It goes without saying that the coronavirus pandemic has rattled the economy; as a result, businesses are facing difficulties honoring contracts. This Davis Graham legal alert focuses on contracts for the sale of goods—generally governed by Article 2 of the Uniform Commercial Code (“UCC”)—and some UCC provisions that may arise in these uncertain times.

First, parties should consider whether performance under the goods contract has become “impracticable” due to COVID-19 or the various government orders instituted as a result of the pandemic. Under UCC § 2-615, a seller’s inability to deliver goods as agreed is not a breach of the contract if (1) its ability to do so “has been made impracticable” because of unforeseen events or compliance with an applicable government law; and (2) it properly notifies the buyer.[1]
Where only a part of the seller’s capacity to deliver is affected, it “must allocate production and deliveries among his customers . . . in any manner which is fair and reasonable.”[2]
Whether the seller has satisfied these requirements is generally an issue of fact decided by a jury (or, if acting as factfinder, the court).[3]

As drafted, this section appears to apply only to sellers. However, both the UCC Official Code Comments and some courts indicate that buyers may invoke § 2-615 to excuse performance.[4]

But no matter the party asserting the defense, a mere increase in cost or collapse in the market is unlikely to constitute impracticability.[5]
Parties suffering generally from the bad COVID-19 economy are not automatically excused from honoring their contracts. Rather, an impracticability defense should invoke a specific circumstance such as “a severe shortage of raw materials or of supplies due to a contingency such as . . . unforeseen shutdown of major sources of supply or the like.”[6]

There may also be challenges asserting impracticability where the parties’ contract has already allocated the risk of nonperformance in some way. For instance, the Tenth Circuit analyzed whether the buyer’s performance was excused under a “take-or-pay” contract.[7]
In such a contract, a buyer may perform in either of two ways: It may “take” specified amounts of product or “pay” the seller a penalty.[8]
Relying on “settled law” that “the impracticability of one alternative” is not an excuse if “performance by means of the other alternative is still practicable,” the Tenth Circuit held that the impracticability of the buyer’s duty to take did not automatically absolve it of its duty to pay.[9]
However, the court’s decision leaves open the possibility that a buyer could be excused from both obligations if unforeseen events or compliance with a government law renders both obligations impracticable.

In addition to impracticability, COVID-19 and related economic difficulties might trigger these other UCC Article 2 provisions:

• UCC § 2-502 – Buyer’s Rights upon Seller’s Insolvency.

Under this section, [10]
a buyer may recover goods if the seller becomes insolvent and certain other circumstances are present. The UCC says a buyer or seller is insolvent if the party has (1) ceased to pay its debts in the ordinary course of business, (2) cannot pay debts as they become due, or (3) is bankrupt as defined by federal bankruptcy law.[11]
The goods sought to be recovered must generally be “identified,”[12]
meaning that the goods have been designated or set aside as the ones to be delivered to the buyer.[13]

• UCC §§ 2-702 and 2-705 – Seller’s Rights upon Buyer’s Insolvency.

On the flip side, a seller who discovers that a buyer has become insolvent may refuse delivery of goods (except where the buyer pays in cash)[14]
or halt the delivery of goods possessed by a shipper or bailee.[15]
The seller should be sure to give reasonable notice to the shipper or bailee.[16]
This section should also protect a shipper or bailee who complies with a seller’s demand to stop shipment, giving the shipper a defense in any suit by the buyer.[17]

• UCC § 2-712—Cover.

Under this section, if the seller fails to deliver the contractual goods, the buyer may “cover” by purchasing substitute goods and seeking from the seller the difference in price and related damages.[18] Nonetheless, the buyer should be wary of “upgrading” or purchasing goods superior to those contemplated in the contract. If an equivalent product is available, a buyer is unlikely to recover the full cost of cover for an upgraded product.[19]
Notably, however, the UCC says that, “[f]ailure of the buyer to effect cover within this section does not bar him from any other remedy.”[20]
That may be good news for buyers who would find it difficult to secure substitute goods in a challenging market but bad news for sellers who are potentially exposed to greater buyer-side damages.

• UCC § 2-716—Replevin.

Where the seller fails to deliver, the buyer may be able to retrieve the goods in lieu of damages if the goods are “unique” or “other proper circumstances” support retrieval.[21]
Generally, the goods must be identified (as discussed above) and cover must be “reasonably unavailable.”[22]
Unique goods may be those that are “specifically designed” for the buyer.[23]

• UCC § 2-609—Right to Adequate Assurance of Performance.

When a seller or buyer experiences “reasonable grounds for insecurity” with respect to the other party’s performance, “the other may in writing demand adequate assurance of due performance.” Until the party “receives such assurance,” the party “may if commercially reasonable suspend any performance for which [it] has not already received the agreed return.”[24]
Whether there are “reasonable grounds for insecurity” is ultimately a question for the factfinder and thus an issue that presents some risk for a party demanding assurances.[25]

It is also imperative to adhere to the statute’s other requirements for demanding assurances of performance. In Scott v. Crown, the court observed that there were “serious problems with the timing, form, and content of Seller’s demand for assurances of performance.”[26]
Although there were reasonable grounds for insecurity, the seller suspended performance after orally demanding assurances (rather than in writing) and did not specify that he was demanding assurances of performance. As a result, the court construed seller’s suspension of performance as an anticipatory reputation of the contract,[27]
giving the buyer the right to cancel the contract and pursue other remedies.[28]

* * *

This illustrates the various rights available to buyers and sellers of goods confronting COVID-19 and related uncertainties. But with those rights come certain traps for the unwary. Davis Graham & Stubbs LLP’s attorneys have experience litigating UCC disputes from inception through trial and are well positioned to advise parties on how to exercise their rights under the UCC without falling into any of those traps.

Please contact Ben Strawn or Gabrielle Robbie if you have further questions on this topic.

[1] U.C.C. § 2-615; see also C.R.S. § 4-2-615 (Colorado UCC).

[2] U.C.C. § 2-615(b); see also C.R.S. § 4-2-615(b).

[3] 1 White, Summers, & Hillman, Uniform Commercial Code § 4:22 & n.11 (6th ed.) (almost all courts consider impracticability an issue for the trier of fact and collecting cases); see Cliffstar Corp. v. Riverbend Prod., Inc., 750 F. Supp. 81, 87 (W.D.N.Y. 1990) (“The court finds that the question whether [seller]’s allocation to [buyer] was ‘fair and reasonable’ is one of fact to be decided by the jury.”).

[4] U.C.C. § 2-615, cmt. 9; C.R.S. § 4-2-615, cmt. 9; Golsen v. ONG W., Inc., 756 P.2d 1209, 1220 (Okla. 1988) (Kauger, J., concurring) (observing that Idaho, Illinois, and Iowa courts have applied § 2-615 to buyers).

[5] U.C.C. § 2-615, cmt. 4; C.R.S. § 4-2-615, cmt. 4.

[6] Id.

[7] Int’l Minerals & Chem. Corp. v. Llano, Inc., 770 F.2d 879 (10th Cir. 1985).

[8] Id. at 885.

[9] Id.

[10] See also C.R.S. § 4-2-502.

[11] U.C.C. § 1-201(23).

[12] 1 White, Summers, & Hillman, Uniform Commercial Code § 7:37 (6th ed.).

[13] Matter of CSY Yacht Corp., 42 B.R. 619, 621 (Bankr. M.D. Fla. 1984) (yacht buyers were not entitled to recover yacht materials under UCC § 2-502 because there was no evidence that the materials were set aside or designated for buyers’ yacht).

[14] UCC § 2-702; C.R.S. § 4-2-702.

[15] UCC § 2-705; C.R.S. § 4-2-705.

[16] UCC § 2-705(3)(a); C.R.S. § 4-2-705(3)(a).

[17] See Stephen A. Hess, 3 Colo. Prac., Methods of Practice § 88:15 & n. 7 (“It is not necessary for the bailee to establish that the stoppage was rightful. Merely establishing that the seller had in fact stopped the delivery of the goods will suffice.”).

[18] U.C.C. § 2-712; C.R.S. § 4-2-712.

[19] Nartron Corp. v. Amway Corp., No. 201487, 1999 WL 33435058, at *2 (Mich. Ct. App. Oct. 12, 1999).

[20] U.C.C. § 2-712, cmt. 3 (“[C]over is not a mandatory remedy for the buyer. The buyer is always free to choose between cover and damages for non-delivery . . . .”).

[21] U.C.C. § 2-716; C.R.S. § 4-2-716.

[22] U.C.C. § 2-716, cmt. 3.

