Businesses Seek A Legal Escape From Terrorism

Terrorism-related escape clauses and risk disclosures are being added for the first time to U.S. contracts, business deals and corporate public filings after the Sept. 11 attacks.

Despite the bombings of the World Trade Center in 1993 and the Oklahoma City federal building in 1995, terrorism had not registered as a threat to the bottom line of firms operating in the United States.

“Now, it’s everywhere,” said Diana Tabacopoulos, a lawyer in Seyfarth Shaw’s Los Angeles office. “What we’ve seen since Sept. 11 are companies that are either amending their current [securities] filings or making new filings to describe the threat of terrorism.”

Publicly traded companies are detailing their possible exposure to terrorism in documents filed with the Securities and Exchange Commission to protect themselves against possible investor lawsuits, Tabacopoulos said. Companies closer to a possible target, such as airline suppliers, would have to be more detailed than others in these buyer-beware statements.

“A company would practically be negligent to not include terrorism as a risk to their business in public disclosures,” she said.

Terrorism also is being added as a specific exit clause to transaction contracts in much the way earthquake-related provisions were introduced after the 1989 Loma Prieta quake, said Rod Howard, a Palo Alto-based merger lawyer with Brobeck Phleger & Harrison.

“The pattern has always been that people address these things with general language,” he said. “And when some unexpected permutation occurs, they all rush to address that specifically.”

The ultimate effect of the terrorism caveats is a matter of debate. Some lawyers view such changes as knee-jerk reactions that will have little more than a psychological effect. Others believe they will shift costs and liabilities. A shipping contract with an excuse clause for failing to deliver in the event of a terrorist attack, for instance, ought to cost less than one in which the shipper assumes the risk.

In acquisition contracts, the addition of terrorism to what are known as “material adverse change” clauses introduces yet another reason for deals to fall apart.

“Each deal right now is looking at that issue as a matter of first impression,” said Henry Lesser, a merger attorney at Gray Cary in Palo Alto. “A lot rides on this, because deals are more uncertain to close these days than they were three or four years ago.”

Because terrorism hasn’t been spelled out in business contracts, attempts to invoke more general provisions after the attacks could trigger a wave of legal disputes that will take years to resolve. Exit provisions were invoked--or rejected--in a variety of business contracts, ranging from life insurance policies to airline labor contracts.

“Unfortunately, there could be a fair amount of litigation,” said James Salzman, a law professor at American University.

But the closer the parties to a contract are to the effect of the terrorist attacks, the less likely they are to dispute the invocation of a more general caveat, risk allocation experts said. Such clauses in office leases, for instance, probably would allow World Trade Center tenants to escape rent payments and to shield the towers’ owner from his contractual obligations to provide space.

So-called force majeure clauses that were exercised to escape penalties for pulling out of hotel and conference commitments in the days when planes weren’t flying also are likely to go undisputed, said George Preonas, managing partner of Seyfarth Shaw’s Los Angeles office.

“We had booked rooms for a couple hundred lawyers” for a partners’ meeting in Phoenix a week after the attacks, Preonas said. “We invoked our force majeure clause with the hotel [to avoid penalty fees], because no one could get there.

“If our meeting had been in December rather than Sept. 18, we would have had a different argument,” he said. “The further you get away from this Sept. 11 date, the harder it’s going to be to make that claim.”

In a high-profile example, Warren Buffet’s Berkshire Hathaway exercised an exit clause to pull out of its offer to buy as much as $500 million in notes from Finova Group. The deal-killing language was a fairly standard adverse change clause that allows for escape in the event of suspended trading, war or armed hostilities.

From office leases to service and supply agreements, almost every commercial contract contains some type of unforeseen events clause, each one a legal tripwire that could be set off by the unimaginable.

From the French for “superior force,” a force majeure clause is legalese for an excuse from a contractual obligation in the event of any number of acts of man and nature.

“It’s an allocation of risk,” said Marla E. Mansfield, a University of Tulsa law professor. “It’s taking the risk of nonperformance off the person who can’t perform and putting it on the person who wanted performance.”

Force majeure clauses often spell out possible events for which businesses cannot plan. Companies doing business in Southern California, for instance, are more likely to include language about riots than blizzards.

Mansfield has written about force majeure clauses that are ubiquitous in oil and gas contracts and designed to shield suppliers from the consequences of everything from blowouts to guerrilla attacks on foreign pipelines.

Manufacturers use force majeure clauses in sales contracts to shield them from penalties for failing to deliver products in the event a factory is unusable after a storm or earthquake. And employers point to force majeure clauses to avoid paying workers if a natural disaster shuts down a plant.

“At the end of the list of unforeseeable things, they say, ‘And other events of force majeure,’ ” Mansfield said.

When an event is not one of those listed in a contract, the invocation of a force majeure clause is more likely to be disputed in court.

“The question is, ‘Is the court going to let the loss lie where it fell?’ ” said American University’s Salzman. “Or is the court going to step in and say, ‘This isn’t just,’ and flip it around?”

Through much of the 19th century, parties to contracts were expected to deliver--no matter what. “Contract law used to say: ‘You promised it, you do it,’ ” Mansfield said. “Tough luck.”

The contemporary notion of force majeure comes from a British case in the 1860s involving an impresario who booked an opera house that burned down before he was able to stage his show. The would-be producer sued the opera house owner for failing to deliver the opera house as promised.

In deciding for the opera house owner, the court gave rise to the legal notion of impossibility. Simply put, through no fault of his own it was impossible for the opera house owner to deliver the hall. The doctrine, which has evolved somewhat to the “impracticability” excuse, continues to hold sway today, Salzman said.

Under that doctrine, he said, unions probably had the legal high ground when they protested efforts by two airlines to escape labor contract obligations to pay severance to workers laid off after the shutdown. The airlines invoked force majeure, claiming that their losses were so great they could no longer afford to honor the contracts.

Shippers were in a similar fix during the 1956 Suez Canal crisis and balked at making the longer trip around the Cape of Good Hope to meet their deliveries, Salzman said. But courts held them to their contracts.

“The courts are pretty clear that impracticability is not the same thing as impracticality,” he said. “Just because something is more expensive doesn’t say that it rises to the level of being impracticable.”

Among financiers, underwriters and lawyers, the attacks have provoked the latest discussion about which events should be allowed to scotch a deal.

“During the Gulf War, people were doing long memos on ‘Does a blockade constitute a war?’ ” said Michael J. Kennedy, head of mergers and acquisitions for Wilson Sonsini Goodrich & Rosati in San Francisco. “You’ll see some fine-tuning of contract terms.”

Many travelers ran into force majeure clauses for the first time after the terrorist attacks. Initially, the clauses worked in their favor, guaranteeing ticket-holding travelers a seat on a plane once the airlines were up and running again.

But since flights have resumed, skittish travelers trying to get out of trips have found themselves on the other end of force majeure fine print in tickets and tour contracts, said Ed Perkins, a syndicated travel writer and former Consumer Reports travel editor.

In many cases, travelers are able to re-book later, but it has been more difficult for people attempting to cancel altogether and get their money back, he said.

“The people who have been most affected by force majeure are people who had paid upfront for cruises, packaged tours or vacation rentals, particularly cruises,” Perkins said. “The cruise lines have taken a pretty hard-nosed attitude about this: ‘If they airlines are flying and we’re running the cruise, the force majeure is over.’ ”