Update | Rights for debtors to refuse performance in the Corona crisis – creditors can take countermeasures

What is at issue here?

The German Bundestag has passed the act to mitigate the effects of the Covid 19 pandemic. Among other things, this provides for rights of refusal of performance for consumers and small enterprises (fewer than 10 employees and annual turnover totalling a maximum of EUR 2 million). These are to be given the right to refuse the fulfilment of the obligation to satisfy a claim in connection with a continuing obligation until 30 June 2020 if the obligation cannot be fulfilled as a result of the corona crisis or if the fulfilment leads to a threat to the existence of the debtor. The prerequisite is that the relevant contract was concluded before 8 March 2020. Generally, all agreements with continuing obligations are affected, except for rental, lease, loan and employment contracts.

What is to be done from the creditor’s perspective?

In practice, especially medium and large enterprises that have entered into continuing obligations with consumers and micro-enterprises before 8 March 2020 must therefore be prepared for defaults. Since the act does not differentiate according to which side the debtor is on, both payment defaults and default on performance can threaten companies. From the creditor’s perspective, there are now two options. Either the creditor accepts this fact and trusts that the debtor will fulfil its obligations properly. Or the creditor prefers an active approach. For example, it may make sense to renegotiate contracts that were concluded before 8 March 2020. In this way, one can evade the scope of application of the draft law. Especially as long as the debtor is still well off, he might be accept such renegotiation. After all, the parties are only renegotiating what both parties currently want.

Act to mitigate the consequences of the COVID-19 pandemic

The German Bundestag today unanimously adopted the act to mitigate the consequences of the COVID-19 pandemic in civil, insolvency and criminal proceedings in expedited legislative action. With this, the extensive protective measures for companies and private individuals, which the Federal Government already recommended on Monday, will enter into force soon. The law now only has to be approved by the Bundesrat and executed by the Federal President, which is generally regarded as a formality.

If you want to know more about the detailed contents of the passed legislation make sure to check out our detailed reports.

Insolvency: https://blog.actlegal.com/the-planned-changes-by-the-act-to-mitigate-the-consequences-of-the-covid-19-pandemic-in-insolvency-law/

Corporate: https://blog.actlegal.com/the-planned-innovations-in-company-law-resulting-from-the-act-to-mitigate-the-consequences-of-the-covid-19-pandemic/

Commercial/Supply Chain: http://blog.actlegal.com/rights-to-refuse-performance-for-debtors-in-the-corona-crisis-planned-creditors-can-take-countermeasures/

Banking/Finance: http://blog.actlegal.com/corona-crisis-special-features-of-lending-law-from-the-banks-perspective/

Rights for debtors to refuse performance in the Corona crisis planned – creditors can take countermeasures

What is at issue here?

The German government plans to introduce a law temporarily suspending the obligation to file for insolvency and limiting the liability of organs in the event of insolvency caused by the COVID 19 pandemic. The law is to be passed in the short term and provides, among other things, for rights of refusal of performance for consumers and small enterprises (fewer than 10 employees and annual turnover totalling a maximum of EUR 2 million). These are to be given the right to refuse the fulfilment of the obligation to satisfy a claim in connection with a continuing obligation until 30 June 2020 if the obligation cannot be fulfilled as a result of the corona crisis or if the fulfilment leads to a threat to the existence of the debtor. The prerequisite is that the relevant contract was concluded before 8 March 2020. Generally, all agreements with continuing obligations are affected, except for rental, lease, loan and employment contracts.

What is to be done from the creditor’s perspective when the law comes into force?

In practice, especially medium and large enterprises that have entered into continuing obligations with consumers and micro-enterprises before 8 March 2020 must therefore be prepared for defaults. Since the draft law does not differentiate according to which side the debtor is on, both payment defaults and default on performance can threaten companies. From the creditor’s perspective, there are now two options. Either the creditor accepts this fact and trusts that the debtor will fulfil its obligations properly. Or the creditor prefers an active approach. For example, it may make sense to renegotiate contracts that were concluded before 8 March 2020. In this way, one can evade the scope of application of the draft law. Especially as long as the debtor is still well off, he might be accept such renegotiation. After all, the parties are only renegotiating what both parties currently want.

