The bad, the ugly and the somewhat good; Dealing with the coronavirus
QUESTION: I’m particularly concerned about the coronavirus. I’d like to get your perspective on what’s happening and whether the coronavirus might be considered an “Act of God” that gives my customers the right to cancel their reservations and/or contracts. Thanks for any help you can provide.
Answer: Yes, the coronavirus does appear to be having a profound impact on the economy both in the U.S. and throughout the world, resulting in a wave of cancellations and early terminations of contracts, including those for rentals and leases of equipment.
The bad. Though it’s too early to fully assess the macroeconomic impact of the coronavirus, as of the date this article is being written, the virus has spread to almost all of the United States, and as of yet, there appears to be no effective treatment or means of controlling the outbreak. Global supply chains have been interrupted and demand is weakening. As everyone knows by now, the equities markets have taken a severe beating, rolling recessions are being predicted, and industries from travel to trade shows and sales have witnessed steep declines in both demand and attendance.
In response, the Federal Reserve has reduced interest rates to historic lows, the World Health Organization has declared a global “pandemic” and affected parties from pharmaceutical companies to local and national governments have been working feverishly to find an effective treatment, slow the spread of the virus and protect their economies.
The ugly: On a micro level, demand for equipment is slowing in many areas and customers increasingly have been cancelling reservations or terminating existing rentals. Contracts are being cancelled and/or breached, lawsuits are being threatened and if the apparent panic persists, we may well see a more pronounced slowdown or perhaps worse — though hopefully not the raft of defaults and bankruptcies experienced in the Great Recession of 2008-2010, which saw more than 200,000 businesses close and more than three million jobs lost in the U.S., according to Census statistics.
- Overall slowdowns in economic activity and resulting slumps in demand for all types of equipment.
- A cascade of additional cancellations and contract terminations.
- Increases in slow/late/no-pays.
- Customer/contractor bankruptcies.
- Equipment seizures by bankruptcy trustees, particularly with respect to equipment on rental purchase options (RPOs), which haven’t been properly documented.
- Equipment breakdowns resulting from funds-related maintenance delays.
- Increased chargeback claims from customers.
- Increased equipment theft.
- Possible direct impacts on employees and employment relationships in the event of exposure.
- The inevitable expansion of litigation.
This means things could get a lot worse before they get better, however, there is a brighter side.
The somewhat good. It is possible for rental operators to protect themselves contractually from much, though certainly not all, of the fallout from pandemics and other unforeseen problems, including cancellations and terminations, as well as the lawsuits that are sure to ensue. Doing so, however, requires incorporating some provisions that, up to now, routinely have been overlooked in most rental contracts and leases — largely because such provisions tend to be both obscure and somewhat mundane. By that, I mean, they tend to look like the “unnecessary legalese that nobody understands and everyone thinks was just written by some lawyer trying to justify a bill.” That may be true in some cases, but there also are cases where it can literally save your business.
Following is a list of some of the issues and related contract provisions that, in my opinion, are likely to prove most meaningful to rental operators in the current environment:
Acts of God. As you suggest, we’re hearing that many lessees are attempting to use the act of God excuse in efforts to cancel or terminate their rental obligations. Opinions vary as to whether a global pandemic would qualify as an act of God, but even if a judge or jury were to determine that it does, your customer/lessee is likely to be deemed liable for payment in full if your contract is properly written. If it isn’t, you may be unable to collect most or all of what you originally believed were valid receivables.
What does “properly written” mean? As you might guess, there only are a few ways to properly write a contract and there are innumerable ways to do so improperly, including providing unnecessary exemptions to the lessee’s obligations, such as express rights to cancel or terminate; failing to obligate the lessee for the entire term of the rental; failures to effectively waive implied warranties, rights and remedies, including the right to reject and/or cancel under the Uniform Commercial Code and/or case law; failing to close trap-doors to the lessee’s obligations, such as implied cancellation and termination rights, for example, implied rights to terminate in the event of “impossibility,” “impracticability” or a breach of one or more of the above referenced implied warranties; failing to eliminate contingencies to the lessee’s obligations; failing to eliminate claims for reductions and setoffs, such as equitable offsets from what the lessor is owed, based on claims from the lessee that the equipment was late, defective, damaged, etc.; and failing to eliminate extraneous negotiations and alleged agreements, such as emails and texts as well as your advertising and website.
Frustration of purpose. Separately, if for example, an event were to be cancelled as a result of coronavirus concerns, a lessee might argue that the purpose of the contract had been “frustrated,” that is the cancellation rendered the rental company’s proper performance of its obligations worthless to the lessee, thereby excusing the lessee from its associated payment obligation. Depending on what your contract says, a lessee might be able to escape liability if some unanticipated intervening force majeure — literally greater force — perhaps including an epidemic, were to result in the cancellation of a project or event, such as a basketball tournament. That assumes, however, that a court would be willing to countenance at least two arguments:
- That the actual purpose of the contract was “the successful completion of the lessee’s planned project or event” as opposed to, for example, “the successful completion of a rental” — the latter of which could arguably be completed regardless of the occurrence of a pandemic.
