Litigation Issues in the Midst of COVID-19

There are many litigation issues presented by the outbreak of and response to COVID-19 (the disease caused by the novel coronavirus). We address below several practical and legal issues to consider during this challenging time. Kramer Levin’s Litigation Department will continue to monitor developments and update our clients.

Contractual Performance

COVID-19 presents a number of contractual issues for potential litigation. Typically, parties to contracts attempt to address potential “force of nature” disruptions through a force majeure clause, which may be invoked to excuse performance. Importantly, however, even if the contract has no force majeure clause, parties may still be able to excuse performance under two common-law doctrines: frustration of purpose and impossibility.

Force Majeure

A force majeure clause is a contractual provision in which the parties agree to excuse performance if, because of an unforeseen, external event beyond their control, at least one of the parties can no longer perform.^[1] The ability to apply a force majeure clause to COVID-19 will depend on the specific terms of the clause in the given contract.^[2] For example, the clause may broadly or narrowly define what events constitute a force majeure excusing performance, the causal nexus required between the event and ability to perform, and what rights and remedies the nonperforming party has if a force majeure event occurs. The party seeking to enforce such a clause must normally demonstrate that it made reasonable efforts to exhaust alternatives to nonperformance.^[3] The force majeure clause may also require that the nonperforming party provide certain notice to the other party to invoke the clause.^[4]

Under New York law, force majeure clauses are generally interpreted narrowly and to excuse performance only where the clause specifically includes the event that prevented a party’s performance.[5] While most contracts will understandably not have listed COVID-19 in a force majeure clause, the contract might list pandemic, epidemic, national or regional emergency, or other events caused by COVID-19, such as labor stoppage; government actions, laws or orders; or travel bans. The application of any force majeure clause to COVID-19 will be driven by the precise terms and conditions of the contract and the nature and facts underlying the nonperformance at issue.

Frustration of Purpose

The frustration of purpose doctrine applies when both parties to a contract can still perform but, because of an unexpected event, one party’s performance is now wholly valueless to the other party, thereby negating the reason that party signed the contract in the first place (i.e., that party has been denied the benefit of its bargain).^[6] In this regard, reduced profits or increased costs alone will generally not suffice to establish a “frustrated purpose.”^[7] Instead, the parties to the contract must have understood that the frustrated purpose was a foundation for the invoking party to enter the agreement.^[8] A contract may specifically state a party’s purpose for entering the contract, or, absent such language, there may be other evidence demonstrating that a party communicated its purpose to the other side prior to the agreement.

Another key issue for parties asserting frustration of purpose will be proving that the unexpected event was not reasonably foreseeable. Under New York law, “[i]f a contingency is reasonably foreseeable and the agreement nonetheless fails to provide protection in the event of its occurrence, the defense of commercial frustration is not available.”^[9] Parties asserting frustration of purpose must therefore be able to prove that, when they signed the contract, they could never have reasonably anticipated the government order, business interruption, event cancellation or other COVID-19-related event at issue.

Impossibility

The defense of impossibility applies when either the subject matter of the contract or the means of performance has been destroyed.^[10] As with frustration of purpose, “the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract.”^[11]

Given government actions in response to COVID-19 — including orders restricting travel, gathering in groups or conducting certain business — parties might argue that they can no longer perform their contractual duties. New York courts have typically held that “contract performance is excused when unforeseeable government action makes such performance objectively impossible.”^[12] In Bush v. ProTravel International, Inc., for example, the court found that there was a genuine issue of material fact about whether government restrictions imposed after the Sept. 11, 2001, attacks made it impossible for a customer to cancel her contract on time.^[13] The court emphasized that — arguably similar to the current situation under COVID-19 — “New York City was in the state of virtual lockdown with travel either forbidden altogether or severely restricted.”^[14]

Kramer Levin’s Litigation Department can counsel clients that anticipate being or are currently involved in COVID-19-related contract disputes.

Disclosure of Risk Issues

On March 4, 2020, the Securities and Exchange Commission advised all companies to provide investors with insight regarding their assessment and planning for COVID-19 risks “to the fullest extent practicable.”^[15] Such risk disclosures may fuel so-called event-driven securities litigation, which has proliferated in recent years. In such a case, a stock price drop following an extreme external event leads to claims that a company recklessly concealed or misrepresented the risk of such an event.^[16] The prospect of such litigation is heightened with respect to risk disclosures made after the occurrence of the extreme event, in this case COVID-19.

To minimize the risks of such event-driven litigation and to better defend against possible shareholder suits, companies should review and update their specific risk disclosures, assess the adequacy of past disclosures in light of the impact on their business to date, review whether potential forward-looking risks have become or will shortly become actual risks, and take care that material disclosures are disseminated broadly.^[17] Given the rapidly changing nature of this pandemic, it is also wise to give ongoing attention to plans established to address risks presented by COVID-19.

