The Construction Advantage, Performance of a Contract and Questions for Contractors

Performance of a Contract: Unexpectedly Impossible or Unexpectedly Worthless? (It Makes a Difference)

By George F. Burns & Zachary B. Brandwein

COVID-19 has generated a great deal of discussion regarding force majeure clauses and impossibility of performance of contract. One 2017 case involving a quite different kind of flu, Avian flu, sheds light on two quite distinct theories of excuse of performance:   (1) impossibility or impracticability of performance and (2) frustration of the essential purpose of the contract. Rembrandt Enterprises, Inc. v. Dahmes Stainless, Inc., No. C15-4248-LTS, 2017 WL 3929308 (N.D. Iowa Sept. 7, 2017).

The first theory has more to do with the ability of one or both of the parties to perform their obligations (can it be done?). The second has more to do with whether, in light of changed conditions, it makes any sense for the parties to continue performing, even if they can (should it be done?).

Common Misconceptions

Before exploring the Rembrandt case, it is worth taking note of long-standing misconceptions that have resurfaced during the COVID-19 siege:

1. Force Majeure Clauses Are The Only Source of Excuse. Many construction industry professionals are inclined to think that without a force majeure clause, neither party has grounds to seek excuse from performance.  This may not be true.  Even without a force majeure clause:

• The common law may provide excuse from performance if performance is impossible or impracticable.
• If the contract is for the sale of goods, Section 2-615 of the Uniform Commercial Code may provide relief to the extent there has been a failure of presupposed conditions to the contract.[1]

2. Only the Seller Can Seek Excuse from Performance. Another misconception is that there is no excuse doctrine available to the buyer, the person paying for the goods and services.  Again, this is not necessarily true.

• Many force majeure clauses are mutual, providing protection to both the seller and the buyer.
• Some state courts have held that UCC Section 2-615 protects buyers as well as sellers.
• The common law doctrine of frustration is available to both sellers and buyers and, by its nature, is more likely to apply to buyers than sellers.

What the Rembrandt Case Shows

The Rembrandt case goes a long way toward correcting these misconceptions.  Here are the basic facts.

Rembrandt was an egg products supplier to Kellogg and General Mills, or at least hoped to be.  With the goal of dramatically expanding its capacity to meet their demand, Rembrandt embarked on a $100 million expansion of its mill in Thompson, Iowa.   It contracted with Dahmes to purchase an $8 million-plus egg dryer for installation in the mill.  In the middle of the expansion project, the Avian flu broke out and millions of poultry died, reducing Rembrandt’s capacity to 50%, thus changing entirely the commercial landscape.  Rembrandt cancelled the project and breached the egg dryer contract.

Rembrandt based its defense for breach of contract on the common law doctrine of frustration of contract rather than on either the force majeure clause or UCC Section 2-615. Its argument was simple: both sides knew at the time they formed the contract that the purpose of the contract was to increase egg production to satisfy Kellogg and General Mills, a goal made impossible by the Avian flu epidemic.  Thus there was frustration of the underlying purpose of the contract.

The Court noted the key elements of the frustration doctrine:

The defense of frustration of purpose applies where: (1) The party’s principal purpose in making the contract is frustrated; (2) without that party’s fault; (3) by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made. City of Savage v. Formanek, 459 N.W.2d 173, 176 (Minn. Ct. App. 1990) (internal citation omitted).

The purpose that is frustrated must have been a principal purpose of the party claiming discharge. The principal purpose: “[M]ust be so completely the basis of the contract that, as both parties understand, without it the transaction would make little sense.” Restatement (Second) of Contracts § 265, comment a (1981).

It is important to emphasize that the doctrine requires that both parties, not merely the party seeking excuse, know the purpose of the contract at time of contract signing.  Dahmes contended that the only purpose of the contract was to dry eggs, not to fulfill a grand scheme to impress Kellogg or General Mills.  The Court decided that a full trial was needed to determine the purpose.

