Contractual Disputes due to Covid19

The cashflow and operation restrictions imposed by the Covid19 outbreak imperil the financial health of companies and their ability to perform. We have produced this overview for companies to understand how to mitigate further losses in the event of contractual defaults.

Companies should assess the extent to which the impact of the Coronavirus Covid19 may affect their ability to fulfill contractual obligations, as well as assess the reaction mechanisms within reach in the event of a counterparty default.

It is key for companies to identify and proactively act to limit liabilities arising from breach of contract and understand the legal remedies to react against defaults. Important vectors for assessing this impact include contractual provisions, venue, applicable law, type of activity and residual contract law provisions. In today’s globalized economy, the likelihood of cross-border contracts and defaults is common.

Depending on the contract, nonperformance may constitute an event of default or other provisions such as moratoriums, suspensions, or force majeure clauses may apply. Debtors are bound by good faith and must inform the creditor in the event of actual or potential impossibility of performance.

On the other hand, it is not uncommon to find force majeure clauses excluding any liabilities for a breach of contract originated by events deemed to be an act of God. Usually, such provisions contemplate war, terrorism events, natural catastrophes as hurricanes, floods, earthquakes, and storms, and epidemics.

Therefore, should a conflict arise from a possible breach of contract between two parties, due to the new Covid-19 outbreak, claims and petitioned damages would have to be assessed under the scope of rules applicable to a specific contract. However, taking into consideration the rarity of the abovementioned events, it is not uncommon for many agreements to lack such types of clauses.

Specific EU rules to determine the applicable law

Agreements between two EU entities will be regulated under Regulation (EC) No. 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations to determine the applicable law to the contract. 

When addressing possible liabilities arising from breach of contracts celebrated between EU and non-EU domiciled entities, generic international private law dispositions will be applicable on a case-by-case approach.

Portuguese Legal Framework

Contracts signed between Portuguese Parties without provision otherwise, will be regulated by Portuguese law.

The main concern is to determine if nonperformance due to the existing pandemic can be classified as force majeure case, given its unpredictability, abnormality, and uniqueness. It is important to distinguish between rebus sic stantibus provisions, material adverse clauses or force majeure cases.

In cases where a MAC clause has been used, default risks were allocated by the Parties. Absent of such clauses, the Portuguese legal framework provides a regime named the supervenient alteration of circumstances.

The regime allows a party to terminate or force the amendment of an agreement in the event the fundamental circumstances upon which an agreement was made have undergone an abnormal change. It can lead to termination of the Party’s obligation and, consequently, to the release of the debtor by the creditor.

In the event the fulfillment of the obligation has become objectively impossible, and not just more difficult or costly (except if the cost is too burdensome), the non-defaulting party may terminate the contract, or to modify it according to equity. It important that the event leading to the default is not an associated risk of the contract itself.

The ability to invoke these regimes would largely depend on the timeframe of the agreement. In the event the impossibility is temporary, the agreement may be suspended while such impossibility lasts, i.e. while the debtor is facing a force majeure event.

On the other hand, there are cases where the debtor wants to fulfill its obligation. However, the creditor refuses it due to the pandemic situation. In those scenarios, we may be looking at a creditor’s default scenario, which leads to the transfer of the default risk and associated liabilities to the creditor. The creditor must still provide consideration and possibly indemnify the debtor.

Businesses and individuals should now tread carefully in negotiating agreements and establish specific force majeure or even coronavirus clauses that would exclude their contractual liabilities in case of their inability to honor the initial terms set in the contract.

If you require any assistance with Commercial Law or Litigation, please contact us