In the News

March 26, 2020

 

Construction Law Professionals Weigh in on Coronavirus Impact

—Andrew Michaels, editorial associate

The coronavirus is wreaking havoc on industries worldwide, where closures began with factories and are spreading to businesses of all sizes. With confirmed cases increasing in the U.S. every day, construction experts are relying on economists’ predictions in their assessment of the long-term ramifications to the industry.

If there’s one thing economists are beginning to agree upon, it is that a recession is possible. Earlier this month, Anirban Basu, chairman and CEO of Sage Policy Group and chief economist of the Associated Builders and Contractors, said “the risk of recession over the next three to six months is arguably more elevated than at any period since 2007.” Although the outcome is unknown, construction professionals look to economists for guidance, which, from Basu’s perspective, involves “raising cash, determining if their lines of credit are large enough, considering staffing models and ensuring the good graces of bankers and insurers.”

Construction Attorney Steve Lesser, who spoke with Construction Dive, said the industry, particularly contractors, are taking a wait-and-see approach. Lesser highlighted six potential effects the virus could have on construction, some of which also involve material suppliers. At the height of such concerns are delays that inevitably lead to hikes in material prices.

“My gut tells me we’re going to see higher prices and projects canceled although I can’t point to the extent of it,” noted Joe Natarelli, national construction industry leader at Marcum LLP, in a Construction Dive interview. “To be frank, I haven’t seen a huge impact yet on material price increases, but the expectation of it and the uncertainty around the virus is really scaring folks.”

Natarelli added that some U.S. construction companies get up to 80% of their materials from China—a troublesome statistic considering the JLL 2020 Construction Outlook anticipates labor costs could rise by 2% to 4% and material costs could increase between 1% to 4%.

“Since this is a rapidly developing global situation, I suspect there are going to be some shortages with materials in the short term,” said Attorney David J. Merbaum, of Merbaum & Becker, P.C., in an interview with NACM. “How much financial scars remain is yet to be seen.”

Several lawyers recommend materials suppliers remain in contact with subcontractors (subs) and contractors, especially during a time when change is imminent. Michael C. Decker, of Butzel Long’s Construction Law Practice Group, wrote in an article that material suppliers must be prepared for questions from subs and/or contractors involving their current condition as well as plans and procedures moving forward.

“Obviously, the question becomes—would the coronavirus fall within the category of a force majeure or excusable delay event?” Decker wrote. He referred to the following:

  • AIA A201—2017 § 8.3.1: Entitles contractors to an extension of time for delays caused by “labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions documented in accordance with Section 15.1.6.2, or other causes beyond the Contractor’s control.”
  • EJCDC 700 – 2013 § 4.05: Entitles the contractor to “an equitable adjustment” in time if the “Owner, Engineer, or anyone for whom Owner is responsible, delays, disrupts, or interferes with the performance or progress of the Work” or for delays caused by “severe and unavoidable natural catastrophes such as fires, floods, epidemics, and earthquakes,” “abnormal weather conditions,” and “acts of war or terrorism.”

“It is not entirely clear given the novel nature of the coronavirus,” Decker wrote. “Therefore, it is not recommended that construction companies count on relying upon such force majeure or excusable delay provisions to shield them from liability for delays and disruption in their work or their failure to complete their work within the time specified in their contracts.”

 

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Two Weeks into a Pandemic: A Fresh Look at Force Majeure

—Jamie Gottlieb Furia, Esq. and Alexandra S. Droz, Esq.

While the new coronavirus disease (COVID-19) outbreak has already caused unprecedented and far-reaching negative consequences, foremost for many businesses is the difficulty or impossibility of carrying out contractual obligations. During a global crisis such as the COVID-19 pandemic,[1] is a party excused from performance under a contract? The short answer: It depends.

Many contracts contain a force majeure clause that limits damages or excuses performance when an “act of God” or circumstances beyond the parties’ control prevent either party from fulfilling its obligations.[2] However, courts typically construe force majeure clauses narrowly, and will only fully excuse performance if the contract expressly includes the particular event.[3] In order for COVID-19 to more likely be considered an enforceable event excusing performance, a force majeure clause should explicitly contain a specific reference to a “pandemic,” “epidemic,” “virus,” “disease,” “quarantine,” “travel restriction” or “state of emergency.”

When parties attempt to rely on catchall clauses as opposed to specifying triggering events, courts will not typically enforce force majeure if the parties could reasonably have foreseen the event at the time of contracting.[4] Of particular importance to courts interpreting these force majeure clauses will be whether the parties entered into the contract (or relevant rider, statement of work, or subcontract) before the triggering event became foreseeable: here, the global spread of COVID-19. The timing and foreseeability of the pandemic will almost certainly be a hotly contested topic as these clauses are litigated.

Even without an enforceable force majeure clause, a party unable to perform its contractual obligations may be able to assert an impossibility or impracticability defense. Under New York law, for example, the doctrine of impossibility is also narrowly construed, and is only applicable when a party is objectively unable to perform.[5] The various COVID-19 government regulations prohibiting the operation of nonessential businesses may provide valid impossibility defenses to performance.

