| Article | May 2020 | Financer Worlwide |
In March 2020, as a result of the coronavirus (COVID-19) pandemic, Spain declared a state of alarm, ordering a general lockdown and a stay at home policy in the country. The slowdown in the economy caused by COVID-19 and the lockdown has dramatically impacted many companies.
The working capital of companies operating in a wide range of industries has plummeted, and market conditions in some sectors have significantly changed (e.g., a rise in the price of certain goods, restrictions on movement and hospitality industries closed) placing enormous strain on many companies. Such overwhelming disruption has resulted in many companies being unable to meet their contractual obligations under their business agreements as they become due.
In this context, it is worth considering whether parties are entitled to request a modification of the terms of their business agreements and adapt them to the current circumstances, or even to temporarily or permanently suspend the performance of their contractual undertakings. The main legal doctrines available in Spain on this matter are force majeure and rebus sic stantibus. The latter is not expressly set forth in law but is being applied by Spanish case law. Even though Spain has not enacted specific legal provisions that are generally applicable to business agreements in the COVID-19 environment, it should be mentioned that, as an exception, a legal provision has been passed (Royal Decree-Law 15/2020, of 21 April) that permits, since 23 April, some tenants of business premises to request postponement of rent payment subject to certain requirements.
A proper analysis of the remedies available to companies struggling with the current situation ought to be guided by scrutiny of the terms of their particular agreement and the circumstances surrounding purported non-performance (e.g., the specific industry or due time for the performance). Force majeure and rebus sic stantibus doctrines will not necessarily apply to all agreements affected by COVID-19, nor with the same consequences.
In Spain, “outside the cases explicitly mentioned in the law, and those in which the obligation were to require it, no one shall be liable for events which cannot be foreseen or which, being foreseeable, are inevitable” (art. 1105 of the Spanish Civil Code).
Royal Decree-Law 8/2020, of 17 March, has deemed the COVID-19 pandemic as force majeure for certain purposes. So, in some cases, it could be argued that the pandemic may exonerate a party whose performance proves to be impossible in the current state of affairs (but it is worth noting that such exoneration does not apply to payment obligations).
In a similar, though much less serious situation, the ‘influenza A’ pandemic was regarded by Spanish case law as force majeure, discharging liability to a cruise ship company that could not depart due to the ‘influenza A’ pandemic. Nevertheless, today, the pandemic may render performance of a contract impossible during confinement. However, once it is lifted and commercial activity reactivated, it may be possible to perform. In these cases, the force majeure doctrine may be used to suspend the contract rather than terminate it.
Rebus sic stantibus
Rebus doctrine, narrowly applied by Spanish courts, entails the amendment or termination of a contract due to an unpredictable event. This ultimately makes performance too burdensome or significantly more expensive than initially agreed. This doctrine applies especially to long-term contractual relationships.
To apply this doctrine, the following requirements need to be met: (i) an extraordinary alteration of the circumstances at the time of performance of the contract concerning those prevailing at the time of its formation; (ii) an unusual disproportion in the performances of the parties, breaking the balance among them; (iii) the occurrence of a radically unforeseeable event; and (iv) no other remedies available to overcome the situation.
Other legal systems foresee similar doctrines concerning the review of contracts meant for supervening the alteration of circumstances (e.g., the frustration doctrine in the UK) and similar rules can also be found in proposals for harmonisation of European contract law.
Taking into account that a case-by-case analysis is required, it is recommended that the party affected by the coronavirus crisis that cannot perform takes the following actions to avoid liability.
First, analyse whether the pandemic results in the impossibility of performance (force majeure) or in an extraordinary and unforeseeable alteration of the circumstances making the contract too burdensome (rebus sic stantibus).
Second, give notice as soon as possible to the other party of the impossibility or extraordinary difficulty of performance.
Third, communicate fluently with the other party to explore whether a new agreement is possible.
Fourth, communicate in writing to provide evidence in case the breach of contract results in a lawsuit.
Fifth, analyse the wording of the agreement, as both doctrines are subsidiary remedies. They are only applicable if there is no risk allocation clause, placing the risk of an occurrence of an event on one of the parties. It should be noted that material adverse change (MAC) clauses are regularly included in financing agreements and M&A deals. Their wording needs to be analysed carefully.
Sixth, analyse thoroughly any insurance policies entered into by either party to discover whether they cover any damages triggered.
Seventh, mitigate reasonable damages caused by the breach of contract. Otherwise, creditors may bear the consequences of unmitigated damages.
Finally, the emergence of COVID-19 and its worldwide impact has made the world aware of this threat. This may mean that, in the near future, additional lockdowns may be ordered within the de-escalation phase. This should be kept in mind when negotiating contracts going forward since new lockdowns will not necessarily be deemed unforeseeable events for force majeure and rebus sic stantibus purposes.
Article published by Financier Worldwide.