The Effect of Covid-19 on Business Contracts
By: Arend J. Abel, Attorney
With much of the nation shut down during the Covid-19 pandemic, many business contracts may not be performed. One of the questions that arises from that circumstance is whether non-performance will be considered a breach of contract, subjecting the non-performing party to an action for damages. There are three areas to consider in analyzing that question: 1) Force Majeure; 2) Impossibilitiy; and 3) Impracticability. Impracticability is confined to contracts for the sale of goods governed by the Uniform Commercial Code
Force Majeure, a French term meaning “superior force,” is a doctrine that excuses contractual performance made impossible by events listed in a contractual force majeure clause. As the Indiana Court of Appeals has observed “the scope and effect of a force majeure clause depends on the specific contract language, and not on any traditional definition of the term. Specialty Foods of Indiana, Inc. v. City of South Bend, 997 N.E.2d 23, 27 (Ind. Ct. App. 2013). A typical force majeure clause may look something like the following:
If a party cannot perform the obligations of this agreement due to an act of God, legal prohibition, fire, flood, natural disasters, military operations, or any other circumstance not within the control of the party, then the party is excused from performing such obligations.
The key question to ask in considering whether a force majeure clause excused a party’s performance is whether the event causing the non-performance is one of the events listed in the clause. If the language does not specifically include diseases or epidemics, a court may or may not find that general language describing “other circumstances not within the control of the party” covers the event. The Court of Appeals decision in Specialty Foods suggests that the particular clause set out above would cover such an event. However, even slight changes in language can affect the result. For example, a clause that excuse a party from performing for “reasons outside the party’s control such as an act of God, legal prohibition, fire, flood, natural disasters or military operations” might not cover CoVid-19 because the “such as” language might be interpreted to require the unlisted events to be similar in kind to those listed. See Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900, 902, 519 N.E.2d 295, 296 n.* (1987) (language that “other similar causes beyond the control of such party” did not cover an inability to perform due to an inability to obtain insurance coverage).
Under Indiana law, as well as the law of most States, impossibility of performance excuses contractual performance, even in the absence of a force majeure clause. Wagler v. West Boggs Sewer District, 980 N.E.2d 363, 378 (Ind. Ct. App. 2012). However, the party claiming the defense must show that performance is “not merely difficult or relatively impossible, but absolutely impossible, owing to the act of God, the act of the law, or the loss or destruction of the subject-matter of the contract.” Id. (quoting Ross Clinic, Inc. v. Tabion, 419 N.E.2d 219, 223 (Ind.Ct.App.1981), which in turn quoted Krause v. Bd. of Trustees of Sch. Town of Crothersville, 162 Ind. 278, 283–284, 70 N.E. 264, 265 (1904)).
This may be difficult to meet in the case of Covid-19, though perhaps a business ordered to close by the authorities could meet the requirements, depending on the specific contract involved.
The Indiana Court of Appeals has considered whether an epidemic excuses contractual performance on two occasions. Gregg School Township v. Hinshaw, 76 Ind. App. 503, 132 N.E. 586, 587 (1921); Gear v. Gray, 10 Ind. App. 428, 37 N.E. 1059 (1894). In Gregg, the Court held that the fact that a school was ordered closed due to the 1918 flu pandemic meant that the School board did not have to pay teachers during the time the school was closed. In Gear, the Court reached the opposite conclusion when a school was closed due to a local diptheria epidemic. Explaining the different results, the Court in Gregg noted that in Gear, the local health authorities who ordered the school closed did not have express statutory authority to close the schools. In Gregg, the Court noted, there was such authority, and the contract had to be read as incorporating such authority, which rendered performance of the contract impossible.
It is unclear how Gregg will affect contracts of businesses that have been shut down in the latest pandemic. If the contract is one that literally cannot be performed when the business is shut down (such as a contract for an entertainer to appear at a venue), then most likely a court would excuse performance on grounds of impossibility. However, contracts by which a business purchases goods and services may be technically possible to perform, even if pointless. Courts may hold that performance is not excused in such cases.
Where contracts are for the sale of goods, the impracticability provisions of the Uniform Commercial Code could come into play. Section 2-615(a) of the U.C.C. provides:
Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) 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 non-occurrence 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.
Significantly, the provision excuses a failure to deliver goods by a seller but offers no relief to buyers. In addition, to be excused from performance, the seller must comply with paragraphs (b) and (c) of the statute. If the situation only partially affects the seller’s ability to deliver goods, paragraph (b) requires the seller to allocate production and deliveries among customers in a manner that is “fair and reasonable.” Paragraph (c) requires the seller to provide the buyer with notice that there will be a non-delivery or delay, and if an allocation is required under paragraph (b) what the buyer’s allocation will be.
