During and after COVID-19: Force Majeure and frustration as defences against contractual liability

Corporate Clients, Covid-19, Insolvency and Restructuring

SUMMARY

• The Covid-19 pandemic has prompted swift and all-encompassing governmental measures, gumming up domestic and cross-border commerce and making many transactions impossible
• This is a cause for contractual default by businesses
• Along with newly-introduced special legislation, the force majeure and frustration defences are devices Bulgarian law devices that will be used by businesses defending contractual claims and seeking to adjust their economic losses
• Force majeure is based on a party’s inability to perform under a contract. It allows for the suspension of performance (and may allow for complete discharge of contract).
• Force majeure is however inapplicable to purely financial impossibility.
• Frustration allows a party to request contractual adjustment: termination or amendment, where it does not wish to perform and unforeseeable economic reasons make the bargain grossly unfair and contrary to commercial good faith.

BACKGROUND: FORCE MAJEURE, FRUSTRATION AND SPECIAL LEGISLATION

The ongoing Covid-19 pandemic and government actions intended to dampen it strain the performance of contracts sometimes to breaking point. Аmong others, the proximate causes of impossibility to perform include staff absences, newly-imposed workplace health and safety requirements and liquidity crises.

In the general case, where a breach of a contractual obligation would occur as a result of Covid-19 or of epidemic control, what can a contractual party do to defend itself against or mitigate claims for breach of contract? On the other hand, what arguments may be soundly made in favour of performance regardless? We refer to each party prevented from performing as Affected Party (all parties may be Affected Parties: identically or in different ways).

Below we review two relevant concepts of Bulgarian law: force majeure and frustration in turn. In addition to these concepts, which apply non-specifically to the pandemic, s 6 of the recent Bulgarian Actions and Measures under the State of Emergency Act 2020 (AMSEA) may also be relevant. This newly-passed legislation suspends a range of private law obligations and remedies for the duration of a state of emergency (at the date of writing, this state will continue to 13 May 2020). We cover the implications of s 6 in a separate note [link].

FORCE MAJEURE

What is force majeure?

Overwhelming force (below we use the commercially common French variant ‘force majeure’) is an extraordinary event that cannot be foreseen or avoided, which arises after the parties contract. The force in issue may be in the form of a natural disaster (e.g. the Covid-19 pandemic itself) or may be man-made including of a governmental, administrative or legal nature (e.g. the government measures taken in response to the Covid-19 pandemic). The force majeure can apply to all types of contract governed by Bulgarian law.

Is a force majeure clause needed?

Force majeure principles apply by default of law: a force majeure clause does not need to be included by the parties in their contract – though it may be. Spelling out what counts as force majeure between the parties may: (i) help the parties be better aware of it in their dealings; (ii) be useful if the contract is to be enforced by a foreign tribunal or court; and (iii) allow for a more extensive definition than the statutory description of force majeure, applicable specifically between the parties. Parties may not subtract from the statutory scope of force majeure – if an event meets the statutory criteria, it will be considered as force majeure regardless of the parties’ definition.

The flip side of this may be that with a cross-border contract (even one that is intended to be performed in Bulgaria), the parties cannot assume that force majeure would automatically apply – but they can assume so if the contract is governed by Bulgarian law.

Causation

The force majeure event must make at least one contractual party unable to perform its contractual obligations. The causal relationship may be direct (i.e., the overwhelming force is the immediate cause of the impossibility to perform (e.g., in a contract of carriage by air, the impossibility of a flight due to a government ban on flights)) or indirect (e.g. in a manufacturing contract, the inability to import an input material necessary for the product to be produced under the contract due to a flight ban) and as above may be a purely legal cause: e.g., legislation prohibiting the export of certain goods. Where there are arguably more causes of one and the same inability to perform, a more careful analysis of the situation will be needed.

Notice requirement

Further, force majeure must be invoked by the Affected Party. I.e., the Affected Party must notify the party to which they owe performance as soon as practicable. We would recommend that notice be given in writing and following any pre-existing contractual requirements as to how notice should be given that apply between the parties (e.g., as to the address or method of service of notice).

Limits

An important exception from the list of the kind of events that can count as force majeure is lack of money itself, even if it is sudden, unforeseeable and catastrophic. Therefore, if e.g., the force majeure involves a loss of goods which were to be sold under one contract, which in turn results in a lack of funds that is relevant to the performance of another contract, force majeure as a defence of a claim under the second contract is of doubtful use.

The dominant judicial view in Bulgaria however is that a technical inability to pay may be force majeure. E.g., where banks in the country of the payee have closed for business because of Covid-19 (Bulgarian banks continue in business at the time of writing).

Importantly, to make use of force majeure, the Affected Party must not already be in breach (e.g. late with a payment) by the time of occurrence of the supervening event.

