International contracts and Coronavirus from an Italian perspective

The COVID-19 coronavirus and emergency decisions from authorities in various countries, including China and Italy, are affecting the ability of businesses to perform contracts regularly.

This article deals with some legal issues related to the management of international contracts, from an Italian law perspective.

Abstract:

Epidemics and decisions of the health authorities, as unforeseeable and unexpected phenomena, out of the control of the parties, generally fall into the legal category of force majeure. Force majeure is a remedy of civil law countries (i.e. Italy, Germany, France….), which the contractor can invoke, to be exonerated from liability for damages due to non-fulfillment or delay. However, some legal systems, typically common law (including, UK and USA), do not recognize this principle and, in relationships subject exclusively to these national laws, force majeure must be contractually provided for. In addition, the “coronavirus” situation does not have the same adverse effect on the contracts: sometimes, there can be only a temporary or marginal effect and performance does not always become totally or partially impossible. Therefore, first of all, it is necessary to assess the situation affecting the company, taking into account the definition of “force majeure” and its discipline contained in the contract or provided for by applicable law.

International contracts and various national laws require that the contractor who is unable to perform due to force majeure must promptly and adequately inform the other party. In this way, each party may adopt risk and damage mitigation measures; damages which, in general, cannot be compensated by the party who declared legitimately a force majeure impediment.

Once the “coronavirus” has been ascertained as a “force majeure” event, the alternatives may be: suspension, renegotiation or termination of contracts. Termination is necessary in cases where performance becomes impossible. The suspension is a remedy generally agreed in long term contracts, in cases where the situation is uncertain or the impediment is temporary, while renegotiation is typically the instrument to bring the contractual obligations back into balance or to adapt the contract to the new reality. In any case, the possible solutions must be analysed and adopted on a case by case basis, also taking into account the contractual terms and applicable law.

1. Coronavirus and force majeure: introduction

An internationally recognized principle is that contracts must be entirely performed by both parties (“pacta sunt servanda”).

Force majeure exceptionally allows a party to release himself from performance[1] and from the consequent liability (including compensation for damages)[2].

Under Italian law, force majeure is not precisely defined and may be any event that makes compliance impossible (art. 1256, 1st paragraph, Italian civil code).  That event cannot be foreseeable, determined or attributable to any party.

Under Chinese law, force majeure corresponds to an objective, unpredictable, inevitable and insurmountable situation (Article 117 of the People’s Republic of China Contracts Law http://www.china.org.cn/china/LegislationsForm2001-2010/2011- 02/12 / content_21908031.htm).

Pursuant to art. 79 of the Vienna Convention on the international sale of goods, ratified both by Italy and China, the force majeure is the impediment out of control of a party, not reasonably foreseeable at the time of signing the contract, inevitable and not surmountable.

However, the concept of “force majeure” (force majeure) which originates from Roman law and is found in civil law countries (in French, German, Italian and even Chinese law), is not recognized in common law countries. In fact, the theory of English “frustration” and the American doctrine of “impracticability” have a more limited scope than “force majeure”. Therefore, in contractual relations subject exclusively to English or American law (therefore, with the express exclusion of the Vienna Convention, in this case), a party can invoke force majeure only if this remedy is contractually disciplined[3].

In any case, due to the practical implications of this legal issue, in most international contracts there are specific force majeure clauses.

Therefore, upon the occurrence of a potentially definable event of “force majeure”, it is first of all advisable to examine the existing contract and, in particular, the definition and the regime envisaged therein.

 

1.1 The definition of “force majeure” and the coronavirus: attention to contractual terms

Epidemics, as well as natural catastrophic events are generally indicated in international contracts as causes of force majeure, together with wars, insurrections and compelling acts of public authorities (e.g. embargo). Strikes, difficulties in supplies from suppliers, crisis of raw materials or energy sources, as well as problems in transport are generally excluded[4].

In any case, a party may invoke and rely on a remedy of “force majeure” provided that the impediment has a very significant impact on the possibility of performing of that party.

In this regard, the contractual clauses almost always indicate that the external event (i.e. out of the control of the parties) must make performance impossible (in whole or in part). Other clauses allow the party to invoke force majeure even when the performance becomes excessively burdensome. The last exception goes by the name of hardship and is often treated differently from force majeure, in the various legal systems[5].

In principle, however, events that make performance only more difficult are not “force majeure” events.

