A European perspective on the current and future impact of Covid-19 on key terms in franchise, distribution and agency agreements
The basic concept of 'force majeure' – where events outside of the control of a contractual party impede performance – is widely recognised internationally. However, the way in which this concept and other related legal concepts are applied varies according to different legal systems.
Fieldfisher's international team of franchise, distribution and agency experts in the UK, Germany, Italy, Spain and France consider some of the key issues, which are affecting businesses operating franchise, distribution and agency networks.
There are some notable similarities and differences between these important European jurisdictions:
- In the UK, Italy and Spain, there is no statutory definition of force majeure (whereas there is in the civil code of France and the German courts have developed their own definition).
- The German and French definitions stipulate that an event of force majeure must be unforeseeable.
- Italy and France have similar concepts of economic hardship, which can be used by a party to petition a court to either amend a contract or terminate it.
- In the UK, the courts will not intervene to re-write a contract, not will they relieve a party of what is merely a bad bargain.
- Germany, Italy and France have a strong general concept of good faith which applies to commercial contracts, and which therefore applies to the interpretation of force majeure and the related concepts of frustration and economic hardship. There is no such general implied duty in English law, although the Unfair Contract Terms Act 1977 may apply in certain circumstances and with a similar result.
- Both Germany and France have introduced emergency legislation to provide temporary protection from liability to contractual parties, which are unable to perform their obligations as a result of the Covid-19 pandemic.
- Note that for B2B contracts of sale, which involve France, Italy, Spain or Germany and any other signatory states of United Nations Convention on Contracts for the International Sale of Goods (CISG), the CISG's standard force majeure clause will apply unless the contract has effectively waived the application of the CISG. The UK is not a signatory state.
Clearly, Covid-19 is having a huge impact on the ability of businesses to perform their contractual obligations. Where a party's ability to perform their contractual obligations is hindered or prevented by Covid-19, the first point of reference will be a force majeure clause, or adverse change of law clause.
Force majeure clauses often reference pandemics and epidemics as events of force majeure, but even in the absence of express wording, the drafting may be broad enough to claim relief if, for example, it refers to "events beyond the reasonable control of either party".
If the force majeure clause does cover, or it is likely to cover, Covid-19, then the next step is look carefully at any other conditions or caveats. For example:
Does the clause state that the event of force majeure must be unforeseeable at the time of entering into the agreement? For contracts entered into prior to the beginning of 2020, Covid-19 was clearly not foreseeable, but if parties have entered in to contracts since then, or are looking to enter into contracts during the pandemic, then this type of express condition will preclude a party from relying on the clause.
Are there any notice requirements?
Is there an express duty to mitigate loss? An important point to note is that a duty to mitigate loss will still arise in the absence of express words. Case law shows that the duty to mitigate is inherent in how the courts approach force majeure clauses.
What does relief look like? A right to terminate or a suspension? Is relief contingent on anything, such as a party having exercised their business continuity plans? Does the wording require a causal link between the event and the party’s delay or failure to perform the contract?
In the absence of an express force majeure clause, there is no statutory concept of force majeure or implied term. An alternative protection may be available under the freestanding doctrine of frustration, but this is a blunt tool and it has its limits. Frustration requires that the event should be outside the parties' control, not foreseeable, and also that it should make the obligation physically or legally impossible to perform, or else that it makes the contract radically different so that its so-called 'common purpose' can no longer be achieved. The outcome of frustration is that it quashes the contract, which may not be objective of the parties. The reality is that frustration is not going to be available to or appropriate for most parties, as demonstrated by the recent attempt of the European Medicines Agency to exit its 25 year lease for its London HQ, two years after the Brexit vote.
In the absence of contractual force majeure, or the availability of frustration, if a contract becomes uneconomic to perform as a result of the fallout from Covid-19, that in itself will not provide a way out and the parties will have to look to other terms of the contract for help. The courts will not relieve a party of what is merely a bad bargain.
Finally, it should be noted that if the application of a force majeure clause has the effect of limiting or excluding a party's liability under the contract, the other party could challenge its enforceability under the reasonableness test in the Unfair Contract Terms Act 1977.
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Article 1218 of the French Civil Code defines and sets out three cumulative tests for force majeure – it must be (i) an event beyond the control of the debtor, which could not reasonably have been foreseen at the time of the conclusion of the contract, (ii) whose effects could not be avoided by appropriate measures, and (iii) which prevents performance of an obligation by the debtor.
Moreover, Article 1218 of the French Civil Code provides that "If the impediment is temporary, performance of the obligation shall be suspended unless the delay that would result does not justify the termination of the contract. If the impediment is definitive, the contract is resolved by operation of law and the parties shall be released from their obligations under the conditions provided for in the agreement. in articles 1351 and 1351-1". These conditions are cumulative and must be strictly assessed.
