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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Norway

Force Majeure, Hardship and other relevant rules under Norwegian law

“Force Majeure” is not explicitly defined in Norwegian law. However, based jurisprudence and legal theory Force Majeure relates to extraordinary external events that are unavoidable and unforeseeable for the parties, making it impossible for one or more of the parties to perform in accordance with the contract either temporarily or permanently.

Force Majeure is a general contractual principle, meaning that it applies even if the contract between the parties makes no reference to Force Majeure.

It should be stressed that the parties are free to define Force Majeure in the contract, and that this will prevail if it contradicts the general principles above. Force Majeure clauses can vary greatly in their drafting. A simple reference to Force Majeure in the contract should be understood as a reference to the general understanding of the principle.

“Hardship” is understood as a contractual hardship-clause meaning that in given situations, the parties are obliged to renegotiate the contract in order to avoid unreasonable imbalance due to changed circumstances. Thus, Hardship is only relevant if the specific contract contains such a clause, and the consequences must also be governed in the clause. Very often the hardship clause only stipulates an obligation to renegotiate but might also include the consequences of failure to renegotiate, such as a right for the affected party to terminate the contract or a right to submit the question to court/arbitration.

Other rules relevant for the contracting parties in relation to Covid-19

In addition to Force Majeure and Hardship clauses, other rules may be relevant and overlapping when discussing whether a contracting party may be relieved from contractual obligations due to Covid-19 and/or the contractual obligations may be altered as a consequence of Covid-19.

With respect to sale of goods, article 79 of the Vienna Convention on Contract for the International Sale of Goods (CISG)  states that a contractual party is not liable to perform any of its obligations if it proves that the failure was due to an impediment beyond its control and that could have not reasonably been expected at the time of the conclusion of the contract. CISG applies for international sales contracts unless excluded in the contract (which is quite often the case).

The Norwegian Sale of Goods Act and Consumer Sales Act contain a quite similar regulation to that of CISG article 79 in article 27:

However, this does not apply to the extent that the seller proves that the delay is due to impediments beyond his or her control, which the seller could not reasonably be expected to have taken into account at the time the agreement was entered into or avoid or overcome the consequences of.

If the delay is due to a third party who the seller has commissioned to fulfil the purchase in whole or in part, the seller is free from liability only if the third party would also be released therefrom under the provisions of paragraph 2 above. The same applies if the delay is due to a supplier that the seller has used, or to some previous intermediary in the sales chain.

Freedom from liability applies for as long as the impediment exists. If the impediment ceases to exist, liability may be invoked if the seller then undertakes to fulfil the obligation but fails to do so.

The main requirements are that the seller must be able to prove that the delay is caused by impediments beyond the seller’s control and also beyond the control of third parties acting on behalf of the seller, and furthermore that the impediments could not reasonably be to be taken into account when the contract was entered into. It these requirements are met, the purchaser is prevented from claiming damages, but only for as long as the impediment exists.

Thus, article 27 of the Sale of Goods Act is somewhat less strict than the traditional Force Majeure principle and makes the use of traditional Force Majeure with respect to sale of goods obsolete.

The article is not mandatory and can be derogated.

Similar provisions can be found in some other legislation as well.

More generally, article 36 of the Contracts Act may be relevant in case of Covid-19. This general principle states that an agreement may be set aside or altered if it would be unreasonable or a breach of good faith to apply the agreement (or specific clauses of the agreement). When applying article 36 it is also relevant to look at factors that have occurred after the contract was entered into. Even though it should be stressed that article 36 is very rarely applied by Norwegian courts in commercial agreements between professional parties, it might be applicable if Covid-19 makes it unreasonable to demand that the affected party performs in accordance with the contract. Article 36 gives the court the option between setting aside the agreement and altering it to avoid unreasonableness.

The general principle of Frustration of purpose can also be found in Norwegian law.

Conclusion

To summarize, the parties must begin by examining the specific contract. Does it contain a Hardship clause or a Force Majeure clause and if so, what are the specific consequences? That might vary to a great extent.

If the contract does not contain such a clause or the Force Majeure clause only refers to Force Majeure as a general principle, it is necessary to scrutinize the content of the Force Majeure principle as it is understood from jurisprudence and legal theory.

