Post-Pandemic Changes to Contracts and Leases

Eighteenth-century Italian composer Domenico Scarlatti is said to have had a cat named Pulcinella (named after a character in Neapolitan puppetry at the time). Like Scarlatti, Pulcinella (the cat) liked to “improvise” on the harpsichord.

Legend has it that one of Pulcinella’s improvisation sessions so inspired Scarlatti that he wrote down the resulting melody. Scarlatti used Pulcinella’s melody, which at the time was quite unconventional, as the theme for his Fugue in G minor.

Scarlatti didn’t give Pulcinella attribution for the theme, however. The poor cat didn’t receive any credit until the fugue became popular after pianist Franz Liszt included in his programs in the mid-nineteenth century. Around the same time, the composition became known as the “Cat Fugue.”

Fugues are better known to non-musicians as rounds, like “Row, Row, Row Your Boat.” Fugues start with a single voice playing the theme. Other voices enter with the theme later, weaving their parts with that of the earlier voices. Due to the unusual jumps and tonalities in the Cat Fugue’s theme, the composition may have sounded like herding cats to 18th-century listeners.

The year 2020 has included so many unforeseeable circumstances that it might well be considered the year of “herding cats.” In addition to scrambling to address pandemic-related issues as they arise, 2020 has ushered in a new era in how businesses operate and how people use their homes.

The year also has changed how contracts are written and signed. E-signatures, remote notaries, and electronic recording of real estate documents have become the norm. And the pandemic has revealed areas where contract provisions, in hindsight, don’t work with the current reality.

This article is one of a series of articles about changes businesses, and real estate owners should make during and after the pandemic. This article focuses on how contracts should change in light of the pandemic.

Contracts as Risk Allocation Agreements

Fundamentally, whether they are real estate leases or contracts to buy or sell goods or services, all contracts are risk allocation agreements.

By setting a rent amount or purchase price, the parties are agreeing to share the risk of a market change. The landlord or seller bears the risk that the price will go up. But the tenant or buyer, by agreeing to pay rent for a period of time or to buy goods or services at a fixed price, bear the risk that the price will go down.

Most contracts include indemnification provisions, which specifically allocate the risk of certain events. A warranty provision will allocate risk of product failure among the buyer and seller. Duration or term of the contract states how long the parties agree to risk allocation, but survival clauses may extend that allocation for some contract provisions.

Contract Provisions and Herding Cats During the Pandemic

It’s impossible to plan for everything in a contract. Therefore, contracts are written to allocate the risks of the most likely foreseeable events. There hadn’t been a world-wide pandemic of this magnitude for a century. And no one could have foreseen the combination of a pandemic, murder hornets and locusts, economic recession, and civil unrest that came with 2020.

As a result, most pre-pandemic contracts didn’t allocate the risk of loss from the pandemic or its fallout. Without clearly applicable contract provisions, landlords, tenants, business owners, and their attorneys all felt like they were herding cats as they raced to determine how pandemic-related developments fit into their contracts.

Rapid Change in Business Needs

The pandemic and resulting government orders closing businesses led to a rapid change in the business environment for most industries. Required closures led to retail tenants being in breach of leases that required them to be open for a certain number of hours. Many businesses, forced to close, lacked revenue to cover rent or mortgage payments under long-term arrangements.

At the same time, businesses that were open experienced significant increases in their expenses, as well as a loss of revenue due to the pandemic. Businesses needed more cleaning supplies and personal protective equipment. The pandemic also brought an abrupt change from “going green” by using reusable items from shopping bags to dishes and silverware, to one-use items, deemed less likely to transmit the virus.

Offices needed a more robust IT infrastructure that could support telecommuting, which may have required additional laptop purchases. Those same businesses no longer needed their high-speed copiers or printers, nor were they using their leased office space.

The result was that businesses’ equipment sat idle while payments under long-term lease or financing arrangements accrued. Contracts for goods, supplies, and maintenance previously deemed vital to the businesses remained in effect but were no longer needed. Businesses were desperate to find relief from what rapidly became crushing obligations under suddenly unnecessary contracts and leases.

Force Majeure, Impossibility, and Impracticability

With the pandemic having been unanticipated and outside of anyone’s control, parties looked to force majeure clauses and the doctrines of impossibility and impracticability for relief from contract requirements. Frequently those parties were disappointed Although some contracts had force majeure provisions before the pandemic, most real estate purchase contracts did not.

Most contracts that had force majeure provisions limited those provisions to “acts of god,” leading to a debate about whether a pandemic is an act of god. Although the discussion might be intellectually interesting, it wasn’t productive in helping the parties navigate through the crisis.

Where contract force majeure clauses didn’t apply, attorneys looked to the doctrine of impossibility or impracticability for relief. Still, many parties found themselves in technical breach of their contracts, leases, and loan documents, without a legal basis to excuse their performance.

The Future in Contract Risk Allocation

Eventually, the pandemic will end. All cats will have been herded, and things will be calmer. But the experience will forever change how people conduct business and use real estate. These changes, in turn, will make people reexamine how they allocate risk in their contracts.

