Apr 20, 2020 - Corona Virus by |

FRANCHISES, COVID-19, WWI, IMPOSSIBILITY AND FRUSTRATION

By: Jeffrey M. Goldstein

Like many other small businesses, countless franchisees have been devastated by the COVID-19 pandemic. The financial and logistical disruptions of the coronavirus have caused numerous franchisees and small businesses to ponder the effects of the pandemic on contracts in general, including, for instance, their franchise agreements, supply contracts and leases. Although many of these agreements contain force majeure agreements, some of them may be determined to be specifically inapplicable to the COVID-19 situation based on the language in the clause. In such cases, the non-performing business or franchisee must avail himself of one of the common law defenses that could excuse his performance, including impossibility, impracticability, frustration of purpose and mutual excuse.

Unlike many obligations imposed by law, the obligation to meet contractual obligations is generally considered absolute. In almost all cases, a person who fails to perform under a valid contract will not be heard to justify the breach or non-performance by a supervening event, no matter how devastating. This is true even though the party seeking an excuse was not negligent in failing to perform. If strict liability were not the rule, breaches of contract would be rampant where the non-performing parties found themselves in a worse financial situation after signing their contracts when it came time to perform.

The four major exceptions to the absolute duty to perform under a contract (other than where the specific language in a contract explicitly excuses performance in the face of a future consequential event) include impossibility, impracticability, frustration and mutual mistake. Where these are implicated, the non-performing party will be excused from performance. Although these doctrines are connected abstractly by ‘allocation of risk’ considerations, each one is sufficiently unique in scope and breadth to stand on its own.

Frustration of purpose is generally recognized when some circumstance, after execution of a contract, destroys the value to the non-performing party of the other party’s performance such that it frustrates the non-performing party’s own purpose in making the contract. One of the earliest cases invoking this doctrine in the United States is Alfred Marks Realty Co. v. Hotel Hermitage Co., 170 A.D. 484, 156 N.Y.S. 179 (App. Div. 2nd Dept. 1915).

In January 1914, the defendant hotel (the Hotel) contracted with Plaintiff’s assignor, the International Yacht Publishing Company (the Plaintiff or the Publisher), to run its advertisement in a marketing circular or book — “Souvenir and Program of International Yacht Races.” Under the contract, the Hotel agreed to pay for the advertising upon publication.

In August 1914, some of the books with the Hotel’s advertisement were printed opposite a picture of a yacht. About 2500 copies of the book were sold and distributed. On or about August 15, the yacht committee canceled the races as a result of the declaration of WWI. The challenger yacht did not arrive until August 20, at which time three American yachts were having trials to determine which would defend the cup in the September races.

On August 25, the Publisher mailed the Hotel a copy of the program containing its advertisement with the following letter:

As you are no doubt aware the cup races have been postponed until 1915 on account of European disturbances. Even without the races the book as a souvenir is a good seller and a good advertisement. We expect an unprecedented sale before and after the races. Many of which (sic) have already subscribed for cash in advance. We claim it is the best book ever for the price. The work will be placed on public sale later. Kindly remit us your check.

When the Hotel refused to pay for the advertising, the Publisher sued for the fees allegedly owed. Both the trial court and intermediate appellate term court ruled in favor of the Publisher, and the Hotel appealed to the New York Court of Appeal.

The Court began its analysis by pointing out that it was “obvious” that the parties had “in view” the September cup races, and that “Defendant’s advertisement was in connection with this contest.” Citing to a similar case decided shortly before Hotel Hermitage, the Court stated that “a program [for yacht racing] is for events to which it relates, and a souvenir ‘cannot recall what has not taken place’”.

The Court then analyzed the concept of a publication, concluding that the Program “though styled program and souvenir, was anticipatory.” Accordingly, under the Court’s view, it was “not a ‘publication’ in the sense of this contract.” In turn, the Court held that there existed an “implied condition” that the races occur. In addition, “where this feature is obvious, a failure, by giving up the expected contests, abrogates the contract.”

After ruling that the contract had been abrogated, the Court explicitly pointed out that the case was not one where a promisor had failed to guard itself against a vis major; nor was it one where there was “performance on one side, the other having no appropriate clause to excuse default.” Instead,

it is where the situation, as it turns out, has frustrated the entire design on which is grounded the promise. An advance issue of the programs cannot fairly be held to be what defendant was to pay for. The object in mutual contemplation having failed, plaintiff cannot exact the stipulated payment.