Therefore, it will be necessary to verify, on a case by case basis, whether the coronavirus – or rather, the restrictions adopted by the State authorities for public health safety – are such as to compromise the performance of a party and to justify force majeure release.

The conditions to fulfill have to be assessed preliminarily and in concreto, in the light of the legal definition and requirements of force majeure under the contract or applicable law. The general approach of the arbitral courts seems rather restrictive.

In a decision of 5.03.2005, the Chinese arbitration court CIETAC condemned a Chinese seller who had wrongfully invoked Sars as a cause of force majeure to justify his partial deliveries in 2003 to its Duth client[6].

The Court found that as Sars broke out before the date of signature of the contract, it could not be considered as an unpredictable event for the Chinese side. Furthermore, the Chinese supplier had declared force majeure to his Dutch client only in September 2003 – with a delay of a few months – deemed unreasonable by the Court – and providing insufficient evidence even later, only in 2004. As a result, the Dutch client was recognized over $ 5 million in damages.

The aforementioned example also clarifies the need for adequate and timely communication of the cause of force majeure to the other party, as illustrated below.

2. Communication of the impediment of force majeure

In international contracts – but this is also established by several national laws (including the Chinese one) -, the interested party is expected to promptly notify the other party and give evidence of the event of force majeure affecting its performance. Therefore, until the notification date, the party is not exempt from fulfilling the contract and is liable for damages for the delay.

It is therefore important that said notification is timely and detailed; in this way, the other contractor will be able to suspend his performance and, in general, damage will be limited[7].

A delay in communication is, in certain contracts, sanctioned with the loss of the right to invoke force majeure. In general, however, it is believed that the party is liable for damages up to the moment of the delayed communication, unless it proves that the delay was faultless.

This principle is expressly provided for by Chinese law, but also by the Vienna Convention on the international sale of goods which, in art. 79 (4) expressly provides that: “The party who fails to perform must give notice to the other party of the impediment and its effect on his ability to perform. If the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, he is liable for damages resulting from such non-receipt.”

These days, the Chinese government is helping its companies to provide evidence of the impossibility of default due to the coronavirus, through the issue of force majeure certificates centrally and via the web. https://www.ft.com/content/bca84ad8-5860-11ea-a528-dd0f971febbc

The recent Italian decrees approved in March were aimed at limiting circulation of the virus, by prohibiting most commercial activities, such as, bar, restaurants and leisure and sport activities (i.e. theaters, museums, galleries, swimming pools, bath houses, sport centers…)[8]. Severe legal restrictions imposed on the movement and grouping of persons limited the possibility of companies to have their personnel working at the same time in the industrial premises or in the offices. Most of the companies tried to overcome this difficulty by adopting smart working and organizational measures to guarantee health safety of the workers. So, at this moment, the industrial production in Italy is ongoing, even if a part of the companies may suffer for delays or disruptions or may decide a temporary stop. It is hoped that the Italian authorities will issue formal certificates for the companies (in particular, those in the most affected areas of the region of Lombardy), which are unable to produce or deliver goods to their foreign customers.

In any case, it is important not to neglect the disclosure obligations and to provide correct communication to the counterparty, also because omitted or misleading information may lead to contractual liability for damages even only for the delay. If the situation does not fall into a force majeure scenario but the impediment may delay or hinder performance, it would be appropriate to find an agreement between the parties on the new delivery times or to renegotiate further the contract.

3. The consequences of force majeure and contract management

Due to a force majeure event, the alternatives may be:

  • suspension
  • renegotiation or
  • termination of contracts.

 

3.1 The termination

In general terms, force majeure clauses in international contracts such as supply chain, distribution and others long term relationships, do not provide for automatic and immediate termination.

The termination of the contract is however unavoidable if the performance of the counterparty is impossible or no longer executable. In addition, some international contract models (e.g. Fidic, in the construction sector) may require that the termination of the contract follows the communication of the impediment of force majeure[9].

The liquidation of the contract – for (valid) force majeure – will follow the criteria set out in the contract or found in the applicable law, bearing in mind  that, generally, damages for non-performance, including penalties, are not due. This is true, in principle, provided that the party was not already in default for other reasons and not delayed unjustifiably the notification of the impediment to the other party.

