The COVID-19's impact on private contracts:Hardship, Force Majeure.
- Wednesday 25 March 2020
- Civil and Commercial Litigation, Contenzioso arbitrale e giudiziario, Contratti, Contratti privati, Coronavirus, Covid19 emergenza - emergency, Diritto Civile, Diritto Commerciale e Contratti, Diritto dell'Unione Europea, Diritto internazionale, Diritto Societario, Forza maggiore - Force Majeure, Inadempimento contrattuale, Mediazione - Mediation, PMI
- Africa, Asia, China, Europa, Italia, Spagna e America Latina, UK, Unione Europea, USA
The coronavirus (COVID-19) and the restrictive measures adopted by governmental authorities of various countries, including China and Italy, to curb it, are having a significant impact on the ability of individuals and businesses to fulfil their contractual obligations. We are witnessing a daily increase in the number of cases of contract terminations, cancellations and blockages of supplies of goods. In these kinds of scenarios, force majeure clauses are those which are most used among market players, however, do these clauses always justify the termination or the renegotiation of a contract?
This brief text aims to give some general information to help in understanding the current situation.
As a matter of priority, we need to ask ourselves what is meant by force majeure. Provided that to date there is no common and unambiguous definition of force majeure, this can be defined, in broad terms, as an exceptional remedy enabling the party to get rid of the performance and also of the resulting liability, if the contractual non-fulfilment is caused by an unforeseeable and extraordinary event. Given its importance, it is an established practice to include in contracts, whether national or international, clauses allowing its termination or renegotiation upon the occurrence of events of force majeure, which may be described in greater or lesser detail depending on the specific case. Some clauses specifically provide for epidemics and pandemics as causes of force majeure justifying the termination of the contract, while others use a more comprehensive language open to different interpretations. It is, therefore, necessary to check in advance whether the contract under examination includes such clauses and to interpret them to determine whether the current situation is a case of force majeure.
Differently, where the contract does not envisage specific force majeure clauses, the base-line rules are to be found in the law applicable to the contract. In the Italian legal system, there is not a specific definition of force majeure, nevertheless, Italian scholars and jurisprudence have asserted that it can be considered as an unforeseeable and extraordinary natural or human event which is beyond the control of the parties and which makes it impossible to comply with their contractual obligations. To that end, a useful regulatory reference is article 1256 of the civil code that, even though it does not specifically mention force majeure, it establishes the termination of the contract in case it becomes impossible for the debtor to comply with its obligations to due an event that is not attributable to him. The provision calls for two requisites to be applied, the first is of an objective nature and entails the unbiased impossibility to fulfil the obligations set out in the contract, while the second, of a subjective nature, requires that the event is not attributable to the party invoking the impossibility.
On the international plane, the discipline to be followed is enshrined in the United Nations Convention on Contracts for the International Sale of Goods (CISG), particularly in article 79, in the principles of Unidroit and in the Clause Force Majeure of 2003 of the International Chamber of Commerce. Even though the clause is established by different international tools, it recalls generally the same conditions, namely the unpredictability and extraordinariness of the event and the non-imputability of it to the debtor. Besides, it should be added that both on the national and the international level, two extra requirements are needed to legitimately invoke force majeure:
1. that the event triggering the cause of force majeure must precede the stipulation of the contract,
2. that the party which is unable to comply with its obligations shall give timely notice of the occurrence of the event, thereby respecting the principle of bona fide and allowing the other party to take appropriate measures to limit the damages.
These requirements have also been expressly referred to by the courts, for example in one of the cases before the Chinese Arbitration Court (CIETAC). The dispute at stake concerned the non-performance of a Chinese company, which, after concluding a contract with a Dutch company, invoked the outbreak of SARS as justification for its non-performance. The Court held, however, that the Chinese company was responsible for the damages caused to its Dutch counterpart since the SARS emergency broke out before the conclusion of the contract and therefore could not be classified as an unforeseeable event for the party; moreover, the Chinese company had warned the other party of the situation several months later, thus preventing it from taking measures which could have contained and reduced the damages.
A further aspect that should be analysed concerns the effects arising from the use of the force majeure clause. Firstly, it is necessary to verify if the impossibility caused by the event is of a definitive or temporary nature (also article 1256 cc. distinguishes these two types of impossibility): if the impossibility makes the service impracticable sine die it would be qualified as definitive, if instead, the impediment affects the simple duration, in the sense of depending on a cause which is considered to be of a transitory nature, the impossibility will be temporary. This distinction has a relevant practical outcome since the effects that the contract will produce or not produce once the emergency has ceased and the situation is back to the “normal”. If the impossibility is definitive the contract would be terminated and so, once the normal situation is restored, there would be no obligations left for both of the parties. Contrariwise, if the impossibility is temporary, the contract will be suspended, so that the debtor will not be liable for the delay in performance, but once the situation that makes performance impossible has ceased, the contractual relationship will continue in all its parts provided that, taking into account the nature and object of the obligation, the creditor still has an interest in performance.
Besides, in some instances, the service is not impossible but rather more burdensome. In these scenarios, it is possible to apply, in the case of contracts with continuous or periodic performance, or deferred performance, article 1467 of the Italian Civil Code, which allows the party for whom the service has become too onerous to terminate the contract. However, the counterpart could impede the termination by offering to renegotiate the contractual terms and conditions to bring the performance back into balance. Anew, the event that renders the service more burdensome needs to be unpredictable, extraordinary and non-imputable to the debtor. At the international level, the specular remedy is enshrined in the Hardship clause, which requires that the event disrupting the contractual equilibrium is unforeseeable, beyond the control of the disadvantaged party and not attributable to it. Unlike Force Majeure, however, in the case of the Hardship, the contract cannot be terminated but only renegotiated and will, therefore, continue to produce its effects albeit in a manner different from that initially agreed.
This situation necessarily has repercussions also in litigation, since it is the judges (or arbitrators) who are called upon to decide whether the cause of force majeure exists in specific situations. By way of example, the Chinese Supreme Court, during the SARS epidemic, ruled several times on the contractual defaults of Chinese companies, stating that if they were in default for reasons related to the epidemic or the restrictive measures adopted to contain it, they should be considered exempt from liability. Another example concerns the ruling of the Italian Court of Cassation (civil section III), which in 2007 confirmed the legitimacy of the decision to terminate a contract regarding a holiday trip to Cuba since there was an epidemic of dengue haemorrhagic on the island, as this event was neither foreseeable at the time the contract was concluded nor attributable to the travel agency.
In conclusion, another valid tool to manage the current situation could be mediation. This institution has the advantage of helping the parties to find an agreement by favouring renegotiation instead of termination so that not only the contract but also the underlying economic fabric can be preserved. Hence, although that of the resolution is a viable way, it certainly reflects the more drastic solution compared to renegotiation that preserves the economic relations between the companies in view of an improvement in the situation and a return to normality.
Editor's note: this text - far from offering ad hoc solutions for specific cases - can be used as a guideline for orientation in the complex situation we are experiencing.