Legal Consequences of the Coronavirus Epidemic for your Contractual Relationships

Due to the COVID-19 disease, the government declared a state of emergency in the territory of the Czech Republic on March 12, 2020. In this context, the government also issued a series of crisis measures which are published as government resolutions in the Collection of Laws of the Czech Republic. Prohibitions, restrictions, and orders resulting from the state of emergency and crisis measures can have a major impact on individual parties in terms of meeting their contractual obligations. This will be particularly important in the case of long-term customer-supplier relationships, in projects in construction and energy sectors, or for investment projects.

However, the legal consequences of the current emergency situation may vary from case to case. An ongoing epidemic may be a reason to change the contract price, postpone deadlines, or waive the obligation to pay damages. In some cases, the contract may also be terminated. However, these legal consequences may not occur automatically in all cases. Each contractual relationship needs to be assessed individually.

In general, some of the following legal principles may apply in the context of an ongoing epidemic:

  • force majeure (applicable particularly in situations where the proper performance of the contract is hindered by extraordinary and unforeseeable external circumstances);
  • subsequent impossibility of performance (applicable in particular in situations where the contract objectively cannot be performed); and
  • a substantial change in circumstances (applicable particularly in situations where performance of the contract has become extremely disadvantageous to one of the parties).

A more detailed description of these legal principles and the prerequisites for the application thereof can be found in this newsletter. However, it can already be pointed out that the conditions or consequences of force majeure, a subsequent impossibility of performance, or a substantial change in circumstances may (and generally will be, in practice) be regulated individually in the relevant contracts. Therefore, when examining the legal implications of the COVID-19 outbreak to your supplier-customer relationships, it is not enough to only apply statutory rules, but primarily, it is vital to search for relevant arrangements in your contractual documentation.

1) Force Majeure

What is force majeure? There is no legal definition of force majeure in Czech law. Nevertheless, this expression is used in the Civil Code and can also be found in other Czech statutes. Generally, force majeure is considered to be an extraordinary, unforeseeable and insurmountable obstacle that arises independently of the will of the person concerned. In addition to the concept of force majeure, the Czech Civil Code also uses the words “unpredictable circumstance” and “unpredictable and insurmountable cause / obstacle”. In our opinion, it is possible that in a number of legal relationships, the current epidemic of COVID-19 could be considered an event of force majeure. In this context, for the sake of completeness, we would like to point out that force majeure will not apply if a contract has already been concluded at the time of the outbreak or with the knowledge of the ongoing epidemic. In such a situation, it will no longer be possible to regard the COVID-19 epidemic as an unforeseeable event.

What is the result of force majeure? If a force majeure event occurs, it may bring about a number of different legal consequences, which usually take the form of (i) release from a specific obligation, (ii) change to the obligation or (iii) extension of deadlines. According to the Czech legislation, it may include, for example, the following consequences:

  • the obliged party may be released from the obligation to compensate for any damages incurred by the other party;
  • the limitation period may be suspended;
  • a court may decide to increase the price of the work in question if it was determined according to a budget, or to cancel the contract for work in which price was negotiated according to a budget;
  • an entrepreneur may change some of the information in a contract concluded with a consumer which it communicated to the consumer prior to the entering into the contract;
  • an eligible party to a contract may withdraw from the contract if it had the right to choose from several variants of the performance of such a contract, but the possibility of such a choice was frustrated as a result of a force majeure event;
  • the deadlines for submitting a promissory note (bill of exchange) may be extended, etc.

