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Breach Of Contract Due To COVID-19 In Michigan: What Defenses Are Available?

 

On March 10, 2020, the State of Michigan identified the first two presumptive-positive cases of the novel coronavirus (COVID-19) in its borders.  That same day, Governor Gretchen Whitmer issued an executive order declaring a state of emergency based on her authority under Art. 5, Sec. 1 of the Michigan Constitution of 1963, the Emergency Management Act (MCL 30.401 through 30.421) and the Emergency Powers of the Governor Act (MCL 10.31 through 10.33).  “The governor shall, by executive order or proclamation, declare a state of emergency if he or she finds that an emergency has occurred or that the threat of an emergency exists.”  MCL 30.403(4).  “After making the proclamation or declaration, the governor may promulgate reasonable orders, rules, and regulations as he or she considers necessary to protect life and property or to bring the emergency situation within the affected area under control.”  MCL 10.31(1).  “Those orders, rules, and regulations may include, but are not limited to, providing for the control of traffic, including public and private transportation, within the area or any section of the area; designation of specific zones within the area in which occupancy and use of buildings and ingress and egress of persons and vehicles may be prohibited or regulated; control of places of amusement and assembly and of persons on public streets and thoroughfares; establishment of a curfew; control of the sale, transportation, and use of alcoholic beverages and liquors; and control of the storage, use, and transportation of explosives or inflammable materials or liquids deemed to be dangerous to public safety.”  Id.

These orders include Executive Order 2020-41 (superseding Executive Order 2020-21) which requires the following:

  • Until at least April 30, 2020, the temporary suspension of any “in-person work is not necessary to sustain or protect life” and prohibiting “all public and private gatherings of any number of people occurring among persons not part of a single household.”
  • All individuals must adhere to “social distancing measures” such as remaining six feet from other people”. There should be no more than ten people in a room, including for purposes of attending funerals.
  • Employers can only require employees to leave their home for employment if they are “critical infrastructure workers” such as health care workers and necessary government workers. To the extent possible, employees should be permitted to work remotely from home.
  • Stores permitted to remain open must limit customers to 4 people per 1,000 square feet and close off parts of the store dedicated to the sale of carpet, flooring, furniture, garden centers and paint.
  • Individuals should stay in their home or place of residence unless they meet a specified exception such as purchasing groceries, seeking medical or dental care, or attending legal proceedings. After April 10, 2020, travel between different residences is prohibited unless permitted by court order (e.g. child custody and parenting time).

These governmental measures have put the brakes on the U.S. economy and will almost certainly lead to litigation.   Business contracts to complete certain projects within a certain deadline will go unfulfilled because manpower is unavailable or supplies cannot be delivered.  One side refuses to perform as agreed upon because the state of the world will cause that party to derive less value from completion.  Finally, performance of the contract might simply be impossible because of the governor’s executive orders restricting congregation and travel.  For the other side that is losing out for non-performance, can they sue for enforcement of the agreed-upon terms?  What defenses can the defaulting party raise to avoid being liable for a money judgment?

There are three viable defenses that can be raised in Michigan under these circumstances:

FRUSTRATION OF PURPOSE

The frustration of purpose doctrine is an excuse for nonperformance of a contractual obligation.  Liggett Restaurant Group, Inc v City of Pontiac, 260 Mich App 127, 133; 676 NW2d 633 (2003).  The doctrine is “asserted where a change in circumstances makes one party’s performance virtually worthless to the other, frustrating his purpose in making the contract.”  Id at 133-134.  The following conditions must ALL be satisfied:

  • “(1) the contract must be at least partially executory; (2) the frustrated party’s purpose in making the contract must have been known to both parties when the contract was made; (3) this purpose must have been basically frustrated by an event not reasonably foreseeable at the time the contract was made, the occurrence of which has not been due to the fault of the frustrated party and the risk of which was not assumed by him.” Molnar v Molnar, 110 Mich App 622, 626; 313 NW2d 171 (1981).

