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What Impact may the current COVID-19 situation have on your contractual obligations?  

by KSB Covid-19 Task Force

Published: April, 2020

Submission: April, 2020

 



Many governmentalregulations may prevent contractual obligations from being duly fulfilled. How can you best handlethe performance, or more precisely, thenon-performance of your contracts?


Force majeure


Section 2913 of Act No. 89/2012 Coll., The Civil Code, as amended (the “Civil Code”), provides in paragraph 1 that if a party breaches an obligation under the contract, it shall compensate for the damage resulting therefrom to the other party or even to a person in whose specific interest the agreed obligation was fulfilled. Pursuant to paragraph 2 of this provision, the person causing the damage is exempted from the obligation to compensate (freed from liability) if he or she proves that an unforeseeable and insurmountable obstacle, irrespective of his or her will, has temporarily or permanently prevented him or her from performing the obligation under the contract. At the same time, however, if the obstacle arose from the damage causer’s personal circumstances or only when the damage causer was in default of performance of the agreed obligation, or if it is an obstacle that the damage causer was obliged to overcome under the contract, he or she will not be released from liability.


No fault is required to give rise to an obligation to compensate for damage caused by breach of contract (typically due, for example, to delay in delivery of goods or failure to deliver goods), unless the parties expressly agree otherwise. Therefore, the party in breach of the contract cannot claim that it was not at fault. However, for legal reasons, he or she may be exonerated by proving the existence of an event known as force majeure (vismaiororforce majeure). The case law of the Czech courts defines force majeure as a qualified coincidence which cannot be averted by anyone under the given circumstances or with every effort due to its extraordinary and unpredictability (Decision of the Supreme Court dated 31.7.2007, file no. 25 Cdo 2911/2006). This is an unpredictable objective fact over which one has no control and could not directly influence it.


The breaching party is obliged to prove the simultaneous fulfilment of (a) the exceptional nature of the obstacle (which is beyond the regular course of the case), (b) its unpredictability (unexpected when concluding the contract), (c) inability to overcome the obstacle (even when using the best reasonable efforts it was not possible to limit or overturn the obstacle) and (d) occurrence irrespective of the will of the party in breach of the contract (i.e. without its involvement).


The Act also defines facts which, although they could be considered as force majeure, do not constitute a reason for exemption. These are: (a) an obstacle arising from personal circumstances (unfavourable medical condition, family status, injury, adverse financial situation), (b) an obstacle formed only at a time when the breaching party has already been in default of performance (c) the obstacle that the breaching party was obliged to overcome under the contract (if the parties counted on the existence of the obstacle and pledged to overcome it).


For individual contract types, special reasons for exemption from liability may be specified by law. These special reasons are set, for example, for storage contracts in case of damage to property (Section 2426 of the Civil Code), contracts for transport of goods in case of damage to consignment (Section 2566 par. 2 and 3 of the Civil Code) etc.


We consider it appropriate to add that, when new contracts are concluded, since the coronavirus infection is not only socially known but has even been declared a pandemic, it might be very difficult to prove the unpredictability of this fact. The obstacle would no longer be subjectively assessed as to whether this affects the business sector, but would be evaluated objectively, according to the potential imminent threat to interference with the impossibility of meeting its obligations. For this reason, it is advisable that the contracting parties take this into account when concluding new contracts. If, however, the situation deteriorated significantly and the emergency measures were tightened, it would undoubtedly be possible to speak again of the application of a liberating ground within the meaning of Section 291 (2) of the Civil Code.


Substantial change of circumstances


The consequences of a coronavirus epidemic may potentially create a substantial change in circumstances within the meaning of Section 1765 of the Civil Code. This provision states that if circumstances change, it is essential that the change entails a particularly gross disproportion in the rights and obligations of the contracting parties by disadvantaging one of them either by disproportionately increasing the cost of performance or disproportionately reducing the value of the subject matter against the other party to resume contract negotiations or even to defend themselves against the courts and to require the amendment or cancellation of the contract within the meaning of Section 1766 of the Civil Code. In that case, it must proven that it could not reasonably have assumed or influenced the change in circumstances and that the fact had occurred after the conclusion of the contract or that it had become known to the party concerned after the conclusion of the contract. In practice, it is a matter of restoring the balance between the parties, where the court should consider as a basis the same economic considerations as the parties when they concluded the contract.


However, the exercise of the aforementioned right does not entitle the party concerned to suspend performance and thus bears the consequences of any delay. At the same time, the law provides that the aforementioned right shall not arise for the party concerned if it assumes the risk of a change in circumstances.The condition for the possible application of the provisions of section 1765, resp. Section 1766 of the Civil Code is that the parties did not exclude its application in the contract or in the terms and conditions when concluding the contract.


