The Effects of COVID-19 on International Contracts

How to handle the case in which a supplier or customer within an international supply chain defaults on a contract? When can Force Majeure be invoked? What are the consequences on contracts? How to minimize risks to the company’s business?

To answer these questions, it is necessary to analyze the content of the contracts and understand what the law applicable to the individual agreements provides for.

Our experts explain how to manage the effects of the Covid-19 pandemic on industrial and commercial activities and share operational advice for managing international contracts during the emergency.

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Switzerland

How are Force Majeure and Hardship defined under Swiss law?

 “Force Majeure” is not explicitly defined in Swiss contract law, more specifically the Swiss Code of Obligations (“CO”). According to the Swiss Supreme Court, Force Majeure relates to unforeseeable and extraordinary “external” events that are inevitable. In case an agreement contains a Force Majeure clause, contracting parties often include examples of Force Majeure events in their agreements. Acts of God such as earthquakes or floods, but also wars and riots are typical examples.

“Hardship” is similar to the concept of “clausula rebus sic stantibus” which allows courts to deviate from the fundamental principle “pacta sunt servanda” (agreements must be kept) by amending contracts without the consent of one of the contracting parties. In order for a court to modify the terms of a contractual relationship, several requirements must be met:

First, the circumstances relating to an agreement must have changed in a fundamental manner.

Second, the changes of the circumstances must be unforeseeable, extraordinary and inevitable.

Third, the changes of the circumstances must lead to a severe disturbance of the contractual equilibrium, so that it would amount to an extortionate exploitation and abuse of law (i.e., a violation of the duty to act in good faith as set forth in Article 2 of the Swiss Civil Code) if the creditor would insist on the fulfillment of its contractual claims. In other words, the performance of the contractual obligations must become excessively onerous.

While Switzerland is a contracting state of the Vienna Convention on Contracts for the International Sale of Goods (“CISG”), the CISG may be (and often is) excluded in trade agreements. Article 79 CISG, which states that a party is not liable for a failure to perform any of its obligations if it proves that the failure was due to an impediment beyond its control, that could have not reasonably been expected at the time of the conclusion of the contract, is substantially similar to the concept of Force Majeure and the “clausula rebus sic stantibus” under Swiss contract law.

Can the Coronavirus be considered as Force Majeure and what are the consequences?

Whether or not a Force Majeure can be invoked primarily depends on the wording of the Force Majeure clause or, in the absence thereof, on the Swiss Code of Obligations respectively its interpretation by the Swiss Supreme Court and further Swiss courts. The statutory rules governing Force Majeure, in particular Article 103 or 119 CO, are of a non-mandatory nature. Therefore, the parties to an agreement may deviate from the statutory principles by, e.g., allocating risks arising out of Force Majeure events to a specific party.

In principle, contracting parties may also freely decide what kind of events shall qualify as Force Majeure. As mentioned above, earthquakes, floods, wars and riots are typical examples of Force Majeure events that are often explicitly listed in Force Majeure clauses. Unless there are indications in a Force Majeure clause that a list of specific Force Majeure events shall be considered as exhaustive, it seems fair to assume that lists of Force Majeure events shall not be exhaustive, meaning that events not explicitly mentioned in the clause may qualify as Force Majeure as well. This holds true, e.g., for epidemics such as the one caused by the coronavirus. It seems rather unlikely that the parties to an agreement intend to exclude global epidemics from the scope of application of Force Majeure clauses.

In the absence of a Force Majeure clause, it seems quite likely that the circumstances caused by the coronavirus qualify as Force Majeure events for the purpose of, e.g., Article 103 CO (concerning delays caused by Force Majeure events), Article 119 CO (concerning situations where the fulfillment of contractual obligations becomes impossible due to Force Majeure events) or Article 163 CO (concerning the unenforceability of contractual penalties in connection with Force Majeure events).

Having said that, it is important to clarify that the Coronavirus itself does usually not qualify as Force Majeure. In the context of trade agreements, rather the circumstances caused by the Coronavirus may qualify as Force Majeure. By way of example, such circumstances may be:

  • an involuntary temporary closure of manufacturing facilities (e.g., due to the sickness of numerous employees, numerous employees being put in quarantine and thereby prevented from working, a company being forced to temporarily exclude numerous employees from work in order to eliminate a potential risk to the safety and health of other employees, an order by authorities to close down the manufacturing facility etc.);
  • temporary export restrictions (as, e.g., for medical protective equipment, medical devices or pharmaceutical products) or the seizure of goods by authorities; or
  • transport interruptions (as, e.g., in case of closing of borders, a suspension of cargo movements or a breakdown of public transportation).