More Fluid Contract Terms

The pandemic has taught us that life is uncertain. Before the pandemic, long-term contracts frequently seemed like low-risk arrangements because they locked in the price against inflation. With the pandemic and resulting economic and trade disruption, many of those contracts created major financial losses.

For example, commercial leases previously were for five or even ten or more years, frequently with no way for the tenant to cancel the lease early. Those leases served the tenant because it assured they wouldn’t have to move or have unexpected rent increases, and they guaranteed the landlord a long-term income stream.

The pandemic forced office tenants, in particular, to become nimbler. Those tenants have moved much of their infrastructures to the cloud, and employees can work anywhere. Email is replacing mail as the primary means of business communications, and many companies use VOIP phone systems. Without a need for long-term stability in their physical location and a desire to be able to react quickly to change, long-term leases will lose their appeal. Landlords will have little choice but to agree to shorter-term leases.

Other types of contracts may more commonly include flexible pricing or quantity tied to market indicators, currency exchange rates, or foreign trade conditions. Contracts for goods or services may shift to requirements contracts, rather than contracts for regular deliveries. In exchange, suppliers or service providers may require flexibility to charge market rates.

Force Majeure Provisions

The challenge with force majeure provisions with the pandemic was the definition of force majeure. It wasn’t clear whether a pandemic was (or wasn’t) an “act of god.” The solution to this is for parties to carefully craft a definition of force majeure into their contracts to include all extraordinary events that might significantly disrupt contract performance. This definition should be customized for each contract type since an event that interrupts the performance of one contract might not affect the performance of another.

Many parties will be tempted to tag a “catch-all” clause (e.g., “and any other event which materially interrupts a party’s performance”) at the end of the definition. Clauses like this helped many parties who hadn’t written their contract to address a once-in-a-century pandemic. However, the parties should use caution when using catch-all phrases, lest less-than-extraordinary events trigger their force majeure clauses.

Waivers

The pandemic brought a flurry of lawsuits against cruise lines after passengers caught COVID-19 on board. However, passengers learned to their chagrin that their ticket terms included a waiver of or limit to liability for on-board injuries. Those waivers may make it difficult or impossible for passengers to collect from the cruise lines even if they were negligent or intentionally concealed the fact that they had COVID-19 patients on board.

Waivers of liability are a means of allocating risk to the waiving party. Before the pandemic, waivers of liability in commercial leases and contracts frequently were limited or nonexistent. Many pre-printed contracts had seldom-read waivers in the fine print. Post-pandemic parties should read and negotiate waivers with a mind toward fair risk allocation. And parties entering into real estate purchase agreements or leases which have few, if any waivers, should consider whether waivers might be helpful in allocating risk between the parties.

Delivery of Notices

In Giving Notice Under Contracts During the Coronavirus Pandemic, I suggested temporary changes to contract notice provisions in light of pandemic-related office closures. Pre-pandemic, most contracts required that notices be served via hand delivery, certified mail, or FedEx. With interstate contracts, hand delivery isn’t practical. Certified mail takes time and can be refused, and FedEx is expensive. Parties realize that they can safely send notices via email. In the future, more contracts will require service of notices via email or a portal services, which will transmit the notice more quickly to the recipient no matter where they are at significant cost savings.

Electronic Signatures

Electronic signatures aren’t new. I discussed them in 2018 in Signature Blocks and How they Affect Validity, and they weren’t new then. But with the pandemic, electronic signatures have become ubiquitous. Electronic signature certificates, which provide some comfort as to the authenticity of the signatures, will become customary. Contracts will not only authorize electronic signatures but eventually may require digital certificates, which are safer than sending one’s signature on a.pdf, where it could be extracted and pasted into a later document.

Health/Safety Compliance

The pandemic has shown us that health safety is a potential concern in all contracts, not just those for medical, food service, or construction services, where safety concerns are evident. Requiring compliance with health and safety recommendations will become “boilerplate” in most future contracts, even if the necessity for the clause isn’t apparent.

Severability Clauses

As I discussed in Why the Coronavirus Pandemic Will Change Severability Clauses, parties to future contracts will more carefully craft severability clauses to their individual circumstances. Severability clauses state that if one part of the contract is unenforceable, the remainder of the contract remains in effect. Before the pandemic, many considered their severability clauses to be one-size-fits-all boilerplate provisions.

Future contracts will include severability clauses that are customized to the parties’ needs. Severability clauses may include delaying performance, akin to a force majeure, or require the parties to renegotiate the contract, as opposed to a strict severing of an unenforceable clauses. Severability clauses may provide different consequences for unenforceable contract provisions based upon how central they are to the contract.

Contracts and the Cat Fugue

Scarlatti’s Cat Fugue includes an intricate interplay among the voices, as they weave the theme throughout the composition. The pandemic has taught us that risk allocation should be a “theme,” which is woven into the contract fabric.

The challenge isn’t in preparing contracts that address issues should there be another worldwide pandemic—parties now understand how a pandemic might impact contract performance. Instead, the parties must anticipate what the future might hold and prepare contracts that can survive the next surprise event. Otherwise, those parties may once again be left herding cats when that event occurs.

© 2020 by Elizabeth A. Whitman

Any references clients and their legal situations have been modified to protect client confidentiality

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