[23] Colorado-Ute Elec. Ass’n, Inc. v. Envirotech Corp., 524 F. Supp. 1152, 1159 (D. Colo. 1981).

[24] UCC § 2-609(1); C.R.S. § 4-2-609(1).

[25] Scott v. Crown, 765 P.2d 1043, 1046 (Colo. App. 1988).

[26] Id.

[27] Under U.C.C. § 2-610, where one party notifies the other by words or actions that it will not perform, the other party may bring a breach of contract action even though the performance is not yet due. See also C.R.S. § 4-2-610 (same).

[28] Scott, 765 P.2d at 1046.

The Paycheck Protection Program (PPP) established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) has made available up to $349 billion in potentially forgivable loans to small businesses for the payment of payroll costs and certain other expenses. We previously circulated a legal alert outlining the general terms and conditions of the PPP (available here) and a legal alert summarizing certain answers by the U.S. Small Business Administration (SBA) to frequently asked questions relating to the PPP (available here). Note that, as of the date of this legal alert, the $349 billion originally made available for the PPP has been exhausted, and Congress may not appropriate additional funds for the program. The SBA has announced that it is unable to accept new applications at this time for the PPP or the Economic Injury Disaster Loan COVID-19-related assistance program but that Economic Injury Disaster Loan applicants who have already submitted their applications will continue to be processed on a first-come, first-served basis.

On April 14, 2020, the SBA issued an interim final rule (the Interim Final Rule) that addresses the eligibility criteria for certain PPP loan applicants and requirements for certain pledges of PPP loans. The following is a summary of the provisions of the Interim Final Rule that relate to individuals with self-employment income.

Individuals with Self-Employment Income who File a Form 1040 Schedule C:

Eligibility. Individuals with self-employment income are eligible for PPP loans if:

• They were in operation on February 15, 2020;
• Their principal residence is in the United States; and
• They filed, or will file, a Form 1040 Schedule C for 2019.

Maximum Loan Amounts. The Interim Final Rule provides two methodologies for self-employed individuals who file a Form 1040 Schedule C to calculate their maximum loan amounts. One methodology applies to self-employed individuals with no employees, and the other applies to self-employed individuals who have employees.

Permitted Use of Proceeds. PPP loan proceeds may be used by self-employed individuals who file a Form 1040 Schedule C for:

• Replacement of owner compensation (based on 2019 net profit, as more particularly described in the Interim Final Rule);
• Payroll costs for employees whose principal residence is in the United States;
• Mortgage interest payments (but not prepayments or principal payments) on any business mortgage obligation on real or personal property (e.g., mortgage interest for a warehouse purchased for the business or interest on an auto loan for a vehicle used to perform the business); business rent payments (e.g., for a warehouse used in the business or a vehicle used to perform the business); and business utility payments (e.g., cost of electricity for a warehouse used in the business or gas used driving a vehicle used to perform the business); provided that the self-employed individual must have claimed or be entitled to claim a deduction for such expenses on his or her 2019 Form 1040 Schedule C in order to use the PPP loan proceeds to cover such expenses during the eight-week period following receipt of the loan; and
• Interest payments on other debt obligations incurred before February 15, 2020.

Loan proceeds may also be used to refinance an SBA Economic Injury Disaster Loan received between January 31, 2020 and April 3, 2020.

In any event, at least 75% of the PPP loan proceeds must be used to cover payroll costs.

Loan Forgiveness: Loan forgiveness will depend in part on amounts spent during the eight-week period following receipt of the loan on:

• Certain payroll costs (which exclude compensation in excess of $100,000 on an annualized basis for each employee);
• Replacement of owner compensation, limited to eight weeks’ worth of 2019 net profit, excluding certain sick or family leave equivalent amounts for which a credit is claimed under the Families First Coronavirus Response Act; and
• Interest on mortgage obligations on real or personal property incurred before February 15, 2020, rent payments on lease agreements in force before February 15, 2020, and utility costs under service agreements dated before February 15, 2020, in each case to the extent deductible on Form 1040 Schedule C.

The amount eligible for forgiveness may be reduced if employee headcount and compensation levels are not maintained, if applicable. Furthermore, at least 75% of the forgiven amount must be attributable to payroll costs.

Additional Guidance for New Businesses. The SBA intends to publish additional guidance for individuals with self-employment income who were in operation on February 15, 2020 but not in 2019 and who will file a Form 1040 Schedule C for 2020.

Partnerships and Their Partners:

Partners in a partnership may not apply for their own PPP loans as self-employed individuals. Instead, the partnership may apply for a PPP loan and report the self-employment income of its general active partners (up to $100,000 annualized per such partner) as a payroll cost. A limited liability company filing taxes as a partnership is treated as a partnership for this purpose.

If you have any questions regarding the Paycheck Protection Program, please reach out to Jeff Brandel or Lauren Roberts.

Amidst the ongoing coronavirus crisis, Wyoming has enacted House Bill 14, which amends Wyoming’s involuntary pooling provisions under Wyo. Stat. Ann. § 30-5-109. We have prepared a summary of this new legislation, which will become effective on July 1, 2020.

House Bill 14 amends Wyoming’s involuntary pooling procedure under Wyo. Stat. Ann. § 30-5-109 in four ways by: (1) limiting the time period that any issued pooling order is effective under certain circumstances; (2) providing for a royalty interest to be paid to non-consenting unleased mineral owners; (3) reducing the risk-penalty applicable to unleased non-consenting owners; and (4) allowing a non-consenting mineral owner to elect to participate as a working interest owner under the order upon payout of the applicable risk-penalty.

1. Expiration of Issued Pooling Orders – House Bill 14 amends Wyo. Stat. Ann. § 30-5-109 by adding a new subsection (f) that provides that “[a] pooling order issued under this subsection shall expire twelve (12) months after issuance if the person authorized to drill and operate a well fails to commence operations within twelve (12) months of issuance of the pooling order.” Under this new provision, any pooling order issued by the Wyoming Oil and Gas Conservation Commission (“WOGCC”) will expire one year after being issued if an oil and gas operator fails to commence operations to drill a well within the pooled unit. This addition encourages oil and gas operators to commence operations within a pooled unit in a timely manner.

2. Royalty Interest for Unleased Owners During Penalty Period – House Bill 14 amends Wyo. Stat. Ann. § 30-5-109 by adding a new subsection (h) that provides that while the operator is recovering its costs to drill the well(s), the unleased, non-consenting mineral owner will be entitled to a cost-free royalty interest that is equal to the greater of (i) 16% or (ii) the acreage weighted average royalty interest of the leased tracts within the drilling unit. Previously, unleased mineral interest owners who were forced pooled did not receive any royalty interest while the operator was recovering its costs and expenses of drilling and completing a well.

3. Penalty Calculations for Leased versus Unleased Mineral Owners – House Bill 14 amends Wyo. Stat. Ann. § 30-5-109 by adding a new subsection (g)(ii) that reduces the risk penalty for unleased non-consenting mineral owners. Prior to House Bill 14 being enacted, Wyo. Stat. Ann. § 30-5-109 subjected all non-consenting parties to a risk penalty of up to 300%. The amended statute reduces the amount of risk penalty imposed on non-consenting mineral owners who are not subject to a lease or other contract for oil and gas development as follows: (i) for the first well drilled under a pooling order a 200% risk penalty, and (ii) for each subsequent well drilled under the pooling order a 150% risk penalty.

4. Election to Become a Working Interest Owner – House Bill 14 amends Wyo. Stat. Ann. § 30-5-109 by adding a new subsection (j) that, after payout of the applicable risk penalty, allows a non-consenting mineral interest owner who initially chooses to receive a royalty interest to elect to participate under the pooling order as a working interest owner. Within 30 days after recovering its costs and expenses of drilling, the operator is required to send notice to the non-consenting mineral owner offering the owner the opportunity to elect to either i) participate as a working interest owner under the order, or ii) continue to receive the royalty interest outlined above. If the non-consenting owner elects to become a working interest owner under the order, then that party’s share of costs and expenses would be deducted from its share of revenue and the balance paid to the non-consenting owner.

For more information on these changes or House Bill 14 generally, please contact Greg Danielson or Jessica Fredrickson.

