A recent decision by a U.S. Bankruptcy Court in the Northern District of Illinois held that a tenant's obligation to pay rent under a commercial lease was partially excused under a "force majeure" clause, because of an executive order that limited the tenant's ability to operate its business on the premises. This decision is instructive for family business owners and managers who are trying to understand how Covid-19 and related governmental responses might affect the application of force majeure clauses in their contracts.
The decision, which was issued in Chapter 11 proceedings for Hitz Restaurant Group ("HRG"), can be found here:
Although the HRG decision relies on Illinois law, it nevertheless is representative of the way courts might apply the law of most states when construing or enforcing a force majeure clause.
What is a "Force Majeure" Clause?
A force majeure clause in a contract, such as a lease or a contract to deliver goods or services, says that if an unforeseen event that is out of the parties' control, such as a natural disaster or an act of war, prevents one of the parties from fulfilling its obligations under the contract, that party is excused from doing so. Usually, a force majeure clause is specific about what events qualify as force majeure. The clause may have additional language that includes events that are not expressly identified, or excludes all other events.
The concept of force majeure in contract law is similar to the common law defenses of "impossibility" or "frustration of purpose." Sometimes, a force majeure clause in a contract is deemed to supersede or preclude similar common law defenses.
What Happened in the HRG Case?
According to the HRG decision, HRG owned a restaurant in Chicago that it operated out of space that it rented from a third party landlord. In March of this year, the Governor of Illinois issued an executive order to help suppress the spread of Covid-19 in Illinois. The executive order stated, in part…
"[A]ll businesses in the State of Illinois that offer food or beverages for on-premises consumption—including restaurants…—must suspend service for and may not permit on-premise consumption. Such businesses are permitted and encouraged to serve food and beverages so that they may be consumed off-premises….In addition, customers may enter the premises to purchase food or beverages for carry-out…."
The executive order ran from March 16, 2020 through May 29, 2020.
HRG, which was in bankruptcy at the time, did not pay rent to the landlord for March, April, or May. The landlord applied to the bankruptcy court to recover the rent for those months. HRG argued that the force majeure clause in its lease excused HRG from paying the rent during the period of the executive order.
The force majeure clause stated, in part…
"Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by…laws, governmental action or inaction, orders of government…."
But the clause also stated, "Lack of money shall not be grounds for Force Majeure."
What Did the Parties Argue?
Generally, the party seeking the protection of a force majeure clause has the burden of proving that it applies to the facts of the case. In this case, HRG argued that the Governor's executive order impaired HRG's ability to operate its restaurant business on the premises to generate sufficient income to pay its rent. HRG conceded that the restaurant could continue to provide carryout service but said that still left 75% of the premises (i.e., the bar and dining areas) unusable. HRG pointed out that the force majeure clause expressly identified "orders of government" as force majeure.
In response, the landlord made three primary arguments as to why the force majeure clause should not apply. First, the executive order did not shut down the banks or the post office, and therefore it did not literally prevent HRG from paying the rent. Second, the force majeure clause expressly stated that "lack of money" was not grounds for force majeure. Third, HRG could have applied for a loan from the Small Business Administration under the Paycheck Protection Program to obtain money to pay the rent.
What Did the Court Decide?
The court stated that application of the force majeure clause was a question of contract interpretation. This usually means that the court will try to determine how the parties intended the contract to operate based on the language of the contract itself. Courts prefer not to take into account evidence of the parties' intent outside the language of the contract except when the contract language is too ambiguous to interpret on its face.
In this case, the court held that the force majeure clause "unambiguously" applied to the rental payments, at least in part, during the term of the executive order. The court stated that the executive order was an "order of government," which was specifically identified in the lease as force majeure. The court found that the executive order prevented HRG from operating its business at full capacity and thus was the proximate cause of HRG's inability to pay its rent during the term of the order.
In response to the landlord's arguments, the court stated that the first argument (i.e., the executive order did not close the banks or post office) was "specious." It said that the force majeure clause was not about whether HRG could literally write and mail a check; it was about whether HRG could operate its business and thus generate income to pay the rent.
As to the landlord's second argument (i.e., the clause expressly excluded "lack of money" as force majeure), the court found that the language identifying an "order of government" as force majeure was more specific than the exception for "lack of money." The court held that if the two provision were in conflict, then the more specific language referencing "order of government" should prevail over the less specific language referencing "lack of money." On that point, the court relied on precedent for contract interpretation under Illinois law (but that principle of interpretation is commonly recognized throughout state and federal law).
As to the landlord's third argument (i.e., HRG did not seek a loan to mitigate the effects of the order), the court stated that there was nothing in the lease that required HRG to seek a loan if a force majeure event occurred. This was consistent with the idea that the court was interpreting the contract based only on the language of the contract.
In the end, the court's order was something of a compromise position. The court held that the force majeure clause excused HRG from paying 75% of its rent during the term of the executive order because it could not use 75% of the premises for its restaurant business until the order expired. The court held that HRG was liable for 25% of the rent during that same period because it could continue to use 25% of the premises to operate a food carryout and delivery business.
What's the Lesson?
I don't think the right decision in this case was obvious or particularly predictable, but the court's decision may seem reasonable to most people. One lesson from the case is that parties who are attempting to rely on a force majeure clause arising out of the effects of Covid-19 on their business will have a better chance of prevailing if the language of the clause specifically applies to their circumstances. Perhaps the more obvious lesson is that, even when the language is specific, the court's interpretation and application of a force majeure clause may be unpredictable. In such cases, it may make most sense for the parties to negotiate a compromise, rather than take their chances in court.
I will continue to watch for court decisions arising out of Covid-19 that may have relevance to family businesses and discuss them in future posts.
July 13, 2020