You take out insurance coverage to protect yourself from foreseeable bad events. For example, when you buy car insurance, the insurance company understands that you may crash your vehicle in a car accident. Or, your car could be stolen. While you don’t wish for those events, both parties know they can happen. When any of the covered events occur, the insurance company will bear the cost, or at least a part of it.
But what if events occur that neither party expected? That’s when the force majeure clause comes into play.
What Is a Force Majeure Clause?
Force majeure is a contract provision that limits liability if an unforeseen event makes performance impossible. The force majeure clause can be triggered by events such as pandemics, labor actions, wars, terrorism, new government regulations, and natural disasters such as earthquakes or floods.
How Does the Force Majeure Clause Work?
Generally, force majeure provisions are specific to each contract. The type of event that can trigger the clause depends on the words in the contract. Most state laws require courts to interpret the force majeure clause narrowly. This means that your contract must include a particular event as a “triggering event” before the courts can allow you to escape your responsibility because of that event.
If a government policy prevents you from fulfilling your contract, you may not rely on force majeure. Before the court will let you off the hook, your force majeure clause must have specifically listed a change in government policy as an intervening factor.
What Are the 3 Elements of Force Majeure?
Generally, three elements must be present before an event can activate the force majeure clause.
The Event Must Have Been Unforeseeable
This requires the event to be one that the parties could not have anticipated or mitigated when entering into the contract. In other words, it must be unforeseeable or beyond the control of the parties involved. The COVID-19 pandemic is an example. No one could have foreseen a global pandemic in 2020 that would cause lockdowns and supply chain problems.
On the other hand, if an event known to be a possible occurrence is the reason a party can’t fulfill their obligation, they may not be able to rely on the force majeure clause. For example, if flooding happens in an area prone to floods and makes you unable to fulfill your contract obligation, there may not be enough ground to activate the force majeure clause, as you should have anticipated flooding.
There Must Be an Impossibility of Performance
The unforeseen event must render the performance of the contract impractical, illegal, or impossible. It’s not enough if all the event did was to make performance more difficult or financially burdensome. A party must show that the event has made it fundamentally impossible for them to fulfill their contractual obligations. For example, a war breaking out in the country where you get your raw materials cheaply may not qualify as a force majeure. If you can still source the material somewhere else, even if it’s much more expensive, it won’t trigger the force majeure clause.
The Event Must Be External
To rely on the force majeure clause, you must show that the non-performance or delay in performance is directly linked to the force majeure event. In other words, the non-performance is not because you were negligent or not diligent.
This also means you must have attempted to mitigate the effect of the event. So, a party can’t invoke the force majeure clause if their action contributed to the event. Or, they could have found an alternative way to still fulfill their obligation.
What Are the Consequences of Force Majeure?
The force majeure clause usually outlines the consequences if the clause is successfully invoked. Here are three major effects:
Suspension of Performance
A force majeure clause may outline the conditions under which parties can suspend the performance of contractual obligations. If the event affected a party’s ability to fulfill their obligation, they can do so after the circumstance ends.
Consultations/Discussion
The force majeure clause may provide that when the events happen, parties will come together to assess their impact on contract performance and determine the next course of action. Usually, this requires the affected party to notify the other party promptly when the event occurs. Parties may modify the contracts, explore alternative means of performance, or adjust timelines.
Termination of Contracts
A force majeure provision may allow parties to end the contract when the event making contract performance impossible occurs. Or after a specified period. This is the most serious effect, and it’s usually the last resort after both parties have explored other options.
How Does the Force Majeure Clause Work in Insurance Contracts?
It’s common to see the force majeure clause in commercial contracts. However, insurance companies also use it in insurance policies to exclude or limit coverage for events caused by “acts of God.” This is commonplace in property insurance and business interruption insurance.
Force Majeure Clause in Homeowners Insurance
Insurance companies can use the force majeure clause to avoid responsibility for damage to insured property from unexpected events. Many homeowners insurance policies don’t cover property damage from floods or earthquakes. If you want more protection, you may have to buy additional coverage, such as flood insurance or earthquake insurance.
Force Majeure Clause in Business Interruption Insurance
Business interruption insurance helps cover the losses your business suffers from disruptions. These disruptions may require you to limit your operations or temporarily close. Your insurance contract might have a force majeure clause. In this case, the clause deals with situations where things outside your control interrupt your business.
The COVID-19 pandemic has shown that health concerns can lead to business interruptions. So, if your policy includes a force majeure clause, the insurance company may argue that the pandemic is an unforeseeable event beyond your control. This may limit their liability for business interruption losses.
SOURCES:
American Bar Association: Force Majeure Clauses in the Aftermath of the Covid-19 Pandemic and the Implications for Government Entities
Investopedia: Business Interruption Insurance: What It Covers, What It Does Not
