The most basic rule of contract law is that the plain and unambiguous language of a contract controls, but every rule has its exceptions. In times of crisis, government authorities sometimes step in to modify or supersede even the clearest terms of private contracts.
The bankruptcy of a counterparty to any contract (whether an insurance policy, lease, construction agreement, project finance agreement, investment or other agreement) can result in the modification or even termination of certain contractual rights. At minimum, immediately upon a bankruptcy filing, an automatic stay generally prevents you from terminating your contract or enforcing obligations past due. If you think your counterparty is financially stressed, you should immediately consider the following steps:
As we have seen over and over in past financial crises, numerous businesses (landlords, lenders, insurance companies, energy and construction companies, funds, just to name a few) need considerable assistance and counseling in order to maximize the value of their contract rights during pre-bankruptcy and bankruptcy-related disputes and negotiations. As the impact of COVID-19 shakes out, we are likely to see numerous companies stressed and seeking out-of-court debt restructurings or filing for bankruptcy.
Ad Hoc Government Actions
In times of crisis, especially in highly regulated sectors—e.g., insurance, finance, housing, public health—governments can try to alter contract performance to alleviate the crisis.
Following disasters like the Northridge Earthquake (1994), the September 11 attacks (2001), and Hurricane Harvey (2017), politicians and regulators put severe pressure on the insurance industry to pay claims their policies did not cover. Similarly, states also have imposed moratoria on enforcing rent and mortgage obligations in times of financial crisis.
In the midst of the COVID-19 pandemic, governments are actively seeking to alter both insurance and housing contract rights. Several states have proposed legislation prohibiting insurers from denying business interruption claims, regardless of their policy terms. Several states have issued or are exploring eviction and foreclosure moratoria, or even rent or mortgage forgiveness, not just deferral.
These government measures will face constitutional challenges. First, the US Constitution’s Contracts Clause provides, “No State shall … pass … any Law impairing the Obligation of Contracts.” In Sveen v. Melin, the US Supreme Court recently stated the legal standard: Has the state law “operated as a substantial impairment of a contractual relationship”? If so, was the impairment an “appropriate” and “reasonable” means to “advance a significant and legitimate public purpose.”
The Fifth Amendment’s Takings Clause may also be relevant. The Clause states that no one shall be “deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.” What is “just compensation” will likely be open for dispute.
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