A Look at the Post-Covid Tech/IP World
CORONAVIRUS AND FAILURE TO PERFORM:
THE LOOMING BUSINESS CONTRACT AND IP LICENSE BRAWL
©2020 Robert Payne, Payne IP Law
You’re the president at Sigma Technologies. The COVID-19 crisis has shut down most incoming orders or your business has shuttered. As a patent licensee, Sigma is contractually obliged to make a scheduled periodic minimum or milestone royalty payment in four days. You are currently getting no value from the license. Are you obliged to make the payment?
Your business colleague at Delta Industries is concerned about its manufacturing patent agreement. The U.S. company producing a critical component for Delta’s key product under a patent license is able to supply only a fraction of the required quantity of components because of COVID-19 disruption. Further, your colleague is worried its own commitments, just as Sigma is. Your colleague wonders what rights it has under the manufacturing patent agreement.
You may well need to get full-throated advice on the issue, but it’s good to know some basic principles at the outset. Keep reading even if you have no agreement regarding patents: these principles apply to all business contract disputes.
Your first order of business is to look at the agreement. Does it have a force majeure clause, dealing with non-performance or delay caused by unforeseen or uncontrollable events? If so, does it give clear guidance on rights and duties? Before addressing that, let’s ask what your options are if your agreement has no such clause.
WHAT IF THE AGREEMENT IS SILENT?
If your license agreement does not have a force majeure clause, contract law recognizes two defenses, even if the parties failed to expressly address such eventualities in the license.
The doctrine of “impracticability” or “impossibility.” Most jurisdictions will excuse a breach of license agreement if an unforeseeable event makes performance impracticable by causing a high level of difficulty or high level of added expense for the breaching party if it were to perform under the contract. In the seminal English case, Taylor v. Caldwell, the owner of a music hall was excused of liability for failing to make the hall available due to an accidental fire that destroyed the building.
However, there are additional requirements. The event must be beyond the control of the breaching party; and the breaching party must not have assumed the risk of the event occurring. Given that the occurrence and rapid spread of COVID-19 was unforeseeable at the beginning of this year, a breach may be excused if the contract was entered into before then and if performance becomes impracticable.
What constitutes a “high level” of difficulty or expense? Some jurisdictions, notably New York, require impossibility of performance. California case law does not. Generally, the performance should be at least so impractical, viewed objectively, that it is inconsistent with the basic assumption of the parties at the time the contract was made. The event may also have to be so unlikely that a reasonable party would not have guarded against it in the contract.
The doctrine of “frustration of purpose.” Similar to the doctrine of impracticability, the unforeseeable event here must go so far as to “destroy the purpose of the contract.” Its origins trace to Krell v. Henry. Henry rented a room from Krell for the purpose of viewing the coronation of English King Edward VII. But the King fell ill, and the coronation was postponed. The very purpose of the contract—a room with a view of the coronation—was frustrated, and performance was excused.
Frustration of purpose requires many of the same elements as the principles of impossibility or impracticability: (1) an event substantially frustrates a party’s principal purpose; (2) the nonoccurrence of the event was a basic assumption of the contract; and (3) the event was not the fault of the party asserting the defense. The question is whether the unforeseeable event has so altered circumstances that performance would no longer fulfill any aspect of its original purpose. Will cancellations in the supply chain render the object of a license agreement completely “valueless”? Maybe not.
There are two primary obstacles to successfully invoking this defense. First, courts interpret a party’s “purpose” broadly. Merely being unable to take advantage of the agreement in an preferred or expected manner may be insufficient. Second, frustration must be near total. It generally is not enough that the activity in question has now become unprofitable. It is not considered a “basic assumption” that existing market conditions or the financial situation of the parties will not be disturbed. As a result, mere market shifts or financial inability to perform generally do not constitute unforeseen events the nonoccurrence of which was a “basic assumption” of the contract.
California and Other Statutes. Notwithstanding the absence of force majeure provisions in the agreement and the requirements under common law, some states have legislated remedies, such as California. California Civil Code 1511 provides that nonperformance/delay of performance under contract is excused when it is caused “by operation of law” or “by an irresistible, superhuman cause” “unless the parties have expressly agreed to the contrary.”
A FORCE MAJEURE CLAUSE OVERRIDES COMMON LAW DEFENSES
If a contract does have a force majeure clause, most courts will rule that it overrides the impracticability and frustration of purpose common law defenses. The logic is that the parties are determining for themselves what delays or nonperformance will be excused, altering the common law default rules. The only requirement is that the events be beyond the parties’ control, for obvious reasons. Foreseeability is viewed by a different lens as well. Unlike the common law defenses, a foreseeable event specifically identified in the force majeure clause will excuse performance.