We are committed to assisting our clients in drafting and evaluating risk disclosures in light of COVID-19 and in minimizing the risk of disclosure-related litigation.

Business Interruption Insurance

Faced with closure or suspended operations as a result of COVID-19, businesses are reviewing their insurance policies to determine whether coverage can mitigate financial losses. Business interruption policies protect against losses sustained due to disrupted operations. Coverage typically requires physical property damage,^[18] and claims have been submitted for COVID-19-related losses on the theory that it constitutes a form of property damage or is otherwise covered.^[19] It remains to be seen whether these claims will succeed, and the specific provisions of the policy will be a significant factor in that regard. For example, many insurers specifically excluded coverage resulting from epidemics following the severe acute respiratory syndrome (SARS), Ebola and Zika outbreaks.^[20]

Civil authority coverage may also be available where a governmental order has cut off access to an insured property.^[21] In the first COVID-19 insurance suit, a prominent seafood restaurant in New Orleans’ French Quarter has asked a state court to confirm that its policy will cover lost revenue due to civil authority orders limiting dine-in options.^[22] More litigation of a similar nature should be expected.

In response to COVID-19, lawmakers and regulators are taking actions that will impact insurance claims. For example, the New Jersey Legislature is considering a bill that would mandate business interruption coverage despite applicable viral and bacterial exclusions. The bill, New Jersey Bill A-3844, would apply retroactively to policies in place as of March 9, 2020 — when Gov. Phil Murphy declared a state of emergency — and would apply to New Jersey businesses with fewer than 100 eligible employees (full-time employees who work 25 or more hours per week).^[23] The bill has raised concerns about legislative interference with private contracts and is potentially subject to constitutional challenge.^[24] As of March 19, 2020, the New Jersey Senate had not put the bill to a vote.

The New York State Department of Financial Services (NYSDFS) issued guidance requiring insurers to disclose “certain information” about commercial property policies active in the state.^[25] Pursuant to the guidance, insurers must disclose the volume of business interruption and civil authority policies issued statewide. They must also explain each policy’s coverage as it relates to COVID-19 — in other words, whether the policyholder is potentially eligible for coverage — and then send such explanations to each policyholder.

Federal lawmakers are taking steps as well. In a letter to insurance industry leaders, a bipartisan group of 18 members of Congress called on insurance companies and brokers to cover COVID-19-related losses as part of their commercial business interruption coverage, citing small businesses that have been forced to send employees home or shut their doors altogether.^[26] The lawmakers promised to work with insurance companies on any future measures.

We are monitoring these developments and anticipate a protracted period of litigation of these issues, as well as additional governmental measures to address insurance coverage in light of the pandemic.

Agreeing to Arbitrate

Civil litigants now have limited access to the court system, as courts across the country have postponed hearings and trials. In New York, pursuant to an administrative order dated March 22, 2020, all court filings, except for certain matters deemed essential, have been suspended.^[27] Clients should consider, particularly for time-sensitive matters, arbitration as a means of efficient and seamless dispute resolution.^[28]

Parties may mutually agree to submit a dispute to arbitration. For example, under New York law, parties may enter into arbitration agreements even after a dispute has arisen.^[29] While many contracts contain judicial forum selection clauses, the parties to such a contract will typically be able to amend that provision through a mutual written agreement to arbitrate.

The ability of one or more arbitrators to resolve a dispute without the need to empanel a jury, as well as the ability to litigate the dispute remotely on a schedule agreed upon between the parties and the arbitrator, may make arbitration an attractive alternative to the court system during this time of social distancing. Arbitrations are not a proxy for a courtroom litigation and do not confer all the same potential benefits. For example, arbitrators are not normally bound by the rules of evidence, and there may be benefits from a jury trial that are lost in arbitration. Arbitrations, however, generally produce a final resolution much quicker than the courtroom does. Among other reasons, parties in an arbitration have, at best, limited appeal rights.

We remain available to assist clients in weighing the pros and cons of pursuing arbitration as an alternative to traditional litigation.

^{[1] Macalloy Corp. v. Metallurg, Inc., 728 N.Y.S.2d 14, 14 (App. Div. 2001).}

^{[2] See Constellation Energy Servs. of N.Y., Inc. v. New Water St. Corp., 46 N.Y.S.3d 25, 27 (App. Div. 2017) (“When the parties have themselves defined the contours of force majeure in their agreement, those contours dictate the application, effect, and scope of force majeure.”).}

^{[3] Route 6 Outparcels, LLC v. Ruby Tuesday, Inc., 931 N.Y.S.2d 436, 437 (App. Div. 2011).}

^{[4] See, e.g., PT Kaltim Prima Coal v. AES Barbers Point, Inc., 180 F. Supp. 2d 475, 482 (S.D.N.Y. 2001) (force majeure clause required that nonperforming party provide notice and try to minimize the effects of the force majeure).}

