COVID-19 has impacted most businesses in the EU and around the world. You may be considering what happens if you cannot fulfil your obligations under various commercial contracts. If these are cross-border contracts, the governing law of the contract will be important. If English law is applicable, the impact on the contract is likely to be different compared with a contract in other key European jurisdictions. We set out below the position under English law and highlight some of the key differences with key European jurisdictions, France, Germany, Italy and the Netherlands.
Practically, a party’s first option may be to discuss the matter with the other party(ies) to the contract to see if any changes to obligations can be agreed. If this is possible, the parties should document the new obligations and the reasons why they have done this.
If the parties cannot agree changes, under English law, you may either
- Invoke a force majeure clause within your contract; or
- Try to apply the common law concept of “frustration”.
These are considered below and we have highlighted the differences between English law and law prevalent in other EU jurisdictions.
Force majeure clauses
Definition
These clauses define a set of circumstances (the force majeure events) beyond the reasonable control of the parties to a contract. Unlike in other jurisdictions such as the Netherlands and France there is no legal definition of “force majeure” under English law and each contract will define these set of circumstances differently. Broadly there are two types of force majeure clauses: one which lists out specific events such as fire, flood, pandemic etc. (exhaustive list) and those which refer a more general concept of events beyond the control (or reasonable control) of a party often accompanied by some examples (non-exhaustive list). The vast majority of B2B trading contracts in the UK would have some kind of force majeure clause (normally the non-exhaustive kind). Sometimes specific events are excluded from the definition of force majeure (e.g. strike action).
In the Netherlands, there is a legal definition of force majeure in the Dutch Civil Code. To invoke force majeure, it is necessary to show a shortcoming in the fulfilment of the agreement which is not the fault of the party claiming force majeure and which was unforeseeable at the time of entering into the agreement. Performance must have become impossible with no reasonable alternative.
In France, the criteria for force majeure are that the event should have been unpredictable on the day the contract was agreed and the effect of the event is to unavoidably prevent performance of the contractual obligation. It is for the judge to determine, on a case-by-case basis, whether the event actually has the characteristics of force majeure and the parties remain free to contractually adjust the definition of force majeure.
The legal situation in Germany is fairly similar to English law however, parties should bear in mind that the German legislator has issued a COVID-19 Mitigation Act on 27 March 2020. According to this a party may be entitled to refuse specific performance of a contract, including without limitation payment obligations, for the time of the pandemic. The provisions of this new Act are mandatory and binding law; thus, they may prevail over force majeure clauses, if the latter were less favourable.
Italian law provides rules for two situations: (a) impossibility to perform obligations (impossibility situation) and (b) performance is excessively onerous (excessively onerous situation). Determining whether an event falls within these two situations requires interpreting case law. Natural disasters such as earthquakes, epidemics, floods, hurricanes, acts of terrorism and war generally fall within the category of “force majeure” for the purposes of the impossibility situation. However, each event requires individual assessment based on the circumstances.
The second (excessively onerous) situation depends on the finding of an extraordinary event (i.e. statistically infrequent one of exceptional nature) that was unpredictable (i.e. one that the parties, considering their knowledge and experience, did not take into account).
Cause and effect
Under English law, if your force majeure clause does cover the current set of circumstances, you will then have to show that it was, in fact, the force majeure event – whether this is the pandemic itself or the associated restrictions on travel and physical gatherings – that caused your performance under the contract to be delayed, hindered or prevented altogether. It is highly unlikely that an obligation purely to pay money would be excused by COVID-19 – partly because force majeure clauses are sometimes drafted specifically to exclude this but also because so long as banks are still lending money it would be hard to argue that the performance of the payment obligation is genuinely prevented by the pandemic.
If you can show this causal link, the force majeure clause will then detail if you are excused from your obligations entirely or if you are just entitled to delay the performance of your obligations. Generally, a party’s obligations (and their liability for non-performance) are suspended while the force majeure event is taking place and these obligations are resumed once the event has come to an end. If the event carries on for a substantial period of time, the parties may have the option to terminate the contract. There is nothing to stop (in B2B contracts) one-sided termination rights.
In the Netherlands, the potential consequences of successfully using force majeure depend on the facts and circumstances. For example, one party may not be obliged to compensate the other for damages suffered, the parties’ obligations may be suspended temporarily or permanently, and parties may be entitled to terminate the contract. If the contract is terminated, this will not stand up in court if the event only impacted a minor part of the parties’ obligations. Additionally, under Dutch law, force majeure applies automatically to all contracts. However, parties can contractually limit or extend the application and consequences of the doctrine. In the event the parties do not agree on the applicability of the doctrine in the circumstances, they can request the court to decide if the use of the doctrine is justified or not.
Under English law, to invoke a force majeure clause, typically the clause will require you to notify the other party and take other steps to mitigate the situation. It is important that these requirements are met. English force majeure clauses do not deal with a situation where as a result of the force majeure event the contract has just become unprofitable or inconvenient for one of the parties – there must be a direct impact on performance. And, whether you have an applicable force majeure clause or not, there is no possibility to ask the court to intervene to deal with any perceived unfairness (unlike, for example, in other European countries (see below)).