- That the pandemic did, in fact, “frustrate” that purpose. One of the ways a rental contract or lease can help the lessor in this regard is to indicate that the customer/lessee selected the equipment without the lessor’s assistance. Assistance by the lessor in selecting the proper equipment for an event or project could suggest to a judge or jury that the lessor knew that the real purpose of the rental was really to successfully complete the lessee’s specific project or event. Conversely, if the contract states that the lessee independently selected the equipment without the lessor’s assistance, the lessor then can credibly argue that the true purpose of the contract was simply the completion of a rental and not the underlying project or event. In response, one might be tempted to argue, “But equipment lessors routinely help their lessees select the right equipment.” Perhaps, but there almost is no way such an acknowledgment could be helpful to you, as a lessor. Remember that one of the primary purposes of your rental contract should be to protect you and make sure you get paid.
Assuming a judge or jury might be inclined to find the lessee’s cancellation or termination justified in the case of a pandemic or other unforeseen catastrophe, the court also would then be faced with applying other rules of contract interpretation and enforcement, including freedom of contract, which is the right of parties to negotiate and execute legally binding contracts without government interference; the rule that “parties will be held to the contracts they sign in the absence of fraud or unconscionability;” and the “four corners rule” that the parties’ agreements are deemed to exist within the “four corners” of the document they signed, ignoring other side or implied agreements unless a compelling reason exists to do otherwise.
Consequently, in most instances, other than perhaps in the case of a government-mandated shutdown, one would expect the courts to apply extremely high bars for proving that “frustration of purpose” provides a valid reason for allowing lessees to escape their contract obligations. A government-mandated shutdown might render the lessor’s performance frustrated or worthless, but it still would not render either party’s performance impossible. A lessor still could provide the equipment and the lessee could still pay the rent. In most cases, courts do impose high bars for “frustration of purpose” arguments. Consequently, though an implied cancellation right based on a government-mandated shutdown might be found to exist in the case of an epidemic or natural disaster, a court would be much less likely to approve a cancellation by a private individual or entity — think the NBA or NCAA — merely as a result of a drop in attendance, which essentially is an effort to simply limit financial losses, but not necessarily as a result of government intervention. In either case, this is where your contract can make the difference between winning and losing. Eliminating contingencies, trapdoors, setoffs, prorations, counterclaims and extraneous agreements is crucial to protecting the lessor, particularly in these types of cases.
That is where some often-overlooked legalese can prove invaluable. Consider the following. If any of these should fail to appear in your rental agreement, now would be a good time to consider updating it to include them:
Unconditional duties. A statement that the customer’s duties under the rental agreement are unconditional arguably eliminates the customer’s ability to later imply that “one of the conditions to its performance was that economic conditions remain relatively constant” or that “no pandemics, natural disasters, changes in global economic circumstances, government interference or other events beyond our reasonable control will intervene and frustrate the purpose of, or render impracticable, your contract.” An unconditional duty is arguably just that — a duty that is not conditioned on any outside factors, whether or not capable of being anticipated.
Eliminate allowances, credits and setoffs. Couple the foregoing unconditional duties with contract language that eliminates “prorations, reductions and setoffs” and also eliminates “allowances for period(s) of nonuse.” Such language expressly waives the customer’s claims — legal and moral — for reductions of the rent and other amounts owing under the contract.
Make prepayments non-refundable. Make all prepayments, including rent deposits non-refundable unless otherwise agreed by you, the lessor. Sunk costs can dissuade parties from cancelling or terminating early and, in any event, can soften the financial blow of a large cancellation.
Selection. As noted above, a provision indicating that the customer has selected the items to be rented without input from the rental operator can go a long way toward bolstering the argument that the rental operator had no knowledge of any particular purpose for which the equipment was to be used. Consequently, if the customer’s purpose in renting the items was not communicated to the rental operator, it arguably could not serve as justification for permitting the customer to escape liability, inasmuch as that purpose was never understood by both parties to serve as the basis for the contract, its sole purpose being simply the completion of a rental.