It is important when reading ‘frustration’ cases to note several points made by the Hotel Hermitage Court. First, it was not ‘impossible’ for the Hotel to pay for the advertising. Nothing prevented the Hotel from cutting a check and mailing it; yet, the Court excused the Hotel’s obligation to pay the remaining portion of the fee. Second, the definition of frustration required a determination of (1) the main purpose of the contract, and (2) that this larger purpose has been prevented. Third, it was obvious that at the time of contracting, both parties had ‘in view’ the September cup races; hence, the parties had as a basic assumption that the races would occur. Fourth, the entity responsible for canceling the yacht races was not influenced by or affiliated with the Publisher.

Fifth, when discussing the issue of the underlying assumption of the parties regarding the supervening frustrating event, the Court did not discuss or refer to the issue of foreseeability. In contrast, modern-day legal contracts analysis of ‘frustration’ uses foreseeability, in difficult cases, as one analytical tool to ascertain whether the non-occurrence of the supervening event was a “basic assumption” on which both parties made the contract. However, under current law, even where an event is foreseeable, that does not drive a conclusion that its non-occurrence was not a basic assumption. It is likely that the Court felt no such foreseeability inquiry was necessary since viewed it obvious that the non-occurrence of cancelation of the races was a basic assumption of the parties in executing the agreement.

The most interesting point from a pedagogic legal perspective is that the Hotel Hermitage Court seems to have braced its decision on the finding of an ‘implied condition’ that cancelation of the yacht races would not occur. However, the Court failed to provide any explanation as to the source for or functioning of this ‘implied condition’ analysis; accordingly, no roadmap was provided for how this appraisal was to fit doctrinally into existing contracts law at the time. Modern contracts law has for the most part rejected this ‘implied term’ mode of evaluation for impossibility and frustration cases. Instead, the focus of modern courts is upon whether the non-occurrence of the supervening circumstance was a basic assumption on which the contract was made.

At the end of the day, a review of the relevant case law regarding excuse cases shows that cases involving impossibility, mistake, impracticability and frustration are exceedingly difficult to reconcile, predict or assess. This impenetrability is extant in both the legal and factual aspects of these cases. Indeed, in the context of frustration of purpose, courts have ruled against the applicability of the excuse despite very similar fact patterns. For instance, in Herne Bay Steamboat Co v Hutton [1903] 2 KB 683, the Kings Bench deemed a contract was not frustrated where the defendant had hired a steamboat to take him on a voyage to see a naval review, which ultimately did not occur; as the Kings Bench stated: “the object of the voyage is not limited to the naval review, but also extends to a cruise round the fleet … and the fleet was there …”

Modern day excuse cases appear to focus on identifying the party who has assumed the risk of the non-occurrence of the supervening event. For instance, in impracticality cases, in contracting for the manufacture and delivery of items at a fixed price, the seller assumes the risk of reasonable increased costs. However, if a disaster causes a sudden 100-fold increase in cost to the seller, it is possible to convince a court that the seller did not assume this risk by concluding that the non-occurrence of the melt-down of the supplies market  was a ‘basic assumption’ on which the contract was made. And, as noted above, while the foreseeability of the disaster is a factor in the analysis, it is not always dispositive.

Another way that some courts examine these issues is to conclude that the obligor is excused from performance because the contract was made on a different ‘basic assumption,’ one not covering the supervening event situation. As so postured, the analysis of these cases proceeds under a more traditional contracts ‘gap methodology.’ As the Restatement, Second, of Contracts states: “Ordinarily, the just way to deal with the omitted case is to hold that the obligor’s duty is discharged, in the case of changed circumstances, or has never arisen, in the case of existing circumstances, and to shift the risk to the obligee.”

In considering whether a small business or franchisee has an excuse from performing under its franchise, loan, supply or lease agreement, both the effects of COVID-19, as well as the response by national and local government agencies, must be identified and evaluated. While in some cases COVID-19 itself might offer an excuse (e.g., death of contracting party; inability to obtain supplies to operate the business), in some other cases the effects of COVID-19 on customers can offer an excuse (e.g., death of or fear of death by customers), and in other cases government ordinances, decrees and regulations prohibit owners from operating and customers from visiting many businesses.

One strong word of caution is in order regarding an attempt to use one of the excuse doctrines discussed above. First, because the applicability of these excuse doctrines is highly fact sensitive, laymen should not attempt to invoke them without legal guidance from an experienced litigator specializing in complex litigation, like antitrust or franchise law. Second, no state’s laws on these doctrines is identical; accordingly, there are many substantive legal nuances that normally will not be picked up by a layperson without the assistance of an experienced litigator.

Third, some states’ laws require that a party attempting to invoke one of these legal excuses to engage in certain conduct, including providing legal notice of such invocation at a specific time and in a distinctive manner. Last, arguably a few states impose an amorphous duty to mitigate on the non-performer; in such cases, this could impact on the degree and duration of non-performance that will be accepted by a court.

 

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