On April 10, 2020, the U.S. Environmental Protection Agency (“EPA”) issued its Interim Guidance on Site Field Work Decisions Due to Impacts of COVID-19 (COVID-19 Field Work Guidance), which addresses decision-making related to continuing, pausing, or reducing ongoing field work activities at EPA-led cleanup sites during the COVID-19 (novel coronavirus) pandemic. This guidance applies, but is not limited to, cleanups being conducted under the Superfund (or Comprehensive Environmental Response, Compensation, and Liability Act) program; the Resource Conservation and Recovery Act (RCRA) corrective action; Toxic Substances Control Act (TSCA) PCB cleanup provisions; the Oil Pollution Act; and the Underground Storage Tank (UST) program.

In sum, the new guidance states that EPA will make decisions to suspend or delay cleanup site field work on a case-by-case basis, an approach that balances EPA’s priorities to protect public health and safety during the COVID-19 pandemic while maintaining the agency’s ability to prevent and respond to environmental emergencies and imminent threats posed by these sites. The guidance also explains that decisions to continue, reduce, or pause on-site field work will be made in accordance with relevant provisions of any existing agreements or enforcement instruments that normally govern unforeseen events warranting delays in complying with performance obligations (e.g., modification of schedules, force majeure). Finally, the guidance encourages EPA staff to use this time as an opportunity to make progress on non-field work tasks that can be done virtually, such as settlement negotiations with potentially responsible parties (PRPs) and drafting cleanup decision documents and site progress reports.

EPA’s press release accompanying the guidance recommends that “Superfund site teams cancel or postpone in-person public meeting events, door-to-door visits, and other site-related face-to-face interactions to be consistent with” COVID-19 related guidance issued by the CDC and other federal and state officials. EPA stated that it has already “reduced or paused on-site construction work at approximately 34 EPA or PRP-led Superfund National Priority List sites, or 12% of all EPA sites with ongoing remedial actions, due to the evolving situation with COVID-19.” A more detailed description of the guidance, as well as other relevant considerations, is included below.

The COVID-19 Field Work Guidance follows a similar guidance document that EPA released on March 29, 2020, describing its enforcement discretion policy under other environmental statutes (e.g., the Clean Air Act and Clean Water Act) as a result of the ongoing pandemic. The COVID-19 Field Work Guidance also supplements the Office of Land and Emergency Management Considerations and Posture for COVID-19 Pandemic document dated March 19, 2020, and provides additional criteria to be considered for Emergency Response, Superfund Removal/Remedial/Federal Facilities, RCRA Corrective Action, and leaking underground storage tank (LUST) cleanups when determining whether site field work should begin, continue, or be suspended. With the issuance of the COVID-19 Field Work Guidance, EPA now has put in place temporary pandemic policies for all of the agency’s environmental regulatory programs.

General Guidance & Factors to Consider for Site Field Work Decisions

The new guidance is consistent with common-sense based approaches that have already been made at a number of cleanup sites by EPA and state-equivalent agencies due to coronavirus concerns. Case-by-case decisions on whether to continue, reduce, or pause field work will either be made unilaterally by EPA Regional offices or in response to “requests from outside parties (e.g., states, tribes, local governments, other federal agencies, potentially responsible parties, property owners, etc.) for extensions or delays in performance.” Such decisions to modify or suspend work activities will be considered for all phases of response activities: “pre-construction, construction, and post-construction.” And although the guidance directly applies to EPA-led sites only, EPA suggests that the regions share the guidance with their state counterparts, as similar issues and decision-making will occur at state-led sites.

In making decisions, EPA regions are encouraged to consider whether federal, state, tribal, or local health declarations (e.g., shelter-in-place orders) are in effect, in addition to “the safety and availability of work crews, EPA, state or tribal staff; the critical nature of the work; logistical challenges (e.g., transportation, lodging, availability of meals, etc.); and other factors particular to a site.”

The COVID-19 Field Work Guidance lists the following “site-specific factors” that should be part of EPA’s decision regarding whether response actions will begin, continue, or be reduced, paused, or resumed:

• State, tribal, or local health officials have requested particular site operations or types of operations that would pertain to particular sites be suspended.
• Site workers have tested positive for or exhibited symptoms of COVID-19.
• Sites where there may be close interaction with high-risk groups or those under quarantine, such as work inside homes.
• Sites where contractor field personnel are not able to work due to state, tribal, or local travel restrictions or medical quarantine.
• Sites where social distancing is not possible.

The guidance also includes a non-exhaustive list of factors EPA will consider in making these decisions. The list includes:

• Whether failure to continue response actions would likely pose an imminent and substantial endangerment to human health or the environment, and whether it is practical to continue such actions. This may be, but is not limited to, the following types of sites or site activities:
  • Superfund and oil spill emergency responses, CERCLA time critical removal actions, and other sites with ongoing or a threat of imminent acute or direct human exposures that would compromise public health (e.g., where EPA or PRP supplies alternative drinking water supplies).
  • Sites where prevention of exposures that pose an imminent threat to public health and welfare and the environment, such as response actions to prevent a catastrophic event (e.g., mine blow outs), preventing contaminated groundwater plume expansion that may affect drinking water sources, preventing releases to waterbodies that are likely to have adverse effects on downstream communities (e.g., treatment of acid mine drainage); on-site security or activities necessary to prevent unauthorized access to sites; and disposal of materials off-site (e.g., mine waste).
• Whether maintaining any response actions would lead to a reduction in human health risk/exposure within the ensuing six months (e.g., residential site work with current exposures to residents or active remediation, such as operating water treatment facilities, are prioritized and are more likely to continue utilizing procedures to protect both the public and site workers).
• Whether activities that would not provide near-term reduction in human health risk could be delayed, suspended, or rescheduled to a future date. This may include things like periodic monitoring, routine sampling activities, field sampling for remedial investigation/feasibility study (RI/FS) work, and active remediation of otherwise stable conditions.

Existing Agreements & Enforcement Instruments Will Govern Requests & Decisions to Delay Performance Obligations

EPA cautions that decisions to extend or pause work obligations because of COVID-19 “do not operate to supersede or amend [existing] enforcement instruments.” Rather, case-by-case decisions to extend or pause work obligations will be made in accordance with the terms of applicable enforcement instruments. Such enforcement instruments often contain provisions allowing for adjustments to schedules to be made at the discretion of EPA’s project manager and/or “force majeure” provisions. The guidance advises PRPs to consult these instruments “for directions on providing the requisite notice and other information described in the provisions” related to a requested extension, delay, or suspension.

The force majeure provisions of these cleanup agreements, which are most typically invoked for events like natural disasters (e.g., wildfires, floods, or hurricanes) and work strikes, often require the settling party to notify EPA of an unforeseen circumstance out of its control that may result in a delay of its performance obligations. The settling party’s notification generally must detail what work will be delayed and the duration of the delay, as well as identify what measures the party has taken to avoid or minimize the delay. For COVID-19, there is inherent uncertainty as to when routine activities will resume. Thus, “EPA intends to be flexible regarding the timing of the notices” and “to make these determinations promptly.”

Opportunity to Focus Efforts on Non-Field Site Work

EPA suggests that, to the extent project teams can coordinate remotely during this time, this work should continue along with virtual agency communications via online teleconference, webinars, etc. Activities unrelated to field work and contact with the public are expected to continue. For example, EPA suggests this situation presents an opportunity to make progress on activities like negotiations between the parties on settlement agreements and administrative orders; drafting cleanup decision documents, workplans, and progress reports; and maintaining compliance with obligations such as financial assurance.

Next Steps When Site Work Is Paused

The process for getting cleanup work back on schedule post-pandemic is less fleshed out in the COVID-19 Field Work Guidance. It says that “[i]f a decision is made to temporarily reduce or suspend field work, Regions will continue to monitor site conditions and plan the logistics for resuming field work as soon as possible when appropriate.” EPA does, however, note that it will update this guidance as the COVID-19 situation evolves.

Davis Graham attorneys are looking at the COVID-19 Field Work Guidance—as well as related federal, state, and local guidance documents and directives—carefully and will continue to closely monitor this evolving situation in coordination with EPA project managers and others as the agency updates its COVID-19-related guidance documents and makes site-specific decisions related to this issue. Although the COVID-19 Field Work Guidance and related guidance documents should offer some comfort to PRPs that certain non-essential field work requirements will be relaxed during this time, parties should strive to satisfy all other existing obligations and do what they can to protect their employees and contractors, the public, and the environment.

If you have any questions regarding the EPA’s interim guidance documents or how it may affect a particular cleanup site or your business, please contact Mave Gasaway or Lucas Satterlee.

The Paycheck Protection Program (PPP) established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) makes available up to $349 billion in potentially forgivable loans to small businesses to assist those businesses in paying payroll costs and certain other expenses. We previously circulated a legal alert that outlines the terms and conditions of the PPP.

