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Catalytic “black swan” events that impact the global economy are becoming more frequent this millennium. As a society we did not prepare for the recent pandemic and have not internalized its effect on businesses. Models in insurance and law are based on underlying principles when predicting risk (ex., natural disasters, flooding, and fire). This outlier occurrence is not within the range of what is covered. It is not just the legality of it all, it is our failure as a species to imagine that a global pandemic could happen.
COVID-19’s black swan effect has not impacted only our health and healthcare systems. The greater danger could be the impact on our global economy as we deal with a pandemic defying legal precedents. There will be unprecedented lawsuits. We are already seeing chaos with the banking system’s allocations of the government’s stimulus package. As this becomes the Wild West, insurance companies, contract law, and business owners have to understand risk in this Brave New World.
What is force majeure?
Force majeure is defined as “1: superior or irresistible force, 2 : an event or effect that cannot be reasonably anticipated or controlled — compare ACT OF GOD.” An event like a pandemic leads into murky legal ground. It is not just the impact of a pandemic but its unintended consequences (i.e. the government shutting down businesses and not letting people work).
Because this is far outside the range of normal contract law, the judicial system will have to address this, particularly as lawsuits pile up and large sums of money are at stake. Businesses that were humming along have been wiped out in weeks, and their owners will have to do whatever it takes to recoup losses, especially if the government forced them to close.
How this looks in practice
The effects will be felt in every industry impacted by COVID-19. As we are at the beginning of this drama, we do not know how it will play out. Some Chinese companies have already used the “Force Majeure” clause when their businesses took a hit. As quoted in this Fast Company article “the Chinese government issued force majeure certificates exonerating certain companies for contractual non-performance resulting from COVID-19; those certificates may or may not be recognized under contracts governed by U.S. law.” The caveat here is “may or may not be recognized under contracts governed by U.S. law,” so we will have to see what US judges decide.
We are also seeing how this plays out with the NBA regarding players’ contracts, but it will most certainly impact other industries aside from sports and entertainment. Global supply chains transporting millions of dollars of goods could see this clause used by companies claiming losses. It is also about context and interpretation. This Quartz article predicts that most businesses may not be able to utilize this clause and will need to stomach their losses. An example is the airline industry: “the US Department of Transportation has taken a far less liberal view in a seemingly identical situation. In an enforcement notice published April 3, the US Department of Transportation left little wriggle room for troubled US airlines to lean on force majeure clauses. “Passengers should be refunded promptly when their scheduled flights are cancelled or significantly delayed.”
What the future may look like
One thing is certain: pandemics will be covered by insurance in the future, and that will certainly impact rates. It will be interesting to see if other outlier events will start to be anticipated and accepted. No need to read science fiction novels; we will probably see the onset of reports detailing potential black swan force majeure occurrences by management consulting firms. With booming populations, the proliferation of deadly weapons, and environmental and ecological erosion, we are more likely to experience outlier events like COVID-19. In the restaurant industry, insurance companies are denying claims for damages because a pandemic was not part of the coverage. Will the government make insurance companies amend agreements with clients and cover damages caused by COVID-19?
With all that is happening, many small- and medium-sized business owners are experiencing sleepless nights. This will be a tough time for our country, but we believe a future generation of companies can withstand and thrive when the next force majeure event occurs.
With false force majeure claims on the rise, Interfor has been asked to investigate if business interruptions did indeed occur due to Covid-19-related issues or if fraud plays a role.