Pandemics are likely to be considered as "force majeure" events if a party is unable to perform its contractual obligation in its totality. However, the simple fact that the performance of the contract is more expensive or more complicated because of a pandemic is not sufficient to be considered as a "force majeure" cause.
Article 1195 of the French Civil Code recognises the concept of "hardship" ("imprevision") as an alternative to force majeure. This article provides that "If a change in circumstances unforeseeable at the time of the conclusion of the contract renders performance excessively onerous for a party that had not agreed to assume the risk, that party may request a renegotiation of the contract from its co-contractor. It shall continue to perform its obligations during renegotiation. In the event of refusal or failure to renegotiate, the parties may agree to the termination of the contract on such date and on such terms as they may determine, or ask a judge to revise or terminate the contract within a reasonable period of time."
Order No. 2020-306 of 25 March 2020 also has consequences in contractual matters, since it provides for the suspension of time limits relating to breach of contracts and their termination and cancellation, until 24 June 2020.
In practice, this means that:
Clauses that are intended to sanction the breach of an obligation within a given time period (penalty payments, penalty clauses, termination clauses, etc.) will be deemed not to have begun to run or to produce their effects if this time period expires during the period.
These clauses will resume their application within a period of one month following the end of the period, i.e. as of 24 July 2020.
As a result, breach of contract occurring between 12 March and 24 June 2020 cannot be sanctioned if the contracting party then performs its obligation before 24 July 2020*. The period between 24 June and 24 July, which is quite uncertain at the moment, will have to be carefully examined.
Penalty payments and the application of penalty clauses which took effect before 12 March 2020 are also suspended during this period. They will start running again on 24 June 2020.
Deadlines for termination or cancellation expiring during the period will be extended until 24 August 2020 (e.g. license agreements which must be terminated, before tacit renewal for two more years, within a set time period expiring during the period, may be terminated until this new date).
Should difficulties in contract performance persist following the public health crisis, it will always be possible to resort to the mechanisms provided for under ordinary law (force majeure and unforeseen circumstances in particular). It will then be necessary to make assessments on a case-by-case basis, depending on the situations encountered.
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Force majeure is defined by the German courts as:
"An external event, caused externally, by elementary natural forces or by the actions of third parties, which is unforeseeable according to human insight and experience, cannot be prevented or rendered harmless by economically-accepted means, even by the utmost care that could be reasonably expected in the circumstances, and which is not to be accepted by the operating company due to its frequency. Examples include war, terrorist attacks or natural disasters."
If a German law contract does not contain a force majeure clause, the general legal provisions under German law will apply. Pursuant to these provisions, cases of force majeure are treated under the rules of impossibility under section 275 BGB, or the loss of the basis of a transaction (frustration of contract) under section 313 BGB.
Section 275 BGB exempts a party from the performance of its obligation where performance is impossible (this also includes legal impossibility). A party is also exempt from its performance of its obligations if it would involve unreasonable expenses in exceptional cases. In such cases, the other party's obligation to perform their part of the bargain does not apply.
The decisive factor for a claim for damages is whether a party has caused the obstacle to performance. A fault-based liability will apply here, by which fault is presumed and the burden of proof is on the party seeking to rely on this protection, to show they are not at fault. The supplier must also prove, as is the case when relying on a force majeure clause, that performance is impossible and that the force majeure event could not have been avoided by purchasing from an alternative source.
Section 275 BGB may be relied upon, for example, where a supplier can prove that its production facility was closed down due to an official order. If the impossibility is only temporary and performance can be provided at a later date, a party is only released from the obligation to perform for the duration of the impediment of performance; the same applies to the other party and their respective obligations (i.e. as regards consideration). However, it may be possible for the other party to withdraw from the contract (according to section 323 BGB).
In general, the other party shall not be entitled to claim damages, except for special circumstances, for example if the production facilities have been closed on a voluntary basis purely as a precautionary measure (without a corresponding official order). In this case, a party would need to prove that the closure was necessary. If the absence of such proof, the other party may claim damages on the grounds of failure to perform or a delay in performance. Such damages may include e.g. costs for additional purchases from alternative sources and loss of profit.
Where the principles of impossibility are not applicable – particularly in cases of disruptions of equivalence in the contract execution – Section 313 BGB (frustration of contract) may be applied, which allows for an adjustment of the contract if there has been a material change in the circumstances upon which the contract was based. The prerequisite for this is that the obligated party can no longer be reasonably expected to adhere to the contract and that the circumstances were not foreseeable at the time the contract was concluded. If an adjustment of the contract is not possible or cannot reasonably be expected, the contract may ultimately be terminated. However, the bar is high as regards the requirements that must be satisfied. Section 313 BGB may be applicable if production materials are still available due to an unforeseeable event, the risk of which neither party should have to bear, but are significantly scarce and more expensive.
