The impact of the novel coronavirus (COVID-19) outbreak has been widespread with implications for multiple sectors of the global economy. We set out below some practical steps businesses could take to assess potential upheaval and identify some implications of coronavirus for contracts governed by Spanish law.
What practical steps can I take now?
With this rapidly developing situation, it is important to closely monitor its business impact and how it may affect your contracts. Some practical steps that may be taken include the following:
- assess whether COVID-19 could have any concrete impact, factually speaking, on the performance of obligations under contracts currently in force and take reasonable steps to work around the identified risks or discuss them with your counterparty. As a first step, the contractual terms of the relevant contracts should be analyzed to see: (i) whether the contract foresees the possibility of situations such as the one we are experiencing, (ii) whether COVID-19 would fall within its ambit, and (iii) whether the contract specifies the corresponding consequences that such a situation would give rise to;
- consider whether the contracts are subject to any specific law that expressly provides for the consequences of unforeseeable and unavoidable circumstances;
- where you can perform some but not all of your contracts, think carefully about which contracts you prioritise, bearing in mind applicable laws and relevant contractual provisions;
- in a supply chain context, identify whether you are dealing with different laws applying to different points of the chain and what that means in relation to the overall performance of the contract. If your supply chain is exposed to the effects of the outbreak, line up fall-back options;
- consider whether your insurance policies cover the outbreak or its knock-on effects;
- assess what rights you have and what you need to do to protect them. For example, be aware of notice requirements that are preconditions to exercising a force majeure clause or insurance protection;
- collate evidence of all the circumstances that prevent the performance of the contract as well as the due diligence measures taken to avoid these situations. Consider carefully the text of any communication or record that is produced bearing in mind that what you write may be later scrutinised by the other party’s lawyers and by a court. Consider also obtaining the early advice of legal experts to review said communications and notifications to ensure that the evidence gathered can be relied upon in potential legal proceedings and that effective dispute resolution provisions are in place;
- consider the longer-term relationship with your counterparties, and whether force majeure, the rebus sic stantibus clause or the other principles discussed below might be used as leverage to negotiate a sensible commercial solution to current issues, which does not put profit or the absence of any loss before all else by adopting absolute or extreme positions;
- consider other commercial and reputational risks that may arise from the outbreak, including HR/employment issues and the risk of counterparties becoming insolvent; and
- assess whether and how to communicate with counterparties pre-emptively to seek solutions to the issues raised.
How might COVID-19 affect my contract?
Contracts may be affected by the legal and economic consequences of the COVID-19 crisis, including supply chain disruption, travel restrictions and upset across different markets. The first step is to review existing contracts and those being negotiated (including standard terms of business) to ensure whether the terms and consequences for this type of situation have been expressly foreseen.
In contracts presently in force, parties may struggle to perform them properly or seek to get out of them altogether. Whether a contract counterparty is excused from its contractual obligations or could seek to terminate a contract will depend on the terms of each contract and the relevant factual circumstances. Both the contractual rights, such as force majeure, as well as remedies in law such as rebus sic stantibus rules, situations such as supervening impossibility of an obligation to do something or supervening legal impossibility of the subject-matter of the contract, will need to be considered. These mechanisms are addressed below
In contracts which are being presently being drafted, it may be wise to include additional commercial terms to try to protect yourself against the effects of the outbreak. For example, pricing adjustment clauses for contracts relying on tariffs or affected by exchange rate fluctuations, or step-in or buy-out rights to address performance concerns.
Can I or my counterparty terminate or request the modification of the terms of Spanish law contracts because of COVID-19?
This will depend on specific terms of the contract and the relevant facts in the case in question. There are several bases under Spanish law that could provide an affected contracting party with recourse to terminate or request the modification of the terms of a Spanish law contract:
Force majeure: this is an exception from liability for non-performance of contractual obligations where such non-performance is caused by an unpredictable event, or one which was foreseeable but is inevitable.
