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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Italy

Update on March 25, 2020

Law decree 17.03.2020 n. 18 the so called Save Italy Decree, at art. 91 stipulates that compliance with the measures taken due to the spread of Coronavirus might be considered as non-attributable cause i.e. Force Majeure in order to exclude liability of the debtor pursuant to articles 1218 and 1223 c.c. in case of delays or breach of contract. The assessment on whether or not it recurs Force Majeure, though, should be conducted by the Judge on a case by case basis.

The said provision represents a recommendation to the judge to evaluate with benevolence a Force Majeure defense raised because of the Covid-19 pandemic.

Art. 91 clearly supports the debtor even in terms of burden of the proof but the simple provision might not be enough in the international context where the counterparts increasingly demand to receive certificates issued by public entities attesting Force Majeure as a result of Covid-19’s spread and the measures taken to contrast it.

In the light of the above, on March 25th, 2020 the Ministry for the Economic Development (MISE) has issued a communication whereby it envisions the possibility for the local Chambers of Commerce, to issue a certification of Force Majeure resulting from the epidemic and the restrictions imposed by the Law for its containment.

The Chambers of Commerce will then be able to certify that they have received a declaration from the company stating that they were unable to fulfil their contractual obligations previously undertaken for unforeseeable reasons beyond their control due to the restrictions imposed by the authorities. The certification shall be issued in English at the request of the companies whose activity has been affected and with reference to contracts with foreign counterparts.

The companies shall then submit to their counterpart the certification in order to support the impossibility of fulfilling contractual obligations already undertaken within the time limits, for unforeseeable reasons beyond the company’s control and capacity and due to the restrictions imposed by the law for the containment of the epidemic.

Two seem to be the legal issues and limits concerning the certification issued by the Chamber of Commerce.

  • The first one regards the legal value from a formal point of view of the certification issued by the Chamber of Commerce whose role is simply to attest that a mere declaration coming from the party has been received without any confirmation the truthfulness of its content.
  • The second regards the fact that the certification might relate only to nonperformance or delays due to the restrictions imposed by the authorities excluding other cases where, for example, suspension of the activities has not been ordered.

Due to the said limits it is rather questionable whether or not the declaration issued by the Chamber of Commerce will serve as evidence to support a Force Majeure defense.

Update on March 22, 2020

Due to the urgent measures incessantly enacted by the Italian government, it is necessary to constantly update the report. The last piece of regulation i.e. a Decree of the President of the Ministers’ council “DPCM” has been published on the 22.03.2020 and shall be effective on the 25.03.2020.

Pursuant to letter (a) of art. 1 of DPCM, in theory, all industrial and commercial activities are suspended with the exception of those listed in the Annex 1 to the said decree.

I underscored, in theory, because beside the exceptions specifically enumerated the provisions of DCPM further specifies other exceptions in a more subtle way.

Now the order issued by the authority to suspend all industrial and commercial activities, in principle, reasonably represents an impediment that make it impossible the fulfilling of the obligations either temporally of definitely. In those cases, respectively a non-attributable-cause shall justify either the delay or the non-performance. The occurrence of the impediment, furthermore, shall assure the immunity od the debtor insulating it from damages’ claims pursuant to article 1218 c.c.

In sum, except for the debtor’s obligation to inform the creditor promptly, (a) a definitive impossibility due to non-attributable cause leads to the termination of the obligation; (b) the temporary impossibility excludes the debtor’s liability for damages pursuant to art. 1218 c.c.

Nevertheless on should point out that, according to case law, the discharge of the debtor in the event that the performance becomes impossible due to an order of the authority (Factum Principis) does not free the debtor to act in any way, according to ordinary diligence, to overcome or remove the impediment (C. 14915/2018).

In this respect DPCM goes on and at letter (c) further specifies that the activities which would be suspended “may nevertheless continue if organized in remote or smart working mode”. This statement is likely to impact on performance or non-performance in the sense that if fulfillment might be achieved when the work is organized in remote or smart working modem, then the debtor has a duty to perform or at least to try to perform its obligations acting in such a way.  As a consequence, one should construe letter (c) as it follows: where possible remote and smart working should be implemented in order to fulfil the obligations of the pending contracts and overcome the order of suspension issued by DPCM.

