen that a government directive might be issued banning its use.

B. New York's Strict Reading of Force Majeure Contract Clauses

In Kel Kim Corp., the parties included a force majeure clause in their lease. However, the section was silent on whether common law claims were excluded, and Kel Kim was able to argue for relief under both the contract provision and the common law doctrine. The clause reads as follows:

"If either party to this Lease shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes beyond the control of such party, the performance of such obligation shall be excused for the period of the delay." Kel Kim Corp., 70 N.Y.2d at 902.

The court found no relief for Kel Kim under the contract provision. The court held that "[o]rdinarily, only if the force majeure clause specifically includes the event that actually prevents a party's performance will that party be excused." Id. at 902-03. Despite the catchall phrase at the end of the clause, the court held to its narrow reading, explaining that such catchall phrases "are confined to things of the same kind or nature as the particular matters mentioned." Id. at 903. In this case, Kel Kim's failure to obtain public liability insurance because his original insurer was financially incapable of renewing the policy did not fall into any of the articulated events. The court found that the enumerated events were "day-to-day commercial operations," while maintaining an insurance policy is an ongoing obligation that is not affected by such daily operations. See id.

An example of successful contract drafting can be found in the New York Appellate Division case Bouchard Transp. Co., Inc. v. New York Islanders Hockey Club, LP. 40 A.D.3d 897 (2d Dept. 2007). In that case, Bouchard Transportation Company, Inc. (Bouchard) paid the New York Islanders professional hockey franchise (Islanders) to lease a suite at the Nassau Veterans Memorial Coliseum for the duration of the 2004/05 National Hockey League regular season. However, the season was canceled because of a league-wide lockout.

Bouchard subsequently sued for breach of contract. The Islanders sought to dismiss the complaint, arguing that it was protected under the force majeure clause of the lease, and countersued for nonpayment of rent. The lease's force majeure clause provided in relevant part that the Islanders' performance is excused "by cause or causes beyond Lessor's control which shall include, without limitation, all labor disputes." Id. at 898. Bouchard argued that for the clause to trigger excused performance, the labor dispute must be beyond the Islanders' control, and the Islanders could end the lockout by settling. Nonetheless, the court found that the contract clause was specific in excusing the Islanders' performance in this case. Although the court agreed with plaintiff that, under strict reading of the contract, the labor dispute must be beyond the Islanders' control, the court found that because the Islanders were but one of the 30 teams participating in the lockout, the labor dispute was in fact out of the Islanders' control. With that, the court announced that the Islanders' summary judgment motion be granted and that Bouchard must pay the unpaid rent.

Beyond The Core Concept: Common Pitfalls In Force Majeure Contract Clauses

Clearly, in New York, "it is well settled that performance of a contract should be excused only in extreme circumstances." Radiosurgery New York L.L.C. v. Cabrini Med. Ctr., 19 Misc. 3d 1102(A) (Sup. Ct. 2008). These circumstances are limited to events that make performance objectively impossible; "[m]ere impracticality or unanticipated difficulty is not enough to excuse performance." Phibro Energy, Inc. v. Empresa De Polimeros De Sines Sarl, 720 F.Supp. 312, 318 (S.D.N.Y. 1989). Moreover, such events must have been wholly unforeseeable. However, the contract drafter can circumvent this strict standard with a contract clause that satisfactorily allocates risk among all parties. But, as has been previously shown, merely including a boilerplate force majeure clause in the contract will not suffice. Courts are equally strict in their reading of the contract clause. They refuse to interpret enumerated terms broadly, and give narrow construction even to catchall phrases. See Kel Kim Corp., 70 N.Y.2d at 902-903.

Thus, in order for the contract drafter to allocate appropriate risk among the parties, he or she must be very specific when drafting the force majeure clause. The following cases deal with common pitfalls of the force majeure contract clause, from which useful drafting tips can be derived.

A. The "Litany" Approach

In response to the requisite specificity of the force majeure contract clause, drafters commonly draft a "stand alone litany." Stark, supra, at 328. This method simply enumerates in a list all of the events that will qualify as force majeure events under the contract. This approach indeed has the virtue of being specific, but its inadequacy in anticipating future circumstances has spawned additional case law.

As has already been discussed, the attempt by drafters to include a catchall provision at the end of a stand alone litany did not bring about the desired result. Kel Kim Corp. issued the accepted rule that catchall provisions in a litany of events will be construed narrowly.