As part of a package of measures to deal with the impact of Covid-19, the German government enacted temporary regulations on 27 March 2020, which allow debtors who are unable to fulfil their contractual obligations due to the COVID-19 pandemic to temporarily refuse or discontinue performance without incurring adverse legal consequences for them. For many contractual obligations, a right to refuse performance is established for consumers and micro-enterprises (enterprises with up to 10 employees and an annual turnover not exceeding EUR 2 million) until 30 June 2020, for those currently unable to meet their obligations (without jeopardising a reasonable livelihood or the economic basis of the respective business) arising from contracts which contain material continuing commitments and were concluded before 8 March 2020 due to the consequences of the COVID-19 pandemic. The right to refuse performance is excluded if its assertion is unreasonable for the creditor. In this case, the debtor has a right of termination.
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There is no statutory definition of 'force majeure'. However, article 1467 of the Civil Code allows a party to terminate a contract if performance of an obligation becomes “excessively onerous” for extraordinary and unpredictable reasons, outside of their control. If the contract contains specific terms on force majeure, those terms will apply in the first instance.
Italian law contracts are also subject to articles 1256, 1258 and 1464 of the Italian Civil Code, which contain the rules on the impossibility, or partial impossibility, of fulfilling a contractual obligation. In the event of impossibility of performance, a party's obligation to perform is extinguished. If a party's ability to perform an obligation is only partially impeded, there will be a proportional reduction of the other party’s obligation.
As a general principle, the above remedies must be applied in good faith. Article 1375 of the Civil Code states that the contract must be fulfilled in good faith, and article 1366 of the same Code provides that the contract must be interpreted in good faith. Therefore, a claim for relief citing impossibility and/or the excessively onerous nature of an obligation must be judged through the prism of good faith, considering the actual circumstances.
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In Spain there are three main principles which apply to non-performance in these circumstances:
- Pacta sunt servanda, which means that a contract must be fulfilled according to its terms (ex.- arts. 1091, 1255 y 1281 of the Civil Code).
- The principle of retention of contracts.
- The duty to act in good faith and the prohibition of abuse of law (ex arts.- 7.1 y 1258 of the Civil Code).
In the first instance, the parties should refer to the express terms of the contract to see if they regulate a party's inability to perform their contractual obligations. If there is not a specific force majeure clause in the contract, the legal framework is as follows:
- force majeure (ex. Art. 1105 of the Civil Code): the party who believes that force majeure applies is exempted from fulfilling their obligation without any liability. The counterparty can claim for compensation in court and the judge will have to decide if force majeure applies; and
- rebus sic stantibus, which means that under extraordinary circumstances, a party may request a judge to change the agreement to balance one or both parties obligations according to these circumstances. Rebus sic stantibus is not specifically regulated by law but has been developed by the Supreme Court.
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|Cristina Ruiz de Alda
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The UK is not a signatory to the United Nations Convention on Contracts for the International Sale of Goods (CISG), but Germany, Spain, Italy and France are signatories. In respect of contracts involving trade between these states and other signatory states to CISG, CISG will apply to the sale of goods unless expressly waived by the parties.
CISG contains a force majeure provision in Article 79. It expressly provides for the exemption of the obligation to pay damages and excludes the supplier's liability in cases where the inability to perform contractual obligations results from a force majeure. The burden of proof is on the party failing to fulfil its contractual obligations to show that non-fulfilment is due to an obstacle beyond its control. In contrast to the German Civil Code, the UN CISG thus excludes the liability of the seller, irrespective of fault. It is generally accepted that, in addition to the expressly-regulated exemption from liability for damages, the obligation to fulfil the contract also ceases to apply if fulfilment would, objectively, be impossible.
However, Article 79 does not completely exclude the obligation to avoid the obstacle to performance or to bear additional expense. For example, alternative means of transport may involve significant financial loss for the supplier but may be considered reasonable in the circumstances.
Irrespective of the legal jurisdiction, we recommend that businesses consider the following:
- What is the realistic effect of Covid-19 on you and the counterparty and the ability to perform or benefit from the contract?
- Have you communicated with the counterparty and has it been discussed or agreed how risk or liability should be allocated should the contract be delayed or not performed?
- Can the obligations be performed using contingency measures?
- Review the terms of the agreement, in particular give thought to whether the impact is fundamental and whether there are any relevant force majeure /material adverse change provisions in the contract, review whether they apply or whether termination or another form of relief is available.
- Is it possible for you or the counterparty to obtain insurance in the event that performance is delayed or prevented?
- If you are due to enter into an important commercial contract in the coming days, weeks or months, do you want to ensure that you and/or the counterparty can rely on force majeure if a party cannot perform the contract due to the coronavirus?
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