Moreover, letter (d) postulates that the activities which are functional to ensure the continuity and the chain of the activities listed in Annex 1 (the activities not suspended), as well as public utilities and essential services referred to at letter (e) are permitted subject to prior notification to the Prefect of the province where the activity is located.

Letter (d), in other words, suggests that if the activity is not specifically allowed but is functional to the activities listed in the Annex 1 one should file an application to the Prefect in order to have a permit so as to avoid suspension. Even in this latter case filing the application can be considered a necessary step to be taken in order to eventually invoke later on the impediment consisting in the denial of the Prefect’s authorization. In addition, letter (d) stipulates that if the application is filed then the business entity can run its activities until the possible Prefect’s denial. The application is therefore a condition precedent in order to avoid at least temporarily the suspension of the activity. The said application should be filed pursuant to DPCM should be filed immediately i.e. before the 25.03.2020 when DPCM shall be effective.

The same applies according to letter (g) for continuous production cycle companies where the interruption results in damages to the plants or in accidents. Even in this hypothesis one should immediately apply to the Prefect in order to avoid suspension unless the activity is aimed at ensuring the supply of an essential public service.

How are Force Majeure and Hardship defined in the Italian Civil Code (“c.c.”)?

Under Italian law pursuant to article 1218 c.c. a party to a contract who does not perform exactly its obligations shall be held liable to pay damages if it fails to demonstrate that the non-performance or the delay were due to the impossibility of performance resulting from non-attributable causes.

Having put forward the overall principle, one should investigate what does it mean “a non-attributable cause” which is corresponding in general terms to the tenet of Force Majeure.

The principle of Force Majeure which under Italian is intimately accompanied by the notion of Fortuitous Event are not clearly defined by the Italian Legislator.

In other words, under Italian law, there is no precise definition of Force Majeure or Fortuitous Event since there is no provision explicitly describing the cases at hand.

The expressions Fortuitous Event and Force Majeure are nonetheless mentioned throughout the c.c. for instance at article 1693 c.c. regarding the responsibility of the carrier or at article 1785 c.c. concerning the boundaries of the innkeeper’s liability. Because of the inadequacy of the description of their characteristics, the scholars have made converge those two notions in the unifying concept of “non-attributable causes”. Moreover, the notion of “non-attributable causes” should not be construed as a mere absence of fault but should be considered as a positively identifiable fact (better impediment) capable of preventing liability in case of non-performance.

The events/impediments in which the Force Majeure and Fortuitous Event can be exemplified in a sort of troika:

  • of the natural fact (Force Majeure), as for the impediment consisting in a natural fact; in order to exempt from liability, the impediment must be unpredictable at the time the contractual obligation has been undertaken and unavoidable (see Cassation Court (“”) n. 09/23412);
  • the so-called Factum Principis, as for the impediment consisting in an order or in a prohibition issued by the administrative, judicial or governmental authorities (see C. n.14/18880). For instance, in this respect, the embargo declared by the United Nations against Iraq has been considered as a Factum Principis preventing the fulfillment of contractual obligations towards subjects having their headquarters or premises in that country.
  • of the fact of the third such as, for example, the abandonment of dangerous objects on the road (see C. n. 783/2013).

Clauses of Force Majeure or Fortuitous Event, both at national and international level, are invariably inserted in contracts especially with continuous, periodic or deferred performance, commonly as boilerplate.  The most standard clauses provide that the nonfulfilling party in case of exceptional and unforeseeable events is discharged from liability for non-performance and may suspend performance and, if such events persist, may eventually terminate the contract.

“Hardship” under Italian law the notion of Hardship is akin the “disproportionate overcoming onerousness” doctrine. Art. 1467 c.c. states that in contracts with continuous, periodic or deferred performance, if performance of one of the parties has become excessively burdensome due to the occurrence of extraordinary and unforeseeable events, the party who owes such performance may terminate the contract.

Furthermore, the said provision specifies that termination may not be required if the onerousness of the contract falls within the normal scope of the contract.

