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News

Can coronavirus be a legitimate reason for non-performance of contractual obligations?

16.03.2020
Company: Bříza & Trubač, s.r.o. advokátní kancelář

On Wednesday, March 4, 2020, the article on the recently discussed subject of coronavirus, written by Petr Bříza, was published on the epravo.cz webpage.

Petr primarily dealt with the possible impacts of the virus on the performance, or rather non-performance, of contractual obligations in domestic and international trade. The article addresses, for example, the extent to which a coronavirus epidemic may be considered as a force majeure or a substantial change in circumstances, or a foundation for the impossibility of performance. It further discusses related issues of liability and contractual penalties. These issues are analyzed not only from the perspective of Czech law but also from the perspective of private international law. In many cases, coronavirus cannot be a legitimate excuse for non-performance of contractual obligations, which should be borne in mind when concluding new contracts. To avoid any surprise, we recommend reading Petr's article - you will find its English translation below.

Coronavirus as a reason for non-performance of contractual obligations in domestic and cross-border trade: can late delivery be justified by a virus?

Coronavirus, respectively its form referred to as COVID-19 ("Coronavirus"), has become a major media topic, and its influence (or panic-induced influence) extends to many areas of human activity. Undoubtedly, it will not avoid law either, not only in the field of hygiene regulations and administrative law in general but also in private law.

In this article, I would like to address the possible impacts of Coronavirus in the area of ​​trade, not only domestic but also international. I have no ambition to examine this topic in every detail, instead I would like to make a few general remarks applicable across contract law considering business relations.

Coronavirus got in the Czech Republic only a few days ago, however, in countries that are severely affected by the virus (such as China, South Korea, Italy, etc.), factories and other operations are being closed and thus supplies of goods or services are being delayed, suspended or canceled. Something similar may soon happen in the Czech Republic. But can Coronavirus be a spell that relieves our entrepreneurs or their foreign partners of liability for delayed or defective delivery of their products? Can it possibly become an effective excuse to get rid of a disadvantageous contract or gain more time to meet contractual obligations? Could it be a reason for a refusal to accept and take-over a delivery (e.g. arriving from infected areas)? Let’s have a look at these issues first through the eyes of the Czech Civil Code[1] and then more widely in a cross-border context, i.e. the perspective of private international law.

Coronavirus and contracts under Czech law

Coronavirus-type epidemics can generally be classified as cases of “force majeure” (vis maior), i.e. unforeseeable objective phenomena over which a person is in principle not in control and which occurrence typically (at least immediately) could not be influenced. Thus, these epidemics may meet the requirements of Section 2913 (2) of the Civil Code (“CC”), according to which a person who breaches contractual obligations (e.g., is in default with the delivery of goods) may be relieved from liability for damages if he proves that he was prevented from performing that obligation by an “extraordinary unforeseeable and insurmountable obstacle incurred irrespective of his will”. Importantly, this obstacle shall not arise when the infringing party was already in default. Therefore, Coronavirus cannot be an ex post justification for non-performance if the delay occurred before the alleged epidemic had any impact on the infringing party.[2] Similarly, contracts concluded with partners in areas where the epidemic already is on the rampage (or can be at any moment), should take into account that Coronavirus is no longer likely to be considered an “unforeseeable” obstacle to the contract if it already objectively exists or it spread threatens. From this point of view, it is recommended that all the new contracts currently concluded take the Coronavirus into consideration,[3] at least the contracts which performance could be affected by a possible epidemic (or by measures taken against it). However, if there is an unexpected worsening of the situation that can be considered unforeseeable, Section 2913 (2) of the CC may still be applied.

