Coronavirus: Hardship and Force majeure scenarios
April 27, 2020
Dr. Ahmed Ali Dayhom, Of Counsel
Mahmoud Ayman Rabie, Junior Associate
It now has been well over a month since COVID-19 has emerged as not only a threat to people’s lives, but also as a complicating influence affecting financial transactions and the performance of obligations pursuant to commercial contracts. Many local and international businesses have suffered as a result of the disruptions caused by COVID-19. These disruptions have affected many entities’ ability to adhere to the contractual obligations set out in contracts that in most cases were signed prior to the COVID-19 outbreak.
The announcement on March 11, 2020 by the World Health Organization declaring COVID-19 a “pandemic” is indicative of the severity of the disruptions being suffered on a global scale. Director-General Tedros Adhanom Ghebreyesus has said the situation will get even worse. “We expect to see the number of cases, the number of deaths, and the number of affected countries to climb even higher,” said Tedros, as the director-general is known, confirming his belief that the disruptions introduced by COVID-19 will not end in the near future.
His sentiment was recently reflected in the United States stock markets in the form of a Thursday selloff that was the steepest one-day fall since the October 1987 stock market crash, driven by fears that the COVID-19 pandemic will push the global economy into recession, ending one of the longest running bull markets in US history.
Further, crude-oil prices have fallen to nearly $30 a barrel after entering bear-market territory in February, as the global spread of COVID-19 and new travel bans add pressure to oil-and-gas companies and their lenders. Stock and bond prices of US oil-and-gas producers have come under heavy selling pressure amid the tumult, with bond investors now expecting some shale producers to go out of business.
In this context two questions arise: (i) is COVID-19 a Force Majeure event, and (ii) if so will an obliged party be held accountable for not performing its obligations as agreed under certain commercial contracts?
To determine if COVID-19 qualifies as a Force Majeure event, we should recognize how dangerous this virus can be. The virus is transmitted between animals and people, it is highly contagious, and can remain active on surfaces for an extended period of time. The virus causes respiratory symptoms, fever, cough, shortness of breath and breathing difficulties. In more severe cases, infection can cause pneumonia, severe acute respiratory syndrome, kidney failure and even death. Based on the above it appears that COVID-19 is a significant threat and clearly has the potential to disrupt an obliged party’s ability to perform its contractual obligations due to the disruption of daily life.
For example, most countries have postponed the work of their courts fearing the virus might infect more people. Even sporting events have been postponed. Therefore, in determining whether COVID-19 qualifies as a Force Majeure event or merely a hardship we need to consider French and Egyptian Law.
Force Majeure & Hardship under French Civil Code:
Civil Law applies a general rule providing that “the contracting party that must perform, but does not perform, is liable for breach of contract”. However, as an exception to this rule the French Civil Code in Article 1195 recognizes a “hardship” as a change in circumstances which could not have been anticipated at the time the contract was entered into and which renders performance of the contract excessively burdensome for a contractual party who had not assumed that unforeseen risk. In those circumstances a party suffering from hardship may request its counterparty to renegotiate the contract.
A court will consider a change of circumstances as a “hardship” if the following conditions are satisfied: (i) the change in circumstances was unforeseeable at the time of conclusion of the contract, (ii) none of the parties have expressly contractually accepted to assume the risk of that hardship, and (iii) the execution of the contract has become excessively burdensome or costly.
With respect to the third condition referred to above, the French Supreme Court (Cour de Cassation) previously has held that, despite evidence in some cases demonstrating that suppliers had increased their prices by 4% to 16% which then resulted in a 58% decrease in the gross margin of the affected contracting party that was seeking invoke Article 1195 of the French Civil Code, these increases did not constitute a hardship as the decrease in gross margin did not “fundamentally” alter the balance of benefits. Accordingly, relying on hardship is no easy task.
Alternatively, Force Majeure is defined by new French Civil Code Article 1218 as “the occurrence of an event which is beyond the control of the obligor, which could not have been reasonably foreseen at the time of the entry into of the contract the effects of which cannot be avoided by appropriate measures, and which prevents performance of its obligation by the obligor”. If the effects of the event are temporary, the performance of the obligation should be suspended unless the delay resulting therefrom justifies termination of the contract. If the effects of the event are permanent, the contract is automatically terminated and the parties are discharged from their obligations (without damages being due).
The impossibility to perform obligations due to Force Majeure does not in itself lead to the termination of a contract. Rather, it exempts the debtor from liability for non-performance. Since French law adopts the principle that an obligation to do the impossible is void (impossibilium nulla obligatio), initial or temporary impossibility renders the contract void, but with restitution and other ensuing consequences.
Force Majeure & Hardship under the Egyptian Civil Code:
In determining whether an event of disruption will be categorized as “Force Majeure” the jurisprudence sets out that the impossibility of performance must be due to a reason beyond the control of the debtor and that the debtor had nothing to do with. The burden of proof is on the debtor since he must demonstrate that it is absolutely impossible (or at least reasonably impossible) to perform his obligations and to what extent the force majeure has affected negatively the fulfillment of its obligations.
