Coronavirus and contracts 2020 (infringements, consequences, cancellation)

With regard to the current development of the pandemic of COVID-19, there is an increasing number of emergency public law measures (including the quarantine ones) and, ultimately, workers who remain at home because of childcare or ordered quarantine (e.g. after returning from a stay in some of the risk-countries).

Many manufacturing businesses and other contractors are therefore having difficulties with the proper and timely fulfillment of their contractual obligations to their customers.

If you are addressing the most appropriate way to minimize potential customer sanctions and your liability for failure to fulfill or late fulfillment of contracts, you are at the right place. It is the purpose of this article to show contractors how to achieve this in the most efficient way.

Coronavirus as Force Majeure in Contract?

You must have already heard something about applying force majeure provisions – but what does it actually mean?

Force majeure can be characterized as a certain unusual and unforeseeable circumstance that is independent of the person claiming it (in our case the contractor), and the consequences of which could not be prevented despite all the care taken. [1] It is apparent from this definition that coronavirus and related measures to prevent its spread fulfill this definition. The concept of force majeure can then be further modified by the contractual arrangements of the parties (i.e. "what is force majeure can be written directly in the contract  for further explanation continue reading!").

What Is Written in Your Contract Is Valid!

If you are faced with paralyzed operation due to coronavirus, first analyze the contracts with customers where is a risk of missing the deadline!

Generally supply contracts often contain provisions regulating force majeure and its impact on the contractor’s obligation to deliver in due time (e.g. by extending the delivery term by the duration of an obstacle of force majeure or eliminating contractual penalties or damages in case of contractor's delay, etc.). For these so-called force majeure clauses, it is then necessary to assess whether coronavirus, resp. consequences resulting from it, can be subordinated under such definition of force majeure or not.

If the contractor is currently concluding a contract with a customer at a time when the pandemic has already commenced and is still in progress, it is recommended to include provisions which take into account the existence and other consequences of the spread of the infection (including possible further stricter measures).

If there already is a widespread of coronavirus, it can no longer be seen as force majeure, since at the time of contracting the disease no longer met the requirement of 'unpredictability' (it is not fulfilled that the contractor could not foresee this obstacle when contracting). The contractual provisions on force majeure and the legal provisions norming such (see below) would not apply.

What If You Do Not Have Written Contract or No Force Majeure Clause?

If a supply contract, general terms and conditions, framework contract or other contractual basis for supply cooperation do not contain a force majeure clause, it is necessary to focus on the coronavirus as force majeure through the lens of the law.

Act No. 89/2012 Coll., The Civil Code, as amended (hereinafter referred to as the “Civil Code”), lays down some institutes that work with force majeure. In this article, we will focus on the most common of these, namely (i) force majeure (coronavirus) as a liberation reason for compensation for damages for breach of contractual obligation, (ii) force majeure (coronavirus) as a substantial change in circumstances giving rise to the option of contract change or cancellation.

When Is Compensation for Damages Not Covered in Cases of Coronavirus?

If you, as a contractor, are in delay with the delivery date of the goods (e.g. due to the fulfillment of coronavirus-related public law quarantine measures), the customer may be entitled to compensation for damages. However, you do not have to pay damages if you meet the following conditions (so-called liberation reasons):