The party against whom termination is sought may avoid such termination by offering to modify the terms of the contract in an equitable manner.

The excessive burden incurred is due to extraordinary and unforeseeable events. Economic burdens that fall within the normal risk of the contract, e.g. ordinary and foreseeable market fluctuations, cannot be invoked by the debtor. Those normally excluded by insurance policies are typical extraordinary events.

A specific application of the tenet under question is the one regarding construction contracts. Art. 1664 c.c. provides that if as a result of unforeseeable circumstances, there has been an increase or decrease in the cost of materials or labor force such as to result in an increase or decrease of more than one tenth of the agreed total price, the contractor or the client may request an adjustment of the price. The adjustment may be granted only for that difference exceeding one tenth. Furthermore, the provision at stake provides that if, in the course of the work, due to geological, water and similar causes not foreseen by the parties, performance difficulties arise which make the contractor’s performance considerably more expensive, the contractor is entitled to fair compensation. Even article 1672 c.c., always regarding construction contracts, is an application of the principle of Force Majeure.

Additionally, the principle of good faith and fair dealings encompassed in articles 1175 c.c. and 1375 c.c. which permeate our legal system suggests that the parties should renegotiate the clauses which have become excessively burdensome, regardless the provisions inserted into the contract.

At the international level contrary to what happens in the national sphere, Force Majeure is generally defined. For instance Article 79(1) of the Convention on the International Sale of Goods (the so-called Vienna Convention of 1980 or “CISG”) provides that a party is not liable for a failure to perform the obligations undertaken if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.

In the international context Force Majeure clauses are aimed at excusing a party from liability if some unanticipated event beyond the control of that party prevents it from fulfilling its obligations. Hardship Clauses, on the other side, essentially mandate a re-negotiation of the original conditions of the agreement if the performance of one of the parties has become excessively burdensome due to unpredictable and unavoidable circumstances.

The International Chamber of Commerce (“ICC”) has developed in 2003 a Force Majeure Clause and a Hardship Clause, Force Majeure is defined in the opening formula of the template clause as an impediment beyond the reasonable control that it could not reasonably have been expected to occur at the time of the conclusion of the contract and be avoided or overcome.

The template caluse is rather interesting since it itemizes the impediments commonly accepted in the international context as causes of Force Majeure.

Can the Coronavirus be considered as a Force Majeure in Italy?

The increasing spread of the Covid-19 in Italy over the last few weeks has pushed the government to issue several Decrees of the President of Council Ministers (“DPCM”) so as to provide for urgent measures in order to contain and handle the emergency. The latest decree issued on the 11.03.2020 orders specific measures applicable to the entire Italian territory.

The above-mentioned urgent measures consist in the nation-wide suspension of certain types of the businesses, while in the so-called “red zones”, it has been imposed also the suspension of any transport of goods.

Those measures, if applicable to the contract in question, represent a Factum Principis i.e. one of the cases of Force Majeure and are able to affect negatively the correct performance of the contract.

If the urgent measures taken by the DPCM directly impact performance and cause an impediment to the performance, one has to look at the contract and verify whether or not it contains a Force Majeure clause.

Where the contract contains a Force Majeure clause, the contractual provisions on Force Majeure shall apply: typically, as see above, first the suspension of the performance and, if the impediment is protracted, termination.

Where the contract does not contain a Force Majeure clause the general principles as set forth above on the impossibility of performance resulting from non-attributable causes i.e. Force Majeure or disproportionate overcoming onerousness i.e. Hardship shall apply (depending on the specific case).

As far as the impossibility of performance resulting from non-attributable causes i.e. Force Majeure is at stake, one has to distinguish:

  • the case when the impediment is not reversible and where the impossibility is therefore absolute: the contract shall be automatically terminated;
  • the case when the impediment is transitory and where the impossibility is only temporary:

(i) if the fulfilling party has no longer an interest in performance the contract shall be automatically terminated, (ii) if not the contract shall not be terminated and the delay in the performance shall not produce any consequence.