At the same time, it should be noted that a force majeure event does not automatically lead to a release from the obligation to pay liquidated damages (a contractual penalty) to the other party unless such an exemption is expressly agreed in the contract. Indeed, liability for liquidated damages (a contractual penalty) generally (unless expressly agreed otherwise) arises absolutely – i.e. irrespective of fault.

The contractual arrangements for force majeure events are essential. It is customary for the parties to negotiate force majeure clauses in their contracts which govern (i) what specific events are considered to be force majeure events under the given contract and/or (ii) what specific consequences the force majeure has regarding the rights and obligations of the parties. Such individual arrangements will generally take precedence over statutory regulation of force majeure. Each contract must therefore be subject to an individual legal analysis. In this context, please note that some contract templates (e.g. FIDIC) may contain specific clauses governing force majeure events.

Beware of any international element. In the case of contracts with an international element, it is first necessary to consider the law applicable to the contract in question. This is because force majeure legislation may differ substantially from one legal system to another. In addition, it should be noted that some international treaties (e.g. the Vienna Convention on the International Sale of Goods – CISG) may contain their own rules for force majeure events.

How to proceed in case of a force majeure event? As mentioned above, the specific procedure may depend on the contractual regulation of force majeure. In general, however, the following steps may be recommended to a party to a contract affected by a force majeure event:

  • notify the other party without delay that a force majeure event has occurred;
  • carry out a legal analysis of the relevant contract to determine what your course of action should be;
  • continually assess the impact of force majeure on your obligations and provide evidence to help you demonstrate the impact of the force majeure event on your obligations;
  • try to minimize the consequences of the force majeure event.

2) Subsequent Impossibility of Performance

What is the subsequent impossibility of performance? Under the expression “impossibility of performance”, the Czech Civil Code regulates a situation in which the payment of a certain debt or complying with an obligation becomes objectively impossible. In this context, the Civil Code states that performance is impossible if it cannot objectively be fulfilled, not even (i) under difficult conditions, (ii) at a higher cost, (iii) with the assistance of another person, or (iv) after a specified period elapses.

What is the consequence of subsequent impossibility of performance? In the event that a particular performance becomes objectively impossible, the relevant obligation to provide such performance ceases to exist by operation of law. According to the Civil Code, the obligation can also completely cease to exist even if the performance is impossible only partially, but due to the nature of the obligation or the purpose of the contract (which was known to the contracting parties at the date of the contract), the performance of the remaining portion of the obligation is pointless for the entitled party (the creditor).

Contractual clauses on subsequent impossibility of performance. The consequence that an obligation automatically ceases to exist if its fulfillment is objectively impossible cannot be excluded by contract. However, the contracting parties may agree to a wider range of situations when the obligation ceases to exist (e.g. where performance is objectively possible, but only at significantly higher costs). Likewise, the parties may contractually adjust the scope of the liability for damages in the event of subsequent impossibility of performance. Each contract must therefore be subject to an individual legal analysis.

Beware of any international element. In the case of contracts with an international element, it is first necessary to consider the law applicable to the contract in question. Indeed, the rules governing the subsequent impossibility of performance (and, where appropriate, the related compensation) may differ considerably from one legal system to another.

What to do in case of subsequent impossibility of performance? As mentioned above, the specific steps to take in the event of subsequent impossibility of performance may to some extent be regulated by the contract. In general, however, the party the performance by which has subsequently become impossible should immediately notify the same to the other party. In this context, we would like to point out that under the Czech Civil Code, a contracting party which has not notified the impossibility of performance in time is obliged to compensate the other party for any damage caused by such late notification of the subsequent impossibility of performance.

For completeness, we would like to mention that subsequent impossibility of performance may in some cases be caused by governmental measures in crisis or by the announcement of the state of emergency. In such a case, compensation for damages against the state under the Crisis Act can be requested if the statutory conditions are met. You can find more information on this topic in a newsletter of our law firm dealing with this issue.