It is also important to separate sale of goods from other contractual obligations. For sale of goods, Force Majeure is obsolete and replaced by the specific regulation in article 27 of the Sale of goods Act, which is quite similar to CISG article 79. Thus, Force Majeure is only really relevant for other contractual obligations (for instance lease agreements) unless the contract regarding sale of goods includes a Force Majeure clause.

In addition, article 36 of the Contracts Act and the general principle of Frustration of purpose can be relevant and also overlapping.

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

Whether or not Force Majeure can be invoked as a result of the Coronavirus depends on the wording of the specific Force Majeure clause. In the absence of such a clause or if the clause only refers to Force Majeure without any definition, the understanding of the concept is based on jurisprudence and legal theory.

As seen above, Force Majeure must relate to 1) extraordinary external events that are 2) unavoidable and 3) unforeseeable, 4) making it impossible to perform in accordance with the contract.

The existence of the Coronavirus in itself does not qualify as a Force Majeure. The question must be if the virus causes obstacles for the contracting parties that qualify to the conditions above. For instance, the following circumstances should qualify in general, save for the situation that the contract is entered into after the parties should have been aware of the Coronavirus and its effect on society:

  • An involuntary temporary closure of manufacturing facilities as a result of public orders to shut down
  • Temporary export restrictions of goods in question
  • Transport interruptions, for instance closing of borders

If the situation qualifies as Force Majeure, the legal consequence again depends on whether or not this is addressed in the specific contract. Without specific regulation, the consequence is that the performing party cannot be held liable for breach of contract due to non-performance during the duration of the Force Majeure situation. If the situation is permanent or of an indefinite period, the party’s obligation may cease altogether.

With respect to article 27 of the Sale of Goods Act, the consideration will be quite similar. However, the legal consequences are not identical. The legal consequence would rather be that the seller is not liable to pay damages due to the delay and that the customer may not demand delivery as agreed, but that other remedies due to breach of contract are available to the customer, such as termination if the delay is material.

How to prove that the Corona Virus can be considered as Force Majeure event?

In the absence of a Force Majeure clause that allocates the burden of proof to one of the parties, the burden of proof lies with the affected party. The affected party must be able to prove that all conditions mentioned above are met in order to qualify as Force Majeure.

A similar burden of proof follows directly from article 27 of the Sale of Goods Act.

What is recommended in case of notice of Force Majeure?

The affected party (debtor) should begin by analyzing its relevant contracts in order to assess the specific terms applicable for the individual contracts, if such a clause exists. The Force Majeure clauses might vary. Based on such individual assessments of the applicable Force Majeure clause or the general principles if no clause is present in the contract, the affected party must consider whether or not the conditions are met (and can be proved) in order to invoke Force Majeure, including the situation with regard to subcontractors/suppliers. The affected party must also consider what other steps that are necessary to perform. This includes notification to the other party and seeking alternative solutions to ensure performance, e.g. finding other subcontractors/suppliers etc.

In addition to the above, the following steps should be taken:

  • Inform the contracting party as soon as possible of the situation and expected consequences. The affected party should also continue to inform the other party of the development and, if the Force Majeure is limited in time, when performance is likely to resume.
  • Undertake all reasonable steps to mitigate damages.
  • Initiate negotiations if desirable to reach amicable amendments
  • Gather necessary proof that the conditions necessary to invoke Force Majeure are met.
  • Draft future agreements in light of the situation and spend time on considering and negotiating Force Majeure clauses in agreements that you consider entering into. Ensure that the clauses are similar towards customers as they are towards suppliers/subcontractors.
  • Reflect on the consequences of the current situation when accepting contractual obligations that might be difficult to perform because of the Corona Virus. As mentioned above, Force Majeure cannot be invoked if the obligation was not unforeseeable.
  • Check if insurance policies are applicable, and if so, contact the insurance company as soon as possible. One should also consider if insurance policies are available for future needs.

The non-affected party (creditor) should in a similar way assess the contract and object in writing as soon as possible if it is of the opinion that Force Majeure cannot be invoked by the other party. Furthermore, the non-affected party should consider how its possible contractual obligations towards third parties are affected and act accordingly.

A quite similar approach should be taken if article 27 of the Sale of Goods Act is applicable.

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