By contrast Force Majeure cannot reasonably be invoked if the urgent measures taken by the DPCM merely perturbate the ordinary course of business without directly impacting performance and without causing an impediment to the performance. In other words, the contract might not be terminated if a party’s performance has become more problematic or less profitable as a result of the measures taken by the government and more in general of Covid-19. On the other side, as previously mentioned, based on the principle of fair dealing and god faith, one may try to renegotiate in a more balanced way the obligations undertaken or invoke the disproportionate overcoming onerousness doctrine i.e. Hardship.

The last piece of legislation that has been enacted i.e. Law decree 17.03.2020, n. 18 at art. 91 provides that compliance with the measures taken due to the spread of Coronavirus might be considered as non-attributable cause i.e. Force Majeure in order to exclude liability of the debtor pursuant to articles 1218 and 1223 c.c. in case of delays or breach of contract.  The assessment on whether or not it recurs Force Majeure should be conducted by the Judge on a case by case basis.

The said provision is also aimed at excluding debtor’s liability with regard to the application of any forfeiture or penalties resulting from delays or breaches of contract due to the measures taken against Covid-19.

Is the Coronavirus unpredictable and its consequences unavoidable?

An unpredictable and inevitable impediment is not enough in order to exempt from liability the non-fulfilling party in case of non-performance due to Force Majeure, the party invoking this remedy has also to demonstrate that the impediment is not due to his or her fault. In sum, the impediment must be objective and absolute. According to the case law an impediment is objective and absolute when a person endowed with normal or qualified diligence (depending on the type of contractual relationship) would not have foreseen its occurrence and could not in any way have counteracted it after the impediment occurred. (see C. n. 7293/1996).

  • The cause of the hindrance was foreseeable at the time the contract was entered into

If at the time the contract was entered, the circumstances in which the impediment occurred were such as to make it foreseeable and avoidable, Force Majeure cannot be invoked.

  • Insolvency

As seen above the impediment that justifies the non-performance must be absolute and objective and must find its source in a case not attributable to the parties, thus excluding personal events such as insolvency (C. n.21599/2010). Insolvency therefore does not justify invoking Force Majeure.

  • Illness

In order for the illness to constitute a case of Force Majeure, it must be so serious as to prevent any kind of activity on the part of the non-fulfilling party. That assessment must be carried out on case by case basis in order to examine whether in the specific circumstances the use of ordinary diligence, could have prevent the impediment (C. n.214/2016).

  • Risk to life, health, freedom, etc.:

Under the Italian legal system in torts it has been settled the so called state of necessity doctrine (see art. 2045 c.c. which states that when the party committing a tort was forced to do so by the necessity to save himself or others from an incumbent danger of serious personal injury, and the danger was neither intentionally caused by him nor otherwise avoidable, the injured party is awarded with an indemnity and not with damages).

The amount of the indemnity to be awarded is left to the fair evaluation of the judge. In the Italian Legal System, the state of necessity doctrine responds to a notion of equity that allows the judge to reduce the damages to a mere indemnity, after having compared the conflicting interests.

The scholars have debated whether the state of necessity doctrine might have been extended to the liability in case of breach of contract, case law by contrast has simply denied such a possibility (C. 2660/1971).

It should be noted that in torts atmospheric events might be considered Force Majeure if they are exceptional and unpredictable in this respect a state of emergency declaration alone does not constitute in itself an exceptional and unforeseeable event (C. n.14861/2019).

  • The debtor’s inexperience

Force Majeure is an unpredictable and imponderable impediment that suddenly becomes part of the causal sequence of factors determining non-performance, nevertheless the exceptional character of the impediment is not sufficient alone, to configure an exemption and excuse non-performance, but its predictability should be excluded on the basis of the so-called common experience.

What are Unforeseen circumstances (Hardship) under Italian law?

The “disproportionate overcoming onerousness” doctrine as we have seen above is applicable in case of extraordinary and unforeseeable events. The economic burdens that fall within the normal risk of the contract cannot be invoked by the non-fulfilling party to justify the breach. Those events whose occurrence cannot be assessed at the time the contract was entered can be considered as extraordinary and unforeseeable.

According to the case law, in contracts that entail continuous, periodic or deferred performance, each party bears the risk of events that might alter the economic value of the respective obligations, within the confines of the normal scope or risk of the contract.