Dahmes also argued the parties had bargained for a force majeure clause in the contract, that the clause was essentially the only source of excuse, and that on its face, the clause did not address an event like the Avian flu.[2]

The Court held that the force majeure clause was irrelevant to whether the commercial frustration doctrine applied. Indeed, the Court held that neither party could reasonably argue that the Avian flu prevented Dahmes from building the egg dryer or Rembrandt from paying for it.  In fact, the Court held that the commercial frustration that Rembrandt was advancing as a defense was not addressed in the force majeure clause at all, thus turning Dahmes’s argument against Dahmes.  The Court then made a crucial distinction between impossibility of performance and worthlessness of performance:

[T]he doctrine of frustration of purpose is a separate doctrine from that of impracticality/impossibility. Section 2-165 of the UCC and the doctrine of impossibility excuse a party when that party’s performance becomes impracticable; the common law doctrine of frustration excuses one party’s performance when the other party’s performance becomes unexpectedly worthless due to an unexpected supervening event. The doctrine of frustration will thus excuse the performance of a buyer like Rembrandt, even if the buyer is able to pay, “[i]f an event occurs which renders goods to be purchased worthless to the buyer.” (Doc. 55-1 at 20.) (Emphasis added.)

While stating or implying that Section 2-615 did not apply, the Court rejected Dahmes’ argument that under Minnesota law Section 2-615 provides a defense only to sellers of goods, not to buyers:

Rembrandt is not relying on the doctrine of impracticability to excuse its performance under the Agreement under UCC § 2-615. Consequently, it is unnecessary to address Dahmes’ mistaken argument that § 2-615 only excuses sellers from performance. See Melford Olsen Honey, Inc. v. Adee, 452 F.3d 956, 954 (8th Cir. 2006) (under Minnesota UCC, commercial impracticability excuses both parties’ performance).

Lessons to Be Learned

The Rembrandt case is only one case, and other courts and arbitrators may not agree with its reasoning or conclusions, but it does provide an outline of considerations before and after the signing of a contract.

1. The Common Law Frustration of Purpose Doctrine Might Apply Independent of any Force Majeure Clause

Suppose A and B enter into a construction contract for the erection of grandstands for a horse racing track to be completed by June 2020 just in time for the summer season, but then COVID-19 generated a governmental ban on crowds gathering at such an event. Under the logic of the Rembrandt case, the owner might be able to cancel the contract on the grounds that both parties assumed that the fundamental purpose of the contract could be fulfilled, did not foresee otherwise, and that there is commercial frustration under the common law, quite independent of what any force majeure clause might say and without regard to whether either party is able to perform.

1. UCC Section 2-615 Might be Available to Buyers as well as Sellers

Under some state court precedent, Section 2-615 might apply to buyers as well as sellers.

2. A Force Majeure Clause May or May Not Supersede Section 2-615

Not entirely clear in the Rembrandt opinion is whether and to what extent a bargained-for force majeure clause supersedes Section 2-615.  Dahmes argued:

When parties negotiate and include a force majeure clause in a contract, that clause supplants the UCC §2-615’s gap-filling provision and the common law frustration of purpose doctrine to specifically allocate the risk of certain events occurring to excuse performance. See, e.g., Perlman v. Pioneer Ltd. Partnership, 918 F.2d 1244, 1248 (5th Cir. 1990) (“The language in the force majeure clause … is unambiguous and its terms were specifically bargained for by both parties. Therefore, the [common law] ‘doctrine’ of force majeure should not supersede the specific terms bargained for in the contract.”); Commonwealth Edison Co. v. Allied-Gen. Nuclear Servs., 731 F. Supp. 850 855-56, (N.D. Ill. 1990) (finding that because the parties “deal[t] with the question of regulatory force majeure with considerable specificity … it is the contract, rather than a body of judicial doctrine, [the court] must interpret.”).

In apparently rejecting this argument, the Court noted that the UCC itself states that the common law generally supplements the UCC and does not supplant it.