The Small Business Administration (SBA) has recently published a document providing answers to frequently asked questions relating to the PPP. The SBA intends to update the document on a regular basis. Below we highlight some of the guidance provided therein as of the date of this legal alert.

Eligible Borrowers:

Businesses eligible to receive PPP funds include the following, to the extent operating on February 15, 2020:

• Small businesses, nonprofits, veterans organizations, and tribal business concerns:
  • with 500 or fewer employees whose principal place of residence is in the U.S.;
  • with more than 500 employees if the business meets an applicable employee-based size standard established by the SBA for the primary industry in which the business operates; or
  • in the hotel and food services industries, which fall under NAICS code 72, with 500 or fewer employees per physical location;
• Sole proprietors, self-employed individuals, and independent contractors; and
• Businesses that qualify as “small business concerns” under the Small Business Act

The size standard that must be met for a business to qualify as a “small business concern” is either the employee-based or revenue-based size standard established by the SBA for the primary industry in which the business operates or the SBA’s alternative size standard as of March 27, 2020. The alternative size standard requires that both (1) the maximum tangible net worth of the business be not more than $15 million and (2) the average net income after Federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the loan application be not more than $5 million.

Aggregation with Affiliates:

It is the applicant’s responsibility to apply the SBA’s affiliation rules (summarized by the SBA here) to determine all of its affiliates, as well as the aggregate employee headcount of the applicant and its affiliates, before submitting a PPP loan application.

Breaking Affiliation with a Minority Owner:

Under the SBA’s affiliation rules, a minority owner of an entity is deemed to be an affiliate of that entity if the minority owner can prevent a quorum or otherwise block action by the entity’s board of directors/managers or by the entity’s owners. However, the SBA has made clear that if the minority owner irrevocably gives up those rights, it will no longer be deemed an affiliate of the entity for purposes of the PPP (assuming no other relationship creates affiliation under the SBA’s affiliation rules).

Use of a Payroll Provider:

Employees of an eligible borrower that uses a Professional Employer Organization or other payroll provider will not be considered employees of the payroll provider. In connection with its PPP loan application, an applicant may provide a lender with payroll documentation prepared by the applicant’s payroll provider indicating wages and payroll taxes that such payroll provider reported to the IRS with respect to the applicant’s employees.

Certain Exclusions from “Payroll Costs”:

$100,000 per Employee Limit: The definition of “payroll costs” under Section 1102 of the CARES Act excludes the compensation of an individual employee in excess of an annual salary of $100,000. The SBA has clarified that this exclusion applies only to cash compensation and not to non-cash benefits.

Federal Payroll and Income Taxes: Payroll costs do not include the employer’s share of federal payroll taxes. Payroll costs do include, and should not be reduced by, an employee’s share of federal payroll taxes and any income taxes required to be withheld from an employee.

Amounts Paid to Independent Contractors: Any amounts paid by an applicant to an independent contractor or sole proprietor should be excluded from the applicant’s calculated payroll costs. Independent contractors and sole proprietors may be eligible to apply for their own PPP loans.

Time Period for Determining Average Payroll Costs and Number of Employees:

To calculate their maximum loan amounts, applicants may use payroll cost data either from the previous 12 months or from the 2019 calendar year. Seasonal businesses may instead refer to the period from either February 15 or March 1, 2019 to June 30, 2019, and new businesses may instead refer to the period from January 1, 2020 to February 29, 2020.

The same time periods may be used to calculate the average number of employees of an applicant and its affiliates, to determine whether the applicant is eligible for a PPP loan based on number of employees. Alternatively, an applicant may use the average number of employees per pay period for the most recent 12 completed calendar months prior to the date of the loan application, or for each pay period during which the applicant was in operation in the case of new businesses.

Time Period for Determining Loan Forgiveness:

The amount eligible for loan forgiveness will be determined based on a borrower’s eligible costs over the eight-week period beginning on the date the loan is funded.

Date of First Disbursement of a Loan:

A lender is required to make the first disbursement of a loan no later than ten days after the date of loan approval.

Authorization to Sign Application and Make Certifications Therein:

A single authorized representative of an applicant may sign the PPP loan application on behalf of the applicant. However, by doing so, this person is representing to the lender and the U.S. government that he or she is authorized to make the certifications set forth in the application, with respect to both the applicant and each owner of 20% or more of the applicant’s equity.

Loan Documentation:

The SBA has provided a standard form promissory note that may be used by lenders in connection with PPP loans. Alternatively, lenders may use their own promissory notes.

Effect of Updated Guidance:

No action need be taken by an applicant or lender based on updated guidance from the SBA after the submission of the applicant’s PPP loan application. However, an applicant may revise its loan application if the loan has not yet been received, in order to reflect updated guidance from the SBA.

If you have any questions regarding the above or the Paycheck Protection Program generally, please reach out to Jeff Brandel or Lauren Roberts.

On April 2, 2020, the U.S. Small Business Administration (SBA) issued an interim final rule regarding its implementation of the Paycheck Protection Program (PPP) contained in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed into law on March 27, 2020. The PPP makes available up to $349 billion in potentially forgivable loans to small businesses to assist those businesses in paying certain expenses, including payroll costs. On April 3, 2020, the SBA issued an additional interim final rule addressing the affiliation rules applicable to the PPP.

Small businesses, nonprofits, and sole proprietorships are currently able to apply for and receive loans through SBA qualified lenders. Independent contractors and self-employed individuals can begin to apply for and receive loans, beginning on April 10, 2020, through SBA qualified lenders.

The PPP program is open until June 30, 2020, or until funds made available for the program are exhausted. Due to the limited availability of funds, eligible businesses and individuals that desire to take advantage of the program should apply as quickly as possible. The interim final rule issued on April 2, 2020 describes the availability of the loans as “first-come, first-served.”

Eligible Borrowers:

Eligible borrowers include the following, to the extent operating on February 15, 2020:

• Small businesses, nonprofits, veterans organizations, and tribal business concerns:
  • with 500 or fewer employees whose principal place of residence is in the U.S.;
  • with more than 500 employees if the business meets an applicable employee-based size standard established by the SBA for the industry in which the business operates; or
  • in the hotel and food services industries, which fall under NAICS code 72, with 500 or fewer employees per physical location; and
• Sole proprietors, self-employed individuals, and independent contractors.

Generally, in determining the number of employees of an applicant, all employees of the applicant’s affiliates will be counted. Stock ownership, control rights, common management, and identity of interests are among the factors taken into account to determine whether persons are affiliates under applicable SBA rules. However, the SBA’s affiliation standards are waived for small businesses that:

• are in the hotel and food services industries, which fall under NAICS code 72, and have 500 or fewer employees;
• are franchises in the SBA’s Franchise Directory; or
• receive financial assistance from small business investment companies licensed by the SBA.

The SBA has published a summary of the affiliation rules applicable to PPP loans, which is available here.

How to Apply:

Borrowers must apply for a PPP loan through an existing SBA lender or through any participating federally insured depository institution, federally insured credit union, Farm Credit System institution, or depository or non-depository financing provider approved by the SBA. Interested businesses and individuals should consult their existing lender or bank as to whether it is participating. Visit www.sba.gov for a list of qualified SBA lenders.

Applicants must complete the PPP loan application, which is available here on the SBA website, and submit the application with the required documentation to an approved lender that is available to process their application by June 30, 2020.

Applicants will need to provide lenders with:

1. payroll and tax documentation;
2. a list of the applicant’s owners with a greater than 20% ownership stake;
3. if the applicant or any owner is an owner of any other business or has common management with any other business, a list of such other businesses and a description of the relationship; and
4. details of any SBA Economic Injury Disaster Loan received by the applicant between January 31, 2020 and April 3, 2020.

Any Economic Injury Disaster Loan received by an applicant between January 31, 2020 and April 3, 2020 that was not used for payroll costs will not affect the applicant’s eligibility for a PPP loan. If an applicant received an SBA Economic Injury Disaster Loan between January 31, 2020 and April 3, 2020 that was used for payroll costs, the applicant’s PPP loan must be used to refinance the Economic Injury Disaster Loan.

An eligible borrower may not receive more than one PPP loan.

Certain Terms of the Loans:

• Loans will be made by qualified lenders, not directly by the SBA.
• Loans carry a 1.0% fixed rate.
• Loans have a two-year term and may be prepaid without penalty.
• No collateral is required.
• No personal guarantee is required.
• Loan payments will be deferred for six months.
• No requirement that applicants try to obtain some or all of the loan funds from other sources.