Parties are free to agree which events will qualify as force majeure for the purposes of their contractual relationship and / or what consequences an event of force majeure will have on this relationship. They may, without the law preventing it, lawfully include in their contracts penalty clauses that operate in any event, even in cases where the facts triggering the penalty could qualify as force majeure events. Similarly, the parties can exclude from the concept of force majeure certain events, establish the consequences of force majeure, and so on and so forth.
In cases where the contract, or special law, does not specify which events will have the status of force majeure, the following requirements for a particular event to be considered as such should be met: (i) unpredictable, because it lies outside the normal course of life; (ii) foreseeable, but nevertheless inevitable, insurmountable or irresistible; (iii) that the failure to perform is not due to the will of the alleged defaulting party (including that at the time of force majeure, there is no failure to perform); (iv) it makes it impossible to perform a previously contracted obligation or prevents the circumstances arising that would give rise to the performance of a contractual obligation; and (v) that the non-performance of the obligation is causally linked to the event that gave rise to this non-performance (meaning there is an implicit obligation to mitigate the damage or to try to perform the obligation).
Force majeure does not lead to the extinguishment of contractual obligations in all cases; this will depend on the obligation the performance of which is impeded by the force majeure event. In particular: (i) if the force majeure event renders performance of the obligation totally and definitively impossible, the obligation to perform will be extinguished, and the defaulting party released without incurring contractual liability for non-compliance; (ii) if the force majeure only prevents the partial performance of an obligation, the defaulting party will only be released from performing that part of the obligation from which it is prevented by the force majeure event, and it will continue to be required to perform that part of the contractual obligation that can still be carried out; and (iii) if the impossibility is merely temporary the defaulting party will be released from the responsibility for the delay but not from the obligation to perform the obligation when it can.
The qualification of COVID-19 as a force majeure event is not automatic; it requires detailed analysis on a case-by-case basis in order to ascertain whether the party in potential breach was able to comply with its contractual obligations.
Rebus sic stantibus: this entails that if the circumstances at the time of performance are substantially different from those on the basis of which the parties concluded the contract, the obligations therein cannot be maintained in the form in which they were agreed.
The application of this rule is premised on the following cumulative requirements: (i) an extraordinary change in circumstances from when the contract was concluded to when it is to be performed; (ii) a significant change to the balance of risks and benefits under the contract to that which the parties agreed; and (iii) said significant change is the result of radically unforeseeable circumstances.
As a general rule, it does not imply release for the parties from their contractual obligations. Its application may involve: (i) the modification of the conditions of the contract during the changed circumstances; or (ii) if it is absolutely impossible to restore the balance of the risks and benefits under the contract, its termination (this latter remedy being much rarer).
It is recalled that in general the Spanish courts adopt a very restrictive approach to any application of the rebus sic stantibus rule.
Supervening impossibility of an obligation to do something: this refers to situations where the defaulting party will be relieved from obligations to do something when the provision is legally or physically impossible to perform.
For it to be applicable, the impossibility of performance must occur after the creation of the contractual relationship and the following cumulative conditions need to be met: (i) physical or material impossibility (including moral or economic impossibility) or legal impossibility; (ii) performance of the obligation must be impossible for the relevant contracting party and any other person; (iii) it is not possible to perform the obligation even if the content of the obligation is reasonably altered in line with the purpose of the contract; (iv) it cannot consist of a merely transitory or temporary impossibility or one that arises from an accidental situation created by the defaulting party; and (v) the impossibility is not attributable to the defaulting party, which is not in arrears for making payment.
Supervening legal impossibility of the subject-matter of the contract: this refers to situations in which the performance of a contract becomes impossible because of the enactment of legal rules or regulations by competent authorities. The legal impossibility extends to any legal impossibility, including laws, regulations, and any rule or resolution enacted by competent authorities.
This type of impossibility requires, in addition to complying with the general requirements of supervening impossibility, that the party in default: (i) exercises the required diligence in the specific situation; and (ii) that it does not remain passive in the face of a new law, regulation, rule or resolution.
A supervening impossibility leads inexorably to contractual breach, but, for the sake of good faith and equity and in order to avoid unjust enrichment, it is incumbent on the defaulting party to return the benefits that it has derived from the other contracting party.
The information contained in this note is general, and it does not constitute legal advice.