Subsequent impossibility of fulfilling the obligation


Consideration may also be given to the application of Section 2006 of the Civil Code, which stipulates that if a debt becomes impossible after the obligation is incurred, the obligation ceases to exist due to the impossibility of performance. However, fulfilment is not impossible if the debt can be met under more difficult conditions, with higher costs, with the help of another person or after a specified period of time. Impossibility of performance is to be proven the debtor.


Objectively, such an obligation cannot be fulfilled if its fulfilment is impossible not only for the obligated party but also for anyone else, because after the conclusion of the contract it became virtually (physically) or legally (virtually possible but prohibited by law) impossible or because the performance is tied to a specific person (who, for example, has died). It should be noted, however, that a permanently non-performing obligation will not apply if the reason for the legal impossibility of performance is a legal regulation with limited (from the beginning limited) effect.


Withdrawal from the Contract


Any of the above contractual liability waiver mechanisms will only be applicable if the parties were unable to fulfil their contractual obligations immediately (in a causal context) due to the coronavirus pandemic. For the sake of completeness, please note that if a situation related to a coronavirus pandemic and crisis measures justifies a waiver of damages (caused by a breach of contractual obligations by one of the parties in a causal context), the actual breach of contract will not cease as such.


Thus, the provisions on the right of withdrawal in the event of failure by the other party to fulfil its contractual obligations or arrangements for a penalty or default interest could be applicable.


Contractual entitlements under EU law


The general contractual principles will also apply to a certain extent in cross-border relations. Primarily, it will be necessary to examine whether an international element is present in these relations. Given that this is a pandemic, it will also be necessary to examine which authorities of specific states (usually courts) are competent in dispute resolution, respectively, on the interpretation of the contractual arrangements, the facts and the law of the respective state. It will be necessary to ascertain from the authorities designated to deal with the law, first of all, from the conflict rules of the state, which law will be applicable to the contract. It is precisely by interpreting the law applicable and the contract that one can conclude to what extent the legislation of the given country differs from the above-mentioned Czech legislation. In general, it can be assumed that virtually all jurisdictions have their own force majeure rules which would apply in this respect.


Interpretation of legislation, contracts and potential claims will also have to be interpreted within the limits of mandatory standards, which may be the aforementioned emergency measures or other quarantine measures. The application of mandatory rules is always taken into account irrespective of the applicable law, as it is a provision of fundamental importance, the application of which must always be maintained, as is clear from Article 9(2) of Regulation (EC) No 593/2008 of the European Parliament and of the Council 17 June 2008 on the law applicable to contractual obligations (“Rome I”). This provision obliges courts to always apply mandatory rules when the situation falls within their jurisdiction. Article 9(3) of Rome I even imposes an obligation on the court to apply the mandatory rules of the state in which the contracts were to be performed. It will therefore always be necessary to investigate whether the specific imperative standards, respectively emergency or other quarantine measures have a real effect on the performance or non-performance of the contract.


Contractual Claims under CISG


In the People's Republic of China (“China”) there is an epicentre of the coronavirus epidemic, which largely affects the local market. With regard to the fact that most of production power has been transferred to China in recent years, we note the potential claims of companies against suppliers from China. China is a signatory to the United Nations Convention on Contracts for the International Sale of Goods (Vienna Convention) ("CISG"), which applies when either party is domiciled in a CISG signatory state or has chosen CISG as the applicable law.


Based on the assumption that Article 79 of the CISG, which provides:“A party shall not be liable for a failure to fulfil any obligation if it proves that such failure was due to an obstacle not dependent on its will and for which it is not reasonable to expect a party to count on it at the time of conclusion of the contract, or that such an obstacle or its cause could be limited or overturned” thus, it is necessary to assess the facts of each individual case, whether it is possible at all to consider potential freedom from liability in the event of failure to fulfil a contractual obligation.


The contracting party must prove that it was an unmanageable cause which is outside the debtor's sphere of influence. Typical causes outside the sphere of responsibility are primarily natural events such as floods, earthquakes, storms, lightning strikes, fire, drought or frost and the like. Similarly, in the case of epidemics (Cf. Tichý, L. Article 79. In: Tichý, L. CISG (United Nations Convention on Contracts for the International Sale of Goods). 1st edition. Prague: C. H. Beck, 2017, 412 p., or see also S. Tang In: Conflict of Laws). It is also essential that the cause is causally linked to the breach of contractual obligations.


In parallel, the condition of unpredictability and unavoidability of these causes must be met. Unpredictability can be defined as an external obstacle which the contracting party was not aware of or could not take into account at the time the contract was concluded. It means, in other words, that if the debtor could recognize such an obstacle, he or she cannot be relieved of his liability. Unforeseeable external obstacles alone do not relieve the debtor of liability if the debtor could have avoided them or could have overcome their consequences. The debtor must make every effort to fulfil his contractual obligations (see also Tichý, p. 412).


 



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