Likewise, proving impracticability of performance is a high bar. A party must be able to demonstrate that the event preventing performance was truly unforeseeable and could not have been prevented by the obligated party. It is typically not enough to claim that performance is inconvenient or more expensive than anticipated at the time of contract.

Small and large businesses alike with contracts impacted by the COVID-19 crisis should promptly take the following steps:

  • Analyze contractual rights and responsibilities to determine the potential impact of the global outbreak on performance.
  • Determine contractual notice obligations, as many contracts require that a party seeking to rely on a force majeure clause provide prompt notice to its counterparty. In some cases, the failure to provide notice may constitute a waiver of rights.
  • Assess alternatives to performance before invoking a force majeure clause.
  • Document all decisions and actions, and maintain any corresponding documentation.
  • Communicate with the counterparty as soon as possible to discuss the impact of COVID-19 on performance, potential delays or alternatives to performance as written under the contract, and to hopefully craft a mutually agreeable solution.

While much remains unknown about the COVID-19 pandemic, it is essential for businesses to understand their own abilities to invoke and defend against force majeure arguments if contractual performance becomes impracticable or impossible.

Jamie Gottlieb Furia, Esq. and Alexandra S. Droz, Esq. of Lowenstein Sandler LLP.

[1] The World Health Organization declared COVID-19 a pandemic on March 11, 2020.

[2] See Beardslee v. Inflection Energy, LLC, 25 N.Y.3d 150, 154 (2015) (“Generally, a force majeure event is an event beyond the control of the parties that prevents performance under a contract and may excuse nonperformance”); see also Facto v. Pantagis, 390 N.J. Super. 227, 231 (App. Div. 2007) (“Even if a contract does not expressly provide that a party will be relieved of the duty to perform if an unforeseen condition arises that makes performance impracticable, ‘a court may relieve him of that duty if performance has unexpectedly become impracticable as a result of a supervening event.’” (quoting Restatement (Second) of Contracts § 261).

[3] See In re Cablevision Consumer Litig., 864 F. Supp. 2d 258, 264 (E.D.N.Y. 2012) (stating that force majeure provisions are narrowly construed and “will generally only excuse a party’s nonperformance if the event that caused the party’s nonperformance is specifically identified”).

[4] See Kel Kim Corp. v. Cent. Markets, Inc., 70 N.Y.2d 903 (1987) (“The principle of interpretation applicable to [catch-all] clauses is that the general words are not to be given expansive meaning; they are confined to things of the same kind or nature as the particular matters mentioned”); Seitz v. Mark-O-Lite Sign Contractors, Inc., 210 N.J. Super. 646, 650 (Law Div. 1986) (“Under this principle, the catch-all language of the force majeure clause relied upon by defendant is not to be construed to its widest extent; rather, such language is to be narrowly interpreted as contemplating only events or things of the same general nature or class as those specifically enumerated”).

[5] See, e.g., Urban Archaeology Ltd. v. 207 E. 57th St. LLC, 34 Misc. 3d 1222(A), 951 N.Y.S.2d 84 (Sup. Ct.), aff’d, 68 A.D.3d 562, 891 N.Y.S.2d 63 (2009) (collecting New York cases interpreting impossibility doctrine).

 

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Construction Deemed Essential in New York

—Michael Miller, managing editor

Governors across the U.S. are closing nonessential businesses to help control the spread of the coronavirus (COVID-19). But the definition of “nonessential” varies from state to state and even from county to county, especially when it comes to the construction industry. Announcements from the government are challenging workers and business owners on a daily basis with the rollout of new executive orders. However, while the executive orders are meant to save lives, and everyone hopes that is the case, there is still a real-life strain on the economy, which is costing employees jobs and businesses revenue.

The type of construction project is also important when it comes to determining if work is considered nonessential. Earlier this month, Boston suspended nonessential construction, but allowed emergency construction to continue—road and building work, gas leaks and health care facilities, among others. San Francisco County suspended all private construction, while public works and essential infrastructure could continue. Colorado’s San Miguel County shut down all construction minus limited essential building. Meanwhile, in New York, one of the most impacted places in the U.S., construction has been allowed to continue as an essential business.

However, earlier this month, New York Gov. Cuomo issued Executive Order No. 202 to declare a disaster emergency in the state, which gives him the power to suspend or modify statutes. To help combat the COVID-19 pandemic, specific time limits for the commencement and filing of legal action, notice or motion among other processes is “tolled from the date of this executive order [March 7, 2020] until April 19, 2020.”

In New York State, courts are shut down except for essential purposes such as criminal matters—arraignments, bail applications, etc.—and family court proceedings including child protective matters among other deemed essential proceedings. The governor’s executive order suspends statutes of limitations in legal matters, and no paper or electronic filings will be accepted except for the established essential matters.

“While we continue to remain open, all nonessential functions of the courts will be postponed,” said New York Court of Appeals Chief Judge Janet DiFiore in a statement. “All essential functions of the courts remain available to ensure that New Yorkers may access the justice system during this extremely challenging time.”

