Introduction. Almost as soon as the COVID pandemic flared up, I began to receive calls asking whether the virus could constitute the basis for refusing to perform under a pending Sale Agreement. One broker reported that the buyer wanted out of the contract because of “uncertainty”.
These are not altogether unreasonable reactions to performance; after all, we’ve never experienced anything like this pandemic before. However, over the years, comparable issues have arisen, the most obvious being wars, strikes, and natural disasters. So let’s take a look at how the courts have dealt with these events in the past.
Oregon Court Decisions. Oregon courts recognize impossibility, impracticability, and frustration of purpose as defenses to breach of contract claims. Impossibility and frustration are very old concepts, while impracticability has become a term that encompasses the idea of impossibility as well. In some legal discussions, the differences between these defenses get blurred and are used almost interchangeably.
Collectively, these defenses seek to excuse some aspect of performance of an otherwise valid contract. Usually there is an intervening event that did not exist at the time the contract was made – or it existed but was unknown to the parties. In such instances, performance may become impossible, overly burdensome, or ultimately pointless.
Impossibility. There are 5-6 grounds for an impossibility defense: (1) Act of God; (2) Supervening illegality; (3) Death or disability of a person in a personal services contract; (4) War; and (5) Labor strikes/unavailability of goods. (Citations omitted.) (6) Occasionally a sixth ground is raised: That the performance is possible, but the expense or difficulty in doing so renders performance practically impossible.
For purposes of performance under the OREF Oregon Real Estate Sale Agreement, Act of God, War, and Extreme Expense/Difficulty (i.e. impracticability) are the most relevant grounds for the impossibility defense.
- Act of God. Oregon courts have defined an “Act of God” as: “a natural occurrence of ‘extraordinary’ and ‘unprecedented proportions’ *** not foreshadowed by the usual course of nature, and whose magnitude and destructiveness could not have been anticipated or provided against by the exercise of ordinary foresight.” (Citation omitted.) Not surprisingly, true Acts of God are rare, with the court refusing relief if the only issue is that performance of the contract is more difficult or expensive.
- Likewise, the court has stated that the Act of God “must be the sole proximate cause of the injury complained of. An “Act of God” *** excludes all circumstances produced by human agency.” Whether the alleged event constitutes an Act of God is a question for the jury. (Citations omitted.)
- Government actions taken which impede existing contracts may justify non-performance. However, the bar is set high, and where performance became more expensive, but was not impossible, war did not suffice to excuse performance. (Citations omitted.)
- The Governor’s March 23, 2020 Executive Order 20-12 (here) to “Stay Home, Save Lives” is close to such governmental action, but, does not represent a complete prohibition against conducting business, so long as social distancing rules are observed.
- Cost Overrun or Difficulty in Completion. Contract law does allow for extreme expense or difficulty to constitute an impossibility. “In applying the doctrine, courts recognize that unexpected difficulty or expense may approach such an extreme that a practical impossibility exists. To operate as a discharge, however, the hardship must be so extreme as to be outside any reasonable contemplation of the parties.” (Citations omitted).
Frustration of Purpose. This defense is basically an amalgam of those discussed above, with similar definitions, and sharing the idea that the non-occurrence of the supervening event is a fundamental assumption of the contract. In other words, to be successful, the defense must be based upon an assumption that such an event would not occur.
It has been explained thusly: “…where, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made” then performance may be discharged unless the contract has expressly provided otherwise. (Citation omitted.)
A classic example was a contract to rent the window of an apartment in London along the parade route for the coronation of King Edward VII. The King’s coronation parade was canceled therefore frustrating the purpose of the would-be renter, and rendering the contract void. Oregon courts have, to date, addressed the frustration of purpose defense, but have not decided any cases on those grounds.
Frustration generally requires an examination of the supervening event to see if it is something that the parties should have foreseen, and if so, how they chose to allocate the risk. That event will not excuse performance if its occurrence could have been reasonably anticipated and could have been addressed by an express provision in the contract. (Citation omitted.)
Impracticability. The defense of impracticability often incorporates elements of impossibility and frustration of purpose. To prevail, the intervening event must have made the agreed-upon performance impracticable; its non-occurrence must have been a basic assumption upon which the contract was made; the promisor (i.e. party whose duty it is to perform) cannot be at fault; and the contract must not have imposed the risk of the event on the promisor. (Citations omitted.)
Impracticability does not require that performance be impossible – it just requires that it is unreasonably difficult or expensive. However, the parties to the contract are expected to have exerted “reasonable efforts to surmount obstacles.” (Citations omitted.)
One authority makes a further distinction between subjective and objective impracticability, asserting that in any contract “a party generally assumes the risk of his own inability to perform his duty.” In other words, true impracticability is objective (“it cannot be done”) rather than subjective (“I can’t do it”). (Citations omitted.)
Force Majeure. The term, which is French, means “superior force”. In contract law, a Force Majeure clause permits the party, whose duty it is to perform, to avoid liability for not doing so if the nonperformance resulted from the intervention of certain serious and unanticipated events.