In principle, Force Majeure events may not only relate to a contracting party itself, but also to third party suppliers on whom a contracting party must rely in order to be able to perform its own obligations. If, e.g., a third party supplier has to supply raw materials or components that are a necessary input for the manufacturing of certain goods by the contracting party, the contracting party may be exonerated from its contractual obligations towards the counterparty on the basis of a Force Majeure events relating to the third party supplier. This threshold is quite high though.

There are cases where it might be possible for the contracting party to replace the third party supplier subject to a Force Majeure event with another supplier who is still able to supply. In such a case, the Force Majeure event relating to the third party supplier who was supposed to supply to the contracting party will normally not exonerate the contracting party, since the contracting party could still perform its obligations by relying on other suppliers not subject to any Force Majeure events. This is normally the case, e.g., if the third party supplier has to supply generic goods such as raw materials (e.g., steel or copper); the less alternative suppliers, the more likely that the contracting party will be exonerated on the basis of Force Majeure, and vice versa.

The availability of alternative suppliers depends on numerous factors as, e.g., contractual product requirements set forth in the contract between the contracting parties (e.g., origin requirements) or regulatory requirements or the existence of intellectual property rights. If, for example, a third party supplier supplies components to the contracting party which are (at least partly) protected by intellectual property rights, alternative suppliers are likely missing. For instance, a wholesaler of goods of a specific brand will not be able to fulfill its supply obligations towards retailers if the manufacturer of the branded goods is prevented from manufacturing due to a Force Majeure event. Therefore, the wholesaler will likely be exonerated from its supply obligations towards retailers.

In case a Force Majeure event does not make it impossible for a contracting party to perform its contractual obligations, but performance becomes “just” (much) more costly, the contracting party will usually not be exonerated because of Force Majeure. Such cases must be assessed under the title “hardship” respectively the clausula rebus sic stantibus.

In the event that a contracting party is temporarily prevented from performing its contractual obligations due to a Force Majeure event, the following principles apply:

  • First, the debtor is discharged from liability (damages) for late performance to the extent the delay is caused by the Force Majeure event. Indeed, the debtor will not be considered to be in default as long as performance of its obligations is impossible due to Force Majeure (Article 103 para. 2 CO).
  • Second, contractual penalties for late performance (including, e.g., a reduction of the purchase price by 1% for each day of delay) will not be enforceable (Article 163 para. 2 CO).
  • Third, the debtor will also not assume any liability for random events, as it is the case for culpable delays (cf. Article 103 para. 1 CO).

If performance of an obligation becomes permanently impossible due to a Force Majeure event, the obligation is deemed extinguished and the debtor is exonerated. The debtor must return any consideration already received from the creditor on the basis of the statutory provisions on unjust enrichment and loses its counterclaim against the creditor to the extent it has not yet been satisfied (Article 119 para. 1 and 2 CO).

Having said that, it is important to keep in mind that parties can deviate from these statutory principles, e.g., by allocating the risks arising out of Force Majeure events to one of the parties. Such allocation may not only take place in the Force Majeure clause itself, but also in other provisions of an agreement (e.g., relating to contingency plans). Moreover, a contracting party will usually not be exonerated on the basis of Force Majeure in case there was a prior culpable delay in the performance of its contractual obligations, unless such party can prove that Force Majeure would have occurred anyway, i.e., even if the contracting party had not been in a culpable delay (Article 103 para. 2 CO).

Can the Coronavirus be considered as Hardship and what are the consequences?

Parties are free to include Hardship clauses in their contracts. Such clauses may describe specific cases of Hardship and their consequences in detail. “Hardship-like” clauses are, e.g., common in supply agreements where parties may provide for an adaptation of prices in case of major changes in price indexes (such as the Swiss consumer price index), exchange rates or prices of raw materials. In contrast, Hardship-like clauses can also explicitly exclude any adaptation of a contract in case certain events occur.

In the absence of contractual Hardship clauses, Hardship must be analyzed under Swiss statutory law. As mentioned above, Hardship respectively the clausula rebus sic stantibus is based on Article 2 of the Swiss Civil Code, i.e., the obligation to act in good faith.

Some provisions specific to certain kinds of contracts contain additional Hardship-like rules. By way of example, Article 373 para. 2 CO, which relates to practically important contracts for works and services, states that where performance of the work was prevented or seriously impeded by extraordinary circumstances that were unforeseeable or excluded according to the conditions assumed by both parties, the court may at its discretion authorize an increase in the price or the termination of the contract. In contrast, the statutory rules applicable to mandate agreements do not contain a similar clause. However, Article 404 CO, which is mandatory law, states that either party may terminate mandates at any time, subject to the compensation of damages (negative interest, i.e., to bring the other party in the position as if the mandate had never been concluded) in case the mandate is terminated at an inopportune moment.