According to cases decided by the Egyptian Cassation Court, for an event to be categorized as “Force Majeure” it (i) must be unexpected and (ii) impossible to prevent. If one of these two conditions are not met then the event in question will not be categorized as “Force Majeure”. It is not necessary that the debtor consider the event as unexpected if its unexpected nature would be apparent to a reasonable person, since the unexpected nature of the event must be absolute, not relative to the debtor. The criterion in this case is objective and not subjective.
In other words according to the Egyptian Cassation Court annulment of a contract on the basis of an event of Force Majeure requires that execution of the contract is absolutely impossible, and is due to a for an external cause that has nothing to do with the debtor. That means, if the event of Force Majeure presents a temporary obstacle to performance, then it has no effect other than to postpone performance for the duration of the event. Once the event is gone, or the obstacle to performance is removed, the obligation of execution shall return in full force.
Article 165 of the Egyptian Civil Code supports these judgments by requiring a Force Majeure event to be unpredictable and beyond the control of the debtor.
Furthermore, under Egyptian law, Force Majeure clauses in contracts are customary and widely used. It should be noted that the Egyptian Civil Code explicitly permits the parties to agree on another allocation of risk than the one envisaged under Article 147 (2) of the Egyptian Civil Code; this means that a contracting party is permitted to accept unexpected risks if the parties so agree. In these circumstances the contractual allocation of risk would normally take priority over the provisions of the Egyptian Civil Code. Therefore, before relying on the provisions of the Egyptian Civil Code the parties must first carefully review the contract and the allocation of risk envisaged therein.
Contractual Force Majeure clauses normally envisage that the contract is suspended by force of law, and will not require a judicial decision. It is not possible to exclude the defense of hardship altogether; this follows from Article 147 (2) of the Egyptian Civil Code, according to which the principles of hardship must be satisfied.
According to the Egyptian Cassation Court, an event of Force Majeure relieves a party of its contractual obligations and its liability to pay compensation for damage, but only if the performance of the obligations is impossible, the event was unexpected, and it was impossible to avoid it. (Cassation no. 393 of Judicial year 32).
Also, Article 215 of the Egyptian Civil Code provides that “the debtor shall be exempted from compensation for failure to fulfill his contractual obligations if it proves the impossibility of execution has arisen from an external cause that he has nothing to do whatsoever with it”.
Case study from the USA
In this regard the United States District Court, S.D. Texas, Corpus Christi Division decided in the case between Sherwin Alumina L.P., Plaintiff/Counter-Plaintiff/Counter-Defendant, v. AluChem, INC., Defendant/Counter-Claimant that there is no genuine issue of material fact that the circumstances of this case do not constitute grounds for Sherwin Alumina to exercise the force majeure provision in the Supply Agreement, and there is no genuine issue of material fact that AluChem is entitled to specific performance of the terms of the Supply Agreement. Accordingly, AluChem’s first motion for summary judgment (reinstated D.E. 16) was granted in its entirety, and Sherwin Alumina was ordered to comply with the terms of the Supply Agreement until its termination.
As for Hardship under the Egyptian Civil Code, Article 147 grants Egyptian courts discretionary power to reduce, in light of the circumstances, onerous obligations under a contract. This discretion cannot be excluded by contract. The term “excessively onerous” is expressly stated to be of a standard lower than “impossibility”. However, the event affecting performance must be of a “general character” and must be “exceptional”. Egyptian judicial decisions have held Article 147 to apply to emergency occurrences the impact and effect of which are of general application, and which are impossible for the ordinary person to predict or foresee (regardless of whether the particular contract counterparty has actually envisaged its occurrence or not).
Pursuant to Article 147 (2) of the Egyptian Civil Code, the judge/arbitral tribunal is authorized to determine, in its absolute discretion, the measure(s) required to restore the economic equilibrium of the contract and mitigate the effects of the exceptional circumstances. According to the prevailing doctrine, the judge may deem that the circumstances do not necessitate the reduction of the onerous obligation, nor an increase of the counter-obligation, but rather suspend the performance of the contract until the unforeseen event ceases to exist. The judge may also deem necessary to increase the counter-obligation, or reduce the onerous obligation.
Hardship under other jurisdictions:
– In Italy, the parties may insert a clause defining the circumstances of hardship and, more specifically, what a change in economic circumstances could be.
– In England and Wales, it is possible to provide for a change in circumstances, which could not have been foreseen and, if those circumstances apply, then the party providing the goods or services is excused from performing the contract.
– In Poland, the civil code introduces contractual freedom regarding all actions taken by the parties, which are allowed to modify the relationships between them as long as the contractual provisions are not against the nature of the contractual relationship, legislation, and the principle of social coexistence. That is why the parties are allowed to introduce a hardship clause in their contract in accordance with the above-mentioned conditions.
– Belgian case-law allows hardship clauses. However, when such a clause is not provided for in a contract, the judge cannot change the obligations of the contractors in the event of changed circumstances, which makes it more difficult (but not impossible) for the debtor to achieve the result to which he has committed himself.