Generally, occurrence of the event must be beyond the reasonable control of the party required to perform; the ability to perform must have been “prevented, impeded or hindered” by the event; and the Performing Party “must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences”.[1]
Plus, when such an event does occur, the non-performing party has a duty to mitigate, i.e. they must have taken all reasonable steps to avoid the event and its consequences.
Force Majeure clauses are frequently found in supply contracts and similar agreements where the cost, availability, and delivery of goods are time-critical, and are subject to external forces, such as strikes, natural disasters, and political events, etc.
The OREF Sale Agreement has never contained a Force Majeure clause. I’ve not seen any real estate purchase and sale agreements contain one.[2]
COVID-19 Related Nonperformance Under the OREF Oregon Real Estate Sale Agreement. The COVID-19 virus is unprecedented in modern law. The last time a pandemic swept the globe was more than 100 years ago. It was the Spanish Flu, and American case law on contract performance was essentially nonexistent or inapplicable.
American contract law does provide for impracticability caused by governmental action:
If the performance of a duty is made impracticable by having to comply with a domestic or foreign governmental regulation or order, that regulation or order is an event the non-occurrence of which was a basic assumption on which the contract was made. (Citation omitted.)
Parties to a contract are not required to violate a government order simply because performance is still technically possible. Under the Oregon definition of impossibility, such an order likely falls somewhere between war and supervening illegality. However, so far, COVID-19 has not resulted in any orders, laws, or rules, that actually forbid any aspects of an ongoing real estate transaction from occurring.[3]
Some might argue that the Governor’s Executive Order, No. 20-12 to “Stay Home, Save Lives”, is a prohibition against brokers actively showing available residential properties for sale. This is incorrect, so long as they have a written office policy that deals with social distancing.[4]
While many major life activities are interrupted under the current quarantine, with the Internet and other available means for electronic transmission, there do not appear to be any major reasons why real estate transactional documents cannot be executed, and closings consummated, using the same general tools we have had for years: E.g. Sale Agreements and Addenda are signed via DocuSign®; they are transmitted via electronic mail; funds are deposited into escrow electronically; and where necessary, mobile notaries are available – and Oregon is likely going to pass an electronic notarization law in the current 2020 Legislative Session.[5]
However, while the COVID-19 quarantine does not make impossible or impracticable any of the above activities, there are several others conducted by third-party providers whose work is essential to completion of the transaction: E.g. home inspections; appraisals; banks/mortgage lender services; and title/escrow services.
With the exception of obtaining a loan preapproval in advance, most such are not normally contacted in advance of the Sale Agreement being signed by the parties. That may be changing, as it is now important for home sellers, buyers, and their agents, to know what social distancing protocols the providers will follow when accessing a seller’s home.
In most cases, it is the buyer’s financing and due diligence activities that are outside the control of the parties, and this is a risk that can result in delay or failure of the transaction to close.
Two Separate Scenarios. In addressing the risk of a sale-fail, and various defenses to non-performance, there are two different scenarios:
- Transactions entered into before the Governor’s Executive Order. With the lapse of time, this scenario is rapidly disappearing. But before March 23, 2020, the effect of the COVID-19 virus was clearly an event that was not reasonably contemplated by the parties. On March 23 and thereafter, if the Stay at Home Order prevented the closing, say, due to the inability of the buyer to obtain an inspection, or the lender to secure the appraisal, the transaction would simply fail to close by the Closing Date for reasons outside of the buyer’s control, and the earnest money would be refunded.[6] There is little question but that the failure to close due to the Governor’s Stay at Home Order following the execution of a Sale Agreement, would likely fall within several of the above defenses if nonperformance was outside of the buyer’s reasonable control, e.g. due to a provider’s inability to perform an inspection or appraisal.
- Transactions entered into after the Governor’s Executive Order. It is here that the above discussion on impossibility and impracticability becomes germane. That is to say, neither seller nor buyer can claim they were unaware of the virus, the Executive Order, or its potential to prevent a timely closing. Accordingly, if the risk is not addressed up front e. at the time the contracted is entered into – who bears the risk of the buyer’s failure to complete his/her due diligence before the closing date? It is likely the buyer, which means that without an Addendum executed at the time of the Sale Agreement, the seller is not obligated thereafter to agree to an extension of time. Oregon law does not impose upon a party the duty to do something the contract does not otherwise require.[7]
To put a fine point on this, if a transaction was entered into on or after March 23d without:
(a) An effective Addendum addressing, in advance, COVID-related delays in closing; or (b) The seller’s voluntary agreement to postpone them;
in order to protect his/her earnest money, the buyer would need to immediately reject the inspection report (assuming the inspection period had not lapsed), or the lender would have to decline to make the loan.
So the take-away is that brokers are well advised to consider using a good COVID Addendum to address the inevitable delays that will occur in real estate transactions going forward.
What Should Such an Addendum Look Like?[8] First, this article addresses only the current state of COVID-19 regulations today; they could change tomorrow.
Second, as noted above, without an Addendum entered into at the time of the Sale Agreement on or after March 23, a seller is not required to agree to any extension of time. Of course, if the parties both agree, they can do so at any time in the transaction.