Next, the Supreme Court of the United States in United States v. Brooks-Callaway Co. addressed the issue of how to interpret a litany in the context of the entire force majeure clause. 318 U.S. 120 (1943). In that case, the force majeure clause excused performance "because of any delays. . . due to unforeseeable causes beyond the control and without the fault or negligence of the contractor, including. . . acts of God, or of the public enemy, acts of the Government, fires, floods, epidemics, quarantine restrictions, strikes, freight embargoes, and unusually severe weather. . . ." Id. at n. 1. The Court ruled that events set out in the "including" phrase of the litany section will be modified by the requirements for excuse set out in the contract. Thus, since the requirements were that the event be unforeseeable and beyond the control of the nonperforming party, the Court found that those requirements modified each enumerated event in the litany (for example, under the terms of the contract between the parties in this case, "floods" meant unforeseeable floods beyond the control and without the fault or negligence of the contractor).

Despite these shortcomings, the litany is a helpful tool for drafting a robust force majeure clause. The reasons for this are two-fold. First, the litany allows drafters to greatly expand what may be considered a force majeure event. This is because the litany of events does not need to be limited to events or occurrences commonly considered to be force majeure events. See Capital City Gas Co. v. Phillips Petroleum Co., 373 F.2.d 128 (2d Cir. 1967). Second, drafters can circumvent the aforementioned flaws of the litany by using it as a component of a larger force majeure framework, rather than having it stand alone as the entire understanding of the parties. Used in this way, the litany can serve as an explicit, specific, non-exhaustive list of examples of events that meet the requirements of force majeure contained in the agreement.

B. The Unforeseeability Requirement

A fundamental part of the common law doctrine of force majeure is that the intervening event must have been unforeseeable. See VJK Productions, Inc. v. Friedman/Meyer Productions, Inc., 565 F.Supp. 916, 920 (S.D.N.Y. 1983) (force majeure defense not available if "the event which renders the performance impossible could have been anticipated and provided for in the contract."). Contract drafters might think that by simply enumerating possible events in the force majeure clause they can sufficiently allocate risk away from their client. However, if the contract is silent on foreseeability, "there is a danger that a court will read one in." Stark, supra, at 330.

The Eastern District of New York did just that in Vernon Lbr. Corp. v. Harcen Const. Co. See 60 F.Supp. 555, 558 (E.D.N.Y. 1945). There, a lumber company sought to be excused from performing under a sales contract because there was a change in the law that made it impossible for it to deliver the goods. The parties agreed that performance of the contract was "subject to conditions beyond control [of the lumber company]." Id. at 558. The court agreed that changes in law are indeed beyond the control of individual parties, but refused to excuse performance because it read an unforeseeability requirement into the clause. Thus, only unforeseeable changes in the law could excuse performance, and in this case the lumber company could have foreseen the change that occurred.

Therefore, parties should draft the force majeure clause to eliminate or modify the unforeseeability requirement. Even if parties desire an unforeseeability test, they should articulate in their own words what "unforeseeable" means, instead of being "subject to the vagaries of the court's or jury's imagination." Stark, supra, at 330.

C. The Due Diligence Requirement

The due diligence requirement, while not a default rule in the common law, is "commonplace in negotiated force majeure provisions." Id. at 331. The purpose of the requirement is to ensure that the nonperforming party cannot use the force majeure contract clause to walk away from its obligations without making a reasonable effort to continue performance in the face of an intervening event.

What constitutes due diligence, however, is debatable, and the case law in New York on the issue is not entirely clear. For example, in one case the Supreme Court of New York defined due diligence as "the duty of the promisor to make a bona fide effort to be relieved of the restraint which operates to prevent his performance." Brown v. J.P. Morgan & Co., 177 Misc. 626 (Sup. Ct. 1941) rev'd on other grounds, 40 N.Y.S.2d 229 (1st Dept 1943) aff'd sub nom. Brown v. J. P. Morgan & Co., 67 N.E.2d 263 (1946). Compare that to another New York Supreme Court case where due diligence was construed to mean "it is defendant's duty to perform in whatever way is left open to it." Van Der Veen v. Amsterdamsche Bank, 178 Misc. 668, 671 (Sup. Ct. 1942). Thus, the lower courts have had varying opinions as to the level of effort that the nonperforming party must exercise to constitute due diligence, and drafters might want to consider more definitive language for the due diligence requirement.

D. The Notice Requirement

Also not a default rule, but commonly included in negotiated force majeure clauses, is a notice requirement. The notice requirement demands that the nonperforming party give the other party notice in a prescribed manner and time after realizing that a force majeure event has occurred. When drafting the language of the notice requirement, it is important to make sure that it is clear that a force majeure defense is conditional upon giving notice. If the force majeure defense is not expressly made conditional on giving notice, then the nonperforming party is not barred from excusing itself from performing under the contract in the event that a force majeure event occurs. See Toyomenka Pac. Petroleum, Inc. v. Hess Oil Virgin Is. Corp., 771 F.Supp. 63, 67 (S.D.N.Y. 1991) ("Under New York law, a contractual duty will not be construed as a condition precedent absent clear language showing that the parties intended to make it a condition.").

