The impact of the COVID-19 pandemic is continually becoming a greater burden on companies and enterprises. Many companies are confronted with the absence of sick employees. Even more substantial are the indirect strains due to officially ordered closures, the shortage of supplies or the “cancellation” of purchases and orders by customers. For example, customers are claiming that their own company was closed, a project was stopped, or a planned event was cancelled for reasons such as the consideration of health issues, an official order, an official recommendation or solely due to economic pressure. Sometimes, while a planned event will only take place in the future, the reason for its cancellation is the apprehension that the health situation will not have improved in time, and a later short-notice cancellation would threaten to cause further, more profound damages and liability claims.
Due to the mutually dependent relationships of the economy, many different constellations can currently arise, in which a contractual relationship is affected either directly or indirectly by the COVID‑19 pandemic. These cases can seldom be rated the same way under legal assessment and the question of the economic riskbearing, responsibility or liability for failure of contractual obligations can be answered differently.
This article evaluates the various risk and liability exposures companies are facing during the current situations and presents specific recommendation for the upcoming decisions, measures and communication methods.
1. What should your company do now?
At this point, every company should take measures to minimise the impact of COVID-19 and guarantee a course of business as unobstructed as possible for the near future. At the same time, it is also recommendable to develop a strategy for the time after COVID-19.
Depending on the respective contractual negotiations and the specific individual situation, companies will increasingly be confronted by the topics of force majeure and impossibility. Making provisions to be prepared should the worst case occur is essential. We suggest specifically:
- Be proactive – determine on which contractual obligations COVID‑19 could have an impact and where risks could have severe consequences. Estimate the amount of damages your company could face for the default of contractual obligations, considering liability clauses of existing contracts.
- Monitor your chain of supply – take measures to secure your capacity to perform. For example, look for alternative suppliers and document agreements.
- Prioritise – evaluate which of your company’s obligations take priority. Analyse your company’s commercial situation and identify your most important contractual partners.
- Prepare for a possible worst-case scenario – check whether your existing contracts with business partners include clauses on force majeure. Analyse and differentiate between cause and effect of individual measures for the fulfilment of the contract or the default thereof. Determine the existence or non-existence of insurances, the law applicable to contracts and the place of jurisdiction.
- Swiftly and clearly communicate with your contractual partners, point out the risks of a delayed or lack of performance, actively offer options to amend contracts.
- In case you could claim damages: Set deadlines when delays in performance occur and meticulously document any already incurred damage.
Should your company be unable to perform at all, in time or properly due to the impact of COVID‑19, please especially heed the following:
- Make sure you can prove the presence of force majeure or impossibility upon occurrence. In particular, document the exact circumstances that impaired your performance (e.g. official orders, notices of delays or cancellations).
- Further reduce your liability risk by contacting your respective contractual partner as soon as possible, giving him the opportunity to take measures to avert or minimise damages.
2. Legal framework
Many contracts include clauses that stipulate the termination of the contract as a legal consequence upon occurrence of force majeure. Depending on the individual case, that possibility can depend on further conditions, so the respective policy should be closely reviewed. Whether the criteria for a force majeure event have been satisfied is an additional deciding factor and needs to be determined in each individual case.
Should the term force majeure be defined in the contract, further examination is in order: For example, should the contract specifically names epidemics or quarantine measures as force majeure events, it should also stipulate the exact conduct that must be followed in case such a situation impairs the performance of contractual obligations.
Those clauses usually stipulate the parties’ (possibly temporary) release from their performance obligation while doing everything in their power to minimise the damage to the other party. A right for termination or withdrawal will usually only apply after a certain period and claims for damages will only be excluded if all regulations on conduct have been followed.
In case such a clause is included in the contract but does not specify whether epidemics or quarantine measures constitute a force majeure event, the contractual regulation must be interpreted. Should German law apply, relevant case-law on the SARS outbreak of 2003 suggests in many constellations that the Coronavirus pandemic also constitutes a force majeure event. German rulings usually assume a case of force majeure if “an event occurs from the outside and is not avoidable by the greatest reasonably expectable caution”. Yet, that depends on the wording of the contractual clause. Where the wording is accordingly specific, it could be that the listed events are intended to be final and exclude constellations such as an epidemic, official quarantine measures or other indirect consequences of such a constellation as a force majeure event. These cases fall back on general German contract law.
Should a contractual force majeure clause not apply or nothing else be agreed upon in the contract, statutory regulations apply. Pursuant to German law, a contractual party is released from their performance obligations insofar as the performance or a part of the performance becomes impossible, Sec. 275 German Civil Code (Bürgerliches Gesetzbuch – BGB). However, the presence of impossibility can be denied if the performance obstacle is only “annoying”, economically “expensive to avoid” or even “temporary”. Furthermore, the consequences of an assumed (final) impossibility are often economically undesirable, as consequently the opposing party is always released from its performance obligation as well (and no longer has to pay, for example).
Where a long-term service contract was concluded, such as the annual contract of a gym with an athletic customer and the gym temporarily has to close due to official orders, the period of closure could be considered as a mere “interruption”, after which the performance of services remains “possible” after the regular term of contract has expired and can be “made up for later”.
An interference with the basis of transaction pursuant to Section 313 BGB could also be assumed, but the relation of that interference to impossibility is disputed. If such an interference is affirmed, a party can demand the amendment of the contract and withdraw or terminate it should an amendment be impossible or unreasonable.
For cases of international purchases of goods, the United Nations Convention on Contracts for the International Sale of Goods could potentially apply, which again includes different assessments and consequences for an existing contractual relationship during times of crisis.
The fact that we are talking about a pandemic does at least not yet necessarily lead to the impossibility of every contractual performance obligation, to the inability of every supply relationship or to the right to “cancel” any order and “stop” any project. If a supplier delivers late or not at all, the obligation to look for alternative suppliers may apply. It is also of significant legal difference whether a contract is breached because a contractual partner would like to withdraw from their obligation for consideration of health issues or perhaps because of a shortage of supplies, the absence of employees, an official order directly or only “indirectly” affecting their business or maybe even “just” due to a commercial risk assessment and a planning decision for the coming weeks and months.
Every constellation conceivable could be rated very differently in a legal assessment and simplified views on the current “Coronavirus crisis” should be discarded where severe economic damages to companies are to be limited and averted. A strict and diligent contract and damage management are urgently required while considering the individual constellations.
One important rule applies to almost all constellations: the contractual partner of an existing binding contractual relationship must inform the other party about the occurrence and duration of a force majeure event, as well as the impossibility or unwillingness to fulfil existing contractual obligations. If such notice is not or not timely given, that is usually “as fast as possible” after “becoming aware” of the relevant circumstances, the affected party may be liable for damages resulting from the late notice.