^{[5] Reade v. Stoneybrook Realty, LLC, 882 N.Y.S.2d 8, 9 (App. Div. 2009).}

^{[6] PPF Safeguard, LLC v. BCR Safeguard Holding, LLC, 924 N.Y.S.2d 391, 391 (App. Div. 2011) (holding that Hurricane Katrina did not frustrate the purpose of an indemnity agreement because, despite the disaster’s effects on New Orleans, it did not impact the value of the contract’s performance).}

^{[7] Rockland Dev. Assocs. v. Richlou Auto Body, Inc., 570 N.Y.S.2d 343, 343 (App. Div. 1991).}

^{[8] PPF Safeguard, 924 N.Y.S.2d at 391.}

^{[9] Gander Mountain Co. v. Islip U-Slip LLC, 923 F. Supp. 2d 351, 360 (N.D.N.Y. 2013), aff’d, 561 F. App’x 48 (2d Cir. 2014); accord In re Schenck Tours, Inc., 69 B.R. 906, 911 (Bankr. E.D.N.Y.), aff’d, 75 B.R. 249 (E.D.N.Y. 1987) (“If a contingency is reasonably foreseeable and nonetheless the agreement fails to provide protection in the event of its occurrence, the party adversely affected will be deemed to have assumed the risk.”).}

^{[10] Kolodin v. Valenti, 979 N.Y.S.2d 587, 589 (App. Div. 2014).}

 ^[11] Id.

^{[12] Bush v. Protravel Int’l, Inc., 746 N.Y.S.2d 790, 795 (Civ. Ct. 2002).}

^{[13] Id. at 794-98.}

^{[14] Id. at 795.}

^{[15] SEC Provides Conditional Regulatory Relief and Assistance for Companies Affected by the Coronavirus Disease (COVID-19), SEC (Mar. 4, 2020), https://www.sec.gov/news/press-release/2020-53 (SEC Press Release).}

^{[16] See Julie G. Reiser & Steven J. Toll, Event-Driven Litigation Defense, Harvard Law School Forum on Corporate Governance (May 23, 2019), https://corpgov.law.harvard.edu/2019/05/23/event-driven-litigation-defense/.}

^{[17] See SEC Press Release, supra n.15.}

^{[18] Randy Paar, The Elements of a Business Interruption Claim, 2 No. 7 E-Commerce & Tech. 13 (Apr. 30, 2002).}

^{[19] Leslie Scism, U.S. Businesses Gear Up for Legal Disputes with Insurers Over Coronavirus Claims, Wall St. J. (Mar. 6, 2020), https://www.wsj.com/articles/u-s-businesses-gear-up-for-legal-disputes-with-insurers-over-coronavirus-claims-11583465668.}

^{[20] Noor Zainab Hussain, et al., Many global firms, excluded from epidemic insurance, face heavy coronavirus costs, Reuters World News (Jan. 29, 2020), https://www.reuters.com/article/us-china-health-insurance/many-global-firms-excluded-from-epidemic-insurance-face-heavy-coronavirus-costs-idUSKBN1ZS1CU.}

^{[21] See John K. DiMugno, Insurance Coverage for Loss of Business Income Following Hurricane Sandy, 34 No. 19 Ins. Litig. Rep. 532 (Nov. 26, 2012).}

^{[22] Leslie Scism, New Orleans Restaurant Kicks Off Coronavirus Insurance Coverage Litigation, Wall St. J. (Mar. 19, 2020), https://www.wsj.com/articles/new-orleans-restaurant-kicks-off-coronavirus-insurance-coverage-litigation-11584631384}

^{[23] New Jersey Assembly No. 3844, 219th Legislature (Mar. 16, 2020).}

^{[24] See Elizabeth Blosfield, Proposed N.J. Bill Would Require Insurers to Pay COVID-19 Business Interruption Claims, Insurance Journal (Mar. 19, 2020), https://www.insurancejournal.com/news/east/2020/03/19/561643.htm.}

^{[25] New York State Department of Financial Services, Call for Special Report Pursuant to Section 308, New York Insurance Law: Business Interruption and Related Coverage in New York (Mar. 10, 2020), available at https://www.hinshawlaw.com/assets/htmldocuments/Alerts/NYDFS%203-10-2020.pdf.}

^{[26] Representative Nydia M. Velázquez, et al., Letter to Insurance Industry Leaders, Mar. 18, 2020, available at https://cunningham.house.gov/sites/cunningham.house.gov/files/wysiwyg_uploaded/Signed%20BII%20Letter_Final.pdf.}

^{[27] N.Y. Admin. Order AO/78/20 (Mar. 22, 2020).}

^{[28] As of March 23, the American Arbitration Association and JAMS remain operational and have shifted to remote work structures in light of COVID-19. According to their respective websites, each organization is offering a variety of technological alternatives to in-person hearings.}

^{[29] N.Y. C.P.L.R. § 7501.}