In Molnar, the Michigan Court of Appeals found a frustration-of-purpose in a provision of the divorce settlement.  The ex-husband had agreed to make partial mortgage payments for the home that his son and ex-wife lived in until his 18th birthday.  Unfortunately, the son died before reaching the age of majority and the ex-husband successfully argued that his purpose in agreeing to said payments was to provide a good home for his son, not his ex-wife.  In addition, the death of his son was unforeseeable at the time the agreement was made.  The court agreed and found that the changed circumstances justified a modification.

However, in Riewe v Baron, unpublished per curiam opinion of the Court of Appeals decided October 20, 2015 (Docket No. 321318), the Court of Appeals rejected a frustration of purpose argument because the event cited was not unforeseen.  A pawn shop owner contracted an auction company to sell an impressive artwork collection of approximately 400 pieces and both sides initially anticipated big profits.  There was a sliding scale for the auctioneer’s fees and, in the event of a weak sale, the auctioneer would receive a $200,000,00 commission.  Shortly after the contract was signed, the auctioneer discovered that many pieces were of Spanish Colonial origin and their sale might be implicated by a U.S-Mexico treaty.  He decided that 300 pieces could not proceed to auction without further investigation and only sold the remaining 115 pieces.  The owner acquiesced, indicating he needed the money.  The auction only yielded $55,515 in proceeds and the auctioneer demanded his $200,000 commission.  The owner refused and litigation followed.  The owner tried to argue that the contract should be rescinded, reformed or avoided based on the frustration of purpose, arguing “that the core purpose of the contract was frustrated when a majority of the collection was held back from auction based on the United States-Mexico treaty.”  The Court of Appeals disagreed, finding that while his purpose to make a profit on all 400 items was frustrated, he was not affected by an unforeseen event.

  • “The treaty also did not frustrate the purpose of the parties’ contract because defendant waived any original intent to auction approximately 400 items when, after discovering the treaty, he decided to continue to auction with only 115 items. Thus, even if the original intent was to liquidate defendant’s inventory, the purpose of the parties’ agreement morphed from the sale of at least 400 items, to the sale of 115 items with the ultimate purpose of yielding a profit. When given the option to postpone the auction after learning of the treaty, defendant said, “I gotta do an auction. I need the money.” “The Frustration of Purpose Doctrine does not apply to errors in prediction as to future occurrences or non-occurrences. A party cannot enter into a contract, expecting to make a profit, and then demand rescission when the deal turns out to be less lucrative than he had hoped.” Tri-State Rubber & Equipment, Inc v Central States Southeast & Southwest Areas Pension Fund, 677 F Supp 516, 520 (ED Mich, 1987).”

It is possible that the COVID-19 crisis may be considered an unforeseen event that would frustrate the purpose of a contract justifying release from performance.

FORCE MAJEURE CLAUSES

A force majeure clause is a contract provision that relieves the parties when certain agreed upon circumstances arise that are beyond control.  These events can include natural disasters, fires, strikes and “acts of government”.  Historically, courts read these provisions very narrowly.

In Kyocera Corp v Hemlcok Semiconductor, LLC, 313 Mich App 437; 886 NW2d 445 (2015), the parties had entered into a “take-or-pay” contract.

  • “A take-or-pay contract obligates a buyer to purchase a specific quantity of product from the seller (usually also the manufacturer of the product) at a fixed price; if the buyer purchases less than that quantity, it is nonetheless obligated to pay the seller for the full specified quantity at the specified price. The very essence of a take-or-pay contract is therefore to allocate to the buyer the risk of falling market prices by virtue of fixed purchase obligations at a long-term fixed price, and to thereby secure for the buyer a stable supply, while allocating to the seller the risk of increased market prices and, by virtue of the buyer’s obligation to take or pay for a fixed quantity of product, removing from the seller the risk of producing product that may go unpurchased.”

