Financial Crisis and Contractual Obligations

01 June 2009 Publication
Authors: Craig Florence

TGCFReport

The full effects of the financial crisis on business in the United States remain to be seen. As a result of the restricted credit market, many companies are finding it difficult to honor their financial contractual obligations or discovering that others are having difficulty. The concept of excusing contractual performance as a result of a financial crisis is not new. In the United States, many believe financial impediments provide no excuse for nonperformance. A party generally assumes the risk of financial ability to perform when entering any contract. Given the severity of the current situation, many companies may find themselves in bet-the-company litigation that turns on the viability of certain affirmative defenses to contract claims. The following is an overview of how such defenses may fare in litigation.

Force majeure clauses are designed to excuse contractual nonperformance resulting from unforeseen circumstances such as natural disasters, acts of war, acts of terrorism, civil unrest and labor disputes. Historically, economic depressions have not constituted a force majeure because contracting parties typically assume the risk that the contract may not inure to their benefit in such instances. For this reason, force majeure clauses generally do not insulate a party from market shifts and the resultant inability of that party to profit from the bargained-for contract. But not all force majeure clauses are created equal.

It is important to remember that courts approach contract claims on a case-by-case basis, given the legal maxim that a contract stands as the law between the parties. If a force majeure clause includes language that contemplates a financial cause or economic instability, courts may be willing to excuse nonperformance due to the restricted credit market. For example, in Guillory Farms, Inc. v. Amigos Canning Co., decided by Beaumont’s 9th Court of Appeals in 1998, the contract provided that “should Buyer’s performance be prevented or delayed by any such [force majeure] cause, Buyer may during such period accept portions of the [product] as it deems, in its sole judgment, it can economically process.” The appellate court interpreted this provision to excuse the defendant’s refusal to buy any further product, in breach of the contract, due to an economic decline in the market for the product. Thus, the broader the scope of the force majeure clause regarding financial causes or economic instability, the more likely a court will be to excuse nonperformance.

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