Covid-19 and its potential effects on contracts
Allende & Brea, Buenos Aires
Is there a legal solution to this problem?
Under certain commercial contracts, the material or legal impossibility of complying with contractual obligations could be considered a force majeure event. A force majeure event takes place when there is a current and absolute impossibility of performing certain obligations, arising from unforeseeable and unavoidable events beyond the debtor's control.
For an event to be considered as a force majeure event, it must be:
- objectively unpredictable;
- current, that is, taking place at the moment the damage or the breach is caused, without being an eventual threat or impossibility;
- unrelated to the breaching party, occurring beyond its range of control;
- subsequent to the creation of the obligation;
- absolute and unsurpassable, that is, an unavoidable obstacle for the compliance of obligations; and
- prior, in the sense that there was no default by the debtor before the triggering event occured.
The burden of proof of a force majeure event lies on the party that invokes it. Although the Covid-19 pandemic is a publicly known and notorious fact, whoever claims it as a force majeure event must provide evidence as to how and why it affects their ability to meet their contractual obligations.
The effect of a force majeure event will be exemption from liability for the party that is unable to comply with its obligations. In order to analyse the specific effect of force majeure on contracts, it is necessary to consider whether the impossibility is definitive or temporary:
- Definitive impossibility causes the termination of the obligation with all its accessories, as well as the termination of the contract, without creating any type of liability to the breaching party. If both parties have yet to comply with their mutual obligations, the risk must be borne by both parties and, in that case, mutual and simultaneous restitutions shall be made, with the exception of those obligations already fulfilled. If the obligation has been performed solely by one of the parties, that party will have rights of recovery against the other.
- Temporary impossibility solely relieves the debtor from the consequences of default as long as the situation persists. The contractual tie remains in place – but suspended – unless the compliance of said obligations needs to be rendered within an essential period of time, or if the creditor's interest is lost, in which case the contractual tie shall be terminated.
The impossibility of compliance with an obligation due to a force majeure event does not per se imply a waiver of liability in every situation. There are several exceptions, including:
- the assumption of responsibility for force majeure events under the agreement;
- the transfer of responsibility for the force majeure event by a legal provision;
- the force majeure event that follows a default;
- the debtor's fault;
- inherence of the force majeure event to the property or activity performed;
- duty of restitution for a wrongful act; and
- particular situations in consumer agreements.
Unaffected party by a force majeure event
The unaffected party in a force majeure event may, as a preventive measure and to avoid the aggravation of the damage, suspend its own performance until the other party complies or provides a guarantee.
Actions to be taken when force majeure events arise
Analyse applicable law
In many civil law jurisdictions, force majeure events and their consequences for agreements is contemplated by the general law, such as in the Civil and Commercial Code of Argentina. However, this is not the case in many common law jurisdictions.
Check if the contract includes a force majeure clause
Analysing this clause is essential as, even though general law may contemplate it, parties are generally able to modify their rights and obligations, assuming certain risks. Consequently, parties may even agree that neither would benefit from force majeure protection under applicable law. Moreover, in many jurisdictions, courts are inclined to construe force majeure clauses narrowly. For instance, under a contract governed by New York law, a party will (generally speaking) only be excused if the force majeure clause specifically includes the event that actually prevents a party’s performance of its duties.
Check if the requirements under the contract or, failing that, which apply by law, have been met
The mere existence of a force majeure clause does not necessarily mean that you have the right to invoke this relief in all situations. Force majeure clauses are typically drafted to include descriptions of situations that trigger such clauses. Whether the current situation constitutes a force majeure event may be a matter of interpretation.
Identify the conditions of implementation of the clause (as applicable)
Force majeure clauses generally establish a procedure which has to be followed to claim relief. It is essential to do so, as case law suggests that failure to comply with such procedure may jeopardise subsequent legal claims and make the clause inapplicable.
Analyse the execution
When a party seeks to excuse performance based on a force majeure clause or a related doctrine, that party generally has two options: either try to negotiate a resolution of the issue with its counterparty, which ideally would deliver a fair and realistic outcome for all parties, or alternatively seek to solve the dispute through formal dispute resolution mechanisms under the contract.
As the party seeking relief will have the burden of proof, it is highly important to keep evidence of the force majeure situation; of the efforts to comply with contractual terms; and of the communications with the other party.
Doctrine of unforseeability
The Argentine Civil and Commercial Code, as is the case with many other jurisdictions, has certain provisions that could be applicable when events such as the Covid-19 pandemic arise and force majeure provisions do not apply (be that because the parties have waived their rights, or because there is not an actual impossibility of complying with contractual obligations). These provisions include the ‘Teoría de la Imprevisión’ (Doctrine of Unforeseeability). This might be used by the affected party to seek relief or termination of the agreement.
The ‘unforeseeability situation’ is one in which the performance of obligations becomes excessively burdensome for a party, due to supervening, unforeseeable and extraordinary circumstances that alter the original economic equation, such that the contract loses its commercial equilibrium. In these cases, performance is not legally or materially impossible, but seriously harms one of the parties due to the extreme change of circumstances.
Consequently, this statutory provision, in the interest of fairness, enables the affected party to terminate the contract, or to request that a court of law adjust its obligations.
The Covid-19 pandemic has created enormous challenges for businesses trying to continue their activities and has opened a Pandora’s box for legal practitioners. Even though there are various legal alternatives for parties seeking relief, in extreme situations (such as the current one), we cannot ignore the fact that an affected party that does not benefit from contract provisions or applicable law may nonetheless seek judicial relief (at least in Argentina). Courts ruling based on equity may exceptionally grant such relief by applying the ‘shared efforts’ doctrine, by which parties should distribute losses. This was applied as a consequence of the 2001 local economic crisis.
If anything, situations like this make us realise (even further) the importance of contract drafting so as to protect the parties concerned and provide some sort of certainty in highly uncertain times, by at least establishing negotiation and termination mechanisms and remedies, so that when extreme situations arise, parties at least know how to act and what to expect.