3) Change of Circumstances

What is a substantial change in circumstances? The legal regulation of substantial change in circumstances primarily regulates a disparity in the rights and obligations of the parties that occurs as a result of a change in external circumstances. Typically, it is a change of circumstances caused by war, a coup, revolution, embargo, boycott or prohibition of certain goods. However, this legislation may be also applied to changes in circumstances caused by epidemics and quarantines.

Legal regulation of substantial change in circumstances relates in particular to longer-term liabilities and facilitates. It makes easier the path to the continuation thereof despite unexpected fluctuations in important external factors. In this context, it should be noted that not every change in circumstances is a reason for a change of the obligation (typically to a contract). The mere fact that, as a result of objective external causes, the performance of the contract becomes less favorable does not alter the continuation of the obligation to perform the contract, even under these difficult conditions. From the point of view of legal implications, only a change in circumstances that brings surprising (extreme) impacts on the partiesʼ position in the contractual relationship (one that does not correspond to any reasonable review and assessment of risks) is substantial.

The Czech Civil Code lays down the following defining features of a substantial change in circumstances that must be met simultaneously: (i) the existence of a change of circumstances; (ii) the unpredictability of the change; (iii) the uncontrollability of the change; (iv) absence of acceptance of a future risk of a change of circumstances; (v) the occurrence of a particularly gross disproportion in the rights and obligations; and (vi) causal link between the change and the emergence of a particularly gross disproportion.

What is the consequence of a substantial change in circumstances? If all the above statutory prerequisites are met, then the affected party has:

  1. primarily the right to pursue a renewal of the contract negotiation (thus, the law urges the parties to reopen the contract, to consider changes that have occurred and to restore the balance that the original distribution of rights and obligations in their original arrangement was aimed at); and
  2. in the event of unsuccessful negotiations of the parties to restore balance, the right to ask the court to modify the content of the obligation by its own decision or to cancel the obligation as of the date and under the conditions specified in the decision.

Contractual clauses on substantial change in circumstances. In the basic statutory regime, the legislation is based on the principle that each contract is concluded subject to a change in circumstances. However, the parties may deviate from this legal regime in their contract. The parties may assume the risk of a change in circumstances and, as a result, bear the costs resulting therefrom. This may include assuming all risks or only some of the risks (e.g. all currency risks, technical, legal, etc.) or risks specifically laid down by the parties. Each contract must therefore be subject to an individual legal analysis of whether and to what extent the risk of change of circumstances has been assumed by either party.

Beware of any international element. In the case of contracts with an international element, it is first necessary to consider the law applicable to the contract in question. The rules governing substantial change in circumstances may, in principle, differ from one legal system to another.

What steps to take in case of a substantial change in circumstances? The party concerned (i) must exercise its right to resume contract negotiations vis-à-vis the other party, (ii) shall state the reasons on which its right is based, and (iii) prove the facts that justify its claim. The said right should be exercised within a reasonable period of time, which – as the default – the Civil Code regulates to be no later than two months after the party must have ascertained the change in circumstances. The consequence of this deadline elapsing in vain is that the party concerned loses the right to demand the subsequent restoration of the contractual balance by a court.

What to do (preventively) if the Coronavirus paralyses the business?

The coronavirus is currently hitting the headlines worldwide. The German economy is already feeling the effects because many production facilities, especially in China, are no longer able to supply and business with other Chinese partners is also faltering considerably. If the coronavirus continues to spread epidemically in Germany, the economic impact in Germany and Europe will be even more drastic.

In particular, internationally operating companies must be prepared for the coronavirus to have a temporary negative impact on their own business, regardless of whether the underlying cases of the disease are to be found within their own ranks or with business partners or anywhere else in the supply chain.

Many companies are already receiving large numbers of force majeure notices from suppliers. These ads are likely to become commonplace in the near future.