3. Points to Keep in Mind Around Contract Signing

Before Signing:

The safest course when negotiating a force majeure clause is to state that it is not exclusive of other remedies.  This will be difficult to negotiate in most cases.  If that is not possible, be prepared to hear your opponent urging a judge or arbitrator to view it as exclusive, despite Rembrandt.

If you are the buyer, consider stating in the contract itself what the basic purpose of the contract is.  Such a recital will be strong evidence of both parties’ recognition of that purpose.  If you are the seller, beware of such recitals.

After Signing:

Remember that a force majeure clause may not necessarily supplant the frustration of purpose doctrine.  That doctrine may apply even when both sides can perform, but performance itself makes no sense.

Do not forget that in many settings the other party may have grounds for excuse from the contract, whether under the force majeure clause, the common law of frustration, or, regarding the sale of goods, Section 2-615.

[1] § 2-615. Excuse by failure of presupposed conditions

Except so far as a seller may have assumed a greater obligation and subject to section 2-614 on substituted performance

(1)  Delay in delivery or non-delivery in whole or in part by a seller who complies with subsections (2) and (3) is not a breach of his duty under a contract for sale, if performance as agreed has been made impracticable by the occurrence of a contingency the nonoccurrence 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.

(2)  Where the causes mentioned in subsection (1) affect only a part of the seller’s capacity to perform, he must allocate production and deliveries among his customers but may at his option include regular customers not then under contract as well as his own requirements for further manufacture. He may so allocate in any manner which is fair and reasonable.

(3)  The seller must notify the buyer seasonably that there will be delay or non-delivery and, when allocation is required under subsection (2), of the estimated quota thus made available for the buyer.

[2] The force majeure clause was mutual and stated:

Force Majeure. Neither party shall be liable to the other for failure or delay in performance of the Work caused by war, riots, insurrections, proclamations, floods, fires, explosions, acts of any governmental body, terrorism, or other similar events beyond the reasonable control and without the fault of such party (“Force Majeure Event”). Nevertheless, such party shall use its best efforts to mitigate the effect and to perform in spite of the difficulties causing such failure or delay and shall resume performance with the utmost dispatch as soon as the cessation of the Force Majeure Event permits. Any party claiming force majeure shall give prompt written notice thereof to the other party. Notwithstanding the foregoing or any other provision of this Agreement, if either party is unable to resume performance within ninety (90) days after commencement of a Force Majeure Event, then the other party shall have the right to immediately terminate this Agreement with all available insurance proceeds to be held in a separate account by the policy insured as a fiduciary which will distribute the proceeds between the parties in an equitable fashion.

7 Questions for Contractors … and a Few Proposed Answers

Previously published in the April 20, 2020 issue of the AGC of NH newsletter, Construction Connections

By Richard C. Gagliuso

The COVID-19 pandemic has presented the construction industry nationwide with unprecedented challenges. Even as we have done our best to navigate these waters and stay afloat, there is no question that we are in uncharted waters, placing a premium on staying informed and exercising good judgment.

One of the principal challenges facing contractors, owners and others involved in construction has been to identify and ask the right questions. Even if the answers remain unclear, there are questions that should be occurring to everyone with a role in construction projects. Here are some questions that I commend to you for consideration:

• Can I safely permit our construction projects to continue?

There is no general answer to this question, but it should be on the mind of every contractor, subcontractor and project owner. All contractors have a duty to provide a safe work environment for their employees. Regardless of whether construction activity is legally permitted under some circumstances, consideration must be given to whether construction work can be performed safely, and if not, whether suspension of the work may be appropriate.

• What steps do I need to take to ensure the health and safety of those on our job sites?

