Force Majeure in Private Contracts After the Global Health Emergency caused by COVID-19
Force Majeure and Other Changes in Contractual Circumstances As Grounds For Exonerating or Releasing From Liability for Breach of Contract
Is it Important to Analyze Commercial Contracts in the Light of Force Majeure While We Face COVID-19 Epidemic Outbreak?
Definitely yes. It is very important to take a series of precautions in commercial relations between businesses in the face of the consequences of COVID-19 epidemic. This is why we have previously published our Practical Guide for Businesses on how to deal successfully with the COVID-19 pandemic..
The truth is that the vast majority of businesses are experiencing a situation like this for the first time, and are thus facing its unforeseen consequences. Uncertainty is inevitable, and companies must have a clear idea on how to proceed in the face of all this.
What Measures Can Be Taken?
There is still time to take action with respect to the application of force majeure clauses, and we can carefully re-calibrate our response over the course of this situation. These are both preventive and remedial measures against the potentially harmful effects of the global health crisis, especially those arising from a scenario of protracted duration.
- We must review and classify active contracts according to their importance and probability of being affected by the pandemic, i.e. the possibility of default.
- The consequences of non-compliance with contractual obligations must be weighed against the classified contracts.
- It is very important to identify the contractual clauses relating to Force Majeure, if any, and how they are applied according to the wording of the clause itself. If there are no such clauses, we must analyze the ways in which they could be applied in accordance with the applicable law.
- It could be very interesting to assess whether there are other clauses in the contracts that are alternatives to Force Majeure, the application of which would lead to more favorable results.
What is Force Majeure?
Force Majeure is, roughly speaking, a means of defense against a default or breach of contract. It is a justifiable cause of non-performance (usually for a limited duration, after which time the contract should be terminated), and depending on the applicable law and provisions of the contract, may even exonerate from all the consequences normally attributable to non-performance.
Is COVID-19 An Event Of Force Majeure?
This will depend on the law applicable to the contract, and the provisions of the contract itself. In addition, it will be necessary to assess the borderline situations, i.e. those defaults or breaches that occur very close to the start of the measures taken against the pandemic, or very close to its end.
When assessing the concurrence of Force Majeure by COVID-19, we must therefore distinguish between several scenarios:
- Defaults or breaches coinciding in time with the pandemic, but not linked to the consequences of this pandemic. In short, when, despite the pandemic, contractual obligations could have been fulfilled.
- Defaults or breaches indirectly linked to the pandemic. These may be situations such as a breach which, although partial, became a total, unjustified non-fulfilment. Or other borderline situations which, due to their proximity to the start or to the end of the pandemic, need to be assessed in terms of their degree of linkage to COVID-19.
- Law applicable to the contract.
In fact, this last point, the applicable law, applies to all situations. In Spain and a large part of the European Union Member States, Force Majeure can be traced in their Civil Codes. However, in Anglo-Saxon countries, where we find the common law, this can vary significantly.
By way of example, there are two important differences in the American continent:
- - If the applicable law were that of one State of the United States, we must consider that overall States law requires the existence of a Force Majeure clause in the contract for its consideration.
- If the law of a province of Canada is to be applied, common law prevails everywhere except in Quebec, where its Civil Code provides in section 1470 the dispositive nature of the clause of exoneration, so that compensation for damages for non-performance can be agreed even in the presence of a Force Majeure event.
Is There An Alternative To Invoking Force Majeure?
In fact, there are at least two alternatives to the invoking of Force Majeure. We are talking about the judicial doctrine «Rebus sic stantibus» in Spain and the legal theory of frustration of the contract in the Anglo-Saxon legal sphere.
The so-called Rebus doctrine deals with a modification of the terms and conditions of the contract due to a supervening impossibility of performance, which affects the fulfilment of the contractual obligations. Since this is a doctrinal theory supported by case law, the requirements for this figure can be found in the case law of Spanish courts, and are as follows:
- The existence of a completely extraordinary alteration of the circumstances of the contract, at the time of its fulfilment, and in relation to the concurrent ones at the time of its conclusion.
- An abrupt and significant break in the balance of performance of the contract.
- The alterations that generate this situation shall arise from circumstances beyond the control of the affected party, being unpredictable at the time of conclusion of the contract.
The main problem we find with this doctrine is that its contractual applicability must be recognized by the courts.
With regard to common law, we should refer to Material Adverse Change (MAC) and Material Adverse Effect (MAE) clauses. These clauses are similar in spirit to the Rebus doctrine but are much more specific in fact.