Amount Available to Be Borrowed:

Applicants can borrow up to 2.5 times their average monthly defined payroll costs (which exclude compensation in excess of $100,000 on an annualized basis for each employee) for the applicable period (in most cases, the last year) plus the amount of any SBA Economic Injury Disaster Loan received after January 31, 2020 and refinanced under the PPP, subject to a $10 million cap.

Permitted Use of Proceeds:

Loan proceeds may be used to pay:

• The following payroll and benefit costs for employees whose principal place of residence is in the U.S.:
  • Certain salary, wages, commissions, or tips, except any compensation paid to an employee in excess of an annual salary of $100,000;
  • Employee benefits, including costs for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payments required for the provision of group health care benefits including insurance premiums; and payment of any retirement benefit; and
  • State and local taxes assessed on compensation;
• For a sole proprietor or independent contractor: wages, commissions, income, or net earnings from self-employment, capped at $100,000 on an annualized basis; and
• Interest payments on mortgage obligations, rent payments, utility payments, and interest payments on any other debt obligation incurred before February 15, 2020.

Loan proceeds may also be used to refinance an SBA Economic Injury Disaster Loan received between January 31, 2020 and April 3, 2020.

In any event, at least 75% of the PPP loan proceeds must be used to cover payroll costs.

Loan Forgiveness:

Loan amounts may be forgiven to the extent that:

• The loan proceeds are used, over the eight weeks after receiving the loan, to cover certain payroll costs (which exclude compensation in excess of $100,000 on an annualized basis for each employee or independent contractor), interest on mortgage obligations that existed before February 15, 2020 (but not payments of principal), rent under lease agreements that were in force before February 15, 2020, and utility costs for services that began before February 15, 2020;
• Employee and compensation levels are maintained; and
• Not more than 25% of the forgiven amount is for non-payroll costs.

Borrowers can submit a request for forgiveness to the lender that is servicing the loan. The request must include documents that verify the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease, and utility obligations. Borrowers must certify that the documents are true and that the forgiveness amount was used to keep employees and make eligible mortgage interest, rent, and utility payments. The lender must make a decision on the forgiveness within 60 days. The interim final rule issued on April 2, 2020 states that the SBA will issue additional guidance on loan forgiveness.

Borrowers must repay any amount not forgiven in accordance with the terms of the loan.

Reduction of Loan Forgiveness:

Loan forgiveness will be reduced if:

• Full-time equivalent employee headcount is decreased; or
• Salaries and wages are decreased by more than 25% for any employee who made less than $100,000 annualized in 2019.

Re-Hiring:

To avoid a potential reduction of the amount forgiven, borrowers have until June 30, 2020 to restore employment and salary levels for any changes made between February 15, 2020 and April 26, 2020.

Required Certifications in the Application:

The application for a PPP loan requires the applicant, or the authorized representative submitting an application on behalf of the applicant, to certify to a number of statements, including the following:

• The applicant is eligible to receive a loan under the rules in effect at the time the application is submitted that have been issued by the SBA implementing the PPP (the Rules).
• The applicant (1) is an independent contractor, eligible self-employed individual, or sole proprietor, or (2) employs no more than the greater of 500 employees or, if applicable, the size standard in number of employees established by the SBA in 13 C.F.R. 121.201 for the applicant’s industry.
• To the extent feasible, I will purchase only U.S.-made equipment and products.
• The applicant is not engaged in any activity that is illegal under federal, state, or local law.
• Any SBA Economic Injury Disaster Loan received by the applicant between January 31, 2020 and April 3, 2020 was for a purpose other than paying payroll costs and other allowable uses loans under the Rules.
• Applicants that are individuals authorize the SBA to request criminal record information about them.
• Current economic uncertainty makes the loan necessary to support the applicant’s ongoing operations.
• Funds will be used to retain workers and maintain payroll or to make mortgage, lease, and utility payments; and I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable, such as for charges of fraud.
• Loan forgiveness will be provided for the sum of documented payroll costs, covered mortgage interest payments, covered rent payments and covered utilities, and not more than 25% of the forgiven amount may be for non-payroll costs.
• During the period beginning on February 15, 2020, and ending on December 31, 2020, the applicant has not and will not receive another loan under this program.
• The information provided in the application and supporting documents and forms is true and accurate in all material respects.
• Acknowledgment that the lender will calculate the eligible loan amount using required documents submitted.

If you have any questions, please contact Jeff Brandel or Lauren Roberts.

A reality of the COVID-19 pandemic is that many businesses are facing unexpected difficulties complying with their contracts. Do pandemics such as the spread of COVID-19 excuse parties from their contractual obligations? The answer is maybe, via a force majeure clause in the parties’ contract.

“Force majeure”—French for “superior force”—refers to an unexpected and uncontrollable event or effect that prevents one from honoring a contract. The term can include acts of nature, such as floods and hurricanes, and acts of people, such as strikes and wars,[1]
but does not generally include mere economic hardship.[2] For example, a force majeure provision might state:

No party shall be liable or responsible to the other party, nor be deemed to have defaulted under or breached this Contract, for any failure or delay in fulfilling or performing any term of this Contract, when and to the extent such failure or delay is caused by or results from acts beyond the impacted party’s reasonable control, including, without limitation, the following force majeure events: (a) acts of God; (b) flood, fire, earthquake, or pandemic; (c) war, terrorist threats or acts, riot, or other civil unrest; (d) government order or law; (e) actions, embargoes, or blockades in effect on or after the date of this Contract; (f) action by any governmental authority; (g) national or regional emergency; (h) strikes, labor stoppages or slowdowns, or other industrial disturbances; (i) shortage of adequate power or transportation facilities; and (j) other similar events beyond the reasonable control of the impacted party.

Ultimately, the types of events that constitute force majeure depend on the contract’s specific language.[3]
To illustrate, in Gillespie v. Simpson, the Colorado Court of Appeals accepted a geothermal lessee’s argument that the government’s refusal to issue permits for the development of geothermal wells until certain regulatory actions occurred constituted a force majeure event, excusing the lessee from paying rent to the lessor. This was the case even though the lessee was actually able to pay rent—and did so—during the duration of the force majeure event. The contract defined force majeure as any action by the state that interferes with the lessee’s rights. The court reasoned that the interference was “obvious in that the lessee [wa]s deprived of an opportunity to generate income by development of the [wells] for payment of the rentals. Accordingly, it held that the lessee was entitled to a rent credit equal to the amount of rent paid during the force majeure event.[4]

One aspect that is not always clear from the language of the force majeure provision is the extent to which a party must be rendered unable to perform due to the force majeure. In Ergon-W. Virginia, Inc. v. Dynegy Marketing and Trade, the Fifth Circuit analyzed a natural gas clearinghouse’s claim that recent hurricanes constituted a force majeure preventing the clearinghouse from fulfilling its contractual obligation to supply plant managers with gas.[5]
In doing so, the Fifth Circuit rejected the plant managers’ argument that the clearinghouse’s “physical capacity to continue supplying gas” and ability to “purchase gas on the spot market” prevented it from invoking the force majeure clause, which required that parties be “rendered unable” to perform.[6] A contrary interpretation, the Fifth Circuit reasoned, “would make the force majeure provisions essentially meaningless because it would mean that a seller could never invoke force majeure so long as there was some gas available anywhere in the world, at any price.”[7]

In a similar vein, jurisdictions are split regarding how to construe the scope of force majeure clauses in “take-or-pay” contracts—contracts requiring a buyer to take specified amounts of product or pay the seller a penalty. Some jurisdictions have explicitly or implicitly concluded that a force majeure excusing the buyer’s obligation to “take” also excuses the buyer’s obligation to “pay.”[8]
This is so even though the force majeure does not make it impossible for the buyer to pay the penalty.[9]
Other jurisdictions—including the Tenth Circuit—have concluded that a force majeure clause excusing the buyer from taking the product will not excuse the buyer from paying the penalty.[10]

All this is to say that parties should examine their existing contracts and consult with in-house or outside counsel to see if those contracts include a force majeure clause that may cover coronavirus—especially if the pandemic is impacting the parties’ contractual obligations. Parties should pay attention to any requirements that the party provide evidence of impacts or information, along with a notice that the party is invoking the force majeure clause, or that the party mitigate damages incurred as a result of the force majeure event. Going forward, parties should consider insisting that their contracts include epidemic or pandemic as a force majeure event in case performance becomes impossible due to COVID-19. Parties struggling to honor their contractual obligations might also consider a mutual solution, such as negotiating a contractual amendment to move performance to a time after the health crisis has passed.

