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COVID-19 Litigation

As the nation prepares to return slowly back to work, many businesses must reckon with a sharp decline in revenues, a reduced work force and an uncertain future. Rebuilding will be difficult. Where does one even begin? To help cut through the information overload, we offer this short summary of three key topics: the CARES Act, business interruption insurance, and contractual performance obligations.

CARES Act Loans for Small Businesses

The federal government enacted the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) on March 27, 2020. In the weeks that have followed, the Small Business Administration (“SBA”), Treasury Department, and other federal agencies have issued numerous bulletins and “FAQ” guides intended to clarify the scope and application of the Act. Even so, it is a complex piece of legislation and its implementation has been something of a moving target. At its core, the CARES Act provides economic aid to, among others, businesses with 500 or fewer employees. For business owners, the main components of this legislation are the Paycheck Protection Program (the “PPP”), the Economic Injury Disaster Loans (“EIDL”) program and a tax benefit package. Under the PPP, a small business may borrow 2.5 times its average monthly payroll (up to $10 million). But the PPP “loan” is actually a federal grant so long as the business uses 75 percent of the loan proceeds for payroll costs and the remainder for non-payroll costs, such as mortgage interest, rent, or utility costs. To qualify for loan forgiveness, these payroll and non-payroll costs must have been paid or incurred within eight weeks of loan origination. Further, the company must also retain all employees through at least June 30, 2020, or the loan forgiveness will be reduced. The cost of the PPP loan forgiveness, though, will be felt when the business files its tax return next year. The IRS in its Notice 2020-32 has advised that expenses paid for through a forgiven PPP loan will not be deductible by the business. The rationale for that advice is that permitting the deduction of such expenses would result in a double tax benefit for the business. The IRS’s position is being challenged by the AICPA and other business and accounting organizations. The PPP loan application process is relatively straightforward — businesses must submit an eight-question, one-page application (with additional pages of certifications and instructions) to its local bank. Theoretically, completed loan applications are processed in the order in which they are received. Notably, the first $349 billion earmarked for the PPP was depleted on April 15th, just 12 days after banks started accepting applications. Congress approved an additional $310 billion for PPP loans on April 25th. These funds will probably run out quickly as well. Whether the federal government will fund the PPP a third time is an open question. The EIDL program has been expanded and streamlined under the CARES Act. Under the enhanced version of the EIDL program, businesses may apply to the SBA for an emergency grant of $10,000 as an advance on the EIDL loan. This grant does not need to be repaid even if the EIDL application is denied. Critically, however, EIDL loans are not eligible for forgiveness. The CARES Act also contains a bundle of tax deferments and credits. It allows employers to defer their portion of Social Security payroll taxes for 2020 over the following two years, with half of the payment due by December 31, 2021 and the remainder by December 31, 2022. Certain businesses may also qualify for an “employee retention” tax credit of 50 percent of wages paid to employees after March 12, 2020. The main eligibility criteria for this credit is that the company’s quarterly revenues declined by 50 percent or more. But beware of the fine print — a business cannot take advantage of the tax deferment or employee retention credit if its PPP loan has been forgiven.

Business Interruption Insurance Coverage

Many businesses carry business interruption insurance. For companies that have been paying premiums for this special coverage, it would seem to be the perfect time to make a claim for business interruption. After all, few events have interrupted business to a greater degree than the coronavirus pandemic. But will insurance carriers pay for the losses sustained as a result of the months-long lockdown? The answer depends on the language of the policy. And even if the loss is covered, there are usually significant limitations on business interruption claims. The first step in determining whether an insurer will pay a claim is to establish coverage. Business interruption insurance offers several distinct types of coverage: physical loss, loss due to acts of a civil authority, and loss sustained due to loss to a “dependent property.” Physical loss generally requires direct loss of or damage to property, which may include “damage” to “air or physical surfaces” caused by viruses. If the insured can establish that the virus has infected the place of business, physical coverage may be triggered. Civil authority coverage applies when a governmental entity mandates a business’ closure because of a general public health crisis such as the coronavirus pandemic. Notably, the stay-at-home orders issued by the City and County of Los Angeles, as well as other state and local governments, explicitly provide that the business shutdown is due to the “physical loss and damage to” property. Finally, “dependent property” coverage protects against losses caused by the shutdown of certain defined third-party businesses, such as critical suppliers. The second step in the claims analysis is to evaluate whether any exclusions apply. Many policies contain broad language excluding a variety of perils from coverage. For example, some policies exclude any loss caused directly or indirectly by “any virus…capable of inducing physical distress, illness or disease.” In some cases, this exclusion will result in the denial of coverage even if there is a separate basis for coverage, such as “civil authority” or “dependent property” coverage. The third step is to ascertain the extent of the coverage. Many policies, for example, limit business interruption coverage to 30 days. And while that loss payout will almost certainly be worth the time and effort of making a claim, the coverage may not justify litigating a denied claim. It is no secret that carriers will aggressively scrutinize claims, so care should be taken by the insured when speaking with a claims adjustor or even the insurance broker (whose compensation may depend in part on the rate of paid claims). The starting point is to read the policy and understand the coverage available and the exclusions. If the potential claim is significant, the insured should consider seeking advice from an attorney.

Contracts in the Age of COVID-19

Nobody planned on the Coronavirus Pandemic Business Shutdown of 2020. There may be blame for the way our government handled the crisis, or even theories about how the virus originated, but none of the finger pointing will solve the immediate financial problems of businesses. Among many other issues, companies must confront whether and to what extent contracts can be enforced. Who will bear the loss when an agreement cannot be performed because of the worldwide pandemic and resulting governmental orders shutting down commerce? Written contracts frequently contain “force majeure” clauses that provide that if an act of God or other “irresistible superhuman” event occurs — and the coronavirus pandemic almost certainly qualifies — performance will be excused. But even where an agreement contains no such provision, a business could credibly invoke the common law defense of impossibility (or “impracticability” in legal parlance), asserting that the government shutdowns shield the party from any breach of contract claim. The coronavirus epidemic is not, however, a free pass to shirk all contractual obligations. First, the party raising the force majeure or impossibility defense must establish that it exercised prudence, diligence, and care. If, for example, a supplier or service provider should have delivered the goods, or completed its work, before the shutdown, that party may be liable for breach of contract. Second, partial or delayed performance may be required. Could some of the work be done safely at home? Could performance be delayed until after the epidemic is resolved and the stay-at-home orders lifted? If the answer to either question is yes, partial or delayed performance may be required, even if such performance engenders greater cost or inconvenience to the party required to perform. The outcome of contract disputes depends heavily on the specific facts of the case. Disputes involving non-performance because of the coronavirus pandemic will likewise depend on a myriad of factors, starting with the governing contract language. If a business resolution cannot be easily achieved, a consultation with an experienced attorney may be the best course of action.

Conclusion

There is currently no obvious solution for the coronavirus pandemic, nor is there a clear understanding as to when businesses may resume “normal” or “near normal” operations. The three issues discussed above will continue to be a topic of legal discussion, and quite likely litigation, for some time to come.

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