1. Exceptionality of Obstacle: Coronavirus and the follow-up measures against its spread must not be in compliance with the usual course of business, which will undoubtedly be met for measures that could not have been envisaged at the time of concluding of the supply contract.
2. Unpredictability of Obstacle: The obstacle must not have been foreseeable by the contractor when concluding the contract with the customer. Thus, this condition will limit the exemptions for contracts entered into at a time when it was objectively foreseeable that coronavirus may have an impact on the performance of the contract.[1] Determination of the degree of predictability of this obstacle by the contractor is then dependent on whether the contractor, when concluding the contract, offered professional performance as a member of a certain occupation or profession (then the contractor will be perceived with the perspective of an expert within the meaning of Section 5 (1)) or not (with the perspective of the average individual within the meaning of Section 4 (2)). [2]
3. Insurmountability of Obstacle: Furthermore, it must be an obstacle that the contractor could not objectively overcome even with the best reasonable effort. The degree of insurmountability of the obstacle is then again dependent on the assessment of whether or not the supplier has offered professional performance as a member of a certain occupation or profession when concluding a contract with the customer (see above). This condition will limit cases of exemption from compensation for damages, when it is still objectively possible to meet the delivery date, but at a higher cost, under difficult conditions or through another person. In these cases, the condition of insurmountability of the obstacle will not be fulfilled, and therefore the contractor will not be liberated in relation to damages. Obviously, it is precisely with regard to the overcome or insurmountability of an obstacle that the most frequent disputes will arise between the contractor who wishes to relieve himself of the obligation to compensate the damages due to failure to meet the deadline. The burden of proof regarding the assessment of an obstacle as insurmountable shall lie with the contractor. He will have to prove that, for example, the extraordinary measures against the spread of coronavirus have affected his production so much that even when reasonably foreseeable measures to meet the delivery date were taken, it was not possible to meet the delivery deadline (e.g. because the contract could not be subcontracted, the operation of subcontractors was similarly limited by this obstacle, etc.). As the burden of proof is on the contractor, it is recommended to obtain sufficient evidence on the insurmountability of the obstacle (e.g. communication with subcontractors who refused to execute the demanded job due to lack of labor force, etc.).
4. Independence of Obstacle on Contractor's will: It must therefore be an obstacle which arose without the contractor's involvement. If a contractor takes certain precautionary measures, for example by limiting his own operations at his own discretion (although there is no urgent need), this will generally not be an obstacle independent of the contractor's will, as he himself has decided to adopt such measure (and thus caused the impossibility of contract performance).
5. At Time of Occurrence of Obstacle (e.g. quarantine measures) Contractor Shall Not Be in Delay with Fulfillment of Obligation to Deliver Goods in Time. If the contractor was already in delay in complying with his obligation when the anti-coronavirus measures that paralyzed his operation were introduced, the law does not provide him with the option of liberating himself, since he could meet his obligation in time to avoid the obligation to compensate for damages.
6. Contract with Customer Must Not Include Contractor's Obligation to Overcome Obstacle. For example, the contract with the customer must not include provisions that the contractor undertakes to meet the deadline of delivery even in the event of an outbreak or pandemic or ordering public law measures against the spread of infection, etc.
7. Obstacle Must Not Arise from Contractor's Personal Circumstances. Another potentially problematic condition that must be fulfilled in order to exempt the contractor from liability for damages due to a breach of contractual obligations is that the obstacle does not arise from the contractor's personal circumstances. If the employer's operation is restricted as a result of quarantine measures affecting its employees, it will be necessary to investigate in more detail what was the reason for applying these measures (e.g. whether they were returning from a risk-area holiday or were sent there for a business trip by the employer despite the employer's knowledge of possible escalation of the infection).

As can be seen from the above-mentioned, coronavirus, as a temporary obstacle, may relieve the contractor from the obligation to compensate damages due to delay in meeting the contractual obligation, nevertheless the customer will still retain the option of withdrawing from the supply contract due to the contractor's delay (constituting a material breach of contract) or to require the contractor to pay contractual penalties (if applicable).

How Can I Demand Changes or Cancellation of Contract?

Coronavirus, including accompanying measures aimed at preventing its spread, represents a so-called substantial change in circumstances that can be characterized as a kind of extraordinary change in the external nature. Commentary literature also includes epidemics and quarantines as such a change.[5]

If there is such a substantial change in circumstances, the Civil Code provides in Sections 1765 to 1766 the possibility of the affected party to claim adaptation of the content of the contract to this change (e.g. the extension of delivery date).

However, the application of the provisions of Sections 1765 to 1766 of the Civil Code is often excluded or at least limited, whereby the contracting parties usually confirm that they assume the risk of a substantial change of circumstances. However, if the parties do not assume the risk of a material change of circumstances, the following conditions must be met (and proven by the contractor) for the successful implementation of the procedure of the party concerned to achieve the change or even cancellation of the contract:

1. Existence of Substantial Change of Circumstances. Coronavirus and other related measures can be found to meet the definition of a substantial change in circumstances. However, their impact on the contractor's obligations towards the customer must be so intense that a gross disproportion will arise (see below). Contrary to the case of liberation in the context of damages for breach of contractual obligations, a substantial change in circumstances may also consist of changes in the contractor's personal and property circumstances. [6]
2. Unpredictability of Substantial Change of Circumstances. A change in circumstances (represented by coronavirus and related quarantine measures) must be unpredictable, similarly as in the case of liberation from compensation of damages for breach of contractual obligations for contractors (at the time of conclusion of the contract). In this case too, the determination of the degree of predictability of this change in circumstances will depend on the assessment of whether or not the contractor has offered professional performance as a member of a certain profession or occupation (then the contractor will be perceived with the perspective of an expert within the meaning of Section 5 (1)) or not (with the perspective of the average individual within the meaning of Section 4 (2)).
3. Independence of Substantial Change of Circumstances on Contractor's Influence. The change in circumstances caused by coronavirus and its consequences must not result from the contractor's actions but must be an external cause and cannot be influenced by him. Apparently, a situation where the contractor, as an employer, would restrict the operation of his business (although there is no urgent need) and consequently not meet the agreed deadlines would not constitute a substantive change in circumstances.
4. Occurrence of Substantial Change of Circumstances or Knowledge of Such change Must Occur After Conclusion of Contract. Furthermore, the general rule that must be generally fulfilled is that the change of circumstances occurred or became known to the contractor after the conclusion of the contract. Probably it may also be allowed that a change in circumstances may have existed objectively at the time of the conclusion of the contracts but its impact on the parties' rights and obligations could not reasonably have been anticipated by the parties or the party concerned (e.g. when the coronavirus infection was in its bud on another continent but the contractor could not predict its spread and impact on the contract). However, the burden of proof of such lies on the contractor, The controversial question is whether the application of Sections 1765 - 1766 of the Civil Code can be demanded by the contractor in a situation when a substantial change in circumstances occurred at the moment when he was already in delay with the delivery of goods. In view of the fact that the provisions in question constitute an exception to the general rule that the contracts are binding (pacta sunt servanda), it may be concluded that the application of those provisions is precluded if the contractor is in delay. An earlier case-law (ruling of the Supreme Court of the Czechoslovak Republic from October 21, 1925, Rv I 1122/25), as well as contemporary literature, also tends to come a similar conclusion. [8]
5. Emergence of Particularly Gross Disproportion in Rights and Obligations of Contractor and Customer. In particular, in the context of coronavirus, a particularly gross disproportion in the contractor's obligations towards the customer emerges due to the fact that the contractor will be disadvantaged under by disproportionate increase the costs of performance on his part (e.g. a sharp increase of the costs of timely delivery with regard to the lack of labor force, where the business is significantly affected by mandated quarantine, etc.).
6. Causal Link Between Substantial Change in Circumstances and Emergence of Particularly Gross Disproportion. The contractor must also prove that the gross disproportion in his and the customer’s rights and obligations is caused by the substantial change in circumstances (quarantine).

If all these conditions are met, the contractor is entitled to require the customer to resume contract negotiations, whereas the customer against whom is this right exercised is obliged to do so. The purpose is to renegotiate the content of the contract and to take into account changes that have occurred in the interim. The motivation of the customer to find consensus when changing or canceling the contract is then reinforced by the fact that if no agreement is reached, the contractor has the right to seek change or cancellation of the obligation in court.

If One of the Parties Refuses to Act, There Is Risk of Court!

Therefore, if the customer fails to fulfill his obligation to renegotiate the contract, or if the parties are unable to reach an agreement within a reasonable period of time, each party has the right to file a claim to the court for a change of obligation or cancellation according to Section 1766 (1) of the Civil Code. In such a case, the court may make a constitutive decision either to change the obligation by restoring the balance of the parties' rights and obligations (e.g. by extending the delivery date, imposing the customer's obligation to pay the increased costs of delivery of the goods, etc.) or canceling the obligation altogether.

However, this submission must be filed within a reasonable period of time stipulated by Section 1766 (2) of the Civil Code, set under a rebuttable presumption as two months from the moment when the contractor had to learn about the change of circumstances. The deadline is precluding, so if it is not met, the petition will be rejected by the court. Similarly, the court will decide if the submission is filed prematurely, i.e. at a time when the reasonable period for negotiating the contract has not yet expired.

The advantage of this procedure is its acceptable cost, where:

1. the court fee for such submission, which needs to be regarded as a motion to change status, is, according to the Item 4, point 1 c) of the fee tariff, CZK 2,000
2. the tariff value would be determined in accordance with Section 9 (1) of the Decree of the Ministry of Justice No. 177/1996 Coll. as CZK 10,000 and one act of a lawyer in case of failure in the dispute would therefore be CZK 1,500.

Sources: 

[1] Decision of the Court of Justice of the European Union from February 5, 1985, C-145/85 Denkavit, point 11.

[3] PETROV, Jan et al. Civil Code. Commentary. 2nd edition. Praha: C. H. Beck, 2019, pp. 3034.

[4] HULMÁK, Milan et al. Civil Code VI. Law of obligations. Special section (Sections 2055-3014). 1st edition. Praha: C. H. Beck, 2014, pp. 1565.

[5] Ibid. pp. 222.

[6] Ibid.

[7] PETROV, Jan et al. Civil Code. Commentary. 2nd edition. Praha: C. H. Beck, 2019, pp. 1835.

[8] Ibid., pp. 222; PETROV, Jan et al. Civil Code. Commentary. 2nd edition. Praha: C. H. Beck, 2019, pp. 1835.