E. To Excuse, or Not to Excuse (Performance)?

When a court upholds a defense of force majeure, the general rule is to excuse performance entirely. See United States v. Gen. Douglas MacArthur Senior Vil., Inc., 508 F.2d 377, 381 (2d Cir. 1974) ("The common law of contract excuses a party from performing his contractual obligations because of 'impossibility of performance' or 'frustration of purpose.' "); In re Fontana D'Oro Foods, Inc., 122 Misc. 2d 1091, 1093 (Sup. Ct. 1983) aff'd as modified, 484 N.Y.S.2d 644 (2d Dept 1985) aff'd, 482 N.E.2d 1216 (1985); Sage Realty Corp. v. Omnicom Group Inc., 183 Misc. 2d 574, 579 (Sup. Ct. 2000); Restatement (Second) of Contracts ยง 261 (1981).

In New York, it makes sense that this would be the default rule, since the courts only grant relief under the doctrine in extreme circumstances of objective impossibility or frustration of purpose. If a drafter is looking to expand the instances of force majeure in her contract, however, then it is possible that she might want a remedy other than discharge of the contract if a force majeure event occurs.

In other states, some courts have held that a supervening event does not completely discharge performance, but instead requires the parties to renegotiate, modify, and reform the contract to reflect the new understanding of the parties. See, e.g., Aluminum Co. of Am. v. Essex Group, Inc., 499 F.Supp. 53, 57 (W.D. Pa. 1980) (Nonperforming party entitled to reformation of long-term toll conversion service contract because nonlabor production costs rose significantly beyond foreseeable limits of risk). Drafters may want to build this out-of-state jurisprudence into their contracts if their clients have an interest in keeping the agreement alive even if costs rise.

Another way to modify the default rule would be to suspend performance, instead of permanently discharge it. This language can become a negotiating point whereby the parties agree to suspend performance for a certain amount of time until it becomes to costly for one or both of the parties, and at that point the parties can elect to renegotiate the terms or permanently discharge obligations. This approach has the advantage of maintaining the original understanding of the contract for as long as possible, keeping renegotiation on the table (but not requiring it), and preserving the option to walk away from the contract.

F. Obligations After Performance is Excused

It may not be obvious that, in the event that a force majeure event discharges performance, the nonperforming party can still have obligations under the agreement. One such obligation is paying damages resulting from its nonperformance. It is well settled that a successful defense of force majeure excuses performance. But see United Equities Co. v. First Natl. City Bank, 52 A.D.2d 154, 157 (1st Dept. 1976) aff'd sub nom. United Equities Co. v. First Natl. City Bank, 363 N.E.2d 1385 (1977) ("The purpose of a Force majeure clause is to limit damages.") (emphasis added). However, the parties may wish to allocate costs incurred in the result of a force majeure event.

Another possible obligation of the nonperforming party after the occurrence of a force majeure event is its obligation to cure breaches that existed prior to the force majeure event. The New York courts have not addressed this issue yet, but the Eastern District of Pennsylvania in Wartsila Diesel, Inc. v. Sierra Rutile, Ltd. announced the common sense holding that a force majeure event does not excuse existing liabilities or obligations to cure pre-existing breaches. See 1996 WL 724929 (E.D. Pa. Dec. 16, 1996). Since the issue has not been addressed in New York, and "such claims [to be excused from pre-existing defaults] have been made nonperforming parties," Stark, supra, at 349, a force majeure contract clause should expressly hold nonperforming parties liable for their breaches.

Conclusion

New York courts have construed force majeure strictly, and grant relief under the common law only in rare and extreme circumstances. However, courts will look to the contract to determine the meaning of force majeure in each case, and careful, granular drafting of the clause can better protect both parties in a real estate deal. Thus, contract drafters should not overlook the force majeure clause, but instead should take care to tailor it to suit their clients' needs.

Michael Liptrot is in his third year at Brooklyn Law School and is a candidate for J.D. in spring 2013. He received his B.A. from The American University in 2010, with a major in Law & Society and minor in Sociology. While in law school, he has interned for the New York City Housing Authority and the New York City Housing Development Corporation. He has also worked in Brooklyn Law School's Corporate & Real Estate Clinic and is currently working in the law school's Community Development Clinic. He is also a contributing author to the online law blog Developments in Real Estate Finance.

Post a comment

(If you haven't left a comment here before, you may need to be approved by the site owner before your comment will appear. Until then, it won't appear on the entry. Thanks for waiting.)

About

This page contains a single entry from the blog posted on February 17, 2013 6:41 PM.

The previous post in this blog was "A Bookseller's Worst Nightmare" by Margarita Golden .

The next post in this blog is Letter From The Editor .

Many more can be found on the main index page or by looking through the archives.