One-way acts of God/force majeure provisions. Remember that customer cancellations are only one side of the act of God/force majeure issue. A lessor also may find itself in need of a right to cancel a contract in the event of an act of God. Rather than relying on the hope that a court might deem the lessor’s performance impossible or impracticable, or its contract purpose frustrated, it is better in my view to include a one-way act of God/force majeure provision that explicitly enables the rental company to escape its performance obligations, but not the customer. Although that may seem unfair or out of balance, remember that the obligations of lessor and lessee under most rental agreements are entirely different; the lessor’s being to provide equipment — in perhaps impossible circumstances, think of requiring a delivery after a bridge collapse; whereas in most cases, the lessee’s obligations are limited to paying rent and refraining from exposing the equipment and others to injuries and damages. As a consequence, an ostensibly reciprocal force majeure clause could impact the parties very differently and may result in either dangerously restricting the lessor’s ability to cancel or unnecessarily broadening the lessee’s right to do so. One call for caution here is the possibility that a lessee might argue that a lessor’s one-way force majeure provision should be judicially extended to benefit the lessee on equal terms in spite of its one-way drafting. The above referenced positional differences, however, coupled with the fact that businessto-business contracts generally are enforced as signed, suggest that the danger of such court-made extensions is limited. In any event, any such danger would be dwarfed by the potential benefits to the lessor of including a one-way provision in the rental contract in most cases.
Selection. Default and remedies. Events of default should be spelled out, and critically for these purposes, the lessor’s rights and remedies should explicitly include the right to collect all rent for the scheduled term, as well as interest, attorneys’ fees, collection costs and other expenses incurred by the lessor in connection with the lessee’s breach. One of the reasons for including such rights is the ability to ratchet up the potential claims faced by the customer if he/she/it risks being found guilty of having breached the contract by refusing to perform based on an invalid act of God/force majeure claim.
Litigation, claims and chargebacks. As money gets tighter, people tend to fight harder with respect to claims of all sizes. This is particularly true with respect to chargebacks and lawsuits that result from maintenance issues and equipment breakdowns. As I’ve mentioned in previous articles, this makes inclusion of indemnity, defense and hold harmless provisions, as well as a clause permitting the lessor to charge all amounts due and coming due under the rental contract to the customer’s debit or credit card critical. In light of the additional threat that others, including event vendors, employees and event attendees may now also file lawsuits, whether arising from cancellations or even from projects/events that were not cancelled but perhaps should have been, lessors should feel even more compelled to include such provisions. If a pandemic outbreak is tied back to a particular project or event, the repercussions for all parties, including the lessor(s) providing the equipment, could be enormous. If you haven’t had this portion of your contract reviewed by an attorney, I would urge you to do so immediately.
Liens. Also, in those states where mechanics’ lien filings are available to equipment lessors, you will need to be prepared to file them. Doing so will be upsetting to property owners, whose titles will be clouded by your liens, and the upstream contractors, whom the property owners will promptly threaten to fire and/or sue, but in a severe downturn, threatening and/or filing mechanics’ liens may be your only means of recovery. Be aware that state statutes on this topic vary widely; some impose extremely short deadlines for filing and often have even shorter deadlines for delivering notices of “Intent to File a Lien” or the like to other interested parties, usually including the above referenced site owners and upstream contractors.
Chargebacks. This issue also makes the use of properly written debit/credit card charge authorizations imperative as a means of limiting chargebacks, particularly those that may not merit the filing of a lawsuit in response. We expect chargebacks to proliferate in the coming months. If you aren’t using an authorization that factors in the new Visa rules, provides a means of determining a specifically authorized charge amount, and waives setoffs, counterclaims and chargebacks, I would recommend doing so as soon as possible.
Rental purchase options (RPOs) — how to not lose a piece of equipment to a bankruptcy trustee. This topic could merit an entirely separate article, but the critical knowledge for lessors is this: RPOs create a real danger that a bankruptcy trustee in the estate of a bankrupt contractor — your RPO customer — might claim that the customer has an implied ownership interest in your equipment, allowing the trustee to seize, and keep, your equipment. Among other things, RPOs must expire before they create such ownership interests, state clearly that the rental company remains the owner of the equipment and state that the lessee’s exercise of the option is not reasonably certain. If you haven’t written your RPO agreement properly and/or timely filed a valid UCC-1 financing statement of public record, you could be rendered an unperfected creditor and lose your equipment. If this market swoon continues and contractors start going bankrupt as they did in the last downturn, RPO lessors could be faced with enormous unrecoverable losses. If you’ve done this in the past and aren’t sure, you may yet be able to take steps to mitigate your losses — you will not be able to eliminate them in most cases as the filing deadlines are extremely short. Contact an attorney familiar with such issues immediately.
Venue. If you must sue, be sure your contract contains a venue provision setting the venue for all lawsuits in as convenient a location as possible, unless you elect to waive it — for instance, if you need to file and/or foreclose on a lien in another county. Doing so properly can save you tremendous amounts of time and trouble, not to mention attorneys’ fees and travel costs. The coronavirus presents a strange dichotomy in terms of its perceived danger, but it is having a profound effect on the global economic environment, the financial markets and, critically, the equipment and event rental industry.