Impracticability is a lesser standard than impossibility, so sellers may have the ability to avoid contracts that become burdensome to perform, though not strictly impossible.
Regardless of whether Force Majeure, impossibility, or impracticability is invoked, the result will depend on particular facts and circumstances affecting contract performance. The issues will also likely depend on contractual language that covers, or can be read to cover, the specific events in question. I have represented businesses in a variety of litigation for over 30 years. If you are in a contract dispute as a result of this pandemic, contact me to discuss how I can help your business and protect your rights.
Will Your Business Also Survive COVID 19?
By: George W. Hopper, Attorney
The well-being of you and your family are of utmost concern during this pandemic. What about the well-being of your business? All businesses, large and small are navigating through the current economic downturn and its unique challenges.
Over the past 38 years, I have been advising business clients through five economic recessions. Each recession had certain similarities, but each was also unique in cause, effect and length. Nevertheless, during each recession, the business clients that survived and ultimately prospered each made the same crucial decisions in common:
- Each client chose to be proactive rather than reactive in confronting economic and legal challenges to their businesses before they exhausted their financial resources; and
- Each client engaged competent legal counsel and financial advisors sooner rather than later in the process.
Of course, it is without question extremely challenging to successfully manage a business in a good economy. During a recession, the task becomes even more challenging and can easily become overwhelming with the addition of new legal issues, shrinking cash flow and reduced available credit. The situation can change and will change dramatically and quickly during this crisis. For this reason, there will be no substitute for timely and competent legal and financial advice.
Depending on the situation confronting your business, there are a variety of tools that can be employed to find solutions. Early in the process, management can consider and pursue solutions that do not involve a formal legal case or proceeding such as:
- Loan restructuring
- Turnaround negotiations with affected creditors
- Sale or merger
If circumstances do not lend themselves to any of the forgoing tools, business clients may have to resort to litigation, or chapter 11 bankruptcy or a combination of the two approaches.
The bottom line is the sooner the business client proactively meets the challenges presented by the current economic crisis, the greater number of options will be available to address the client’s needs. In fact, during and as a result of the 2008 great recession, the vast majority of cases that I was involved in were successfully resolved out of court, which saved many thousands of dollars in professional fees and generated a superior outcome for both the struggling business and its creditors. Each one of those cases began and ended as a result of the timely decision by management to engage experienced legal counsel. It does not pay to wait. Contact me to discuss ways I can help you protect your business.
When do former clients create conflicts of interest?
By: Arend J. Abel, Attorney
Lawyers often conclude that once representation of a client ends, they are free to take on matters adverse to the former client. However, that is not always the case. The Indiana Rules of Professional Conduct specifically provide that there are circumstances where a lawyer may not take a representation that is adverse to a former client. Indiana Rule of Professional Conduct 1.9 provides that a lawyer may not, absent informed consent, represent a client who is adverse to a former client where the matters are “the same or substantially related.” It’s easy to tell if matters are “the same.” The trick is to determine what counts as a “substantially related matter.”
The answer to the question of whether matters are “substantially related” is sometimes counterintuitive. For example, a lawyer who has generally represented a business owner and obtained information regarding the business owner’s finances likely cannot later represent the business owner’s spouse in a divorce, because the financial information learned from the previous representation may be highly relevant to property settlement issues.
On the other hand, a lawyer who has repeatedly defended employment matters for a business may not be disqualified from later representing persons making employment claims against the former client, because the facts of each separate employment matter stand on their own.
There are some cases that fall between those two types of representations. For example, the Indiana Court of Appeals in XYZ, D.O. v. Sykes, 20 N.E.3d 582 (Ind. Ct. App. 2014) disqualified a law firm because one of its lawyers had previously represented the adverse party doctor in six medical malpractice suits and the current representation involved an additional allegation of malpractice, coupled with a negligent credentialing allegation against a hospital for failure to adequately investigate the circumstances of the six prior malpractice suits. The Court of Appeals held that the two matters were substantially related and therefore the lawyer and her firm were disqualified.
The key test to determine whether matters are “substantially related” is whether there is a substantial risk that specific confidential factual information of the kind that would normally have been obtained in the prior representation would materially advance the new client’s position against the former client. General knowledge of the former client’s policies and practices is ordinarily not enough to result in disqualification, at least for organizational clients.
Before taking on a representation that is adverse to a former client, an attorney must carefully consider the scope of the prior representation and the kind of information that would normally have been obtained from the former client for that sort of representation. Then, the lawyer must assess whether information that would normally have been obtained from the former representation could be helpful to the new client. If it is, the lawyer must decline the new representation.