Government agencies like CDC, OSHA and NHDOT have issued guidelines and regulations relating to working safely in the midst of this pandemic, and they should be heeded to the greatest extent possible. Beyond what may be legal required, contractors have a range of safety measures at their disposal, including (i) taking the temperature of all workers upon arrival, (ii) providing personal protective equipment to workers, (iii) providing hand-washing stations, (iv) requiring appropriate distancing among workers, (v) limiting the number of people permitted in job trailers, (vi) posting and distributing written worksite safety requirements, (vii) furnishing visually distinct compliance officers or supervisors tasked with ensuring compliance with all requirements, (viii) strictly enforcing all requirements, and finally, (ix) documenting all such measures taken and their effectiveness over time.

• What steps do I need to take to preserve my contractual rights?

The answer to this question is highly dependent upon the specific terms of your contract, which means that all project participants must be well familiar with all pertinent contract provisions and do their best to comply with them. Nevertheless, some general observations are possible: (i) Contractors should consider seriously putting other parties on notice, “early and often,” of impacts related to COVID-19. Even if the extent of such impacts is not yet known or cannot yet be measured, notice of the existence of impacts may well be appropriate, if not required, under the terms of the contract; (ii) notices should be as detailed and meaningful as possible, and contractors should consider suggesting to the owner or other recipient a desired response; (iii) notices once given should be updated as additional information becomes available, particularly with respect to the consequences of such impacts in terms of both time and cost; (iv) requests for time extensions should be considered as soon as the period of delay is known; and (v) requests for additional compensation should also be considered even if not specifically authorized by contract terms.

• What can I do to recover costs associated with our COVID-19 response?

The hope is that, with appropriate notice of COVID-19 impacts, time extensions associated with such impacts will be liberally granted. The same cannot necessarily be said, however, of claims for additional compensation. Some contracts may purport to foreclose such claims, while others may be silent on this point. The one thing we may confidently say is this: If you do not keep records of the costs you incur in complying with government regulations and guidelines and in otherwise adjusting to working in these conditions, you are not likely to be in a position to recover these costs. Contractors would be well advised to begin tracking these costs immediately and to notify owners and other contracting parties as soon as such costs are known. Please keep in mind also that your contract may contain provisions which would support such a claim even if not expressly authorized. Change provisions and unforeseen conditions clauses, for example, may support an argument that COVID-19 impacts fit within their scope.

• Do I have insurance for costs associated with COVID-19 impacts, including business interruption?

As in other respects, we are in uncharted waters with respect to insurance coverage. The traditional forms of insurance that provide coverage for the various risks related to construction, such as general liability, builder’s risk and property insurance, may or may not provide coverage for some of these costs. The existence of coverage will depend on the specific terms of particular policies, including coverage grants and limiting endorsements. One interesting possibility is that pollution coverage may respond to claims in this area. To the extent losses are sustained, however, that can be traced to the COVID-19 pandemic, contractors should consider submitting claims for such losses. Having a knowledgeable insurance agent on your side will be more important than ever.

• Do I need to do anything different with contracts on new projects in light of the COVID-19 pandemic?

With respect to ongoing projects, of course, your rights and remedies are established by contracts already in place. None of these contracts, with the possible exception of those entered into within the past few weeks, will make specific reference to the current pandemic, and many of them will not even refer more generally to widespread illness or disease as a force majeure event. As contractors consider new projects, however, special care must be taken to account for future delays and costs associated with COVID-19, and for the foreseeable likelihood that performance based on normal assumptions may not be possible. To be specific, materials, labor and equipment simply may not be available within the times and for the prices estimated. Moreover, for reasons beyond the scope of this article, general force majeure clauses in contracts may not be sufficient to excuse non-performance where the pandemic was a known and current event at the time of contracting. Accordingly, contractors would be well advised to exercise caution and obtain advice in entering into new contracts without accounting for impacts from COVID-19.

• And finally, a word about proposals.

The same caution should be exercised in submitting proposals for new work. Again, contractors and suppliers simply cannot assume that they will be able to procure materials, labor and equipment on normal terms or even as promised. Those submitting new proposals would be well advised to shorten the time within with such proposals may be accepted and to include language permitting price increases to be passed on.