Realty Bytes, Episode Two: May the 'Force' Surround You!

I had a call the other day from a landlord who will not deliver timely its build-to-suit premises to his lessee. The landlord really could not prevent the circumstances--the by-now familiar, unyielding financial marketplace. The Lease did provide for delivery of the premises by a certain date, subject to delays for “Force Majeure”:

If the Possession Date has not occurred by December 31, 2008 (except for Force Majeure events or in circumstances of affirmative interference by Tenant or its agents), Tenant may terminate this Lease by affording Landlord written notice of its intended termination, and affording Landlord a ten (10) day cure period for completing and delivering the Leased Premises to Tenant . . . .

The landlord could not, despite commercially reasonable efforts, obtain the funds required to commence the construction of the building and other improvements. The tenant wants to withdraw from the project and terminate its obligations under the Lease, as delivery of the building lies well ahead, under an uncertain timetable. The landlord discovered a broad Force Majeure clause in the hind-quarters of his form Lease. Can he rely on it to hold his tenant to the lease? Something in the circumstances led me to advise that while reliance on that clause might have "legs," it would not be a position I would be over-confident would prevail. Which, then, led me to this reflection.

Here's a Force Majeure clause of the broadest sort:

“If either party to this contract shall be delayed or prevented from the performance of any obligation through no fault of their own by reason of labor disputes, inability to procure materials, failure of utility service, restrictive governmental laws or regulations, riots, insurrection, war, adverse weather, Acts of God, or other similar causes beyond the control of such party, the performance of such obligation shall be excused for the period of the delay.”

Very well; does not the unavailability of debt financing lie at the root of an inability, shortage of funds, to procure materials or labor, or otherwise constitute a "cause beyond the control" of any landlord whose vertical improvements are incomplete--or not launched? Should not a court acknowledge impossibility or frustration of purpose as excusing a landlord's contractual obligation, in the current financial climate? Here, should force majeure entitle landlord to a delay in performance without permitting tenant to terminate its obligation to occupy the premises upon its completion and perform its other lease obligations?

Force majeure generally encompasses unforeseen events beyond the control of, and not due to the fault of, the party seeking a break (in this case, forgiveness for the delay in premises delivery). But hold on! Should "forgiveness" of the risks arising from a supervening event (fire, flood, riot, disease and the like) include those that are allocated, expressly or implicitly, by contract? Doesn't that allocation of risk trump the landlord's reliance upon scarcity, even if the subject scarcity--money--could not be anticipated? If all allocation of risks is to be ignored, is there any point to writing down the parties' promises? Well, if the answer is that allocation of risks expressed in the contract cannot be dismissed, then re-read the Possession Date clause above; did the tenant here not accept an allocation of risk that the premises would not be ready by years’ end—isn’t that what the parties intended by the expression “except for Force Majeure events?” Maybe yes, maybe no—it depends, I suppose, on how carefully the parties studied the terms of the force majeure paragraph.

We will find out, perhaps soon enough, about the power of the “Force.” The real estate developer, Donald Trump along with companies he controls, seek to delay repayment of obligations for borrowed money to Deutche Bank and a syndicate of other banks. The borrowers want a declaratory judgment that prevailing real estate market conditions are within such a clause and beyond the borrowers' control. Accordingly, they want to lawfully delay repayment of a $40 million installment past due under a $640 million construction loan. Their argument is that sales of condo and hotel units which the construction loan supported have failed to materialize as anticipated. Is this argument sufficient to allow "the Donald" to obtain his performance time-out? In New York, the “Force” seems opposed to these borrowers; here’s why.

In Kel Kim Corp v. Central Markets, 519 N.E. 295 (N.Y. 1987), a lessee sought a declaratory judgment to be excused from an obligation to procure insurance on leased premises in light of the liability insurance crisis of the 1980s that made it essentially impossible to buy such insurance. The New York Court of Appeals, affirming both a trial court and intermediate appellate court, rejected the lessee’s common law impossibility and contractual force majeure arguments.

As to the common law impossibility claim, the general rule is that contracting parties agree to perform or pay damages even if unforeseen events make that burdensome. This stance is relaxed under the impossibility doctrine to excuse performance only to reflect the contractual risk allocation the parties manifestly contemplated. This requires circumstances like destruction of the subject matter of the contract or discovery that the means of performance is “objectively impossible.” It also requires proving that the event could not have been foreseen or guarded against by contract. In Kel Kim, the tenant did not meet these requirements for excuse under the doctrine of impossibility, since an inability to obtain insurance could have been foreseen and guarded against in the lease.

Nor was the tenant’s claim within the scope of the lease’s Force Majeure clause, because only if an event is expressly within such a clause can it be invoked to excuse performance. The Kel Kim lease did not explicitly include the inability to obtain insurance. Instead, the listed events dealt with everyday commercial operations, the court found. The catch-all phrase about "other similar causes" did not, in the opinion of the court, expand that class to include insurance. Staying insured is not about frustrated expectations in daily operations. The court reasoned that it is about the landlord's bargained-for protection of its unrelated economic interest, where the tenant operates a particular business at the landlord’s site that poses certain liability risks.

The doctrines (or defenses) of impossibility (sometimes known as “frustration”) of performance and force majeure are related but are not identical as to outcomes. Frustration leads to the conclusion that the entire contract has been rendered permanently impossible to perform, and so typically results in the contract ending as a matter of law. Force majeure, by contrast, does not involve complete and permanent impossibility of performance—indeed, it may be susceptible to performance in all respects, once the event of force majeure has passed. Capital markets will be righted, like a foundering ship; lending ultimately will resume. So will development.

It’s a tough time for landlords developing new projects. The desiccation in lending markets seems as unanticipated, hazardous and devastating as a period of civil insurrection. In the end, however, there’s no way for the parties to realize their reasonable expectations under their lease (which sounds like the essence of good faith and fair dealing) if the articulated allocation of risks and the fundamental promises that form the basis for an agreement may be excused as to one party, while holding the other party to the bargain. I suspect that in the noted circumstances that the commercial tenant will not obtain any relief from his landlord through the courts except damages, if demonstrable, for delay in the delivery of the Premises. The opposite result will lead to a forfeiture of the bargain made by the landlord, a phenomenon Arizona’s courts claim to abhor.

In the meantime, if force majeure becomes elemental in construing the parties’ rights and obligations, it behooves the drafters of leases and other contracts to consider these things:

a. What events are covered—and what events are excluded from coverage?

b. Are any contractual obligations affected by force majeure? Even the payment of money? If so, that needs to be expressly agreed to.

c. If at all, to what extent does the relied-upon force majeure event have to have been unforeseen? After all, shortage of labor or materials always hypothetically is possible; but it usually still falls in the ambit of a force majeure event.

d. Does a degree of “fault” enter into the equation? What if a party claiming force majeure just didn’t take reasonable care, or wasn’t diligent in pursuit of the item that is now scarce or unavailable? If that failure was intended to preclude one party’s reliance on force majeure, that should be made clear in the agreement.

e. Is “impossibility” of performance the standard for the relying party; or is it enough that its performance has been rendered only impractical, or substantially more difficult or perhaps even just significantly more expensive.

f. Notice—should not the party relying on force majeure be required to give notice of the occurrence of the triggering event as soon as practicable after the relying party becomes aware (or should have become aware) of the event?

g. Should not the party relying on force majeure be required to take steps to mitigate the effect of the delay on the other party, or the ancillary fallout if delay is not the main impact on the other party? But how substantial should the steps be? How about commercially reasonable efforts? Heroic efforts? And what is, in the circumstances of the contract, commercially reasonable?

-MNW