Indiana Court of Appeals upholds and “reforms” covenants not to compete and not to solicit customers or employees
By: Arend J. Abel, Attorney
On April 15, 2019, the Indiana Court of Appeals issued a decision that could mark a major shift in the law relating to non-compete and non-solicitation agreements. Heraeus Medical, LLC v. Zimmer, Inc., No. 18A-PL-1823 (April 15, 2019). The decision contains three holdings of significance: (1) that a covenant need not have an explicitly defined geographic scope, (2) that a covenant can protect prospective customers with whom the departing employee had recent contact, and (3) that an express provision in a covenant can permit a court to reform an overly broad covenant so as to make it enforceable.
The case involved two medical device companies who had an agreement for one of them (Zimmer) to serve as the exclusive distributor of bone cement manufactured by the other (Hereaus). Hereaus terminated the agreement in December of 2018, formed its own subsidiary to sell and distribute the product, and hired Robert Kolbe, who had been Zimmer’s Director of Enterprise Solutions for the eastern United States. Kolbe had a non-compete agreement with Zimmer, which also prohibited him from soliciting Zimmer customers and employees.
In part, the employee non-solicitation agreement prohibited Kolbe from soliciting “any individual employed by Company at the time of Employee’s separation from Company employment.”
The “Restricted Territory” for the non-compete and customer non-solicitation clauses was defined as:
(i) any Customer-specific or geographic territory assigned to, or covered by, Employee during Employee’s last two (2) years of employment with Company; (ii) any state or portion of any state assigned to Employee by Company for purposes of any sales or service activities or responsibilities at any time during the two (2) years preceding the termination of Employee’s employment with Company; or (iii) any county, municipality or parish of any state or commonwealth assigned to Employee or in which Employee engaged in any sales or service activities on behalf of Company at any time during the two (2) years preceding termination of Employee’s employment with Company
The customer non-solicitation covenant prohibited Kolbe from soliciting both customers and “Active Prospects, which the agreement defined as:
[a]ny person or entity that Company, through its representatives, specifically marketed to and/or held discussions with regarding the sale of any of Company’s products or services at any time during the last six (6) months of Employee’s employment with Company and with respect to whom, at any time during the six (6) months immediately preceding the termination of Employee’s employment with Company, Employee had (i) any marketing or sales contact on behalf of Company and/or ii) access to, or gained knowledge of, any Confidential Information concerning Company’s business prospects with such Active Prospect.
Defendants first contended that the failure of the agreement to geographically describe the restricted territory rendered it void. However, the Court held that Indiana law “requires only that the geographic scope of restrictive employment covenant be reasonable, not that it be spelled out in explicit terms.” The Court also held that the geographic scope of the covenant could be shown by extrinsic evidence concerning the portions of the country that were assigned to Kolbe.
Defendants also contended that the prohibition on soliciting “active prospects” was invalid, asserting that Indiana Law did not permit covenants that reached prospective customers. Again, the Court rejected the argument, holding that because the covenant applied only to prospective customers with whom Kolbe had contact during the last six months of his employment with Zimmer, it was “limited in both scope and duration,” and therefore was valid.
Finally, Defendants contended that the employee non-solicitation covenant was void because it was overly broad. Specifically, it applied to all employees of Zimmer, including “employees such as drivers or shelf stockers.” The Court agreed that the provision against soliciting employees was overly broad because Zimmer “has not shown that it has a legitimate protectable interest in its entire workforce, which includes many employees who would not have access to or possess any knowledge that would give a competitor an unfair advantage.”
However, the Court refused to invalidate the entire covenant because the parties agreed to a provision in the agreement that “any court interpreting the provisions of this Agreement shall have the authority, if necessary, to reform any such provision to make it enforceable under applicable law.” The Court acknowledged that prior law held that a court could not “not create a reasonable restriction under the guise of interpretation, since this would subject the parties to an agreement they have not made.” But the Court held that the reformation provision made all the difference because “ the parties specifically agreed” that a court interpreting the agreement had the authority to reform any unreasonable provision to make it enforceable.
There are several lessons that can be learned from Heraeus Medical. First, it is permissible to define the geographic scope of a non-compete by reference to the employee’s assigned territory, without expressly naming or describing that territory. Second, restrictions on soliciting prospective customers are enforceable as long as they are limited to prospective customers with whom the employee had contact within a short period before the employee’s departure. Finally, and perhaps most surprisingly, a court can “reform” an invalid non-solicitation provision to make it valid as long as there is an express provision in the agreement providing that authority. Businesses should review (and likely should revise) their non-compete and non-solicitation agreements in light of this new decision.