Coronavirus, or the consequences of this epidemic, could also create a substantial change in circumstances within the meaning of Section 1765 of the CC, which would result in a gross disadvantage of the affected party. In such a case, the affected party could invoke the right to negotiate a contract amendment or request a court (under the conditions specified in Section 1766 of the CC) to amend or annul the contract. The party shall at the same time prove that it could not reasonably have anticipated or influenced such a change in circumstances and that the fact occurred (or became known) only after the conclusion of the contract.[4] However, this possibility does not apply to contracts where the parties have excluded the application of Section 1765 of the CC, which, from my experience, often happens in practice (and often completely unreasonably and unthought through).

Theoretically, the institute of the so-called concept of frustration of a contract within the meaning of Section 2006 of the CC, where the obligation of contractual performance ceases  to exist since the debt has become impossible to fulfill, cannot be completely excluded from consideration. The practical applicability of this provision to epidemic cases is limited by the fact that this provision cannot be invoked if the debt can be met, even if delayed (in the words of law “after the determined time [of performance]”) or at a higher cost, under difficult conditions or with the help of a third party. If the epidemic leads (or will lead) to the cessation of a commercial operation, this will ordinarily mean a suspension of supplies for a certain period, which would have to be extended for a very long time in order to establish the real impossibility of performance. [5] However, one could imagine, for example, a situation where it would be found that some domestic animals carry the virus and were ordered to be killed in order to prevent the spread of the disease (as happened recently in the case of avian influenza in Slepotice, for example). These particular slaughtered animals would then no longer be subject to sale and the contracts relating to them would be extinguished due to the impossibility of performance.

In any case, and it is important to emphasize, it will always be necessary to examine whether all of the above cases of (simply put) very difficult or impossible performance were indeed causally linked to the epidemic in a way that could not be foreseen, averted or overcome. The parties shall make all possible efforts to perform the contract. The mere fact that performance has become more difficult does not relieve them of their obligations (Section 1765 of the CC). So if an entrepreneur stops or limits operations for the sole fear that the virus might spread rapidly in the factory and there are no quarantine measures or recommendations from government authorities (not to mention cases where the disease does not occur in the country yet), in my opinion, this will not relieve him of his liability for failure to comply. Nevertheless, it will always be necessary to examine all the circumstances of the case (including a possible pressure from employees, the level of panic in the country, etc.).

In those cases where an entrepreneur is required to comply with quarantine measures, or possibly even in compliance with “mere” recommendations of state authorities,[6] it will generally be possible to refer to one of the abovementioned concepts of limitation/waiver of contractual liability;[7] nevertheless, it is necessary to examine whether the measures were indeed the main and immediate cause of failure to perform, whether the delay had not occurred before or whether it would have occurred anyway without an epidemic, etc. In doubt, the provisions relieving a party of its liability must be always interpreted restrictively, since they are considered to be an exception to the general principle that contracts are to be kept (pacta sunt servanda, cf. Section 3 (2) (d) of the CC). Therefore, Coronavirus cannot be an easy excuse for non-performance of contractual obligations. On the other hand, as I have noted, it will always be necessary to take into account all the circumstances of the case, since at the same time "the interpretation and application of a legal regulation must not be contrary to good morals and must not lead to cruelty or inconsiderate behavior offensive to ordinary human feelings. " (Section 2 (3) of the CC). Accordingly, no trade should take precedence over people's lives and health, but the point is, in the particular case, these values ​​should be actually and immediately at risk and the epidemic should not merely serve as an excuse to get rid of uncomfortable contractual obligations.

It is also important to point out that even in those cases where Coronavirus is a legitimate reason for excluding liability for damage caused by a breach of contractual obligation, this does not mean that the breach of contract as such will cease. Therefore, the other party - for example, a buyer to whom the seller has not delivered the goods due to an epidemic - will be able to avoid the contract for this violation (so he does not have to wait for the epidemic to pass). Similarly, it cannot be completely ruled out that, even if the infringing party does not have to pay the damage occurred, it will still have to pay the agreed contractual penalty for the violation, since there is in principle no possibility of liberation.[8]

