SR

23-03-2020


COVID-19 PANDEMIC - FORCE MAJEURE OR CHANGED CIRCUMSTANCES

State Authorities from around the world have declared a state of emergency and have taken a number of measures to combat the spread of the COVID-19 epidemic. Measures derogating from human and minority rights have indirectly led to market distortions, challenges in the functioning of domestic and foreign businesses, their relationships with clients / customers, suppliers, joint venture partners and others.

On daily basis, domestic and foreign natural and legal persons are facing the danger of inability to fulfill their contractual obligations, which all raises the question about parties reliance on the “force majeure” clause contained in their contracts, as well as whether circumstances accompanying a state of emergency may be the reason for termination or change of contractual relationship due to changed circumstances.

 

I  FORCE MAJEURE (Vis maior, Act of God)

Force majeure is a fact associated with the creation, change or termination of a legal relationship. The Law of Contract and Torts (hereinafter: the Law) does not contain the definition of term force majeure. However, the Law does mention force majeure in provisions concerning the inability of fulfillment of contractual obligations, liability for damage, as well as provisions related to contractual obligations, and therefore possible effects of force majeure can be analyzed:

 

Inability of performance

The provision of Article 137 paragraph 1 provides: “Should performance of obligation by one party in a bilateral contract become impossible due to an event not attributable to either party, the other party’s obligation shall be terminated too, while a party performing part of his obligation may request restitution  according to the rules of restitution in case of unjust acquisitions”. The provision of paragraph 2 of the same Article of the Law provides: “Should partial impossibility of performance be due to events not attributable to either party, one party may repudiate the contract should partial performance fail to meet his needs; otherwise the contract shall remain valid, while the other party shall be entitled o request proportionate reduction of his obligation."

The provision of Article 354 of the Law stipulates that one of the ways for terminating an obligation is the inability of fulfillment: "An obligation shall come to an end should its fulfillment be impossible due to circumstances for which the debtor is not to blame".

One should be very careful with terminating the contract in these cases, and the evaluation of each specific contractual relationship is necessary.

Further consequences of the inability of fulfilling an obligation are depending primarily on the contractual terms of force majeure (which are certainly the first step to the analysis of further action), and then on the nature of the obligation and the contractual relationship, and also the answers to many questions - is the fulfillment within the deadline an essential element of the contract , whether the obligation can be fulfilled at a later date, does the contract lose its purpose, etc, by defaulting on one side

 

Release of debtor from liability

The provision of Article 263 of the Law, relating the release from contractual liability for damage due to breach of contractual obligation provides: “A debtor shall be released from liability for loss upon providing his inability to perform the obligation, or that his delay in performing the obligation was due to circumstances taking place after entering into contract which he was unable to eliminate or avoid."

In accordance of the above mentioned, the characteristics of the force majeure in terms of the Law are:

- Force majeure is an external event (the cause of the damage lies outside the subject's activity);

- The effect of an external event could not be predicted, avoided or eliminated;

- The effect of an external event directly targets the obligation.

Accordingly, the introduction of a state of emergency can definitely be considered as a force majeure, but it is important to keep in mind that such event does not automatically release the contracting party from fulfilling his/her obligation, for which it is necessary to have direct force, i.e. direct impact on the ability to fulfill an obligation.

This further means that it is not possible to invoke force majeure if the event has only indirectly affected the fulfillment of the obligation (e.g. the tenant did not economize and did not earn enough money to pay the rent, or the manufacturing entity did not have the usual need for raw materials and did not want to order a contractually defined monthly quantity of raw material contracted for the purpose of obtaining discount on the price of the raw material).

Therefore, it is necessary to take into account whether force majeure is affecting a specific obligation or just debtors’ obligation and his/her interest. In the latter case, the debtor should consider applying the institute of changed circumstances.

 

II CHANGED CIRCUMSTANCES (rebus sic stantibus, hardship)

If the particular situation does not target the ability of performing the obligation, but only the debtor himself/herself and his/her contractual interest, there is space for applying the rules of repudiation or alternation of contract due to changed circumstances (rebus sic stantibus).

The provision of Article 133 of the Law provides: “Should after concluding the contract circumstances emerge which the performance of the obligation of one party, or if due to them the purpose of the contract cannot be realized, while in both cases this is expressed to such a degree that it become evident that the contract meets no more expectations of contracting parties, and that, generally speaking, it would be unjust to maintain its validity as it stands – the party having difficulties in performing the obligation, namely the party being unable, due to changed circumstances, to realize the purpose of contract, may request its repudiation."

Further provisions of the Law are showing that termination of the contract due to changed circumstances can only be sought through a judicial process, in which a problem has to be resolved urgently, and all that raises the question as to whether this institute can achieve its purpose in state of emergency or is it better for the contracting parties to take into account the rules of this institute, and to regulate the new situation through the agreement with mutual indulgence and understanding.

Undoubtedly, the Law requires that new circumstances, important for termination or change of the contract due to changed circumstances, have to be such that they cannot be avoided or overcame by the contracting party, have arisen before the maturity of the obligation and are of such a magnitude that the purpose of the contract itself is lost.

Also, the court has to take into consideration the magnitude of the extraordinary event that may require termination or change of the contract.

The specificity of this institute is the possibility for other party to request compensation of damages from the party seeking termination of the contract through the court. It must be taken into account that the damage must be proved, and a number of relevant circumstances must be taken in to consideration.

Certainly, the contract will not be terminated if the party not affected by the changed circumstances accepts a fair modification of the contractual terms.

In conclusion, the party requesting termination of the contract due to changed circumstances is obliged to inform the other party immediately upon the occurrence of the changed circumstance and the intention to terminate the contract. This can also be an initial act that would lead to an out-of-court termination of the contractual relationship or amendment of contractual obligations.

Major and abrupt changes made by the series of measures taken in the wake of the COVID-19 pandemic are justified basis for invoking of the rules of  termination or amendment of the contract due to changed circumstances, especially if the fulfillment of the contractual obligation is more difficult or the continued existence of the contract could be fatal to the economic condition of the contracting party.

Furthermore, the COVID-19 pandemic, as well as competent authorities restrictive measures, are increasingly acquiring the characteristics of force majeure due to which contractual obligations cannot be fulfilled, which also leads to the justification of invoking the inability of fulfilling the obligation due to force majeure.

Given that both institutes are exceptional, it cannot be predicted with any certainty the ultimate effect this situation, or what the subsequent opinion of courts will be on this issue, accordingly it is advisable that the parties try to agree on the newly created situation.

 


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