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Coping with Covid-19 - the Business Response

Businesses’ contractual obligation in a time of pandemic

By Dr Kinga Ziemnicka, attorney-at-law, M&A and Corporate practice, Wardyński & Partners
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Numerous sectors of the economy have been paralysed. The problem is not just closings or restricted access to a range of services, but also absence of staff due to illness, quarantine or childcare. Consequently, businesses cannot operate normally or perform their obligations on time.

A lack of supplies by one company often carries over to an inability of its customers to fill their own orders. This bogs down the whole economy. Time will tell if the new systemic solutions allow Polish companies affected by the epidemic to survive. However, regulations regarding commercial contracts are a separate topic worth analysing.

Coronavirus as force majeure

The coronavirus pandemic is a phenomenon which in certain circumstances may be regarded as force majeure. The term force majeure (literally, ‘superior force’ or ‘higher power’) is used often in laws and contracts, but is not a defined term in Polish law. Nonetheless, force majeure is commonly recognised to mean:

  • An external event

  • Impossible (or nearly impossible) to foresee

  • The effects of which cannot be prevented

These conditions must all occur together.

In contracts between businesses, force majeure is often indicated as a circumstance excluding the parties’ liability for failure to perform their obligations. The definitions used in contracts may differ in their details, but typically they take the form of general clauses, where particular events are listed only as examples, as below:

“Neither party shall be liable for non-performance or improper performance of its obligations arising under this contract if caused by the occurrence of force majeure, which the parties recognise as including for example natural disaster, fire, flood, earthquake, military action, strike, blockade, interruptions in delivery of utilities (power, water), or any other circumstances or causes independent of the parties.”

Of course the coronavirus pandemic is not expressly listed in such a clause, but as mentioned, the instances covered by the force majeure clause most often do not constitute a fixed catalogue but only examples. Thus if contracts provide for liability, including contractual penalties, for untimely performance of services or deliveries, a business failing to perform its obligations as a result of the coronavirus epidemic will be able to avoid such liability due to the lack of fault on its part.

But the circumstances where the epidemic impacts performance of contractual obligations should be demonstrable, to avoid situations of possible abuse. Therefore there must be a causal connection between the state of force majeure and the non-performance or improper performance of the contract. The breach must truly result from the operation of force majeure in the form of the epidemic, and not for example from the lack of due diligence required under the circumstances.

If the contract lacks provisions on force majeure, the parties may rely on general rules. Under Art. 471 of the Civil Code, the party that has failed to carry out its obligation is required to redress injury arising out of non-performance or improper performance of an obligation, unless the breach is a consequence of circumstances for which it is not responsible.

Contractual liability is based on the principle of presumed fault. The burden of proving that a breach was due to force majeure thus rests on the party that failed to perform its obligation.

If the parties to the contract are businesses from different countries, the effects of breach of contract should be considered in light of the law governing the specific contract and the applicable provisions of international law.

Withdrawal from contract, extinguishing of obligation

Contracts concluded by businesses often provide for non-liability or limited liability for a party’s breach of contract due to force majeure. They also allow a party to withdraw from the contract if performance by a strictly defined time is essential for the party (where time is of the essence). The contract’s provisions must be examined in this respect. If a right of withdrawal due to failure to make timely performance is provided for in the contract in the event of default by the other party, then as a rule the party can withdraw from the contract without designating additional time for the other party to perform.

But under the current circumstances, when the performance of contractual obligations often proves impossible for reasons independent of the parties, it is important to note the difference between ‘default’ [zwłoka] and ‘delay’ [opóźnienie]. ‘Default’ may be attributed to a party that has failed to perform a contract on time for reasons for which it is responsible. By contrast, ‘delay’ occurs when the deadline is not met for reasons independent of the party that is late.

Contracts often include detailed provisions entitling one party to exercise a right of withdrawal in the event of default or delay by the other party, even as a result of force majeure, if this state of affairs continues for a length of time specified in the contract.

