The Effects of COVID-19 on International Contracts in Portugal

In the absence of a legal definition in the Portuguese Civil Code (PCC), Portuguese courts have been defining Force Majeure as any natural event or human action that, although predictable or even preventable, cannot be avoided, either in itself or in its consequences.

This means that Force Majeure is any unforeseeable, unavoidable and out of control event that will render the obligations of one of the parties absolutely impossible to perform. If the event could have been predicted by the parties, it would have prevented them from entering into the contract or they would have entered into a different contract.

Force Majeure is therefore treated as a situation of non-attributable non-performance of the contractual obligations, resulting in the termination of the contract without indemnity or compensation for damages.

Hardship is defined in the PCC as a situation where supervening events fundamentally changed the circumstances under which the contract was entered into by the parties, affecting the equilibrium of the contract in such a way that severely hurts the principles of good faith. This triggers a change to the contract to restore the equilibrium or a termination without indemnity or compensation for damages.

Portugal has not ratified the Convention on Contracts for the International Sale of Goods (CISG), but the provisions on Force Majeure and Hardship are similar to the rules on the PCC. 

A detailed examination of the facts and circumstances is always required, but we can assume that the multiple constraints caused by the Coronavirus pandemic are very likely to be considered in some situations Force Majeure or Hardship events. The distinction between Force Majeure and Hardship lies on the effects over the performance of the contractual obligations.

If the performance of the contract has become absolutely and definitely impossible, a constraint caused by the Coronavirus pandemic will be deemed a Force Majeure event, i.e., a situation where the non-performance is not attributable to defaulting party.

This should be the case when a factory is not able to deliver because it was shut down as a result of mandatory orders by the Government (for instance, a declaration of state of emergency) or other competent authorities (for instance, due to a Coronavirus outbreak among the factory workers).

If the performance of the contract is still possible, but a constraint caused by the Coronavirus pandemic fundamentally affected the equilibrium of the contract, representing an extraordinary and unreasonable burden for one of the parties, it will be deemed a Hardship event.

This should be the case when the cost of production skyrocketed because new suppliers of raw materials had to be found in other countries at a much higher cost in order to still be able to perform the contract.

The standard or burden of proof lays upon the defaulting party, who has to be able to establish the facts that support the case.

The mere existence of the Coronavirus pandemic is not in any case an automatic relief from the performance of contracts, even in the most severely affected countries. General claims that non-performance of contracts arise from the pandemic will not be enough to  establish a Force Majeure or Hardship event.

The defaulting party will have to very clearly establish

• the event occurred (for instance, the factory was shut down as a result of mandatory orders by the Government),
• that this event could not have reasonably been predicted when the contract was entered into  and was unforeseeable and unavoidable (for instance, that will not be the case if the contract was already agreed in the context of the pandemic, when the parties should have known that this was a inherent risk to the contract), and
• that there is a connection between the event and the non-performance (for instance, as the factory was shut down, it was not possible to complete the production or to ship the products), or
• that there is a connection between the event and a fundamental change of the equilibrium of the contract resulting in an extraordinary and unreasonable burden for the party (for instance, moving the production to another factory would unreasonably affect the cost of production).

It is therefore crucial to establish whether the Coronavirus absolutely prevented the defaulting party from performing the contract obligations (Force Majeure) or that it caused an unreasonable burden to perform (Hardship). It will not be enough to claim that performance has become more difficult or costly.

Even if the contract includes a pandemic situation in a clause of Force Majeure and even if there is insurance attached to the contract, it is important to be thorough in establishing and proving all the facts.

From a risk management perspective, both parties should first perform an assessment of the situation, identifying the contracts in risk of default or already defaulting and the affected suppliers and clients, and identifying the potential damages that can arise and the existing insurance agreements.

Afterwards, the parties should consider the available alternatives to mitigate the risk of default or the potential damages arising from default, in order to decide which is the best way to manage the overall situation.

Finally, clear and timely communication with affected suppliers and clients is key to solve problems, mitigate damages and  avoid litigation. In any case, it is important to organise and keep documental records to prove the facts.

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