Italian law provides that the party totally unable to perform cannot request the counter-performance to the other party and must return what received. If the impediment has affected only a part of the performance, the counterparty will be entitled to a corresponding reduction (articles 1463 and 1464 of the civil code). These liquidation criteria are often found in international contracts. For example, the Force Majeure clause of the ICC (2003), provides that the party that has benefited from the partially executed contract, must however compensate the other in an amount equivalent to the benefit it received[10].

3.2 The suspension

In international supply and distribution contracts, where the interest in maintaining the relationship is greater, the parties may agree on the suspension of performance, also fixing a definite period of time[11]. Usually, the term of the suspension indicated in the contracts may vary from a few weeks to a few months.

As for the expenses in the suspension period, in the absence of a specific agreement, each contractor is deemed to bear his own costs, since he cannot charge the party who legitimately invoked the cause of force majeure.

Of course, the suspension cannot go on indefinitely and, in many contracts, it is established that, after a certain term, the contract must be terminated or renegotiated.

Similarly to other legislations, Italian law provides for some termination mechanisms if the situation remains uncertain or if one party can execute only partially its obligations. Actually, Italian law allows the creditor to terminate the contract if he no longer has an interest in the performance of the other party or, in any case, if he no longer has an appreciable interest in a partial performance (art. 1256, 2nd paragraph and art. 1464 civil code[12]).

3.3 Renegotiation

In the silence of the contract and in a situation of uncertainty both on the duration and on the extent of the impediment, renegotiation with the counterparty will reasonably be the preferable solution.

The renegotiation may be:

  • a written agreement on the terms of suspension and/ or an extension of the contract term for a time equal to the suspension period;
  • a mere rescheduling of delivery dates and/or sharing of costs and losses;
  • a more complex agreement aimed at rebalancing the mutual obligations of the parties and/or adapting them to the changed situation.

In the absence of a written agreement, it will be necessary to find an appropriate remedy in the light of the law chosen by the parties in the contract or, in the absence of such choice, to the law applicable to the contract.

Bologna, 16 marzo 2020

 

Avv. Mariangela Balestra,

LL.M. in European Business Law

http://www.lexibc.com/

 

 

[1] On the “law of changed circumstances” under international commercial law, see Dionysios P. Flambouras, The Doctrines of Impossibility of Performance and Clausula Rebus Sic Stantibus in the 1980 Vienna Convention on Contracts for the International Sale of Goods and the Principles of European Contract Law: A Comparative Analysis, 13 PACE INT’L. L.REV.267 (2001) also at <http://www.cisg.law.pace.edu/cisg/biblio/flambouras1.html>; See

Hans van Houtte, Changed Circumstances and Pacta Sunt Servanda, in TRANSNATIONAL RULES IN INTERNATIONAL COMMERCIAL ARBITRATION, Gaillard ed.,116 (ICC Publ. No. 480, 4, PARIS, 1993). See too Sarah Howard Jenkins, Exemption for Nonperformance: UCC, CISG, UNIDROIT Principles — A Comparative Assessment, 72 TULANE L.REV.2017 (1998), also at

<http://www.cisg.law.pace.edu/cisg/biblio/jenkins.html>; Tom Southerington, Impossibility of Performance and Other Excuses in International Trade, Tuula Ämmälä ed.,PUBLICATION IN THE FACULTY OF LAW OF THE UNIVERSITY OF TURKU, PRIVATE LAW PUBLICATION SERIES B:55 (2001), at

<http://www.cisg.law.pace.edu/cisg/biblio/southerington.html>.

[2] Domestic and international approach seems quite restrictive. For example, ICC arbitrators seems consistently upholding the force majeure defense only in extreme cases such as war, strikes, riots, embargoes or other incidents listed in the force majeure clause of the contract. Normally, in cases of impediments to performance related to typical commercial risks, arbitrators uphold the principle of pacta sunt servanda. For a general survey of ICC cases, see: M. Augenblick and A. B. Rousseau, Force Majeure in Tumultuous Times: Impracticability as the New Impossibility – It’s Not as Easy to Prove as You Might Believe, The Journal of World Investment & Trade 13 (2012).

 

[3] See M.G. Rapsomanikas, “Frustration of Contract in International Trade Law and Comparative Law”, https://www.cisg.law.pace.edu/cisg/biblio/rapsomanikas.html.