Effect of force majeure

While the force majeure continues, performance of the contractual obligations of the Affected Party and the related obligations of other contract parties are suspended by operation of law. Both the Affected Party and its counterparties with their corresponding obligations are free of liability for breach for as long as the overwhelming force continues.

Moreover, if the suspension lasts so long that there is a ‘loss of interest’ in the performance of the obligation affected by force majeure, e.g. if a party needs a delivery on a certain date and not a day later, it may discharge the contract all performance that is due after the date of notice. Parties can stipulate in their contract the duration of the force majeure before the contract to be discharged – automatically or with the discretion of the parties.

The obligations accrued before the force majeure event remain legally binding on the Affected Party.

Force majeure is typically invoked out-of-court first, though it may need to be litigated on in the competent forum.

How does this apply to your situation during the pandemic?

1. The Covid-19 pandemic is likely such an extraordinary supervening event that it will be recognised as a force majeure in a very wide range of situations. Recognition is not an absolute certainty, but is likely for the majority of courts.
2. Whether a certain inability to perform is caused by the epidemic (or by a mixture of reasons, or not at all by the epidemic) would be a matter of fact and will need to be analysed carefully. The less direct the causation, the more side-causes, the less straightforward the argument.
3. Unfortunately, even where the pandemic is shown to be the cause of an impossibility in performing where the result is an inability to pay (that is not technical in nature), this cannot be pleaded as force majeure.
4. Some defaults may be force majeure, but still not be helpful if you do not wish your counterparty to be able to potentially walk away from the contract.
5. With force majeure, there is no automatic mechanism for price adjustment.

Practical steps

You may wish to:

1. Include a contractual clause that defines what the parties will consider force majeure, define what the fundamental contractual obligations are, and define periods beyond which the contract may be discharged – but they may not in advance exclude the application of force majeure – this is mainly relevant for the future.
2. Consider whether your contract’s difficulties are caused by the pandemic or the response to it and whether you wish to rely on force majeure if it means the contract may be ended. Seek legal advice.
3. Obtain a force majeure certificate issued by the Bulgarian Chamber of Commerce and Industry, where at all possible: this will be useful evidence.

FRUSTRATION

Frustration once again involves events and circumstances relevant to contract performance which were not foreseeable at the time of contracting. (“Foreseeable” to the average business man or woman, who is credited with knowledge of their area of business but not much else). The unforeseeable events make performing the contractual obligations unfair and contrary to “good faith”.

Frustration automatically applies to all types of Bulgarian law governed contracts, just as force majeure does.

Historically, frustration has coincided with economic depression and the dislocation resulting from war or dramatic upheavals like the fall of communism in Eastern Europe and the initial transition to a market economy (e.g., the accompanying high inflation, currency devaluation, etc.). Frustrating events may be also more isolated events, such as an exorbitant spike in the price of a relevant raw material.

Changes in the exchange rate of the contract’s currency are not a ground for pleading frustration in themselves. However, they may constitute a basis together with other causes.

As with force majeure, the party relying on frustration must not be in breach prior to pleading the defence.

Also, similarly to force majeure, parties are free to stipulate in their contract how frustration will apply between them but arguably are not free to exclude its application altogether.

The distinction between force majeure and frustration is that for parties pleading frustration it remains possible to perform, but for economic reasons performance is arguably unfair and contrary to good faith. The bargain they had struck is no longer a bargain of equals and just. Whether this is so, is assessed on a case-by-case basis by the competent forum (court or arbitral tribunal), asked on the matter.

Need for recourse to courts or arbitral tribunals

The party relying on the Bulgarian doctrine of frustration may apply to court to terminate or amend the contract as a whole or in part to correct the gross unfairness, in such a way as requested by the parties. The court cannot alter the parties’ obligations before the date of decision i.e. retroactively. These remain legally binding in full.

As we have written, Bulgarian courts are suspended until 13 April 2020 and this is expected to be extended to 13 May 2020 and at least some of the domestic arbitral centres are not issuing new arbitration proceedings. Some courts now accept claims and open cases during the state of emergency and schedule hearings for after its lifting.

Frustrated contracts will likely have long-term effects, and at least certain effects would apply after the courts reopen for business. They will therefore be capable of re-arrangement by a court or arbitral tribunal at that time. In our view, courts can, and those that open cases during the state of emergency will, backdate the remedy they decide on to the date of the application, making applying as soon as the economic unfairness arises quite prudent.

FRUSTRATION OR FORCE MAJEURE?

While the outcome of the contract adjustment process (applicable in frustration) may generally be less certain than the effect of a finding of overwhelming force, it may be the only attractive remedy where the impossibility one would otherwise plead is purely financial.