COVID-19: The impact of the epidemics on contractual relationships
Authors: Nino Bostič Sluga, Matjaž Verbič, Blaž Ogorevc
In a developed business environment, it goes without saying that agreements must be kept. Slovenian contract law enacts this fundamental principle in the Code of Obligations, which in several places stipulates rules that require parties to fulfil their obligations as agreed upon at the conclusion of the contract. Only a few exceptions enabling one party to unilaterally alter the concluded agreements are provided in the Code.
One of the first questions that arise in the current situation is whether the announcement of a COVID-19 disease pandemic and the adoption of accompanying restrictive measures enables parties to avail of these exceptions. Therefore, we briefly describe these exceptions and their conditions in the following paragraphs – it should be noted, however, that all the circumstances of each particular case need to be considered. Last but certainly not least, all the mitigation measures adopted by the Government and the National Assembly must not be neglected, as they can change your legal position.
Before exercising any of the options below, we advise you to precisely analyze the contracts already concluded and any applicable general terms and conditions – these might already contain provisions which allow the contractual relationship to be adjusted to the current crisis. Furthermore, it is important that you act with due care and, if the current situation makes it difficult or (temporarily or permanently) impossible for you to fulfil your contractual obligations, immediately notify the other party and explain the circumstances that hinder or prevent you from fulfilling your obligations.
Regardless of whether you are the creditor or the debtor, it is advised that you seek an agreement with the other party regarding the arrangement of the contractual relationship, whether it is a change or termination. The current circumstances are likely to have affected both parties and a mutually agreed solution will save both parties considerable uncertainty in the event of litigation and the associated costs.
In the absence of relevant contractual provisions or if you cannot reach an agreement with the contracting party, and if your legal relationship is not governed by foreign law, it is necessary to evaluate whether the current circumstances resulting from the COVID-19 pandemic constitute grounds for exercising the rights conferred on the parties by the Slovenian legislation.
It needs to be additionally noted that certain statutory measures that have been (or will be) adopted intervene directly with the contractual arrangements or with the pre-existing legislation. For example, creditors which are public law entities and are parties to supply agreements or construction agreements need to consider that the Act Determining the Intervention Measures to Contain the COVID-19 Epidemic and Mitigate its Consequences for Citizens and the Economy provides that the contractually agreed periods are prolonged for the time of epidemics and that the provisions on contractual penalties shall not apply.
The legal options bellow will be invoked primarily by debtors who, due to current circumstances, are unable to properly or timely fulfil their contractual obligations and seek to implement a change in their contractual relationship. They are, however, also relevant for the creditors who will need to respond to such requests. In this respect, it shall be noted that the above applies to contracts concluded before the declaration of the epidemic (in Slovenia is was declared on 12 March 2020), otherwise the debtor will generally not be able to refer to them. They also cannot be relied upon by the debtors whose contractual obligations became due before the circumstances have changed.
1. Force majeure
The term which has recently been most often used in relation to inability to fulfil a contract, is force majeure. It should be emphasized at the outset that due to the occurrence of a force majeure event, a party cannot unilaterally change the contract or withdraw from it – such party might, however, not be liable to the other party for damages due to failure to fulfil or delayed fulfilment.
Force majeure may be invoked only by a party who cannot fulfil its obligations for reasons beyond its control and which could not be deterred or prevented, and which did not originate in its sphere of control, but at the same time represent an unexpected and sudden event. Natural disasters, which include the COVID-19 epidemic, could be a case of force majeure.
As indicated in the introduction, invoking force majeure requires the debtor to inform its counterparty. It is also essential that it may apply only if the contract was concluded before the declaration of the epidemic. In the particular state of the epidemic, parties to various contracts (e.g. sales, distribution, sub-contractors, etc.) that cannot timely fulfil their obligations may reasonably invoke force majeure. The force majeure may also be invoked by the parties to lease relationship, however, it is not clear whether the current legislation entitles the tenant, who due to an epidemic cannot use the subject of lease (e.g. business premises) or uses it to a limited extent, to a rent reduction.
When a party invokes force majeure, it is temporarily released from its obligation to fulfil (suspension or restriction of performance of obligations), but its obligation does not cease. However, if the current circumstances representing the force majeure continue beyond the contractual period, the termination may turn into a right to terminate the agreement based on any of the institutes below.
2. Subsequent inability to fulfil the contract
The subsequent inability to fulfil an obligation is referred to when the fulfilment which was possible at the conclusion of the contract, became impossible later. In the case of reciprocal contracts, the inability to fulfil the obligation of one party, due to reasons for which neither party is responsible, causes a termination of the other party’s obligation. In the event that one party has already (partially) fulfilled its obligation, it may claim that its fulfilment is returned. The law also regulates the partial inability of fulfilment, which is subject to slightly different legal consequences.
It should be emphasized that the obligation in respect of which the subsequent impossibility of fulfilment has occurred, must be objective; i.e. such that no one would be able to fulfil this obligation under the same circumstances. As a rule, the inability to fulfil must also be permanent. Given that the current circumstances resulting from the COVID-19 epidemic are likely to be temporary, the debtor shall generally not be able to claim a (permanent) inability of fulfilment and thereby request termination of contractual obligations. It may, however, be released of liability for a delay for the time of the present circumstances, provided that they constitute force majeure as indicated above.