If the clause lists specific events of force majeure (e.g. “strike, riots, war”) those events will excuse or delay performance, even if foreseeable. On the other hand, a list of specific events is often interpreted by courts to limit the force majeure defense to events similar to those on the list. Other truly unforeseeable events, like COVID-19, if not similar or addressed, could well provide no defense. Look for references to “disease” or “epidemic” or “pandemic.” Another thing: Watch for notice requirements in the force majeure clause that must be met.
What if the license agreement is vague, simply referring to “acts of God” and “other similar events” and without specific examples? COVID-19 would then seem to be an unforeseeable event within the phrase, providing a likely defense.
A wild card with force majeure clauses is where they fail to specify the degree of difficulty required to excuse performance. Outcomes here may be difficult to predict, as courts and juries may vary on excuse even where performance is made materially more difficult, expensive or dangerous by COVID-19.
Whether or not there is such a clause, keep in mind that contract and license interpretation is governed by state law, even if suit is in federal court. One of fifty state jurisdictions will apply its own statutory and case law to the question, assuming there are no international legal issues involved.
DRAFTING TIP AND BUSINESS INTERRUPTION INSURANCE
If you want to "pandemic proof" a force majeure clause, consider inserting specific examples, such as "disease outbreak, epidemic, pandemic or other declaration of public health emergency, quarantine restriction and any act of a governmental body that results in the imposition of a tariff or duty not applicable as of the Effective Date of this Agreement."
Last thought: Don’t be limited by thoughts of contractual rules. Do you have business interruption insurance coverage?
After addressing these preliminary thoughts, you will be better prepared to consider contacting counsel or address other initial steps.
Robert Payne is the founder of Payne IP Law, in Silicon Valley, California. His practice focuses on business and intellectual property dispute resolution and litigation. Payne is former Chair of the Executive Committee of the Intellectual Property Section of the California State Bar.
Payne IP Law, San Jose, CA | Payne@BobPayne.com | (408) 981-4293
Glimpsing Our Po§t-Covid World
Will the economic recovery come quickly, or only in slow and wrenching steps? Will “normal” – when we get there – look strangely different? What businesses will survive and how will they cope in the new environment? Tech and IP law will play a critical role in this changed world, and in changing that world. Here are three articles worth a few minutes of your time. We will provide three more articles in each issue of our newsletter.
But rather than focusing on immediate issues like ventilator and vaccine production, we will offer articles on broader tech trends, tech that will adapt to and transform our emerging economic condition.
Where's §To Wit's humor? It will be back. But right now, we have some serious issues to look at. Also, if you find a good article, let us know at email@example.com. If we link it, we will credit the contributor.
Our first article suggests many opportunities in the New World:
- New business models are emerging, especially in sectors such as health, logistics, automation, online office, entertainment, retail, and education;
- New generation smart cities will systematically enhance public management by integrating supply chains, traffic, emergency and disaster warning.
- Big data will be more widely used for public wellbeing, especially for tracking, analyzing, and supporting timely public decision-making.
- Offline-driven businesses begin to shift online, especially in education, entertainment, and retail.
- Social media will serve not just individuals and business, but also the public and government.
Our second article notes the coronavirus pandemic may accelerate digital changes in work already in play, regarding collaboration, sales and marketing practices. Additionally, if most of the workforce can work from home without substantial productivity loss, commercial real estate will suffer dramatically.
Our third article foresees that telecom investment in 5G technology, which was already expanding rapidly, will be spurred further by increased broadband demand requirements of our current and future environment.
OUR §O-CALLED HUMOR ARTICLE§:
Our newsletter started out, and remains, an IP humor site. Here are some of our past hits:
Why Did IBM Skip the Loo?
Save Our Planet
The Dude Abides
Rock, Paper, Scissors, Lizard, Spock
ABOUT §TO WIT
§TO WIT is a blog about IP humor and about IP “news you can use.” What does “To Wit” mean? In formal, legal language, it means “namely,” to clarify and specify. “The indictment charged that Jones knowingly possessed a firearm, to wit: a .38 caliber revolver.” But for us, it’s a salute, well, "to wit." (Pop Quiz: Did we use “To Wit” as a double entendre, a triple entendre or quadruple entendre? Answer: Who cares?)
But we’re more than just fun and games. We also will post articles on IP issues of interest to smaller businesses — for business owners and their general counsel. The articles will be written in plain English and short. Very short. Rather than rewrite what others have said, we'll generally link to a longer article or original source for those who want to know more.
Payne IP Law, San Jose, CA | Payne@BobPayne.com | (408) 981-4293