Coronavirus no longer considered an unforeseen circumstance for future contracts

March 31, 2020 | Blog

The coronavirus (COVID-19) is having an enormous impact on every aspect of daily life, not least on the business community. It is far from the first crisis global business has faced, though. The 2008 credit crunch is still a fresh memory, but companies have also suffered hardship at the hands of the SARS and bird flu epidemics. These crises and the case law emanating from them warrant several conclusions. Use them to your advantage, for the law is not always black and white, unfortunately. Your rights and obligations to your suppliers, customers, principals and/or contractors depend very much on the circumstances. The examples in this blog should provide helpful guidance for anyone struggling with questions on ongoing and future contracts, informing you of possible action to limit the commercial fallout - that is, the possible damage and losses - caused by the coronavirus crisis.

Changed circumstances

Like other crises before it, the coronavirus is having a huge impact. The manufacture of certain products has stalled or even stopped, making it impossible for suppliers to meet their obligations to supply. Market demand for products has dwindled or market prices have dropped, with customers having a reduced need or no need at all for products and/or services (at the agreed price).

We saw the same response when the credit crunch hit - building projects were shut down, purchases of plots of land cancelled, etc. - and after the bird flu epidemic - eggs were in lower demand, if at all, and prices went south. The credit crunch, which started in 2007/2008 and impacted the Dutch retail sector (among other sectors) for quite a long time, taught us that it makes sense for parties about to enter into a contract to anticipate on any future market fluctuations by incorporating financing restrictions, conditions subsequent, cancellation clauses, deferment options, hardships clauses, renegotiation clauses or price review clauses. Our advice would be to make use of such options and clauses when entering into new contracts, for the current uncertainty is sure to last.

Prevention

Parties should avoid entering into contracts they know or can reasonably foresee will not be performed. Any manager entering into an obligation on behalf of the company whilst he knows or should reasonably understand that the company will not be able to perform the obligation or offer any recourse for any damage/loss suffered as a consequence of this failure to perform runs the risk of liability. In such an event, the manager will be personally liable if blame is attributable to them on the ground that the legal entity’s failure to perform was foreseeable at the time of entering into the obligation.

Dependence

The coronavirus crisis has helped the Netherlands face the facts, which are that for the production and supply of a whole range of products we are dependent on suppliers from other countries. There are no companies in the Netherlands producing face masks, for example, another example being the recent shortage of raw materials for medicines. Our advice would be to avoid being dependent on a single supplier, a single customer, or on suppliers based in a single country. Of course, there are cases where having a second supplier is simply not possible. Examples would be where intellectual property rights prevent going elsewhere or the knowledge required is so specific that only one party can provide it. However, where possible, ensure dual sourcing for your purchases and, conversely, when selling ensure a good customer spread or broaden your market.

SARS

It is important to note that these days the coronavirus is no longer an unforeseen circumstance for parties wishing to enter into contracts. In a recent arbitration, the China International Economic & Trade Arbitration Commission denied a force majeure defence - more specifically a defence based on Article 79 of the Vienna Sales Convention (CISG). In the case under review, SARS impacted the production and operation of the seller, making it impossible for the seller to perform its obligation under a contract of sale and purchase. The SARS virus outbreak occurred two months before the contract was executed. Given these circumstances, the SARS outbreak no longer constituted an unforeseen/unexpected event. The arbitrators held that at the time of entering into the contract the seller had had sufficient opportunity to take the impact of SARS in China into account, and ruled the outbreak not to be an impediment beyond his control.

