Flat lay of business concept

Covid and changing of circumstances

Can Covid be considered a “force majeure event” or “changing of circumstances” to end contractual obligations?

The impossibility of compliance and changing of circumstances can lead a party to fail contract obligations in situations that could not be avoided.

Any unforeseeable, unavoidable and out of control impediment that will render the provision of one of the parties absolutely impossible to perform is considered a force majeure event. Earthquakes, storms, volcanic eruptions and acts of war are some examples of force majeure events that can be used by the parties to terminate contractual obligations in advance.

The situation of a supplier, for example, who is prevented from meeting the date of manufacture and delivery of a product due to the fact that most of his/her employees became infected seems clearly a situation of force majeure. The situation changes, however, if the failure is due to the supplier’s lack of diligence in the manufacturing process.

Although Covid can be considered force majeure, it is necessary to determine with certainty whether it “absolutely” prevents one of the parties from fulfilling its obligations under the contract. Only this will legitimise it to terminate the contract without the obligation to indemnify the other party since, under the legal regime, the party who breaches the contract is obliged to indemnify the counterparty for the damages caused.

Thus, the occurrence of an event such as Covid is not enough for the defaulting party to be released from its obligations. It is always necessary to prove that the event occurred outside of your control and that there is a link between the event and the non-compliance, as well as to prove that you could not reasonably foresee the event in question, nor its consequences at the time of the celebration the contract. If this does not happen, the injured party can claim compensation for damages and losses suffered.

Extreme cases, such as the closure of establishments as determined by the authorities, in principle will be considered as “impossibility”, exempting the party that suspends the contract or disengages itself from liability for the damages caused. The invocation, by the affected company, of mere difficulties (but not of impossibility, temporary or definitive) of compliance with the contract will, in principle, be condemned to failure.

As an alternative to force majeure, it is still necessary to consider the feasibility of applying the “changing of circumstances” regime provided for in article 437 of the Civil Code.

This regime determines that a contract can be terminated or modified by one of the parties according to fairness judgments, if (i) the circumstances in which the parties based the decision to contract have undergone an abnormal change, (ii) provided that the requirement of the obligations assumed by the affected party seriously undermines the principles of good faith and (iii) is not covered by the risks inherent in the contract.

Although it is an exceptional regime, in the current context it cannot be excluded that the various direct and indirect impacts of Covid on the economy may justify the application of the changing of circumstances regime in some situations, allowing companies and injured parties to modify the content of contracts or terminate their effects.

Under Portuguese law, as a general rule, the risk of circumstances occurring after the conclusion of the contract, which disturb the balance desired by the parties at the time of contracting, is borne by the debtor, that is, the one who is bound to perform an obligation.

A very marked difficulty, a practical or economic “impossibility”, the exception of the debtor’s ruin or the excessive cost of compliance with the contract, once the respective conditions of admissibility are verified, can trigger the application of the “change of circumstances”, which is applicable when the provision is still possible but implies an unexpected injury at the time of contracting which renders compliance with the contract unenforceable.

The change of circumstances institute is applicable in such a way that the losses resulting from this exceptional circumstance can be shared equally among the parties, allowing the injured party to request the other party to modify the contract (which may, for example, involve a moratorium on payments to be made or for a reduction of price) or, at the limit, its resolution.

The law has a preference for a loss-sharing solution over an “all or nothing” solution that results from the resolution, implicitly imposing on the uninjured party a duty to renegotiate the contract in good faith.

Therefore, if the contract is disrupted, a negotiation process must be initiated as soon as possible to deal with changing circumstances. In any case, the ancillary duties of loyalty and protection are intensified in this scenario, and appropriate measures must be taken to mitigate the losses that the party affected by changing circumstances may suffer.

Although, in the abstract, the current epidemic situation may constitute grounds for the suspension and termination of contracts based on changing circumstances, it does not serve to immediately and automatically justify the early termination of contracts, exempting the parties from fulfillment of obligations to which, freely, in good faith and considering the risks inherent in the contract, they are bound.

By Dr Eduardo Serra Jorge
|| features@algarveresident.com

Dr Eduardo Serra Jorge is founding member, senior partner and CEO of lawyers firm Eduardo Serra Jorge & Maria José Garcia – Sociedade de Advogados, R.L., created in 1987.
In his column, he addresses legal issues affecting foreign residents in Portugal.
Faro office at Gaveto das Ruas Pedro Nunes e José de Matos, 5 R/C
289 829 326
www.esjmjgadvogados.com