LEGAL ISSUE:

What available legal defenses exist for a franchisee to stop paying royalties and a lessee to stop paying rent according to their obligations stated in the lease agreement during a pandemic?

RULES:

The doctrine of impossibility states that “Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate to the contrary.”

According to the doctrine of frustration, ” 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 which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary.”

ANALYSIS:

In the absence of a force majeure clause that excuses the franchisees and lessee’s contractual obligation to pay rent, there exist other defenses based on common law doctrine. The two applicable doctrines are impossibility and frustration.

The main difference between the two doctrines is the degree to which an unforeseeable event disrupts the contractual obligations of the parties. Namely, in impossibility, the contractual obligations are impossible to complete, and in frustration, the event has rendered the performance bargained for worthless.

[1] Restatement (Second) of Contracts § 261

[1] Restatement (Second) of Contracts § 265

Regarding the impossibility defense analysis, performance would be impracticable, no party was at fault, and the non-occurrence of the event was a basic assumption.

Impracticability is challenging to prove since the standard is high. A business must prove more than mere inconvenience. The issue is how your business is affected by the pandemic. If your franchise business is a non-essential business and you need to close shop, the stronger the impracticability argument there is.

The tough cases are in which franchisees can operate on a limited capacity. Then the analysis would be how much revenue is the franchisee making as a percentage of overall revenue earned pre-COVID-19. The smaller the percentage, the stronger the impracticability argument is.

The current pandemic resulting from the COVID-19 virus was not the fault of any party involved.

A basic assumption in a contract concerns the principal issue or object bargained for. For instance, if a contract involves a specific personal property, a vase, and that vase is destroyed, then the basic assumption of the contract is gone as well.

For the majority of franchisees, a basic assumption in the restaurant industry would be that no curfew, stay at home orders, or mandatory quarantines are in place for their customers. Normal market fluctuations or a competing restaurant next to your business would not be a basic assumption.

Concerning the frustration defense, the principal purpose of the agreement must be affected, the frustration must be substantial, no party was at fault, and the non-occurrence of the event was a basic assumption.

The purpose of the franchise agreement and the lease agreement in most circumstances is to provide goods or services for consumers, and since the majority of Americans are under some form of stay at home order, the customer base of the majority of businesses are affected.

The primary legal issue/battle will be what constitutes substantial frustration, and the facts of the case will be the deciding factor. For instance, if the franchise business is forced to close, or the sales of the reduced business operation (e.g., restaurant franchisees who can only do carry out and deliveries) are reduced to practically nothing, then it will bolster the argument for frustration.

Like the impossibility doctrine, the pandemic was no one’s fault, and the basic assumption is not to have national emergency powers used on the restaurants’ clients.

Both impossibility and frustration doctrines should only be used in extreme cases, such as a pandemic.