Risk management

It follows that you should take epidemics into account when entering into new contracts. Make risks manageable. Incorporate clauses explicitly stipulating that epidemics or pandemics are (or are not) considered events of force majeure and stating the specific rights and/or obligations of the parties. Does a circumstance constitute an event of force majeure only if there is no possibility to perform or also if (partial) performance would be considered unreasonably onerous on one of the parties as a consequence of a specific impediment to performance? A good clause to include would be one stating whether a supplier is entitled to adjust his prices if circumstances occur that increase his purchase prices? You could agree that a supplier is required to keep minimum stocks in order to absorb temporary issues with his suppliers, thereby ensuring that he can continue to fulfil his obligations to you throughout that period. If supplies are delayed, would it be justified for the customer to determine a different mode of transport (by air instead of by ship, for example) and who is liable for the costs in that case? These and other issues demand consideration and ironclad agreements. There is more to consider, however, such as notification. For example, is an obligor facing an impediment beyond his control causing him to fail in the performance of his obligations obliged to notify the other party of this impediment and the consequences? And must notice be given immediately? What are the consequences of a failure to notify?

Article 79 CISG explicitly provides for an obligation to notify. If CISG applies and the parties have chosen not to depart from CISG and if the notice is not received by the other party within a reasonable time, the obligor will be liable for damages resulting from such non-receipt. This means that the obligor will be liable to pay the additional losses ensuing from the circumstance that the other party is prevented from seeking timely alternatives or conclude a substitute transaction. If a supplier anticipates being unable to deliver (or deliver in a timely fashion), it is recommended in some cases to give timely notice to the other party and alert this party to its duty to mitigate loss. The reasons for this have been mentioned above.

Force Majeure

The Dutch Civil Code (DCC), more in particular Section 6:75 DCC and the “unless” provision of Section 6:74 DCC, affords obligors a force majeure defence - subject to circumstances. If such defence is successful, the consequences are (i) that any claim for performance will be denied (temporarily or permanently), (ii) that an obligee is not entitled to damages if the failure in performance cannot be attributed to the obligor, and (iii) that the obligee is entitled to give notice of termination of the mutual contract from which the unperformed obligation arises, in consequence of which the obligee is released from his own obligation, such as an obligation to purchase or make payment. Another option, and one which is frequently exercised, is for parties to a contract to incorporate clauses departing from Sections 6:74 and 75 and Article 79 CISG, and restrict or expand their rights or specify events of force majeure, for example. The question is, though, whether failures in performance caused by the coronavirus do or do not constitute events of force majeure within the meaning of the law?

Performance

In principle, where disease was foreseeable at the time of contracting, the force majeure defence will not stand. Where the obligation need not necessarily be performed by the obligor (Section 6:30 DCC), such as the supply of specific goods, disease - caused by the coronavirus - will not constitute an event of force majeure in all instances. Courts have decided in cases that obligors could have engaged third parties to perform the delivery, for example. Of course, this is a different story where the obligation must be performed by the obligor (a Marco Borsato concert, for example). This does represent an instance of disease constituting an impediment, the general consensus being that this impediment cannot be attributed to the obligor. What needs to be assessed is whether the legal measures and the emergency regulations adopted to combat the coronavirus constitute an impediment to the performance of the obligation.

In 2003, Dutch authorities imposed restrictive measures following the outbreak of fowl pest. This resulted in several court actions over payment obligations between the suppliers of hatching eggs and hatcheries - farms where eggs are hatched under artificial conditions. In many cases, hatcheries raised force majeure defences, which the courts denied. The premise is that obligations must be performed. The hatcheries had purchased the eggs, which fulfilled the purchase obligation. If there were any inability to pay on account of cash flow problems, it would constitute a circumstance that, according to the then prevailing opinion, should be for the account of the party unable to pay, several District Courts and Courts of Appeal held. In conclusion, the law did not consider the various cases to constitute events of force majeure and that the hatcheries had to perform their payment obligations.