Under French law, the Colmar Court of Appeal decided that the COVID-19 epidemic qualifies as a force majeure event. Although this decision did not relate to a contractual matter, the Court held that the fact that the defendant could not appear in person at the hearing before the Court because he was potentially infected by the virus constituted a case of force majeure. It remains to be seen in what circumstance the French Courts will uphold such a decision in relation to contractual cases.
Under Italian law, in the first situation (the impossibility situation) performance that has become impossible is extinguished and the party released from its obligations cannot ask for compensation and must return any benefit received in accordance with the rules on the recovery of undue payments. The temporary impossibility, as long as it lasts, counts as an exemption from liability for delay in performance. If performance is excessively onerous, a party may request the termination of the contract, unless the other party offers to modify the terms of the contract fairly.
Unlike the first situation (impossible performance), the second (excessively onerous) situation does not terminate the contract by law, but a court could declare the contract terminated. This can be avoided by the un-aggrieved party offering to modify the terms of the contract fairly to avoid the matter being brought before the court.
Nevertheless, it is possible for the parties to agree a “force majeure” clause and exclude the applicability of both these rules as long as the contract retains the right to other remedies such as an action for performance or compensation for damages.
Frustration
Under English law, if the pandemic makes it physically or commercially impossible to fulfil the contract, or the parties’ obligations are changed into something entirely different from that which they agreed, the contract may be “frustrated”. This is quite a high threshold.
You cannot rely on the concept of frustration if the contract has already made express provision for COVID-19 and its impact (for example under a force majeure clause – see above). And you can’t rely on frustration if the event was or should have been foreseen by the parties, or just because the contract is no longer commercially attractive to perform in the present circumstances. The English courts are in practice reluctant to find that a contract is frustrated. For all of these reasons, the practical relevance of frustration to commercial trading contracts is limited.
If a contract is frustrated, it ends automatically i.e. the parties do not have the option to choose whether to terminate the contract. The parties are excused from performing future obligations under the contract and are not liable for non-performance. In many cases, advance payments made before the frustrating event will be recoverable. Additionally, if a party has incurred reasonable expenses in relation to their contractual obligations before the contract was frustrated, they may be able to recover these. But there is nothing to deal with any unfairness that may occur as a result of the contract abruptly coming to an end (e.g. ongoing commitments which may result in future expenses).
Under German law, modification of a contract may be demanded, if under the current circumstances, the basis of the contract has significantly changed since the contract was entered into, and if the parties would not have entered into the contract, or would have entered into it on different terms, if they had foreseen this change. If modification of the contract is not possible or one party cannot reasonably be expected to accept it, the disadvantaged party may, depending on the nature of the contract, either revoke or terminate the contract. These provisions of the German Civil Code are, however, applied only in very limited circumstances.
Under French Law, contracts formalised on or after 1 October 2016 benefit from hardship clauses or clauses of unforeseeability (imprévision). Parties can agree to set aside these hardship provisions which apply when an unforeseeable change of circumstances renders performance of a contract to be excessively onerous for a party who had not accepted the risk of such a change.
If parties have not excluded these provisions and where the change in circumstance meets the definition of hardship, the affected party can ask for the contract to be renegotiated and performance continues during the renegotiation. If the renegotiation fails or is refused, the parties can mutually agree to terminate the contract or they can ask a judge to amend it. If the parties are unable to agree within a reasonable timeframe, either party can request a judge to revise the contract or terminate it.
On 25 March 2020, the French Government adopted Ordinance n°2020-306 (under which the French Parliament declared a two-month state of emergency in light of the pandemic). The ordinance contains a series of provisions affecting contracts and we note that it is uncertain at this time whether this constitutes overriding mandatory provisions that French Courts will apply irrespective of the foreign law otherwise applicable to the contract.
Under Dutch law it is possible to request a court to modify or even terminate a contract on the basis of unforeseen circumstances where it would be fair and reasonable to do so. The unforeseen circumstance must be of such a kind that it would not be reasonable or fair for the other party to expect the agreement to remain unchanged. There are differences between force majeure and unforeseen circumstances. In relation to the latter, you can still perform obligations under the contract but the circumstances are changed in such a way that fulfilment cannot reasonably be expected of you. Unlike with force majeure, parties cannot exclude the ability to invoke this doctrine of unforeseen circumstances. In general, a judge will not be easily persuaded to modify or terminate a contract due to unforeseen circumstances because judges are reluctant to qualify circumstances as unforeseen. However, given the current unprecedented COVID-19 situation, it is not unthinkable that a judge may decide that these circumstances qualify as unforeseen.
In Italy, where there is a force majeure event that results in the fundamental balance of the relationship being altered (obligations are excessively onerous or performance is excessively degraded), on a party’s request, the parties are obliged to renegotiate the agreement, in good faith, to restore the balance. If the negotiations fail or an agreement has not been reached after a reasonable period of time, the parties may bring the matter before the courts. The court may terminate the contract, dictate the terms and conditions of the termination, or modify the contract to restore balance. In fact, the court may sanction either party (including through an order for damages), if any party did not act fairly and in good faith during the renegotiation.
This is in stark contrast to the position under English law where the courts will not step in and re-write the terms of the contract based on an unforeseen event, no matter how unusual that event might be.
For further information please contact Richard Marke ([email protected]) or Riya Viegas ([email protected]). You can also read more about the English position in an article by Bates Wells’ Robert Oakley, Alex de Jongh and Mindy Jhittay here.