On the other hand, we would have the figure of the frustration of a contract. This is a much more unanimous figure in civil and common law, as well as having a regulatory spirit very similar to the MAC, MAE or Rebus clauses. The main difference is that, at first, the figure of frustration is aimed at the termination of the contract, without any consequences other than the extinction of the relationship itself.
The causes of frustration of the contract do not have to be included in the provisions of the contract, which in common law is an alternative when a Force Majeure clause has not been foreseen, although they are examined by courts more rigorously than the other figures mentioned.
The causes of frustration in general refer to the material and/or legal impossibility, economic impossibility, and frustration of the object or purpose of the contract. The assumptions for these causes are very similar to those required by the Rebus doctrine, i.e. the non-imputability of the circumstances to the party claiming their change, the unpredictability of such circumstances, and their occurrence after the conclusion of the contract. The English legal system is the strictest when it comes to assessing such circumstances, and does not admit economic impossibility as a cause of frustration.
What Would Be The Consequences Of Invoking Force Majeure For Non-Performance?
Continuing with the previous question, it will depend entirely on the applicable law and, as the case may be, on the contractual provisions.
Here it is no longer only the applicable law that is important when assessing the contract clause or legal figure, but also whether the respective state or local governments have issued regulations in relation to the pandemic that affect these cases. Such as the automatic application of force majeure to certain breaches, or the exoneration of the duty to fulfil contractual obligations in certain cases.
The general consequences would be:
- The suspension of reciprocal obligations until the normal course of relations can be resumed.
- The reduction of prices in the event of partial or defective compliance.
- The compensation of payments or obligations in order to mitigate the damages of mutual non-performance.
- Termination of contracts.
The reality is that everything will be left to the parties and their consequent negotiations. Only in the event of disagreement should an external channel be used to resolve the conflict, whether it be through the mediation, arbitration or the courts. Therefore, at Gowper we want to insist that against this it is extremely important that an assessment of each contract is made by specialized lawyers. In most cases it is advisable to have a certain tolerance in order to keep a contract alive. Tolerance not only with respect to discussing or not the applicability of Force Majeure, but also to evoke or not the consequences agreed in these cases and when the applicable law allows it.
Some Practical Tips On The Actions And Measures You Can Take
The first thing would be to review your contracts. Forget about the applicable law, any contractual relationship must primarily be based on mutual trust between the parties and willingness to continue with the relationship. Therefore, if something has been agreed by contract, it has been because the parties wanted to settle the situation in that way. The aim must be to solve the problem by negotiation and dialogue.
That said, in the face of possible conflict:
- As far as the content of the commercial contract is concerned:
- Is there a force majeure clause in the contract, and if so, does it require any formality in terms of notification and deadlines?
- Is there any clause in the contract applicable to the case that constitutes an alternative to Force Majeure, and/or that leads to more favorable outcomes? For example, suspension of the contract, termination of the contract, guarantees, etc.
- With regard to the applicable law:
- Is the case of Force Majeure regulated by law? And if so, is there any dispositive element for the parties in cases of Force Majeure?
- Does the Force Majeure clause in the contract comply with the applicable regulations?
- With regard to the relationship between COVID-19 and non-fulfillment:
- Has the compliance of any of the parties been affected by the pandemic? And, if so, to what extent – partially or totally? Was partial compliance possible, causing less damage than total non-compliance?
- Would fulfillment of obligations, if still possible, involve a cost greater than the agreed price because of the pandemic?
What Legal Advice Does Gowper Offer In This Situation?
We are dedicated to helping all companies that request it in this difficult time. We have decided to apply the same priority treatment that we normally reserve to our clients to the rest of the businesses affected by this situation.
We have published our Practical Guide, which is more exhaustive on the measures to be adopted for business being hit by the COVID-19 pandemic, and we have opened a Rapid Response Channel via our law firm’s WhatsApp, through which we are resolving many questions and extending our opening hours to meet all the needs and emergencies that have arisen at this very special time of uncertainty.
In short, we are supporting as much as we can all the companies that come to us with doubts about contractual obligations being unfulfilled due to this situation, which we that we trust is merely temporary.
Our added value here, especially on the international stage, is to provide legal guidance and assistance, through negotiation of clauses, contracts or agreements, to keep trade relations alive or to achieve a satisfactory outcome, providing our knowledge of private international law and of the regulations of the various countries with which we constantly interact.