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Performance Under Cannabis Contracts During a Pandemic: Do the Contracting Parties Stay Best Buds or Does One Party End Up Feeling Burnt?

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Performance Under Cannabis Contracts During a Pandemic: Do the Contracting Parties Stay Best Buds or Does One Party End Up Feeling Burnt?

The COVID-19 pandemic has wreaked havoc on nearly every industry in the global economy. The nascent and volatile cannabis industry was not exempt and, in some jurisdictions, has been impacted significantly due to local or state shelter or stay-at home orders. In most states where adult-use cannabis is legal, local and state governments have deemed cannabis businesses as essential and, thus, are permitted to continue operating notwithstanding local or state shelter orders. However, despite their characterization as essential businesses, many limitations imposed by local or state shelter orders have greatly affected the way cannabis businesses operate. As a result, cannabis businesses have experienced steep declines in their revenues and, in some instances, have left cannabis businesses unable to perform contractual obligations that they entered into pre-pandemic.

There are several options for a party that is unable to do what it has promised to do under a written contract. In the pre-pandemic world, the non-defaulting party likely would have sent a default notice to the non-performing party, provided the non-performing party with a cure period if required under the contract and, in the event that the non-performing party did not cure, proceed with all remedies available to it, including commencing litigation against the non-performing party. Indeed, there are some who are still taking the foregoing route, regardless of the undeniable wrench that COVID-19 has thrown in the works.

Fortunately, many cannabis businesses are not so quick to call defaults and have worked amicably with one another to renegotiate contract terms. The pandemic has created a shift in power for contracting parties, such that the non-defaulting party may have more power and leverage than it normally would to strictly enforce the contract’s terms against the non-performing party. Notwithstanding the remedies available in a written agreement, many cannabis businesses prefer to work with the non-performing party recognizing that the pandemic and, thus, the power shift, will not be permanent. For most, it makes better business sense to stay friendly and preserve the business relationship with a non-performing party than antagonize it. After all, the non-defaulting party may need to conduct business with that non-performing party at some point in the future.

In some instances, it may not make economic sense for either party to modify the terms of a contract. Undoubtedly, the uncertainty of the pandemic makes it difficult and, in some cases, impossible to determine when performance under the contract can resume, if ever. In cases where the parties cannot reasonably modify the contract, such parties may mutually agree to cancel the contract and forego seeking any remedies against one another.

If the parties are unable to agree to modified terms, or are unable to agree to terminate the contract, then some are beginning to invoke the force majeure clause. In some cases, defaulting parties are asserting force majeure as a defense to a breach of contract claim. In others, parties who know that they cannot perform because of the pandemic are asserting force majeure pre-litigation, with the hope that that clause will excuse their performance without the time and expense associated with protracted litigation.

So what exactly is a force majeure clause and how does it help cannabis businesses that have no other way out of the agreements they can no longer perform? Stated simply, a force majeure clause is a contract provision that either excuses a delay in performance or completely excuses performance on the part of the non-performing party. Generally, the force majeure event must directly cause the defaulting party’s delay or non-performance in order for performance to be excused. For cannabis businesses, this element is particularly important, especially for businesses that were not in the strongest position pre-pandemic. If the non-defaulting party can demonstrate that the defaulting party was not stable from an operational or financial standpoint pre-pandemic such that it could not perform under the contract whether or not there was a pandemic, then it is unlikely that the defaulting party’s non-performance will be excused.

An important consideration for the party invoking force majeure is that the force majeure event was not foreseeable at the time the parties entered into the contract. While a pandemic is something that is normally not foreseeable, a force majeure argument based on the existence of the pandemic does not automatically prevail. For example, a party that entered into a contract after the World Health Organization declared COVID-19 to be a pandemic may have a difficult time proving that it was unforeseeable.

Furthermore, the event must render performance impossible or impracticable; it is insufficient that the economic terms of the agreement are no longer as favorable to, or that performance is less convenient for, the party invoking force majeure. As an example, a manufacturer may assert that it can no longer sell cannabis distillate to a retailer because it cannot obtain biomass from the cultivator who was supposed to supply it. If the manufacturer is able to procure biomass from a second cultivator at a cost that is only slightly higher than the original cultivator but decides not to do so, then it is possible that manufacturer would not prevail if it invokes force majeure. In this instance, the manufacturer could have still performed its obligations, albeit with economic terms that were less favorable than the original contract.

Additionally, the non-performing party must demonstrate that it took actions to mitigate the impact of the force majeure event. This means that the non-performing party must show that it attempted to make reasonable modifications so that its performance could continue. Notably, mitigation is examined on a case-by-case basis and is extremely fact-intensive. Going back to the example above of the manufacturer who could not obtain biomass from the original cultivator, the manufacturer potentially may not be deemed to have mitigated the impact even if the second cultivator charged five times the price charged by the original cultivator. Again, the increase in price would make the economic terms less favorable but the manufacturer’s performance could, conceivably, still be possible. In such a case, other factors must be considered to determine both impossibility or impracticability, as well as mitigation.

Last, the party invoking force majeure must examine whether the plain words of the force majeure clause include a pandemic. Most force majeure clauses specifically identify the events that would trigger that clause, including but not limited to, acts of God, war and natural disasters. While most force majeure clauses include catchall language that accounts for all other events that the parties could not have reasonably foreseen at the time of contracting, some force majeure clauses lack this language. Arguably, a pandemic could be considered an act of God, but clever attorneys can most certainly poke holes in vague force majeure language.

So what is the best course of action for cannabis businesses during the pandemic, whether the business is the party invoking or defending against a force majeure claim? It truly depends on the business needs and goals of the parties to the agreement. It is ultimately a business decision for the non-defaulting party, whether to stay best buds with the counterparty or whether to leave that counterparty feeling burnt.

 

Source: https://www.cannabisbusinessexecutive.com/2020/05/performance-under-cannabis-contracts-during-a-pandemic-do-the-contracting-parties-stay-best-buds-or-does-one-party-end-up-feeling-burnt/

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