In this context, the question arises as to whether and to what extent the coronavirus leads to a suspension of suppliers’ obligation to supply and what steps the affected customers must take to avoid errors and major damage, possibly even threatening their existence, as far as possible.

Legal classification

Usually, national as well as international supply contracts contain so-called force majeure clauses, which provide that in cases of force majeure the supplier’s obligation to deliver is temporarily suspended. In return, the customer is regularly entitled to terminate the supply contract extraordinarily if the delivery stop exceeds a period agreed in the force majeure clause.

In this context, it must first be examined whether the specific supply contract is to be assessed at all under German law. The following statements apply exclusively to this case. If, on the other hand, the supply contract is subject to another legal system, an examination must be carried out on the basis of the foreign law applicable in each case.

German law does not contain any special provisions on cases of force majeure. Courts must therefore refer to the general regulations when assessing obstacles to performance. In principle, the following applies: Whether a case of force majeure exists is, according to case law, strongly influenced by the individual case. As far as is known, there is no comparable reference case in German jurisdiction to date in which a decision has ever been made as to whether a failure to supply as a result of a pandemic outbreak constitutes a case of force majeure. Only travel contract law and UN sales law recognise that epidemics fulfil the requirements for classification as force majeure.

There are certainly good arguments for classifying the outbreak and the consequences of the coronavirus as a case of force majeure, also in the context of supply contracts. But that is not certain.

What is clear, however, is that a case of force majeure will in any case only be present if the supplier cannot avoid the delivery stop, i.e. if the supplier cannot eliminate the delivery stop with reasonable measures.

Important from the supplier’s perspective

Against this background, the primary concern for suppliers is to ward off customer terminations of supply contracts and claims by customers for damages or payment of contractual penalties due to failure to deliver. In doing so, the supplier should not rely on a mere display of force majeure at the time of its inability to deliver:

Firstly, this is not the case because in practice most force majeure clauses do not explicitly provide for pandemics as a case of force majeure.

Secondly, in a possible later legal dispute a court will ask whether the supplier has taken all reasonable measures to prevent the failure to deliver. The supplier who “with his eyes open” for a long period of time does nothing, despite the ever-increasing Corona problem, until his own inability to deliver is established, will not be able to stand up to this question. On the supplier side, it is therefore already important to look into alternative possibilities for securing one’s own ability to supply. This includes, for example, identifying alternative resources and transport routes in good time, drawing up emergency plans within the company, etc. It is advisable to document the search for and results of alternative possibilities accordingly. If the supplier is able to present a comprehensible and verifiable argument in later disputes (also in court), liability can also be excluded due to lack of fault. In this case one must know: It is also reasonable for the supplier to take measures even if they involve additional financial expenditure for him, for example in the form of higher transport costs due to the changeover from sea to air freight. Similarly, customers can demand the procurement of replacement goods as a reasonable measure.

Thirdly, the supplier should inform his customers in good time of any concretely emerging delivery bottlenecks, even if he is not expressly contractually obliged to do so. This is because such information enables the customer to prepare for the delivery shortfall and to avert his own damage early and as effectively as possible. This can have just as much of a damage-reducing effect as allowing the customer to participate in the development of solutions to problems and to have a say in decisions.

Important things from the customer’s point of view

From the customer’s point of view, it is a high priority to avoid own damages as far as possible or to hold the supplier harmless. Since the supplier does not owe any compensation in the event of a delivery stop, if it is a case of force majeure, and since customers must also probably also prepare themselves for the fact that their risk of default is likely to increase, even in the case of justified claims against suppliers, if suppliers see their existence threatened as a result of the claim, customers should prepare themselves as early as possible for the possibility of delivery stops due to the coronavirus. If a customer wants to keep open the possibility of taking action against a supplier due to a delivery failure at a later date, he is advised to document any damage that occurs as well as possible. After all, it is ultimately the customer who must explain and prove in detail all breaches of duty by the supplier and the resulting damages in order to successfully assert claims.