Germany: COVID-19 and its impact on ongoing contractual obligations

As part of the package of measures to mitigate the effects of the corona crisis, the German Bundestag has fast-tracked an act to mitigate the consequences of the COVID-19 pandemic in civil law, insolvency law, and the law on criminal procedure, adopting it into law on 25 March 2020. 

The act contains a civil law moratorium that benefits parties who owe certain forms of contractual performance where the COVID-19 pandemic has forced them into the position that they cannot meet their contractual obligations.

Moratorium – extent and duration of the right to refuse performance

Section 1 of the amended article 240 of the Introductory Act to the German Civil Code (Einführungsgesetz zum Bürgerlichen Gesetzbuch) creates a moratorium on 'essential' ongoing contractual obligations, ie a temporary right to refuse performance for consumers and micro businesses. 

Those owing performance or ‘debtors’ in this sense must refer to their right to refuse performance and demonstrate that they are unable to render performance due to the COVID-19 pandemic because to do so would be to endanger their ability to sustain a reasonable livelihood or, in the case of micro businesses, their commercial viability.

According to the explanatory memorandum to the legislation, the right to refuse performance is designed to prevent the enforceability of the agreed performance and at the same time prevent the creation of secondary claims, eg under default or rescission or claims for damages due to non-performance. The new provision thus suspends debtors’ payment obligation. 

Claims that were already due and payable at the time the legislation enters into force can no longer be enforced, for the time being, upon exercise of the right to refuse performance. 

Where a debtor is already in default with the fulfilment of the performance obligation, the conditions for default are reversed, according to the lawmakers’ intention. However, the payment obligation generally remains valid and is to be fulfilled after the moratorium expires.

The legislation provides that the moratorium initially applies up to, and including, 30 June 2020. However, the German federal government is given the power to extend the duration of the right to refuse performance up to 30 September 2020 by statutory order where it is to be expected that the social life, economic activity of a large number of businesses or the ability to earn a livelihood of a large number of people continues to be detrimentally affected to a significant degree by the COVID-19 pandemic.

Opting out of, or deviating from, the temporary provisions on the right to refuse performance to the detriment of the debtor, either by private individual agreement or in general terms and conditions, is not permitted. However, the provision only applies to contractual agreements entered into before 8 March 2020.

Substantive scope of the moratorium

The moratorium covers civil law consumer contracts. A consumer under the German Civil Code means a natural person who enters into a legal transaction for purposes that are predominantly outside their trade, business or profession. 

In addition, micro businesses, ie businesses employing fewer than 10 employees and whose annual turnover or annual balance sheet total does not exceed €2m, are also protected.

'Essential ongoing contractual obligations' under the new legislation are any contractual agreements that 'are necessary for the provision of essential utilities and services'. 

According to the explanatory memorandum to the legislation, this means, in particular, contracts for gas, electricity and water supply, along with telecommunications services and compulsory insurance. 

The Act does not contain an exhaustive list of contractual obligations that are considered essential. The right to refuse performance itself is restricted where it would cause undue hardship for the creditor of the relevant performance or payment. 

Under the legislation that is the case where non-performance would endanger the creditor’s basic commercial viability. However, in such cases, consumers are then given a right of termination.

Assessment of the new moratorium provision

Assisting consumers and micro businesses that, through no fault of their own, have encountered a financial emergency as a result of the rapid spread of COVID-19 is generally to be welcomed. 

However, it is also clear that the moratorium will cause considerable challenges, particularly for utility providers. 

In addition, the Act creates major legal uncertainty in that it does not detail which continuing obligations are to be deemed essential. 

For numerous companies outside of the sectors mentioned in the legislative rationale, the question is therefore whether and how they will have to react to payment defaults in the coming weeks and months.

The moratorium does not apply if the refusal of performance by the consumer or micro business results in 'endangerment of a reasonable livelihood' or 'endangerment of the economic foundations of commercial viability'. 

However, it is likely to be very difficult to prove and judicially enforce this quickly with regard to individual consumers and micro businesses, especially since the Act also does not contain more specific references to the requirements for such endangerment.

Nor is provision made in the Act for how to proceed in relation to a majority of creditors if the debtor’s financial options are not sufficient to satisfy all claims but performance would at least be partially possible. 

The Act leaves open what criteria are to be used to decide the order in which creditors are satisfied or whether partial performance to all creditors is a permissible approach.

Provision is also not made for how the legislator envisages the situation following the end of the moratorium. 

The moratorium merely pushes back the due date, but the performance obligation fundamentally remains. 

Therefore, it could constitute renewed financial hardship for the debtor if, following the end of the period, they have to render cumulative performance for the period of three (or in the case of an extension up to six) months. 

For the creditors, therefore, the uncertainty remains as to whether and when the debtor will actually fulfill the deferred obligations and when they can and should demand performance or issue a termination. 

It remains to be hoped that further clarification will follow from the legislator here.

Finally, it is also important not to underestimate the psychological effect which the Act will have on the willingness of many consumers and micro businesses to render performance. 

Frequently, debtors, as legal laypersons, will incorrectly conclude quite generally from the intention of the Act that they are able to refuse payments in the coming months without having to fear any disadvantages in this regard. 

Irrespective of the specific requirements and the precise reach of the moratorium, many companies will therefore initially have to brace themselves for massive payment defaults.

In light of this, companies should quickly develop strategies for preventing or minimising payment defaults and how to enforce payments as promptly and cost-effectively as possible. 

These may include proactive offers to accept payment by instalment or contractual amendments, with different approaches potentially being expedient in each individual case.