It follows that the occurrence of foreseeable circumstances that make the performance of the obligation excessively burdensome – and therefore unprofitable – is not relevant in this regard (C. 12235/2007). Likewise, when the debtor, negligently, has not foreseen an event, or when he has contributed with his conduct to determine the disproportionate overcoming onerousness the said doctrine does not apply (C. 2661/2001).

In sum, so as to be able to raise a disproportionate overcoming onerousness defense, two requirements must be met: (i) on the one hand, a superseding imbalance between the obligations of the parties, which was not foreseeable at the time the contract was entered, and (ii) on the other hand, the occurrence of extraordinary and unforeseeable events, which do not fall within the scope of the normal contractual risk.

As far as the notion of normal contractual risk the case has defined it as the economic risk concerning the value of the obligations in a situation that is neither extraordinary nor unforeseeable (C. 6616/1991).

Furthermore, it is important to point out that the extraordinary nature of an event must be objective. In order to determine whether or not and event is extraordinary in nature, one has to take into account and evaluate through quantitative and statistical analysis elements, such as the frequency, the size, the intensity, etc.  The character of unpredictability, by contrast, has a subjective nature and one as to look at the so-called common experience (C. 22396/2006).

The remedy in case “disproportionate overcoming onerousness” is the termination of the contract. A viable alternative is the so-called equitable modifications of the contractual conditions. The fulfilling party who is facing a possible termination is offered the possibility to avoid it proposing to modify the contract’s conditions in a fair manner so as to remove the excessive onerousness that has occurred. This alternative remedy stem from the principles of good faith and fair dealing that are profoundly embedded in the Italian legal system.

How to prove a Coronavirus event of Force Majeure in Italy?

The burden of the proof rests with the debtor raising either (i) a Force Majeure defense in order to justify the non-performance or the delay due to the impossibility of performance resulting from non-attributable causes or (ii) a disproportionate overcoming onerousness defense seeking termination or as alternative the possibility to renegotiate in a fair way the conditions of the contract.

Covid-19 might be considered an extraordinary and unforeseeable event whose consequences are not avoidable for instance where performance is barred by the decrees issued by the Government or by other pieces of legislation.

Moreover, the debtor may also argue that at the international level the 2003 ICC Force Majeure clause explicitly lists “plague and epidemic” as typified impediments. Again, from a statistic point of view, the occurrence of a such epidemic is very rare. A problem might arise if the obligations were undertaken when the virus was at the onset but not yet widely spread or for the obligations undertaken clearly after the outbreak of the epidemic.

Those elements might be taken into consideration by the debtor in order to support a disproportionate overcoming onerousness defense in order at least to try to renegotiate the conditions of the contract.

A state of necessity defense might be raised in torts.

What is the best course of action in case of notice of Force Majeure in Italy?

In conclusion, the assessment to verify whether or not Force Majeure or Hardship apply must be carried out on a case by case analysis to be conducted for each matter in order to examine whether the requirements of foreseeability and unavoidability in the specific circumstances are recurring and if the use of ordinary diligence, could have prevent the impediment or its consequences.

The following countermeasures and actions are in any case recommended:

  • First of all, one should verify whether the obligations undertaken in the contractual relations are affected by the spread of Covid-19 and whether or not performance is jeopardized more onerous or ultimately became impossible.
  • Secondly, one should examine the contract in order to verify whether or not clauses of Force Majeure or Hardship are present. Having done that, one should closely look at the clause, review its scope pursuant to the governing law of the contract.
  • Thirdly, the party non-fulfilling its obligations, or the party facing a possible non-performance or a disproportionate burden should inform in a timely and proper manner the contractual counterparts about possible delays and increasing difficulties in performance or eventually impossibility to perform describing the causes for non-performance and explain why they are non-attributable.
  • Make a list of the clients that should be supplied first and in a more effective manner notwithstanding restrictions and difficulties.
  • Consider viable alternatives and take all the necessary actions so as to limit potential and actual damages.
  • If entering into new commercial contracts, checking whether occurrences such as Covid-19 are adequately covered by the clauses inserted in the agreement.
  • Check whether damages are insured, either with the debtor or the creditor.
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