Third, without there being an express agreement on who will bear the risk of closing not occurring (i.e. buyer’s loss of earnest money, or seller’s risk of a specific performance suit), it will be on the person who fails to perform (or tender performance) under the Sale Agreement.[9]
Since all of the pre-printed contingencies in the Sale Agreement are solely for the buyer, who has due diligence and financing duties, the risk of delay in most instances falls on the buyer, who must depend upon third-party vendors.
Subject to the above qualifications, here are some tips and traps:
- The Addendum should clearly state that it is part of the original Sale Agreement. Why? Because in the event of an argument, the dispute resolution provisions of the Sale Agreement would apply. Otherwise, the Addendum would have to contain its own dispute resolution provisions. The Sale Agreement clearly provides that it is the final agreement between the parties – so unless the Addendum incorporates the Sale Agreement, it is just another separate agreement of questionable enforceability, with no dispute resolution provision or right to prevailing attorney fees.
- Although it does not need to address – nor should it – all the conceivable COVID-related delays that could occur, the Addendum should clearly provide for an automatic extension due to a COVID-related delay. By listing all of the COVID-related delays for which an extension may qualify, Murphy’s Law guarantees that a new delay will occur from the pandemic that wasn’t listed. Will the right to extension apply?
- Exactly what is being extended? The closing date? One contingency period? All contingencies? Does an “event”, such as buyer getting an estimate to replace the roof, or install a wine cellar, qualify for the extension? What if a buyer needs more time to extend the loan commitment? A blanket extension for “everything” being extended opens the door to argument later as to what was included.
- In most cases, the delay should be related to third-party vendors, whose performance seller and buyer have little control over. If a vendor is unable to timely perform, say within a contingency period in the Sale Agreement, the extension of time should be automatic.
- What if the contingency period has already expired? Is it entitled to be extended?
- And what if the extension commences in the middle of a contingency period, does the whole period commence over again, or just the remaining days? If one extension is needed, does it apply to everything?
- What if the COVID-related delay is not due to the buyer’s inspector, but the inspector for the buyer’s buyer where there is a Contingent Right to Sell Addendum? Is there a place to address this as an event qualifying for the extension?
- What happens upon the expiration of the extension period? Are the parties advised to enter into a new extension period before expiration of the original one?
- While it may seem obvious, the Addendum should clarify that upon expiration of the extension period(s), the buyer is entitled to a full refund of the earnest money deposit.
- Are the parties advised to secure their own legal assistance? Is there a disclaimer to protect against broker liability?
- The Addendum should clarify that both parties have a right to terminate the transaction, not just one. For example, if there is no clear provision for a buyer to terminate, and the seller refuses to do so, the buyer’s earnest money will remain at risk until seller terminates or the extension period expires.
- When does the extension period commence? If it is signed at the same time as the Sale Agreement, then the right to extensions would commence at that time, if needed. But if the right to the extension does not apply until later, then the parties will have to reach agreement when to begin counting days, and there is a risk of confusion on the deadline.
Conclusion. There is no question that COVID-19 has thrown a giant monkey wrench into how real estate transactions are going to be conducted in the near future. Many of the legal defenses to delayed performance discussed above would likely apply if the Sale Agreement occurred before the Governor’s March 23rd Executive Order.
But as to transactions occurring after March 23rd the same cannot be said, since both parties and their brokers knew of the risk of a COVID-related delay. Accordingly, it is best dealt with when the Sale Agreement is first entered into – not when the delay is imminent.
After the Sale Agreement is fully signed, if no COVID Addendum is also signed, the seller has no duty to cooperate thereafter, and the buyer’s earnest money deposit could be at risk if completion of a contingency is delayed due to COVID. ~ Phil
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[1] COVID-19: Force Majeure Event? Shearman.com
[2] The contingency of death is normally dealt with in all real estate contracts by making the parties’ obligations binding on their “heirs, executors, and assigns”.
[3] This is not so for the listing of a home, which pre-supposes active marketing and showings for the term of the listing. Some RMLS™ rules have been adjusted accordingly.
[4] On April 1, PMAR distributed such a form for brokers to use, should they choose to do so. It has already been updated due to an update in regulations from the CDC.
[5] https://sos.oregon.gov/business/Pages/electronic-notarization.aspx
[6] I submit that even with the earnest money stipulated as “non-refundable” it would likely be required to be returned if the Sale Agreement occurred before March 23, since a COVID-19 lockdown could not have reasonably been contemplated by the parties when they agreed to make it non-refundable.
[7] This is so notwithstanding the existence of the implied obligation of good faith and fair dealing.(Citations omitted.)
[8] This article is not a critique or commentary on OREF’s recent Form 096. I did not participate in its drafting.
[9] For example, if it appears the buyer cannot close, it is important for the seller to still sign the closing docs and deed. There is a legal exception saying a party does not have to perform a “useless act”, but I prefer there to be no doubt, by seller signing what escrow makes available for seller to close. (And vice versa in cases of seller non-performance.)
