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Should a Severe Recession Void Legal Obligations?


A new twist on the force majeure doctrine argues that the economic crisis is so severe it voids legal obligations

Is the economic crisis akin to an earthquake or an act of war? Under force majeure, a long-standing legal doctrine, companies can argue that natural disasters or other calamities should excuse them from living up to the terms of a deal. Now, a growing number are contending in lawsuits that the economic crisis should similarly let them off the hook.

In a Feb. 3 filing in Delaware Chancery Court, Dow Chemical (DOW) said "a cascading sequence of market failures of historic proportions" justifies its effort to walk away from a July 2008 agreement to acquire Rohm & Haas (ROH). Rohm sued the chemical giant in January to force the $15.4 billion deal to go through, and a trial is scheduled for Mar. 9. Dow Chemical, which lost Kuwaiti funding for the deal in December, says in a statement that "the economic reality of late December and early 2009 is far worse than in July 2008." A Rohm spokesperson says her company firmly believes that "Dow has the means to finance the deal."

By most accounts, Dow Chemical faces an uphill fight. Judges rejected nearly every effort to revise or rescind deals after the oil price shocks of the early 1970s and the Asian economic collapse in 1997. Robert E. Scott, an expert in business transactions at Columbia Law School, says courts tend to dismiss economic force majeure cases because they "don't want to let parties get out of contracts too easily." And Scott doesn't think the current downturn will lead to different results.

Still, lawyers say they expect more businesses to cite the meltdown as an excuse to dodge obligations. Luc A. Despins, a bankruptcy attorney at Paul, Hastings, Janofsky & Walker in New York, says he already has seen several companies use that argument in negotiations with creditors.

Business contracts often contain force majeure clauses, which detail events that can allow a company to delay or cancel what it has agreed to do. Events such as fires, floods, riots, strikes, and terrorism are typically specified. A construction loan pact between Donald Trump and Deutsche Bank (DB) also includes the unusually broad phrase "any other event or circumstance not within the reasonable control" of the borrower. Trump is now arguing in a New York State court that the "calamitous economy" falls under that definition and should preclude Deutsche Bank from collecting $40 million on a loan that he personally guaranteed for a hotel and condominium tower in Chicago. "A lot of people are starting to say that we're in a depression," says Trump, "but it's a lot better if you have the language in your contract." Deutsche Bank declined to comment on the pending lawsuit.

QUOTING GREENSPAN

Even without a force majeure clause, it's possible to argue that a deal should be modified because of dramatic shifts in the environment. In federal court in Indiana, electric cooperative Hoosier Energy is contending that "one of the worst financial crises in our nation's history" entitles it to more time to avoid a $120 million payment demanded by John Hancock (MFC). If that argument prevails, Hancock responded in a brief, "every debtor in a country suffering economic distress could avoid its debts." But in a Nov. 25 ruling, U.S. District Court Judge David F. Hamilton noted that "the credit crisis facing the world's economies in recent months is unprecedented." He temporarily stopped Hancock from pursuing payment, a ruling that is now on appeal.

Companies interested in linking natural disasters to financial crises can look to Alan Greenspan for inspiration. In October the former Fed Chairman told Congress that the nation was experiencing a "credit tsunami." Both Trump and Hoosier Energy have used that phrase in their court filings.

Orey covers corporations for BusinessWeek.

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