Contractual force majeure clause

In the current coronavirus crisis, the interpretation and scope of a contractual force majeure clause are the factors deciding whether a party can successfully rely on force majeure. The importance of a sound contractual force majeure clause was reinforced in a case under the Arnhem Court of Appeal. The contract over which the parties disputed read “Where in an event of force majeure (war, for example) the consequence is that prices drop sharply, the parties will confer.” When in 2003 there was an outbreak of fowl pest, the supplier of chicken hatching eggs continued to supply eggs to the hatchery, save for a stand-still period. The hatchery sell the chicks to fattening farms. During the fowl pest crisis, prices for chicks dropped, whereas the Astenhof price - a fixed price - for hatching eggs remained level or, in fact, rose slightly. Generating revenue from the sale of chicks, the price drop had in impact on the hatchery. It decided to pay a purchase price for the eggs that was below the Astenhof price - which they were not justified to do. The Court of Appeal held that the contract as such was clear: the hatchery has to pay the Astenhof price for the hatching eggs. The contractual force majeure clause offered the hatchery no solace. In this particular case, after all, the contractual force majeure clause did not provide for the case where one party was unable to perform a contractual obligation (the event where, according to statute, an impediment to performance occurs) but only to the event where the general situation is such that either party or both parties cannot fulfil their contractual obligations, such as the fowl pest crisis. In addition, in relying on this clause, the hatchery can only claim that the parties enter into negotiations; it may not claim a - unilateral - price reduction. After all, the clause provides for negotiations in an event of force majeure, but does not set out the details. Also, it was mentioned before that the law did not consider this an event of force majeure.

Unforeseen circumstances

Section 6:258 DCC affords courts the possibility, upon the request of either of the parties, to modify the effects of a contract or to set it aside in whole or in part on the basis of unforeseen circumstances which are of such a nature that the other party, given those circumstances, cannot expect, in accordance with generally held standards of reasonableness and fairness, the unaltered contract to continue to be valid and enforceable. The court may grant such modification or setting aside a retroactive effect. However, the court must not grant modification or setting aside of any part of the agreement to the extent that the person invoking the circumstances is accountable for them pursuant to the very nature of the agreement or pursuant to generally accepted principles. Courts have tended to grant request for modification or setting aside on the basis of unforeseen circumstances in (highly) exceptional cases only, the success of a case depending on the substantiation of the claim. It follows that case law on this point is highly casuistic. A case in point is the one between the operator of a poultry farm and an egg wholesaler, which case went to the Court of Appeal in 's-Hertogenbosch. The court held that the parties to this case had not provided for a circumstance as the outbreak of the fowl pest. Thus, the fowl pest outbreak and any consequences thereof can be considered to be unforeseen circumstances within the meaning of Section 6:258 DCC. It follows from the parliamentary history of the law and from case law that courts should exercise restraint in assuming unforeseen circumstances. The 's-Hertogenbosch Court of Appeal judged that the wholesaler had provided insufficient substantiation for its arguments that the circumstances were such that it could not expect the unaltered contract to continue to be valid and enforceable. It would have been incumbent on the wholesaler to provide factual information about the financial consequences of storage, the amounts paid to market players by way of compensation, etc., which would have enabled the court to make an adequate consideration of the matter in light of the principle of reasonableness and fairness. The wholesaler had failed to provide such information, so its appeal was denied.