Coronavirus and contracts featuring an international element

The principles described above shall also apply to a considerable extent in cross-border relations. However, as in any situation with an international element, it will be necessary first to examine which authorities (courts of which State or which arbitration body) shall have jurisdiction to interpret the contract and to settle the disputes therefrom. In international relations, the competence of the authorities of more than one State cannot be ruled out (consequently it shall depend on in which court the first action is brought, respectively there may be parallel proceedings on the same case in two States). The designation of the authority to deal with the contract is essential to the assessment of many other issues, in particular the conflict-of-law rules, on the basis of which the law applicable to the contract shall be determined. Of course, this may be a law other than the Czech law, and although in principle all legal systems should be aware of situations of force majeure and the associated limitation or exclusion of liability for the performance of contractual obligations, their specific arrangements may differ more or less from the (above-mentioned) approach of the Czech law.

It will therefore always be necessary to examine specifically whether the requirements of the law governing the contract are fulfilled (in the relationship between an Italian seller and a Czech buyer it may be, for example, Italian law). A different legal order may be considered only in case of application of the so-called overriding mandatory norm - a provision of fundamental importance, which shall be applied irrespective of applicable law. The quarantine measures or other public health regulations that prevent (prohibit) the performance of contractual obligations should be, in principle, considered as overriding mandatory norms. The application of overriding mandatory norms is also foreseen in Rome I Regulation,[9] which determines the applicable law in EU courts (except in Denmark where a very similar legislation applies) which obliges the court to always apply its overriding mandatory norms (cf. Article 9 (2) of the Rome I Regulation, i.e. the Czech court should always apply the Czech overriding mandatory norms if the case is subject to its jurisdiction) and, in certain circumstances, to apply the overriding mandatory norms of the State in which the contract was to be performed (cf. Article 9 (3) of the Rome I Regulation). Thus, the quarantine provisions (and their implementation) in the State of performance shall be possible to take into consideration, even if the applicable law does not allow limitation or exclusion of liability.[10] Nonetheless, as mentioned above, it will always be necessary to examine whether the quarantine (or other similar) measure/regulation in question has a direct effect on the (non)performance of the contract.

The last tool always available to the courts is to apply the public policy exception of the State where the court is located if the effect of the application of a foreign applicable law (in other words, the conclusion to which it leads) is contrary to the fundamental principles of the State concerned (i.e., the fundamental rights protection in the Czech Republic). Accordingly, a possible grossly unfair conclusion to which the applicable law would lead may be corrected.

In international trade, it should be borne in mind that the approach of individual courts and arbitration bodies to overriding mandatory norms and public policy exception may differ, and therefore it will always depend on whether and how the authority resolving disputes arising from the contract is regulated therein. For contracts currently being concluded, again, it may be recommended to incorporate an explicit agreement on the potential impact of Coronavirus on contract performance[11].

The Coronavirus epidemic may, therefore, constitute a legitimate reason for failure to perform contractual obligations, although generally only in cases where it is an unforeseeable obstacle that substantially makes it difficult or impossible to comply with the commitment of the affected party. Despite the differences in international trade regulations and approaches, I believe that this conclusion should in principle apply to most countries. [12] [13]

[1] I do not deal with specifics of individual contract types (including various reasons for termination, repudiation or withdrawal) that might be applicable in the context of an epidemic of this type.

[2] For the sake of completeness, I should add that the infringing party shall not be relieved of liability also in the case of an obstacle which originated in his personal circumstances or which he was obliged to overcome according to the contract. The personal circumstances of the debtor include also his employees and therefore also their possible strike, unless it is a strike caused by something outside the circumstances of the debtor, not directly related to him (cf. Melzer, F., Tégl, P. et al. Civil Code – Commentary. Volume IX. Sections 2894-3081. Prague: Leges, 2018, p. 342). A collective refusal to work based on fear of contagion, which the entrepreneur could not prevent despite all efforts, e.g. due to panic resulting from inaccurate or deliberately disturbing information, could fall outside the personal circumstances of the infringing party and no liability for the breach would be determined. The liability of employees for this conduct towards the employer is not discussed in this article.