Thus if performance of the contract within a strictly defined time is essential for a business, the provisions on withdrawal from the contract should be examined in particular, as well as the rules for settlements between the parties, including for advances or down-payments. In the event of dissolution of the contract, a down-payment or deposit made by the buyer must be refunded (not retained as the seller could do if the buyer defaults), and the seller’s obligation to pay double this amount (which would arise if the seller defaulted) also drops out. The same applies if the contract is not performed due to circumstances for which neither party is responsible.

The regulations also provide that if a party obliged to perform declares that it will not perform, the other party may withdraw from the contract – even prior to the deadline for performance – without first setting an additional period for performance.

A party that has withdrawn from a bilateral contract is required to return to the other party all the consideration it has received, and the other party is required to accept the return. Under typical circumstances (apart from force majeure), the party withdrawing from the contract may demand not only return of its own consideration but also redress, under general rules, of the injury arising from failure to carry out the obligation. But if non-performance of the obligation is a consequence of circumstances for which neither party is responsible (such as the coronavirus epidemic), the rules for settlements between the parties are different. Liability for injury resulting from non-performance for reasons independent of the party must be avoided. And a party that was supposed to perform but did not do so due to circumstances for which it is not responsible cannot demand performance by the other party. If it has already received that consideration it is required to return it under the provisions on unjust enrichment.

If performance by one of the parties has become only partially impossible, that party will lose a right to an appropriate portion of the other party’s consideration. But the other party may withdraw from the contract if partial performance would serve it no purpose; in such cases it may withdraw from the contract in its entirety.

If as a result of withdrawal from the contract the parties are to return their mutual consideration, each of them has the right to retain the consideration received until the other party tenders the return of the consideration it has received (or secures the claim for its return).

Apart from the right to withdraw from the contract, under Civil Code Art. 475 §1, if performance has become impossible due to circumstances for which the party is not responsible, the obligation is extinguished. Impossibility of performance which results in the obligation being extinguished covers situations where after the obligation arises, calls for a state of complete, lasting and objective inability for the party to act in the manner provided for in the substance of the obligation – and not just a temporary difficulty in performing.

Clause on extraordinary change in circumstances

If the parties cannot reach agreement, they can rely on the clause on extraordinary change in circumstances, set out in Art. 3571 [CS1] of the Civil Code. This regulation provides that if due to an extraordinary change in circumstances, fulfilment of performance would involve excessive difficulty or expose one of the parties to a glaring loss which the parties did not foresee when concluding the contract, the court may, after weighing the interests of the parties, and in accordance with principles of social coexistence, designate the manner of performance of the obligation or the amount of the consideration, or even rule that the contract is dissolved. When dissolving the contract, the court may, if necessary, rule on the settlements between the parties, guided by the same general principles.

In the existing situation application of this clause is limited not so much by legal reasons as practical considerations. What is needed now is immediate solutions to quickly stabilise businesses’ current operations. Considering that the courts have also limited their activity, taking cases like this into litigation at the same time as the problem becomes widespread would offer neither a fast nor an effective solution, given the tempo of changes in circumstances and mutual business relationships.

What can businesses do in the time of the coronavirus?

Until new regulations and a protective package for business are adopted, businesses should respond on an ongoing basis through mutual concessions allowing everyone to make it through the crisis. Because delays in performing contracts are global, businesses should consider renouncing their existing contracts only as a final resort.

A more practical solution is to renegotiate contracts, in particular commercial contracts or contracts for performance of certain services. It would be worthwhile taking up renegotiations now, even though the situation is hard to predict, to regulate the parties’ mutual obligations to stabilise the current situation – and for the future (after the epidemic ends). Negotiations may involve the possibility of changes in deadlines, spreading payments out over time, and also mutual agreement on repayment of currently outstanding amounts to avoid any loss of financial liquidity on the part of businesses as well as their customers and suppliers.

In these tough times, communications and solidarity are vital in the interconnected world of business. If a customer or supplier fails, it can also threaten one’s own business.

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