Davis Graham & Stubbs LLP’s attorneys have experience litigating commercial contracts containing force majeure clauses. Please contact Shannon Stevenson or Gabrielle Robbie if you have further questions on this topic.

[1] Black’s Law Dictionary, “FORCE MAJEURE” (11th ed. 2019).

[2] 30 Williston on Contracts § 77:31 (4th ed.).

[3] Id.

[4] 588 P.2d 890, 892 (Colo. 1978).

[5] 706 F.3d 419, 422 (5th Cir. 2013).

[6] Id. at 424 n.5.

[7] Id.

[8] See, e.g., Atlantic Richfield Co. v. ANR Pipeline Co., 768 S.W.2d 777, 781–82 (Tex. App. 1989); Sabine Corp. v. ONG Western, Inc., 725 F. Supp. 1157, 1169–70 (W.D. Okla. 1989).

[9] Sabine Corp., 725 F. Supp. at 1170 (reasoning that if the force majeure clause did not excuse the obligation to pay, the intended effect of such clause—to excuse performance under the contract due to unforeseen events—would be rendered “nugatory”).

[10] Int’l Minerals & Chem. Corp. v. Llano, Inc., 770 F.2d 879, 885 (10th Cir. 1985) (“It is settled law that when a promisor can perform a contract in either of two alternative ways, the impracticability of one alternative does not excuse the promisor if performance by means of the other alternative is still practicable. [The contract] does not compel a different result; it would at most excuse [the buyer] from its duty to ‘take,’ not from its duty to ‘pay.’”); see also Am. Soil Processing Inc. v. Iowa Comprehensive Petroleum Underground Storage Tank Fund Bd., 586 N.W.2d 325, 333, 334 (Iowa 1998) (concluding that a force majeure provision is inconsistent with the risk allocation provisions typical in a take-or-pay contract).

The oil and gas markets have suffered historically low prices in recent weeks. On March 30, 2020, the price of West Texas Intermediate crude oil closed at $20.09 per barrel, the lowest since February 2002. And in the last six months, the price of Henry Hub gas has fallen by more than 30 percent, and more than 40 percent since its recent peak on November 5, 2019 at $2.89 per MMBtu.

For many operators, these prices are economically prohibitive—it may make more business sense to shut-in a well or look for other relief until the pricing environment improves. But operators should proceed with caution when considering such measures, as their legal viability will depend on the jurisdiction, the specific lease language, and the relevant factual circumstances.

Whether a lease will permit a lessee to shut-in all of the wells located on the lands covered by the lease, or pooled therewith, because of depressed market conditions, yet maintain the lease in effect by paying shut-in royalties, will depend upon the particular language of the lease’s shut-in royalty clause. There is no industry standard shut-in royalty clause, and the language of these clauses widely varies.

As a gating question, operators will need to consider whether the well is capable of producing in paying quantities. Even where the shut-in royalty clause is silent about production in paying quantities, most courts will imply a requirement that the well be capable of “producing in paying quantities” at the time of shut-in for an operator to invoke the shut-in royalty clause. “Paying quantities” is generally understood to mean a profit in excess of certain operating expenses, however, the costs to be included in the calculation of operating expenses and the length of time over which “production in paying quantities” is to be measured, are fact intensive and vary by state. Note also that in the absence of express lease language, a strict application of this principle may prevent a lessee from invoking the shut-in royalty clause where a well has been drilled but not yet completed, or a recently completed well has increasing—but not yet profitable—production.[1] While this may seem like a logical requirement, the states are divided on this question: some equate “production” with actual production and sales, while others hold the term to mean “capable
of producing in paying quantities” and do not require sales of the product.[2]

A second threshold consideration is determining whether the shut-in royalty clause has a triggering event. Certain shut-in royalty clauses provide for a payment of shut-in royalties while there is a gas well on the premise, “but gas is not being sold or used,” other clauses have a more specific reference to the reason for shutting-in the well. These can include, among other things, lack of market, force majeure, executive orders, or government restrictions.

Take, for example, a shut-in royalty clause that allows a shut-in “if . . . oil or gas be discovered on said land which cannot be profitably produced for lack of a market at the well or wells.” The term “lack of a market” could be interpreted as lack of an acceptable or economically rational market.[3] Historically, an available gas market was often limited to only a single potential purchaser. Today, in many basins, it is more common to see multiple purchasers, including even multiple midstream providers. Thus, depending on the specific lease language and the particular geographic market, an operator who decides to shut-in a well because of low commodity prices may find it more difficult to argue that no market exists.

Even for shut-in royalty clauses that do not include a “lack of market” provision, some courts may still require the lessee to prove that no market exists. Where a lessee claimed “it would not be able to recover its costs of repair” given the limited and depressed market, the Kansas Supreme Court found that even a “limited” and uneconomical market did not allow the lessee to invoke the shut-in royalty clauses.[4]

Continued payment of shut-in royalties that allow for a well to be shut-in for a lack of market by a force majeure, or another triggering event such as a government issued order, may be a viable way to keep the lease alive until a market becomes available.[5]

The shut-in royalty clause may also contain certain limitations to which the lessee must adhere. For example, many leases limit the applicability of the shut-in royalty clause to wells producing only gas, and therefore wells producing oil or a combination of both oil and gas may not qualify. There is no clear authority on what constitutes a “gas well” or an “oil well,” thus reference to state specific statutory or regulatory provisions is necessary. In addition, the shut-in royalty clause in a lease of more recent vintage may expressly limit the length of time that the lease may be extended solely by virtue of the shut-in royalty clause. If so, at the end of the specified time period, the well must be returned to production or the lease must be maintained in effect by some means other than the shut-in royalty clause.

Even separate from a shut-in royalty clause, a lease may offer other options to cease production without resulting in termination of the lease. Some leases may have a “price trigger,” such as a clause that states that if, in the event oil or gas prices fall below a certain threshold, a lessee may be excused from continuing unprofitable production. Such clauses are conceptually related to the common law defense of commercial impracticability to nonperformance of a contract: because of factors outside of the control of the lessee, it is no longer practicable to produce under the circumstances. Some leases may also provide for alternative “triggering” events, such as force majeure, that allow for a lessee to extend the term of a lease. A lessee should make a careful examination of these clauses, as well as the law of the governing jurisdiction. For a more detailed analysis of force majeure and impracticality, see this recent Davis Graham Legal Alert.

Davis Graham attorneys are applying their best-in-market energy expertise to counsel clients through these issues, as they have in previous downturns in oil and gas pricing.

Please contact a Davis Graham partner if we can assist you in any way.

[1] See, e.g., Rogers v. Osborn, 261 S.W.2d 311 (1953).

[2] Compare Freeman v. Magnolia Petroleum Co., 171 S.W.2d 339 (Tex. 1943), with Pack v. Santa Fe Minerals, 869 P.2d 323 (Okla. 1994).

[3] Martin & Kramer, 3 Williams & Meyers Oil and Gas Law, § 632.4.

[4] Tucker v. Hugoton Energy Corp., 855 P.2d 929, 936 (Kan. 1993).

[5] McDowell v. PG&E Res. Co., 658 So.2d 779 (La. App. 1995).

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The enactment of the CARES Act is the latest action taken by the U.S. Government to assist individuals, families, and businesses impacted by the COVID-19 pandemic and the damage it has inflicted on the U.S. economy. This Davis Graham Legal Alert summarizes the key business-related tax provisions contained in the CARES Act and other COVID-19 legislation, as well as the tax implications of actions taken by the President and the Internal Revenue Service (“IRS”) in response to the COVID-19 pandemic.

As discussed in more detail below, the key business-related tax developments are:

• CARES Act:
  • For taxable years beginning before January 1, 2021, net operating loss carryovers (“NOLs”) are no longer subject to an 80% taxable income limitation, and NOLs from 2018, 2019, or 2020 can be carried back five years;
  • For taxable years beginning in 2019 or 2020, the interest expense limitation in Code section 163(j) is increased from 30% to 50% of adjusted taxable income, and taxpayers can use 2019’s adjusted taxable income for purposes of the 2020 calculation;
  • The forgiveness of loans under the “Paycheck Protection Program” will not create cancellation of indebtedness income;
  • Excess business loss limitations for individual taxpayers have been eliminated for 2018, 2019 and 2020;
  • Corporate AMT credits are 100% refundable as of 2019;
  • The creation of an employee retention credit of up to $10,000 per employee (subject to certain limitations);
  • The deferral of employer payroll taxes due for the rest of 2020 (50% due at the end of 2021 and the other 50% due at the end of 2022); and
  • Corrected the so-called “retail glitch” so that businesses may immediately deduct amounts spent on certain improvements to property.