Hardship under UNIDROIT Principles:
According to UNIDROIT principles, hardship may not be invoked unless the alteration of the equilibrium of the contract is fundamental. Whether an alteration is “fundamental” in a given case will of course depend upon the circumstances.
- Increase in cost of performance
In practice a fundamental alteration in the equilibrium of the contract may manifest itself in two different but related ways. The first is characterized by a substantial increase in cost for one party of performing its obligation. This party will normally be the one to perform the non-monetary obligation. The substantial increase in cost may, for instance, be due to a dramatic rise in the price of the raw materials necessary for the production of the goods or rendering of the services, or to the introduction of new safety regulations requiring far more expensive production procedures.
- Decrease in value of the performance received by one party
The second manifestation of hardship is characterized by a substantial decrease in the value of the performance received by one party, including cases where the performance no longer has any value at all for the receiving party. The performance may relate either to a monetary or a non-monetary obligation. The substantial decrease in the value or the total loss of any value of the performance may be due either to drastic changes in market conditions (e.g. the effect of a dramatic increase in inflation on a contractually agreed price) or the frustration of the purpose for which the performance was required (e.g. the effect of a prohibition to build on a plot of land acquired for building purposes or the effect of an export embargo on goods acquired with a view to their subsequent export).
Naturally the decrease in value of the performance must be capable of objective measurement: a mere change in the personal opinion of the receiving party as to the value of the performance is of no relevance. As to the frustration of the purpose of the performance, this can only be taken into account when the purpose in question was known or at least ought to have been known to both parties.
According to the aforementioned under French and Egyptian Laws, two criteria must be satisfied in order for an event or circumstance to amount to Force Majeure:
- an exceptional event or circumstances beyond the affected party’s control has occurred;
- the affected party could not reasonably have predicted or taken precautions against the event or circumstance before entering into the contract in addition the same party also could not reasonably have avoided or overcome the event or circumstance once it arose; and also the event or circumstance is not substantially the result of an act or omission by the affected party.
In determining whether the COVID-19 pandemic qualifies as a Force Majeure event several facts must be considered. The pandemic has affected the banking sector in Egypt such that the Egyptian Central Bank decided to postpone credit entitlements of medium, small and micro companies for a period of 6 months, and not to apply additional revenues and fines due to delay of payments.
Although COVID-19 has hindered the fulfillment of contractual obligations, in the end the judge will determine whether the virus is a root cause for non-performance. Specifically, in claiming the onset of COVID-19 as a Force Majeure event a debtor must demonstrate the following:
- COVID-19 is an event that is beyond its control;
- COVID-19 has prevented, hindered or delayed its performance of the contract. Prevention, hindrance or delay must be addressed. How has the virus prevented, hindered or delayed performance? And precisely how the performance has been compromised?
- The debtor has taken all reasonable steps to avoid or mitigate the event or its consequences.
Thus, Coronavirus shall be considered as a Force majeure event according to French and Egyptian Civil Law as it is impossible to anticipate and avoid. Which gives the party, who cannot fulfil his contractual obligation the right to claim that Coronavirus is a Force majeure event that prevented him from performing according to the agreement. And in the process the said party should demonstrate to the court the reasons why Coronavirus has affected his performance and that he took all the precautions to avoid it. Once he managed to prove so the damages will not be due.
With that being said, Coronavirus is going to affect oral arguments scheduled in all courts around the world, and we have seen a lot of countries take significant precautionary measures to protect their citizens, including those citizens who work in legal facilities. However, this is not the first time such measures have been implemented. The U.S. Supreme Court postponed scheduled arguments for October 1918 in response to the Spanish flu epidemic. The Supreme Court also shortened its argument calendars in August 1793 and August 1798 in response to the yellow fever outbreak. More recently, on March 16 the Supreme Court indefinitely postponed for two weeks scheduled oral arguments, and on March 17, the Northern District of California closed four federal courthouses to the public and suspended all jury trials and criminal cases across the district until May 1. If any judge believes a hearing is necessary, the hearing will be by telephone or videoconference.
On February 28 France’s Minister of Economy and Finance declared that COVID-19 will be considered as a case of Force Majeure in the context of public procurement contracts and that liquidated damages will not be levied for late delivery.
Meanwhile, in Egypt the Ministry of Justice issued a statement regarding COVID-19 instructing the courts and judicial bodies to take the necessary legal measures towards adjourning all the cases pending before the courts of all types for a period of 2 weeks, noting however that administrative work in the courts will continue to meet requests within the legally established dates. Furthermore, the Court of Cassation affirmed that “the period of appeal shall be suspended during the period of Force Majeure” and stated that the time limit for an appeal in accordance with Article 228 of the Commercial and Procedural Law is 40 days unless otherwise stipulated, and failure to abide thereby will result in the loss of the right to appeal unless an event of Force Majeure is realized during that period or if an event occurs that makes it impossible for the opponent to initiate the appeal procedures.