3. Termination of contract owing to non-performance
In principle, contracts can only be rescinded unanimously. Nevertheless, Slovenian law gives contracting parties the possibility to achieve unilateral rescission, i.e. withdrawal from the contract for breach of obligations or default. However, the mere debtor’s default at maturity does not yet allow creditors to rescind the contract – they must give the debtor an adequate additional remedy period. In setting an appropriate additional deadline for the fulfilment, the creditor (e.g. the contracting authority) will have to take into account the current epidemic, especially if the particular circumstances surrounding it are the reason for the delay of the debtor (e.g. contractor). Contracts where the time of fulfilment is an essential component of the contract and the debtor has not fulfilled its obligations within this period, are exempted from this rule. These are rescinded by operation of law, and the creditor can maintain them in force if it immediately informs the debtor and allows it a reasonable additional time to fulfil.
Any withdrawal from the contract must be reported immediately by the creditor to the debtor. The consequence of withdrawal from the contract or its rescission by the law due to the breach is that all fulfilment claims of the contract cease, however, the debtor might be liable for the damage. The parties are released from their obligations and no longer need to accept the fulfilment from the counterparty.
4. Change of circumstances (doctrine of rebus sic stantibus)
One of the institutes for adjusting contractual relationships due to unforeseen events is also the institute of changed circumstances. Changed circumstances can result in the obligations of the parties becoming so difficult that strict adherence to the above mentioned pacta sunt servanda principle could become unfair. In order to successfully invoke the institute of changed circumstances, certain legal assumptions must be fulfilled. The fulfilment of the contract must be, for example, aggravated or there must be circumstances that make it impossible to achieve the purpose of the contract (frustration).
Changed circumstances cannot be invoked by a party who, at the time of conclusion of the contract, could have foreseen such circumstances and has not done everything in its power to avoid such adverse circumstances. If they do occur, however, it must do its utmost to counteract their consequences. The debtor must thus prove that he has done everything to avoid adverse circumstances (e.g. adjusting to the situation if this would not require disproportionate additional costs) and that he has done his best to eliminate the negative consequences of such circumstances (e.g. reorganize work its employees, concluded additional agreements with suppliers, etc.). The debtor must immediately inform the creditor of the occurrence of adverse circumstances. Changed circumstances should, as a rule, be permanent. However, in our opinion, the application of the changed circumstances doctrine, due to the extent of the current crisis as we witness, is not entirely excluded.
If the assumptions are fulfilled, the debtor may request the contract to be rescinded but may not claim (unilaterally enforce) its change. It has to enforce its application for rescission by filing a lawsuit. In the event of rescission, the court orders the debtor to compensate the creditor for a fair share of the damage, which was caused by a rescission.
The creditor is not obliged to agree to the change of contract, but with its unwillingness to negotiate, its risks termination of the contractual relationship. In the case of long term contractual relationships, the latter is probably not in its interest.
Based on the above, it seems most appropriate that the parties seek an agreement and amend the contract in the light of changed circumstances, thereby sharing the burden of the consequences of the COVID-19 epidemic on both parties. Similar shall be the court ruling, if the parties wish to maintain the contract in force: the contract shall not be terminated if the other party offers or agrees to change the relevant contract terms fairly.
5. The opposition of threat
The opposition of threat is applicable if the performance capacity of the other party, after the conclusion of the contract, deteriorate to the extent that it is uncertain whether it will fulfil its obligation or whether this becomes uncertain for other serious reason. In this case, the party who should first fulfil its obligation may defer its own fulfilment until the other party fulfils its obligation or provides sufficient security. We believe that the declaration of an emergency due to the COVID-19 epidemic is one of the serious reasons mentioned. Likewise, an epidemic may have implications for the material circumstances of the contracting party, which may subsequently result in raising an opposition. The party objecting to the threat may ask the counterparty for adequate security. If such is not provided within a reasonable period, he may withdraw from the contract.
6. Termination of permanent contractual relationships
Even contracts concluded for indefinite period of time with no explicitly envisaged exit options, must be eligible for cessation. When terminating such an agreement, the parties must comply with the statutory notice periods; the law stipulates that such contractual relationships can be terminated “at any time, but not at an inappropriate time”. Whether the current crisis represents an “inappropriate time” remains unanswered at this time and will only be answered by the future case law.
If the fulfilment of your contractual obligations has become hindered or even impossible, you should immediately inform your counterparty and elaborate the situation. In doing so, refer to the provisions of the contract or the legal reasons given above, if the legal analysis shows that conditions for their applicability are present.
If you have been notified by a counterparty that it cannot fulfil its contractual obligations, do not ignore it. Analyze its claims and try to reach a well-established legal agreement.
Considering all the above options, we estimate that the current situation is not completely or adequately foreseen in Slovenian legislation. We also dare to assume that there are not many contracts that would regulate the present situation precisely. Many questions arise, which neither the law nor the case law gives a clear answer to, so it is all the more important for both parties to carefully analyze a specific case, which will lead to the optimal choice of legal options to change the contractual relationship and an appropriate approach to resolving a potential dispute.