Published on 3/18/2020
In recent weeks, the COVID-19 pandemic has placed enormous financial pressure on small businesses, including, among others, restaurants, bars, spas, tattoo shops, gyms, and yoga studios. With governments imposing “social distancing” and ordering the closing of these businesses in Washington, Oregon, and California, consumers have reduced their spending. As such, with their income reduced or eliminated altogether, commercial tenants are faced with the inability to make rent payments to their landlords. Moreover, small business borrowers are also faced with the inability to make loan payments to their lenders.
As explained below, when faced with these challenges, small businesses have a number of options to consider when seeking relief from lease and/or loan payments:
- “Force Majeure:” small businesses may have rights under potential “force majeure” provisions in their contracts.
- Impossibility/Impracticability Defense: small businesses may have suffered (or are suffering) sufficient economic hardship to show that their performance under an applicable contract is impossible or impracticable given the current economic climate.
- Business interruption insurance: business interruption insurance coverage may offer other means to obtain relief.
- Subchapter V of the Bankruptcy Code: new Act which became effective on February 19, 2020, offers small business debtors the chance to quickly and efficiently reorganize.
With these uncertain times, small businesses should closely scrutinize their leases, loan agreements, or promissory notes for clauses that may allow them relief as a result of the COVID-19 pandemic. One such possible clause is “force majeure,” which is a French term meaning “superior force.” Depending on the provision’s express terms, a party to a contract may invoke the force majeure provision to excuse that party’s inability to perform its obligations under the contract.
In general, the application of “force majeure” is a question of contract interpretation. Under such provisions, and provided that the express terms support such relief, tenants may be able to argue that they are entitled to rent abatement until the pandemic ends. Moreover, tenants may be able to argue that their landlords should accept whatever rent they can pay at this time with a reservation of rights. Thus, it is important that small businesses consult legal counsel to weigh all available options under their contracts.
In Washington and Oregon, the question of whether a court will enforce “force majeure” clauses to provide for payment relief will depend on the express terms of the contract at issue. Such provisions, if drafted to allow for payment relief, could serve as a critical safety net for small businesses who cannot meet their lease or debt payment obligations.
California courts apply the common law elements of force majeure and basic interpretation of contract principles. In particular, California law requires a showing that the proximate cause of the failure to perform under the contract was a contingency within the express terms of the force majeure provision, and that, in spite of skill, diligence, and good faith on the defaulting party’s part, performance became impossible or unreasonably expensive.
Setting express contract provisions aside, Washington, Oregon, and California recognize the defense of impossibility and impracticability, which can excuse a party to a contract from performance without an applicable force majeure clause.
Washington courts have held that “impossibility” includes not only literal impossibility but also impracticability arising from extreme and unreasonable difficulty, expense, injury, or loss. For the defense to apply, the expense must be unreasonable. The fact that a contract becomes more difficult or expensive than originally anticipated does not justify setting it aside under the doctrine of impossibility.
Similarly, Oregon courts have found that unexpected difficulty or expense may approach such an extreme that a practical impossibility to perform under a contract exists. Again, like Washington, a mere showing of commercial unprofitability, without more, will not excuse the performance of a contract under Oregon law.
In California, impossibility means not only strict impossibility but also impracticability because of extreme and unreasonable difficulty, expense, injury or loss involved. There are some California courts which have found circumstances in which extraordinary expense or difficulty will constitute impossibility even if the performance of the contract is not, in fact, utterly impossible.
Given the unprecedented mass closing of businesses in Washington, Oregon, and California, small businesses may be in a position to argue that impossibility or impracticability is a defense to their lease or debt payment obligations depending on their individual circumstances.
Business Interruption Insurance
Small businesses should also investigate their insurance policies (and those of their landlords) to see whether business interruption coverage is available. Some tenants pay for such policies through their landlords and will need to obtain copies of those policies to determine whether coverage is available for the COVID-19 pandemic.
Subchapter V of the Bankruptcy Code
On February 19, 2020, the newly enacted Small Business Reorganization Act of 2019 (“SRBA”), which has been codified as Subchapter V of the Bankruptcy Code, became effective. As a result, small businesses and struggling entrepreneurs have a new way to seek bankruptcy protection, which is timely in light of the COVID-19 pandemic. This Act provides a streamlined Chapter 11 process for persons or entities engaged in business activity with total debt of $2,725,625 or less. The Act provides powerful tools allowing small business debtors the opportunity to reorganize. These tools include, among others, an enhanced cramdown provision and streamlined confirmation procedures.
Ryan Swanson’s Bankruptcy, Finance, and Restructuring attorneys have over 40 years’ experience handling cases involving distressed businesses and Chapter 11 of the Bankruptcy Code. Our attorneys are prepared for the nuances of the SRBA. If you have questions about your options under a lease, loan agreement, insurance policy, or other debt instrument, feel free to contact Joe Sakay, Adam Doupé or Helen Hapner for more information.
Additional COVID-19 Resources for Businesses
Please visit our COVID-19 Alerts and Resources for Businesses page for an updated list of local and federal resources, along with additional Ryan Swanson COVID-19 practice alerts.
This message has been released by the Banking Services, Creditors’ Rights & Bankruptcy group at Ryan, Swanson & Cleveland, PLLC to advise of recent developments in the law. Because each situation is different, this information is intended for general information purposes only and is not intended to provide legal advice on any specific facts and circumstances. Ryan, Swanson & Cleveland, PLLC is a full-service law firm located in Seattle, Washington.