The contract included a force majeure provision that released the buyer or seller for “delays or failures in performance of its obligations under this Agreement that arise out of or result from causes beyond such party’s control, including without limitation: acts of God; acts of the Government or the public enemy; natural disasters; fire; flood; epidemics; quarantine restrictions; strikes; freight embargoes; war; acts of terrorism, etc.  Kyocera alleged that the force majeure event was the Chinese government engaging in “large-scale dumping,” i.e., “where a foreign producer aided by state support sells a product at a price that is lower than its cost of production to manipulate an industry and capture market share.”  As a result, China gained 75% of the solar market and several Western manufacturers went out of business.  When Hemlock refused to amend the long-term pricing to reflect market conditions, Kyocera filed suit for a declaratory judgment to be relieved of its contractual obligations.  The trial court refused to enforce the force majeure clause and the Michigan Court of Appeals agreed, finding that the Chinese government’s actions might have hurt profit margins but did NOT hurt the ability to perform the contractual duties in question.  Besides, the phrase “acts of the government” is ambiguous and does not specify what would trigger an obligation-releasing event.

A contract must contain a triggering event in a force majeure clause that would be implicated by COVID-19 such as “epidemic”, “pandemic”, “quarantine”, “viral break”, “disruption of supply chains or labor force”, “national emergency”, “government order” or “Act of God”.  Many force majeure clauses also contain a catch-all such as “or other similar events beyond the control of either party”.  However, courts will narrowly apply these charges so it may not be enough to allege “pandemic’ or “government order” without pleading specifically how contract performance was impaired.  Certainly, future contract negotiations going forward should consider some of the economic changes created as a result of the current COVID-19 emergency.

IMPOSSIBILITY OR IMPRACTICABILY OF PURPOSE

When a contract is lacking a force majeure clause, a party looking to be relieved of its obligations may have to turn to the high standards under the doctrine of impossibility.  To determine the application of the defense of impossibility, one must examine whether an anticipated circumstance has made the promised performance vitally different from what was contemplated by the parties at the time of the contract’s formation.  Bissell v L W Edison Co, 9 Mich App 276, 285; 156 NW2d 623 (1967).  The circumstances excuse performance only to the extent that performance is impossible, and the application of impossibility is based on the individual facts of each case.  Id at 286.  Accordingly, a plaintiff must show that the event or circumstance causing the impossibility was not foreseeable at the time the contract was made.  Liggett Restaurant Group, Inc v City of Pontiac, 260 Mich App 127, 134-135; 676 NW2d 633 (2003).

The burden of proof is high.  The fact that a fire could destroy a building or its contents is foreseeable.  Razzook’s Properties, LLC v Yono, unpublished per curiam opinion of the Court of Appeals decided November 21, 2006 (Docket No. 263010).  If it is something that could happen, then it is not impossible.  Like force majeure, the impossibility doctrine will be recognized in very narrow circumstances.  For some transactions, the Michigan Commerical Code recognizes a slightly broader defense of impracticability regarding the sale of goods.  This doctrine also recognizes that an unforeseeable event must occur but inability to perform could also result from government restrictions.  For example, the governor’s executive orders limiting travel and halting non-essential business activities can give rise to the doctrine of impracticability.  Certainly the current COVID-19 crisis qualifies as an “unforeseen event” giving rise to consideration by the courts of a contract’s feasibility.

THE BOTTOM LINE

Hopefully, both sides of a contract that is hampered by the COVID-19 crisis can reach a meeting of the minds and figure out a mutual beneficial solution.  If agreement is impossible, then you may need a skilled lawyer in your corner to protect your rights and defend you from more monetary loss than you have already suffered.  Courts will not easily release parties from their contractual obligation and it may require substantial preparation and skillful argument to convince the judge that frustration of purpose, force majeure or impossibility apply to your situation.  If you or a loved one have questions about a legal contract affected by COVID-19 or need legal representation, then do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC for assistance today.

 

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