The first requirement for the application of the clausula rebus sic stantibus, a fundamental change of the circumstances, implies that the concept may, in principle, apply to continuing obligations only. One-off transactions are usually not within the scope of application of the clausula rebus sic stantibus. Whether the coronavirus amounts to a fundamental change depends on the specific circumstances. Some companies (e.g., manufacturing companies) may be concerned massively by the coronavirus (up to a complete temporary shutdown of the business), whereas other companies (e.g., certain service providers) may be able to continue performing their obligations, e.g., by “simply” letting employees work from home.

The second requirement, unforeseeability, should not be a major concern. Indeed, it is hard to see how someone could successfully argue that the COVID-19 epidemic should have been foreseeable, unless the relevant agreement has been concluded after the first COVID-19 cases popped up in December 2019 in China.

The third requirement, a severe disturbance of the contractual equilibrium, again depends on the specific circumstances and must be analyzed on a case-by-case basis. For example, a manufacturer who has agreed on fixed supply prices that are valid for a certain period of time and whose manufacturing costs rocket, e.g., due to limited availability of raw materials, might suffer under a severe disturbance, whereas other companies might face limited costs increases only. In any event, the disturbance of the contractual equilibrium does not have to lead to the economic ruin of the party suffering under changed circumstances. The starting point is the contract as concluded; an agreement which was unbalanced already at the time of its conclusion cannot be “remedied” through the application of the clausula rebus sic stantibus. Overall, courts dispose of a considerable discretion when deciding whether a severe disturbance of the contractual equilibrium exists.

In case all requirements of the clausula rebus sic stantibus are met, the consequences for the agreement must be primarily assessed in light of the agreement, in particular if the contract contains Hardship-like clauses. In the absence thereof, the courts have to assess the hypothetical will of the parties, i.e., what reasonable parties would have agreed on in case they had known about the change of the circumstances. In principle, the courts dispose of a considerable discretion, as they have several options to choose from:

  • The court can decide that a contract shall be terminated, usually ex nunc, i.e., with effect as from the termination.
  • The court can prolong or shorten the term of an agreement.
  • The obligations of the parties to the contract may be altered, e.g., by adapting prices, deadlines for the performance of obligations etc.
What is the respective burden of proof on the parties to prove the coronavirus outbreak can be/cannot be deemed as an event of Force Majeure?

In the absence of a Force Majeure or Hardship clause that allocates the burden of proof to one of the parties, the burden of proof lies with the party who wish to exculpate itself, i.e., which is affected by Force Majeure or Hardship.

Article 97 para. 1 CO states that a debtor who fails to perform an obligation shall be liable for damages, unless the debtor can prove that it was not at fault. Hence, the creditor does not have to prove that there was no Force Majeure or Hardship, but only the non-performance of the obligation, the damages caused by such non-performance and the causal link between the non-performance and the damages.

What is recommended in case of notice of Force Majeure in Switzerland?

Companies should screen their agreements and assess whether they are able to perform in accordance with the agreement despite of the Coronavirus. In that regard, special attention should be paid to unsubstitutable third party suppliers, on which contracting parties depend for the performance of their own obligations. Such third party suppliers should be contacted proactively in writing and requested to provide written information as to whether and to what extent they are able to supply despite the COVID-19 epidemic. Commercially important contracts (e.g., agreements with a high turnover or which could give rise to high damage claims) should be prioritized.

If it is foreseeable (or at least likely) that a company will be prevented from fully performing its obligations in a timely manner due to the coronavirus epidemic, the company should do whatever is feasible to mitigate the consequences of the epidemic on the performance of its own obligations (e.g., by trying to find new third party suppliers). Such efforts should be documented in an appropriate manner, since such documentation might be necessary as evidence if disputes should arise later on.

In addition, the company should notify affected counterparties as soon as possible in writing about the circumstances which prevent the company from fully performing in accordance with the contract, including a description of measures taken to mitigate the effects of the epidemic and, if possible, a forecast regarding the length of the delay caused by the epidemic. Further notification requirements might be stipulated in agreements, general terms and conditions etc.; if such requirements exist, they should be fully complied with.

Notifications to counterparties should be updated whenever circumstances change, e.g., as soon as it is foreseeable that information in earlier notifications might be outdated.

Companies should check whether there is any insurance in place, which might cover damages caused by the COVID-19 epidemic (e.g., an epidemics insurance, business interruption insurance etc.). If so, the company should notify the claim as soon as possible to the insurance company in accordance with the rules set forth in the insurance policy and the general terms and conditions of insurance. Uncertainties regarding the insurance coverage may be discussed directly with the insurance company.

If a company receives a notification of Force Majeure or Hardship from the other party, but does not agree with the qualification as Force Majeure or Hardship, such company should inform the counterparty without delay in writing that reliance on Force Majeure or Hardship is unjustified and insist on performance in accordance with the contractual obligations.

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