Meaning, while construction has continued, there could be future issues for those in the industry. “I have been proceeding as usual. I have been sending out liens as usual, but now I am sending them out overnight FedEx since people don’t have to sign for documents—I will have proof of delivery,” said Kevin Laurilliard, shareholder with McNamee Lochner P.C. “When someone on the other end processes them is beyond my control. At least I can show I served the general contractor and owner or whoever I have to legally serve. I can show that it was sent for filing to the county clerk’s office.”

By processing the required documents, potential lien claimants can show everything was timely; the fact that people on the other end do not open or file the documents is beyond the claimants’ control. “Recipients at the county clerk’s office may not open liens and process them for a long time,” he added.

In a time when the world is panicking, Laurilliard’s best advice was to not panic. “You can’t control what the courts will decide, but at least the courts will not be able to say you didn’t do everything to comply with the law. It’s really just a complete unknown. Control what you can control, and that’s getting paperwork out the door. From there, I expect significant delays.”

It’s always better to get mechanics’ liens out sooner rather than later because of the derivative rule, Laurilliard said. “In New York, a lien is enforceable only to the extent that there’s money still owed on the contracts. If you’re a supplier, there’s an even longer chain of command; you want to catch money still owed to the subcontractor and general contractor. You want the lien to be able to attach to money still owed. The derivative rule is not applicable with a payment bond, but you rarely see a bond on private projects—bonds are mandatory on public projects for the most part.”

The executive order and administrative order from the chief judge would apply if a lien claimant’s one-year deadline to foreclose on a lien falls within the timeframe of the orders since documents—paper and electronic—are only being accepted for essential matters. “Those orders deal with filings to court and the statute of limitations. I cannot predict with certainty the future decisions from courts relating to these issues, but think their decisions are going to be fine and protect the laudable goals that contractors, laborers and suppliers should get paid,” Laurilliard concluded.

 

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Small Businesses Feeling the Effects of COVID-19 Should Be Aware of the New Small Business Reorganization Act of 2019

—Russell Mills, Esq.

With businesses across the country facing shutdowns — either mandatory or de facto because of social distancing — the likelihood of bankruptcy among them will increase. Small businesses, such as restaurants, bars, entertainment facilities and hotels, may be particularly hard-hit. But a recent change in the law makes the remedy of bankruptcy far less difficult for them than in years past.

With little fanfare, the Small Business Reorganization Act of 2019 (SBRA), appearing in Subchapter V of Chapter 11, was signed into law on Aug. 23, 2019 and went into effect on Feb. 19, 2020. The SBRA was intended to streamline the restructuring process for small businesses, defined as those with non-contingent liquidated secured and unsecured debts not exceeding $2,725,625.

Under the prior law, equity owners were unable to retain their ownership interests in a reorganized debtor without paying creditors in full unless those creditors consented or the equity owner paid “new value” to the debtor for the new equity interests. Known as the “absolute priority rule,” this sometimes led to the loss of the equity or even the failure of Chapter 11 cases. But now, if the debtor commits to pay creditors all of its projected disposable income over three to five years and pays secured creditors the value of their collateral, the SBRA eliminates the application of the “absolute priority” in “small business” cases. This permits equity owners to retain their ownership interests without paying creditors in full, increases the likelihood of a successful reorganization and decreases the likelihood of creditors receiving substantial payment.

The SBRA also removes several requirements that typically drove up the costs of a Chapter 11, including:

  • The possibility of a creditors’ committee, except in unusual cases. Instead, a standing trustee is appointed to oversee the plan process.
  • The need for a disclosure statement and process for approving it. Instead, it requires filing a plan of reorganization within 90 days of bankruptcy filing, and it provides that only the debtor may file a plan of reorganization.

In short, the SBRA lowers costs, simplifies the plan confirmation process and provides more certainty to equity owners looking to protect their investment from creditors. It also arrives at an opportune time for small business owners.

Chapter 11 is ideal for those businesses that represent a profitable business model but, because of economic or other circumstances, suffer from a temporary loss of cash flow. Before now, its costs and delays could outweigh its benefits. But Subchapter V and the SBRA make the benefits of Chapter 11 more affordable and accessible to small business owners. Likewise, creditors should be aware of an increased use of the SBRA and the potential for decreased payouts and less leverage in Chapter 11 proceedings.

Businesses with $2,725,625 in debt made up only 42% of 2019 bankruptcy filings. In light of the coronavirus pandemic and its effect on the economy, many commentators are now calling for at least a temporary increase of the debt limitation to $10,000,000, which would increase eligibility to 59% of past filers. So even if your small business now exceeds the maximum debt limitation, be aware that Congress could be increasing that limitation in the near term as part of coronavirus relief legislation.

Russell Mills, Esq., partner at Bell Nunnally & Martin LLP, is an experienced bankruptcy attorney who represents clients in all aspects of bankruptcy proceedings. His clients include corporations, small businesses, individuals, municipalities, associations and bankruptcy trustees. He focuses his practice on all aspects of commercial bankruptcy and bankruptcy litigation including the representation of secured and unsecured creditors, creditors' committees, trustees, asset purchasers and debtors.