[3] Whether by expressly agreeing to exclude liability for damage caused as a result of this epidemic, by the resolutive condition that the obligation to perform in the event of an epidemic shall cease, or other various contractual arrangements or combinations thereof, depending on the subject matter, the relationship between the parties, etc.

[4] In this case it includes also a circumstance that originates in the personal circumstances of the affected party, so it would include, for example, a widespread illness of employees due to Coronavirus, which would not constitute a reason to justify exclusion of liability under Section 2913 (2) of the CC (see above).

[5] The default should be such a long period resulting in no economic sense of the performance after its expiration. Cf. Petrov, J., Výtisk, M., Beran, V. et al. Civil Code. Commentary. 2nd edition. Prague: C.H. Beck, 2019, p. 2165. A slightly different situation occurs in the case of contracts where the performance is agreed for a certain period of time after which the other party shall no longer be interested in the performance (the so-called fixed obligation), the obligation in this case expires at the end of this specifically established period (Section 1980 of the CC). An example could be a contract under which a musical ensemble is to provide a musical accompaniment to a running race held at a predetermined date.

If the contract stipulates an exact period of performance and if it follows from the contract or from the nature of the obligation that the creditor cannot be interested in the late performance, the obligation expires at the first day of the debtor's default, unless the creditor notifies the debtor without undue delay that he insists on the fulfillment of the contract.

[6] Regarding these mere recommendations (not orders) of the authorities, I admit that this is an ambiguous conclusion, as it does not constitute an insurmountable obstacle, but still it will depend on the nature of the recommendations and other circumstances.

[7] This shall apply not only to the supplying party but also to the receiving party. For example, if the import of goods from China were banned, the buyer shall not be liable for any damage caused by the fact that he could not take over the goods due to this prohibition (of course, if other conditions described in the text are met).

[8] Personally, however, I tend to say that, at least in a case that an entrepreneur would fulfill a public law obligation (resulting from a quarantine measure) by closing down operations, the interpretation imposing a contractual penalty would be very likely contrary to moral principles (see the already cited Section 2 (3) of the CC), since it would de facto be a fine for respecting a public law order. In the case-law of the Supreme Court relating to "old" private law, the theory of “exercising a law contrary to moral principles” has evolved. In any case, it will always be necessary to carefully assess all the relevant circumstances of the case. In my opinion, the institution of "moderation" cannot be used for these situations, because it balances the amount of the fine against the value and significance of the secured obligation, and moreover, according to the case-law of the Supreme Court the relevant moment for the moderation is the moment of negotiating the contract, later circumstances shall not be in principle taken into consideration; cf. Bříza, P., Horák, P. in: Petrov, J., Výtisk, M., Beran, V. et al. Civil Code. Commentary. 2nd edition. Prague: C.H. Beck, 2019, p. 2224.

[9] Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations ("Rome I Regulation").

[10] Thus, even if for some reason the applicable law does not take the quarantine measures into account, the court may still take them into consideration and with reference to them justify the non-performance of contractual obligations.

[11] Ideally, similar epidemics can be directly addressed in general, and the model contract is available to possible future distresses.

[12] Article 79 of the Vienna Convention on Contracts for the International Sale of Goods, which unifies the legislation on international sales contract in more than 80 countries, provides a similar possibility of invoking force majeure as a reason for failure to fulfill contractual obligations.

[13] For recent developments in China where certificates confirming the circumstances of force majeure that prevent local companies from fulfilling contracts are being issued, see article by S. Tang on blog Conflict of laws: available >>> here. I agree with the view therein that the certificate itself does not in any way guarantee that the dispute resolution authority will conclude, under the applicable law, that there is a case of force majeure which relieves the party concerned of liability for breach of the contract.

 

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