• Families First Act: Certain amounts paid as wages under the emergency expansion of the Family Medical Leave Act and Paid Sick Leave Act are available as refundable payroll tax credits.

• National Emergency Declaration: Allows employers to make payments to employees to reimburse expenses related to COVID-19 that are tax free to the employee and fully deductible by the employer.

• Notice 2020-18:
  Delayed tax filing and payment deadlines from April 15 to July 15.

CARES Act

Net Operating Losses

Under the Tax Cuts and Jobs Act of 2017 (“TCJA”), NOLs generated after 2017 generally could only be carried forward to future years and could not be carried back to previous years. Additionally, such NOLs could only be used to offset 80% of a taxpayer’s otherwise taxable income. Under the CARES Act, NOLs that arise in 2018, 2019, or 2020 can now be carried back up to 5 years, and the 80% limitation will not apply for all tax years that begin before January 1, 2021.

These changes will allow businesses to obtain immediate and critical cash flow by utilizing NOLs resulting from the current COVID-19 crisis (or the preceding two years) by filing amended tax returns for prior years to obtain refunds. In addition, these changes allow a corporation to carryback NOLs to years in which the corporate tax rate was 35%, increasing the value of such NOLs.

Limitation of Business Interest

Section 163(j) of the Code limits the ability of certain taxpayers to deduct business interest in a given taxable year. Prior to the CARES Act, the limitation for a taxable year was generally equal to the sum of (i) the business interest income of the taxpayer, and (ii) 30% of the adjusted taxable income of the taxpayer. Under the CARES Act, the calculation of the business interest deduction limitation for tax years beginning in 2019 and 2020 now includes 50% (rather than 30%) of the taxpayer’s adjusted taxable income.

For 2020, any taxpayer can elect to utilize its 2019 adjusted taxable income rather than its 2020 adjusted taxable income in calculating its 2020 business interest deduction limitation, increasing the deductible business interest expense for taxpayers with higher adjusted taxable income in 2019 than in 2020.

Paycheck Protection Program Loans with Loan Forgiveness

The Small Business Administration is to provide $349 billion in loans to eligible recipients including small businesses, self-employed individuals, and nonprofits. The loan proceeds may be used for payroll, rent, mortgage payments, and utility costs. To the extent such funds are so used within the 8-week period beginning on the date the loan is originated, such amounts may be forgiven without the recognition of cancellation of indebtedness income. The amount forgiven is determined by reference to the number of employees retained (without significant reduction in salary or wages).

Excess Business Loss Limitation

TCJA capped the amount of “net business losses” that an individual could take against other sources of income at $250,000 for single filers ($500,000 if married filing jointly). Any excess business losses were converted to net operating losses, subject to additional limitations. The CARES Act eliminates the excess business loss limitation for 2018, 2019 and 2020.

Refundable AMT Credits

While TCJA eliminated the alternative minimum tax (“AMT”) for corporations, corporations that were previously subject to the AMT received refundable credits. Fifty percent of any available credits not used for each of the tax years 2018, 2019 and 2020 were to be refunded to the taxpayer, and 100% percent of any remaining excess credits were to be refunded to the taxpayer in 2021.

The CARES Act accelerates the refundability of the AMT credits by providing for 50% refundability in 2018 and 100% refundability for any remaining tax credits in 2019.

Employee Retention Credit

The CARES Act provides a refundable employee retention credit for employers against the 6.2% Social Security tax on employee wages. Eligibility for the credit is restricted to employers whose business operations (i) were fully or partially suspended during any quarter of 2020 due to orders from a government authority resulting from COVID-19, or (ii) remained open in 2020 but had gross receipts in any quarter that were less than 50% of the gross receipts from the corresponding quarter in 2019. Under the second of the preceding conditions, the employer would be entitled to a credit for each quarter until their business operations produce gross receipts that exceed 80% of gross receipts from the corresponding 2019 quarter.

The credit will be calculated quarterly and will be an amount equal to 50% of the qualified wages paid to each employee after March 12, 2020 and before January 1, 2021 up to $10,000 per employee. This is intended to provide an incentive for employers to continue to pay employees that are not working due to a full or partial business shutdown or a significant decrease in gross receipts.

For eligible employers with more than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services due to COVID-19-related circumstances. For eligible employers with 100 or fewer full-time employees, all employee wages are qualified wages, whether such employer is open for business or subject to a shut-down order. Amounts paid by an eligible employer to provide and maintain a group health plan are also included in qualified wages.

If, during any calendar quarter, the amount of the employee retention credit exceeds the applicable employment taxes during such calendar quarter, the excess will be treated as an overpayment and refunded to the employer.

An employer may not include any employee for which the employer is allowed a credit under any other section of the Code. Furthermore, any wages taken into account in determining the employee retention credit cannot be taken into account for purposes of determining the employer credit for emergency Family Medical Leave Act and Paid Sick Leave Act (discussed below under the Families First Act). Also, an employer is not eligible for this employee retention credit if the employer receives a covered loan under the Small Business Act, as added by Section 1102 of the CARES Act.

Delay of Payment of Employer Payroll Taxes

Under the CARES Act, payroll taxes that are due between March 27 and December 31, 2020, may be deferred with 50% of the deferred payroll taxes payable on December 31, 2021 and the other 50% payable on December 31, 2022. This deferral will also apply to 50% of self-employment taxes for self-employed individuals.

Technical Correction of the “Retail Glitch”

Although not related to the COVID-19 pandemic, the CARES Act provides a much-anticipated technical correction to TCJA. TCJA intended to accelerate the depreciation of “qualified improvement property” (“QIP”), which is generally defined as any improvement made to the interior portion of a nonresidential building any time after the building was placed in service. As a result of a drafting error in the TCJA, however, the depreciable life of QIP defaulted to a term of 39 years, instead of the intended term of 15 years. The CARES Act provides a technical amendment to correct the foregoing drafting error by reducing the depreciable life of QIP from 39 years to 15 years, making QIP also eligible for 100% bonus depreciation applicable to assets with a recovery period of 20 years or less. The change is retroactive to the enactment of TCJA in 2017, and thus, taxpayers should be entitled to file amended tax returns to receive the benefits of accelerated depreciation for QIP.

Families First Act

The Families First Coronavirus Response Act (“Families First Act”) was signed by President Trump on March 18, 2020. The Families First Act, among other things, provides employees access to: (i) 12-weeks of job-protected leave under an emergency expansion of the Family and Medical Leave Act (“Emergency FMLA”), and (ii) 2-weeks of paid sick leave pursuant to adoption of new paid sick leave requirements (“Emergency PSLA”). These provisions apply only to (a) private employers with fewer than 500 employees, and (b) covered public employers. Although the details of these programs are beyond the scope of this Davis Graham Legal Alert, the Families First Act also provides employers certain payroll tax credits to offset the cost of the Emergency FMLA and Emergency PSLA and provides that the amounts paid under the Emergency FMLA and the Emergency PSLA are not subject to the employer’s portion of the Social Security tax.

Expanded Paid Family Leave Credit

Employers are eligible for a refundable credit against the employer’s portion of the Social Security tax for amounts paid by an employer each quarter under the Emergency FMLA. The amount of qualified family leave wages taken into account for each employee is capped at $200 per day and $10,000 for all calendar quarters. The credit is refundable if the credit exceeds the employer’s total liability for the Social Security portion of its payroll taxes.

Eligible self-employed individuals (individuals who would be entitled to receive paid leave pursuant to the Emergency FMLA if the individual was an employee of an employer other than itself) receive a credit against their income tax for 100% of the qualified family leave equivalent amount. The qualified family leave equivalent amount is capped at the number of days the benefit is paid (up to 50) multiplied by the lesser of $200 per day or 67% of the average daily self-employment income for the taxable year (net earnings from self-employment divided by 260). Only days that the individual is unable to work for reasons that would entitle the individual to receive paid leave pursuant to the Emergency FMLA can be taken into account.

Paid Sick Leave Credit

Employers receive a refundable credit against the employer’s portion of the Social Security tax for the sick leave wages paid each quarter under the Emergency PSLA. The credit is limited to $511 per day for employees who are unable to work in order to:

• Comply with a public quarantine or isolation order;
• Self-quarantine based on the advice of a healthcare provider; or
• Obtain medical care for COVID-19 symptoms (collectively, the “Personal Requirements”).