For an interesting analysis of the US Uniform commercial code and the common practice of the oil producers to declare anyway “force majeure”, after the Hurricane Kathrina, see Leon E. Trakman, DECLARING FORCE MAJEURE: VERACITY OR SHAM?, The University of New South Wales, Available at: http://works.bepress.com/leon_trakman/4/ The author also affirms: “If they declare force majeure without a legal or contractual basis, their relief for performance stems from the persuasiveness of their declaration rather than its legal or contractual authority. Whether their declaration is sustained or not depends on the extent to which their customers resort to business sanctions, or to arbitration or litigation. More often than not, the customer acquiesces in the declaration; there is no legal challenge, but that may be changing.”

[4] However, art. 79(2) of the CISG includes the possibility to exempt a subcontractor: (2) If the party’s failure is due to the failure by a third person whom he has engaged to perform the whole or a part of the contract, that party is exempt from liability only if:

(a) he is exempt under the preceding paragraph; and (b) the person whom he has so engaged would be so exempt if the provisions of that paragraph were applied to him.”

According to the Cisg Secretariat Commentary, “the third person must be someone who has been engaged to perform the whole or a part of the contract. It does not include suppliers of the goods or of raw materials to the seller.”http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-79.html

[5] see e.g. Force Majeure and Hardship: Application in International Trade Practice with Specific Regard to the CISG and the UNIDROIT Principles of International Commercial Contracts, PACE REVIEW OF THE CONVENTION ON CONTRACTS FOR THE INTERNATIONAL SALE OF GOODS 199, 327 (Kluwer, 1999-2000), also at<http://www.cisg.law.pace.edu/cisg/biblio/rimke.html>

For an analysis of clauses of force majeure and hardship in international contracts, see: M. Fontaine – F. De Ly, Droits des contracts internationaux, Analyse et redaction de clauses- Drafting International Contracts: an Analysis of Contract clauses, in Révue des droits des Affaires Internationaux/ International Business Law Journal, Translated into Italian by R. Morresi, La Redazione dei Contratti Internazionali,  Giuffrè, 2008.

[6] China 5 March 2005 CIETAC Arbitration proceeding (L-Lysine case) http://cisgw3.law.pace.edu/cases/050305c1.html

[7] A duty to mitigate the loss can be found also in art. 77 CISG and art. 7.4.8. of Unidroit Principles. This principle is present also in Italian law. Art. 1227 Italian civil code  does not allow compensation of the damages that the creditor could have avoided by using ordinary diligence.

[8] The Italian decrees and other Government’s measures are available at http://www.governo.it/it/provvedimenti

 

[9] In Clause 19 of the FIDIC 1999 Red  (FIDIC Conditions of Contract for Construction, 1999),Yellow (FIDIC Conditions of Contract of Plant and Design Build, for electrical and mechanical plant and for building and engineering works designed by the contractor, 1999) and Silver Books (FIDIC Conditions of Contract for EPC/Turnkey Projects, 1999), the term “Force Majeure” is principally identified as being an “exceptional” event or circumstance, beyond the Party’s control, and something that it could not have reasonably provided against before entering into the Contract. Either party may give notice terminating the Contract in the event of prolonged Force Majeure (more than 84 days for one event, or more than 140 days in total) that “substantially” prevents the execution of all of the Works.

[10] see ICC Publication 650 https://iccwbo.org/content/uploads/sites/3/2017/02/ICC-Force-Majeure-Hardship-Clause.pdf For other ICC clauses see also: F. Bortolotti, “Drafting and negotiating International Commercial Contracts”, A practical guide, ICC publication N° 671, 2008.

[12] In a recent decision, Italian Supreme Court made application of these principles against the Arena of Verona foundation which, applying its general conditions of sale, did not reimburse the tickets of an opera that was interrupted at the end of the first act, because of the rain. The Supreme Court affirmed that there was no interest of the spectator (creditor) in seeing only a part of the opera (so receiving only a partial performance) and that the contract had been terminated due to the force majeure impediment, so that the spectator was entitled to receive the refund of the entire ticket (Cass. Civ. n° 8766 of 29th March 2019 and  Cass. Civ. n° 26959 of 20th December 2007). This principle is widely used in consumer law. In a case concerning the refund of the price paid for a holiday in Cuba, at that moment hit by an epidemic of dengue, the Supreme Court affirmed that the travel company could fulfil only partially its obligations. Actually, the travel company could not guarantee normal standards of health safety to its customers, so that, having regard to the interest of the traveller and the objective of the contract, the traveller could terminate the contract (Cass. n° 16315 of 24th July 2007).

By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.

Close