The Covid-19 pandemic and the institution of ‘change of circumstances’: a Portuguese overview

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João Carlos de Gusmão
Abreu, Portugal
joao.c.gusmao@abreuadvogados.com;

Catarina de Medeiros Carreiro
Abreu, Portugal
catarina.m.carreiro@abreuadvogados.com

The crisis caused by the Covid-19 pandemic has renewed interest in the need for legal and contractual mechanisms that promote the adjustment of contracts in the event of unforeseeable and abnormal circumstances.

In this context, foreseeing a growth in litigation around legal concepts such as force majeure and ‘change of circumstances’, we intend to provide an overview of the Portuguese institution of ‘change of circumstances’.

Change of circumstances and Covid-19: a general overview

In today’s world, there seems to be a reversal of positions between the rule and the exception. While the rule imposes the stability of the agreed terms, the exception allows for adaptation of those same terms in the presence of accidental conditions in the historical course of the parties’ will. However, before providing an overview on the legal consequences of exceptional events, we shall start by explaining the rule.

One of the cornerstones of contractual law is the pacta sunt servanda principle, according to which contracts are to be performed as agreed upon by the parties (Article 406 of the Portuguese Civil Code or CC). In this sense, the debtor cannot deviate from the agreed performance (Article 837 of CC), nor be exempted from that performance in case of economic difficulties. Furthermore, this principle prevents the debtor from delaying or fragmenting the contractual performance without an agreement (Article 763 of CC). The principle of stability also prohibits unilateral termination and unilateral modification of the agreement.

However, with the greatest exception being immediate performance, the passage of time has an omnipresent role in the obligations arising from contracts. In exceptional situations, the principle of good faith is called upon to ensure the balance of the performances between the parties to avoid that one of them is imposed a disproportionate disadvantage in relation to the other.[1] In this context, the institution of ‘change of circumstances’ is triggered.

Accordingly, Article 437 of CC provides that:

‘the circumstances under which the parties base their decision to contract have undergone an abnormal change, the aggrieved party shall have the right to terminate the contract, or to amend it in accordance with fairness, provided that the requirement of the obligations assumed by him/her seriously affects principles of good faith and is not covered by contractual risks.’

In other words, ‘change of circumstances’ allow either (i) for termination or (ii) for modification of the contract. It shall be emphasised that, according to the principle of party’s autonomy (Article 405 of CC), Article 437 of CC shall merely be attended when the parties have not agreed on a specific contractual clause (eg, material adverse change, force majeure or hardship clauses).

The concept of ‘change of circumstances’ requires that:[2]

• the relevant change concerns the circumstances upon which the parties based their decision to contract;

• these circumstances have undergone an abnormal change, ie, the event’s occurrence or its scope was unpredictable;

• that change renders the performance of one of the parties excessively onerous;

• the imposition of the contractual performance by the aggrieved party seriously affects the principle of good faith;

• the change in the circumstances is not be covered by contractual risks; and

• the aggrieved party must not be in a situation of default when circumstances changes (Article 438 of CC).

Due to the Covid-19 pandemic, severe restrictions on free movement and private enterprise were imposed which affected supply chains, destroyed business’s performance and lead to the overall decline in business (notably, due to the workforce’s reduction to prevent the spread of the virus). Although Covid-19 can easily qualify as a relevant event to trigger the institution of ‘changed circumstances’, the contract signature date is of crucial relevance. While for contracts concluded at the end of 2019 there is little doubt about the unforeseeable nature of the Covid-19 pandemic, this reasoning can no longer be made in the same terms for contracts concluded in mid-February as Covid-19 was spreading around the globe. Accordingly, the unforeseeable requirement is much more questionable, being almost certainly denied for contracts concluded by 11 March (when the World Health Organisation declared the pandemic situation).[3]

If the parties have not agreed contractually on these issues, Article 437 of CC grants the aggrieved party the right to opt for the termination of the contract or for its modification according to equity. However, upon the request for termination, the opposing party may object to it, if it accepts the modification of the contract according to equity.

Termination has a retroactive effect, unless this effect would be contrary to the parties’ will or the purposes of the termination (Article 434 of CC). Moreover, everything that has been provided shall be returned, or, alternatively, its ‘equivalent amount’ (Article 289 of CC, ex vi Article 433 of CC). This remedy may be claimed out of court.

As for modification, this remedy shall be requested in court, as it is for the court to assess its basis and to modify the contract. Contractual modification is conducted according to equity, which entails the adoption of a flexible solution adapted to a specific case. The court is not bound by the strict rules in force, having the possibility to gather contributions outside the jurisdictional domain.

The rationale of the equitable contractual changes is not the elimination of the damages suffered by the aggrieved party, but the economic adjustment of the contractual balance as originally intended. In other words, contractual changes do not necessarily entail an equal sharing of the burdens, as the initial agreed performance of each party might have different levels of onerosity, as it is possible according to party autonomy.[4]

The judge shall take into consideration the contractual terms, as well as the features of the branch from which it results, as some branches imply specific and even greater risks. Additionally, risk margin may be excluded from the modification scheme, as the aggrieved party shall always bear it. In this regard, the following criteria shall be attended by the court:[5]

• the real will of the parties as it results from the claim, as this represents the threshold for modifying the contract;

• the hypothetical will of the parties, ie, identification of the contractual remedy that parties would have adopted if they had foreseen an unexpected event;

• the parties’ behaviour either to aggravate or mitigate the effects of the changed circumstances; and

• other elements, such as each party’s investment in the contractual stability and the effects of risk distribution scheme on each party’s activity may also be considered.

When modifying a contract, the court shall promote the least possible interference in the originally agreed terms in line with the principle of legal certainty – for instance, by imposing a quantitative change (eg, a price reduction) instead of a qualitative change, or the suspension of the performance until the triggering event ends, if it is deemed sufficient. There remains a wide margin of possible solutions, such as:

• the reduction in the performance of the aggrieved party;[6]

• the extension of the aggrieved party’s performance deadline;[7] or

• the increase of the counterparty’s payment, in case the aggrieved party has already performed.

If the contractual modification is not adequate, the court cannot impose the termination of the contract ex officio, as it would be a decision ultra petita (Article 609 of CC).

Conclusion

We believe that the Portuguese legal system is prepared to settle conflicts arising from contractual changes imposed by the Covid-19 pandemic crisis. This is not the first time that the judicial system has tackled a crisis that has shaken contractual stability. Taking the example of the sub-prime crisis, courts have shown sensitivity in balancing contractual economic interests with the constraints of unforeseen events.

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