The credit is limited to $200 per day for employees who are:

• Caring for an individual who is under quarantine or isolation;
• Caring for a child, if the child’s school or daycare closed or the childcare provider is unavailable due to COVID-19; or
• In any other substantially similar condition specified by the Secretary of HHS in consultation with the Secretary of the Treasury and the Secretary of Labor (collectively, the “Caregiver Requirements”).

The credit is further limited to an aggregate of 10 days of paid benefits. The credit is refundable if the credit exceeds the employer’s total liability for the Social Security portion of its payroll taxes.

Eligible self-employed individuals (individuals who would be entitled to receive paid leave under the Emergency PSLA if the individual was an employee of an employer other than itself) who satisfy the Personal Requirements or Caregiver Requirements are entitled to a qualified sick leave equivalent amount for an aggregate of 10 days. The qualified sick leave equivalent amount for self-employed individuals who satisfy (i) the Personal Requirements is equal to the lesser of $511 per day or 100% of their average daily self-employment income for the taxable year, and (ii) the Caregiver Requirements is equal to the lesser of $200 per day or 67% of the average daily self-employment income for the taxable year.

National Emergency Declaration

President Trump declared a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act on March 13, 2020. The IRS thereafter issued Notice 2020-18, which delayed April 15th tax filing and payment deadlines until July 15th based on its authority to do so when there is a “federally declared disaster.” The IRS’s position that the President’s emergency declaration constitutes a federally declared disaster provides support for employers to provide certain benefits to employees impacted by COVID-19 in the form of “qualified disaster relief payments.” Under Section 139 of the Code, these payments will be tax-free to the employee, but fully deductible by the employer.

Reimbursable Expenses

Section 139 allows for tax-free payments to reimburse or pay the employee for the expenses that are not otherwise compensated for by insurance that are (i) reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a qualified disaster, or (ii) reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence or repair or replacement of its contents to the extent that the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster. Certain COVID-19 related expenses should clearly qualify as reimbursable expenses under Section 139 of the Code, such as

• Medical expenses not compensated for by insurance related to COVID-19, including co-pays and deductibles;
• Other health-related expenses including over-the-counter medication or hand sanitizer; and
• Funeral expenses of the employee’s family as a result of COVID-19.

In addition, absent future IRS guidance to the contrary, an employer should be able to make payments to employees to reimburse the following types of expenses related to COVID-19:

• Child care for workers whose normal source of child care is unavailable due to COVID-19;
• Tutoring expenses for employees’ children;
• Increased telecommuting costs such as computers, printers, or supplies;
• Any increased utility costs associated with the employee and his or her family being quarantined or otherwise confined to the home;
• Housing for additional family members; and
• Increased commuting costs related to the employee’s inability to commute via the usual means of transportation (e.g., using a personal car in lieu of public transit.)

Plan Design and Implementation

Section 139 payments may be made to all of a company’s employees, regardless of length of service. There is also no limitation on the amounts that can be paid to any individual employee or to all employees in the aggregate and be deductible to the employer. In addition, these payments are excluded from gross income and wages for payroll tax purposes and are not subject to information reporting on Forms W-2 or Forms 1099-MISC.

Although an employer does not need to adopt a formal written plan or policy, Davis Graham recommends adopting a written program containing certain key aspects of the program. For example, a written program document will help ensure that the program is administered fairly and equitably to avoid potential claims of discrimination. Employers should also consider providing notice of the program to employees to ensure those in need of assistance are aware of its availability. Other aspects of a disaster relief program that an employer should consider adopting in a written plan include the following:

• Limiting the program to those affected by the current COVID-19 pandemic;
• The class of employees eligible under the program;
• Any aggregate or per-employee dollar limits on assistance;
• The types of expenses that will be reimbursed or paid;
• The process for employees to request assistance (e.g., written application, telephone, email);
• Identification of who will be granted the discretion to determine whether to pay a claim;
• The date, which may be retroactive, on which expenses will be eligible for reimbursement/payment; and
• The date by which claims must be submitted (e.g., 30 days following the end of the declared emergency).

Notice 2020-18

Notice 2020-18 was released on March 20, 2020 and restated and expanded Notice 2020-17 that had been released two days earlier. These notices provided that for all taxpayers:

• The due date for filing U.S. federal income tax returns due April 15, 2020 is automatically postponed to July 15, 2020 without need for the taxpayers to file an extension.
• The due date for making U.S. federal income tax payments (including estimated income tax payments and payments of self-employment tax) due April 15, 2020 is automatically postponed to July 15, 2020.
• The period beginning on April 15, 2020 and ending on July 15, 2020 will be disregarded in the calculation of any interest, penalty, or addition to tax for failure to file any U.S. federal income tax return or pay any U.S. federal income tax postponed by Notice 2020-18. Interest, penalties, and additions to tax with respect to such tax return filings and payments will begin to accrue on July 16, 2020.

For more information on these developments, please contact Davis Graham tax professionals Michael Snider and David Weil.

A force majeure clause provides contractual relief related to events (such as war, a labor strike, or extreme weather) or effects that cannot be reasonably anticipated or controlled. In the context of the spread of the novel coronavirus and the associated economic downturn, you will want to review your oil and gas leases to determine if they contain a force majeure clause and whether that clause will maintain your lease in effect in light of the developments relating to the COVID-19 pandemic.

Issues to Consider When Reviewing Your Force Majeure Clauses:

1. Identify the events covered by the force majeure clause.

• • Review how force majeure events are defined and triggered. Consider whether the COVID-19 situation fits the definition of a force majeure event.
  • Epidemics and pandemics generally will not be specifically defined as a force majeure event. The clause could still be triggered where it (i) covers labor and supply shortages (which are caused by COVID-19); (ii) broadly defines events as exceptional, beyond one party’s control, unavoidable, and not attributable to the other party; or (iii) includes broad catch-all language.
  • Most force majeure clauses frequently list government rules or actions as a triggering event. Governmental orders, such as shelter-in-place orders, should be examined to determine if they trigger the force majeure clause.
  • Courts generally find that economic hardship is not enough to constitute a force majeure event.

2. Consider how your clause links COVID-19 and non-performance.

• • Consider what the link is between the failure to perform and COVID-19.
  • A force majeure clause usually requires performance of contractual obligations to be “prevented,” “impeded,” “hindered,” or “delayed.” To rely on the clause, the event must be the only one affecting contractual performance (unless clearly stated otherwise). In other words, “but for” COVID-19, a party must have been willing and able to perform.

3. Identify contractual notice requirements.

• • The failure to notify in compliance with the terms of the force majeure clause could cause a waiver or limitation of your rights.
  • Consider whether supporting details and evidence of the event and its effects must be provided with the notice.
  • By when and in what form should notices (initial and subsequent) and supporting documents be served.
  • Determine when the COVID-19 starts to affect your contract. If unsure, consider notifying your counterparty of the force majeure event at the earliest opportunity, followed by further periodic notices or updates regarding the continuing disruption so your claim is not time-barred.

4. Understand the tolling effects of a force majeure event.

• • The force majeure clause may limit the term of the suspension or you may need to seek an extension of time.

5. Document evidence which supports your claim.

• • You will have the burden of proof to support your claim of force majeure.
  • Properly record and retain evidence of communications with your counterparties about the disruption and its effects, including order or service cancellations.
  • You must mitigate the effects of a force majeure event. Document reasonable steps taken to do so.

6. Respond to force majeure notices.

• • Failure to respond to a notice within stipulated time limits may constitute acceptance of the counterparty’s force majeure claim.

Application to the Habendum Clauses in Oil and Gas Leases.

• • Some courts have held that a force majeure clause in an oil and gas lease applies to the covenants in the lease but does not apply to extend the term of a determinable fee interest, such as the habendum clause.
  • You will have a stronger argument for an extension of the oil and gas lease if the force majeure clause specifically references the habendum clause and the operations or production related thereto.
  • Many courts have supported an extension of the oil and gas lease even though the force majeure clause does not make specific reference to the habendum clause.
  • A more favorable force majeure clause would be the following:
    When drilling, reworking, production, or other operations are prevented or delayed, whether before or after the expiration of the primary term, by such laws, rules, regulations, or orders, or by inability to obtain necessary permits, equipment, services, material, water, electricity, fuel, access, or easements, or by fire, flood, adverse weather conditions, war, sabotage, rebellion, insurrection, riot, strike, or labor disputes, . . . this lease shall not terminate because of such prevention or delay, and the period of such prevention or delay shall be added to the term hereof.

If you have any questions, please contact Lamont Larsen, Greg Danielson, Sam Niebrugge, or Craig Gleaton.