Obligee's force majeure

We have no way of knowing what new measures will be imposed in the fight against the spread of the coronavirus. Although the EU external borders are closed, the passage of goods is exempted.  But as soon as government restrictions make the purchase of goods or services impossible, relying on obligee's force majeure may offer a way out. In a case also involving the fowl pest outbreak, the Arnhem District Court allowed a hatchery unable to purchase eggs to make this argument. As a result of government restrictions in place to combat the fowl pest outbreak, the hatchery was not allowed to have the eggs transported to its site, as that site was in a restricted area. Thus, performance of the purchase obligation was prevented by an impediment on the part of the hatchery in its capacity as obligee. If this impediment - a legal prohibition - can be attributed to the obligee, the obligee is in default [in Dutch: schuldeisersverzuim]. If this impediment cannot be attributed to the obligee, the event constitutes obligee's force majeure [in Dutch: schuldeisersovermacht] (Section 6:58 DCC). The Arnhem District Court held that the failure to accept the performance offered as a result of the legal prohibition could not be attributed to the hatchery. This failure in performance cannot be attributed to the hatchery if it is neither due to its fault nor for its account pursuant to the law, a legal act or generally accepted principles (cf. Section 6:75 DCC). A sudden and unforeseeable order, made for the purpose of combating the fowl pest outbreak, to cease operations in full and to destroy all eggs and chicks present and a prohibition against the transport of eggs and chicks to and from the company site is not, pursuant to generally accepted principles, for the account of the obligee unable to purchase eggs as a consequence of such order/prohibition, least of all if in the obligee's undertaking no positive test for fowl pest was made. This judgment is in line with the compensation scheme established by the government, pursuant to which companies such as the hatchery were entitled to compensation of disproportionate losses, which should not be for their account. The Arnhem District Court allowed the hatchery's reliance on obligee's force majeure. The legal consequences of obligee's force majeure are not encoded in Dutch law. Rather, the principle of reasonableness and fairness applies. The hatchery could have claimed modification or the setting aside of the contract on the basis of unforeseen circumstances (Section 6:258 DCC), but did not do so. The court interpreted the position of the hatchery to mean that it argued that according to the principle of reasonableness and fairness of Section 6:248 DCC it was unacceptable for the unaltered contract to continue to be valid and that the supplier of eggs had to settle for a lower price per egg. The court allowed the reliance on the restrictive effect of reasonableness and fairness.

In another case, involving a hatchery that could and did purchase eggs, the Zutphen District Court for the same reason disallowed the hatchery's reliance on obligee's force majeure. It did, however, consider it unacceptable according to the principle of reasonableness and fairness to force the hatchery to abide by the payment obligation arising from the contract. After all, if the hatchery had been unable, as a result of government measures, to find enough fattening farms that would purchase the chicks hatched from the eggs, it would have been unable to perform its contractual obligation to purchase the eggs as the consequence of an event of force majeure. This event of force majeure would have resulted in the loss suffered by the obligee due to the failure to purchase any or not all of the eggs would have been for the account and risk of the obligee. After all, if that had been the case, it would have been obligee's force majeure. However, the hatchery went to great lengths - also in its own interest - to find sufficient other fattening farms. Given these circumstances, it would be unreasonable and unfair to allocate the full risk of the consequences of the fowl pest outbreak to the hatchery. For this reason, only part of the purchase price as claimed was allowed, and both parties had to bear part of the risk. It follows that even the restrictive effect of reasonableness and fairness can offer a way out.

Good reasons to suspect that the other party will fail in its performance?

If you suspect or fear that your supplier or contractor will not be able to perform its obligations in time, you are well-advised to seek clarity well in advance, enabling you to anticipate on events. An obligee having good reasons to fear that the obligor will fail in its performance may send the obligee a warning as meant in Section 6:80(1)(c) DCC. If the obligor does not comply with this written warning indicating those reasons and requesting the obligor to declare that he is willing to perform his obligations within a reasonable period specified in that warning, the obligee may, in anticipation of the exigibility of the claim, claim compensation in lieu of performance or give notice of premature termination of the contract between them.

If you have good reasons for such fear, beware of making any advance payment. Section 6:263 DCC entitles the party who is bound to perform first to suspend performance of its obligation if circumstances have come to its attention after the entry into the contract, giving it good reason to reckon that the other party will not perform its corresponding obligations.

In conclusion

Far from being exhaustive, the above summary of possibilities and case law is meant to provide some guidance. If you have any questions, do not hesitate to contact Barbara Mutsaers (088-253 5633). Barbara and her team are ready to answer any questions on contracts and disputes arising out of them, and they have ample experience drafting complex national and cross-border commercial contracts. Remember: an ounce of prevention is better than a pound of cure.

 

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