While businesses close and the economy slows due to COVID-19, questions about obligations in real estate transactions and real property agreements continue to grow. Many parties may find themselves unable to meet their obligations because of the restrictions imposed by Executive Order 2020-21. Numerous companies and service providers supporting a real estate transaction are finding new ways to close and record transactions remotely given the restrictions of the Governor’s Executive Order. However, it is likely we will see an increase in defaults under real estate purchase agreements given the state of continued uncertainty.
This raises the question of what legal and practical risks do buyers and sellers face. The following may prove useful to those individuals seeking to understand their options in an uncertain time.
What is Force Majeure?
Real property agreements and leases often allocate the risk of nonperformance of a contractual obligation occasioned by an unforeseen event or circumstance. Often, this provision appears as a “force majeure clause.”
Michigan does not recognize force majeure as a common law defense. Therefore, a party may use this defense only if its contract includes a force majeure clause. A force majeure clause excuses a party’s nonperformance of identified contractual obligations when certain events defined as “force majeure” occur. Because Michigan courts interpret force majeure clauses narrowly, only those events specifically identified as force majeure will excuse a party’s nonperformance or delayed performance of its obligations.
Even if a force majeure occurs, a party may cancel its obligations only where it establishes the following two conditions:
- A party must show that the occurrence of the force majeure was unforeseeable at the time the agreement was executed.
- A party must show that the force majeure actually prevented or delayed the party’s performance of its obligations. Importantly, performance will not be excused if it is merely made more financially expensive or burdensome.
What are Impossibility and Frustration of Purpose?
If a real estate agreement does not include a force majeure clause, a party may rely on similar common law defenses. First among these is impossibility.
A party is excused from performing a contractual obligation if its performance is made impossible by the occurrence of an unforeseeable event. A party’s performance is impossible both where it is strictly or literally impossible and where it is impracticable. Although impracticability is more lenient then literal impossibility, impracticability still requires extreme and unreasonable difficulty, expense, injury, or loss. Importantly, most courts do not construe impracticability so as to encompass mere financial difficulty.
If a party is able to perform under an agreement, that party cannot use impossibility to cancel its contractual obligations. Still, a party harmed by COVID-19 or Executive Order 2020-21 may utilize frustration of purpose to excuse its performance.
A party may cancel its agreement where a change in circumstances makes the other party’s performance virtually worthless, frustrating the party’s purpose in entering into the agreement. A party must establish three elements to utilize frustration of purpose:
- Its agreement must be at least partially executory;
- The frustrated party’s purpose in making the agreement must have been known to both parties when the agreement was entered into; and
- This purpose must have been frustrated by an event not reasonably foreseeable at the time the agreement was made. Also, the frustrated party cannot have caused the event to occur and cannot have assumed the risk of the event occurring.
A party can use this defense only where the frustration is severe. Therefore, where a party merely loses money or regards a contract as unprofitable, frustration of purpose will not apply.
COVID 19 and Real Property Agreements: Q&A
The following questions address common concerns involving real property agreements. However, the application of each defense is fact-sensitive. You should speak with an attorney before implementing any particular defense.
Is COVID-19 a force majeure? Is Executive Order 2020-21 a force majeure?
The answer to this question depends on the language of each force majeure clause. Some clauses specifically identify illness, disease, or pandemic as force majeure. Even where a clause does not identify these events, COVID-19 may fall within general or catch-all language depending on the court interpreting the clause. If a party cannot assert COVID-19 as force majeure, the party may be able to assert Executive Order 2020-21 as force majeure. “Action of the government” is a commonly identified event of force majeure, and Executive Order 2020-21 falls neatly within this defined event.
Even if a court is satisfied that COVID-19 or Executive Order 2020-21 constitutes a force majeure, a party may cancel or suspend its contractual obligations only if these events actually prevent the party from performing its obligations. In addition, if these events were foreseeable to the parties at the time of contracting, neither would excuse performance.
If force majeure does not apply, do COVID-19 or Executive Order 2020-21 create impossibility or frustration of purpose?
The application of both impossibility and frustration of purpose are inherently fact-sensitive. Most likely, COVID-19 will not make a party’s performance of its contractual obligations impossible. However, Executive Order 2020-21 might. Several court decisions hold that a party may be excused from performing its contractual obligations where a law, regulation, or executive order makes that performance illegal. Because Executive Order 2020-21 requires most Michiganders to stay at home and most Michigan businesses to close, a party may seek to cancel any obligation that would violate this Order.
Whether frustration of purpose applies depends on the purpose of each agreement. Where the purpose of an agreement supposes large gatherings of people, for example, COVID-19 or Executive Order 2020-21 may frustrate this purpose. Because mere financial hardship is not a frustrated purpose, however, this defense has limited applicability.
I’ve recently executed a purchase agreement. Do I need to close?
You should review your purchase agreement to determine whether it includes a force majeure clause. If your purchase agreement does, you should examine its language to determine if your closing obligations might be excused or delayed by force majeure.
If an agreement does not include a force majeure clause, a buyer or seller must rely on common law defenses if it wishes to avoid closing. Impossibility will apply where the virus or Executive Order 2020-21 makes it actually impossible to perform closing obligations or exercise contractual rights. For example, almost all purchase agreements provide buyers the opportunity to conduct due diligence, including an environmental site assessment, an appraisal, a title search, a land survey, a zoning report, and a physical site inspection. However, some of the businesses that perform these services are not able to operate because of Executive Order 2020-21. Because the Order might render due diligence impossible, a party may seek to delay closing or terminate its agreement on these grounds.
Executive Order 2020-21 adopted guidelines issued by the U.S. Cybersecurity and Infrastructure Security Agency (CISA) on March 19, 2020. These guidelines did not expressly provide that residential and commercial real estate services, including settlement services were part of the critical infrastructure. CISA updated its advisory list on March 28, 2020, and expressly identified residential and commercial real estate services, including settlement services as part of the critical infrastructure. Despite this updated list, Executive Order 2020-21 has not in turn been updated. In fact, the Executive Order 2020-21 FAQs states that real estate agents, brokers and real estate service employees are not “critical infrastructure workers”. While many real property transactions may close without disruption, the impact of COVID-19 will likely cause delays given the uncertainty.
A party seeking to cancel or delay its obligations must remember two critical elements of either common law defense:
- The event creating impossibility or causing a frustration of purpose must have been unforeseeable to the parties when the agreement was executed. Therefore, the more recent the agreement, the more likely it is that the virus or Order was foreseeable to the parties.
- Mere financial hardship or market changes do not create impossibility and will not constitute a frustrated purpose.
Where parties are able to perform all obligations, a buyer or seller may still be hesitant to proceed to closing. Yet, this hesitancy is not impossibility, nor will it result in frustration of purpose.
Rhoades McKee is continually monitoring legal developments related to COVID-19 and will keep you updated. In the meantime, should you have any questions about the pandemic’s impact on your contracts or any other issues, please do not hesitate to contact a member of the Real Estate Legal Team at Rhoades McKee.More Publications