May 26, 2020

Seventh Circuit Decision Likely to Affect COVID-19-Related Disputes

On May 6, 2020, the Seventh Circuit decided Acheron Medical Supply, LLC v. Cook Medical Inc., Nos. 19-2315 and 19-2410. The underlying dispute occurred long before COVID-19, but two aspects of the Court’s decision could affect disputes that arise as a result of the pandemic. In particular, the Court held that:

  • Under Indiana’s version of the Uniform Commercial Code (UCC), contracting parties owe each other a duty of good faith and fair dealing in performing their respective, specified obligations under the contract, but the duty does not require the parties to undertake obligations that they did not otherwise agree to perform.
  • A contractual force majeure provision that does not address foreseeability may apply regardless of whether the contracting parties could have reasonably foreseen events, and when the provision specifies that an act of government excuses a party from liability, the party will not be liable for breaching the agreement due to government action.

This case could significantly affect COVID-19-related disputes in at least two ways. First, as the Seventh Circuit observed, there is very little Indiana precedent interpreting or applying the UCC’s duty of good faith and fair dealing. Thus, while not binding on Indiana state courts, the Court’s holding provides needed clarity that a party must perform only its existing contractual obligations in good faith, and the implied duty does not impose new or different obligations that are not spelled out in the parties’ contract. Second, foreseeability is likely to be a hotly contested issue in many COVID-19-related contract disputes. Litigants are likely to rely on (or attempt to distinguish) the Seventh Circuit’s interpretation of what qualifies as an unforeseen force majeure event in disputing the application of force majeure provisions.

Dissecting the Case

A medical device and product manufacturer and a distributor entered into a multiyear agreement under Indiana law, which gave the distributor specified exclusive rights and other non-exclusive rights to distribute certain of the manufacturer’s products and devices to particular federal agencies in exchange for securing purchasing agreements with those agencies. The distributor represented that it had special knowledge and experience contracting through the agencies’ government purchasing programs.

Unbeknownst to the manufacturer, there were at least two agency-imposed impediments to the distributor’s contracting with the government agencies: (1) for the distributor to contract with one of the agencies, the manufacturer was required to agree to an audit of its commercial sales records; and (2) for the distributor to contract with the other agency, the manufacturer had to deactivate its agency pricing agreement so as to work through the distributor’s pricing agreement. The distributor did not advise the manufacturer of these requirements before the parties entered into their agreement, and the parties’ contract did not address these issues.

After the manufacturer declined to submit to the audit or deactivate its pricing agreement, the government agencies declined to contract with the distributor. The distributor sued the manufacturer, alleging that the manufacturer owed it a duty of good faith and fair dealing under the UCC and that the manufacturer’s refusal to submit to the agencies’ regulatory requirements breached this duty. The manufacturer counterclaimed that the distributor had breached the agreement by failing to secure purchasing agreements with the government agencies.

The Seventh Circuit disagreed with both parties. The court affirmed that the UCC implies a duty of good faith and fair dealing into commercial contracts, but it held that this duty applies to the parties’ performance of obligations under the contract; it does not give rise to an independent contractual obligation or allow a party to enforce obligations not present in the contract. In other words, it held that the UCC requires the party to execute its specified contractual obligations in good faith, but no more.

Nodding to the broad freedom that Indiana law gives parties to contract, the court observed that the distributor had failed to negotiate terms in the parties’ agreement requiring the manufacturer to perform either of the agency-contracting obstacles at issue, and it held that the distributor could not attempt to add those terms to the agreement under the guise of an implied duty of good faith and fair dealing.

Although the court agreed that the distributor had materially breached the agreement by failing to secure purchasing contracts with the government agencies, it rejected the manufacturer’s argument that the distributor was liable for its breach. Instead, it held that because the distributor’s breach resulted from the government agencies’ rejection of purchasing agreements, the agreement’s force majeure provision — which provided that neither party would be liable for any delay or default caused by, among other things, an act of government or agency — excused the distributor’s liability. In so doing, the court specifically rejected the manufacturer’s argument that the force majeure provision was inapplicable because the government denials were foreseeable to the distributor. It reiterated that, absent language limiting its application to unforeseen events, a force majeure clause may apply regardless of whether the parties could have reasonably foreseen the event that precluded performance.

As the number of cases around the world grows, Faegre Drinker’s Coronavirus Resource Center is available to help you understand and assess the legal, regulatory and commercial implications of COVID-19.

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