Covid-19 and the change of circumstances in comparative contract law

Back to Young Lawyers' Committee publications

Federico Samudio
LLM (candidate) in Comparative and European Private Law, University of Edinburgh
fsamudio@ppv.com.uy

Introduction

When a crisis emerges, contract law scholars and professionals embark on discussions regarding the scope of well-known concepts: change of circumstances, frustration, hardship, force majeure and other similar ideas related to the performance of contracts. Usually, the academic debate is focused on the legal provisions of each jurisdiction, while the professional discussion relies primarily on the clauses that the parties can introduce during the negotiation, which may prevent a crisis from affecting the economic conditions of the contract.

The question that I intend to pose here lies somewhere in between these two positions. In a legal system that recognises the impact of supervening events in contracts, should legal professionals rely on the black letter of the law in times of crisis? Can legislation effectively prevent the impact of a global crisis like Covid-19 on the performance of contracts? The responses from certain major jurisdictions suggest diverging views of the problem: while certain legal systems strive to provide comprehensive solutions to cases of change of circumstances, other jurisdictions have preferred a piecemeal approach, protecting only a portion of contracting parties (usually those with diminished bargaining power).

A restrictive model: the United Kingdom

The laws of the UK on this matter offer strict and narrow protection against supervening events through the doctrine of frustration. Even though this doctrine relies, to some extent, on the express or implied allocation of risks and the construction of the terms of the contract, authority on the subject states that the factual context of unforeseeable and extreme events is what conceptualises the notion of frustration.

In Taylor v Caldwell,^[1] Blackburn J stated that there must be impossibility of performance; in Davis Contractors Ltd v Fareham UDC,^[2] Lord Radcliff ascertained that the doctrine applies when the obligations have become, ‘[…] incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract’. Frustration can also be applied where the common purposes of the parties are completely destroyed by supervening events.

Frustration causes the termination of the contract. This would probably represent an extreme solution from the perspective of the parties. In a long-term contractual relationship, the parties might agree on the continuation of the contract but disagree on the allocation of risks. Alternatively, renegotiation of the terms of the contract has not been popular among the legal community because of the uncertainty that it causes in terms of its outcome (say, the consequences of the breach of the obligation to renegotiate).

Because of the implications of the Covid-19 lockdown, supervening illegality of the contract is not an impossible scenario. Naturally, performance must be clearly prohibited for this doctrine to apply: hindrance of or mere difficulty in performance is not sufficient. In this sense, UK regulations due to the outbreak of Covid-19 gain great importance: the Coronavirus Act 2020 grants the government extraordinary powers to issue directions and suspend and postpone activities, all of which have caused a huge impact on different economic activities.

Be that as it may, does frustration apply in the case of a pandemic like Covid-19? The doctrine is not frequently applied and the developing common law of the UK has not yet considered frustration by pandemic. Whether courts will consider the effects of lockdown restrictions as cases of supervening illegality for certain contracts is as-yet undefined, as there is no clear precedent to be applied. Reliance on these concepts might not provide sufficient certainty.

This narrow, pre-existing approach to the change of circumstances in contract law has been confirmed by recent Covid-19 legislation. The UK passed the Coronavirus Act 2020, mainly applicable to England, Wales and Northern Ireland, while Scotland introduced its own regulation which is different in sensitive areas. All of this legislation does not introduce any significant change to the general system of contract law, apart from an adjustment to the procedure and terms of eviction for residential and business tenancies (England, Wales and Northern Ireland) and dwelling houses (Scotland), as well as an indirect impact caused by changes to the insolvency procedure.

Apart from the importance of the insurance market in times of uncertainty, the lack of legal response to the change of circumstances affecting contracts puts the parties in a position in which they must rely heavily on the terms of the agreement, both beforehand (at the time of negotiating the terms of the contract), and afterwards (when due performance is jeopardised because of the supervening events). The parties can include a force majeure clause that gives relevance to the supervening events affecting the due performance of the contract. Under common law, it can be said that, not without discussion, force majeure clauses are usually construed restrictively. Party autonomy determines the scope of the clause, its wording and certain frequently used terms and expressions, although there is authority on the implied limitations that apply to the clause.^[3]

Legislating on the change of circumstances: does it outshine the restrictive model?

Traditionally, the doctrine considering the impact of the change of circumstances has divided European jurisdictions between those that have chosen a piecemeal or closed approach, such as the UK, and those that have an established regulation of the doctrine in their legal systems, like Germany, Italy or Spain.

The new French Civil Code has changed not only the European picture, but it has also boosted the debate in Latin America, where the majority of the jurisdictions recognise the relevance of supervening events in the contract (the most notable exceptions are Chile and Uruguay). In a nutshell, the French Civil Code – reformed in 2016 – now requires that the supervening event shall be unforeseeable at the time of conclusion of the contract, causing performance to be excessively onerous to a party that had not accepted the risk of a change of circumstances.^[4] Then, the affected party may ‘ask the other contracting party to renegotiate the contract’ [emphasis author's own], the refusal or failure of negotiations ultimately leading to the termination of the agreement or its adaptation by the court.

That said, shall the parties rely on the black letter of the law in those jurisdictions that have established a doctrine of ‘imprévision’, ‘change of circumstances’ or ‘hardship’? Are the parties affected by the impact of Covid-19 shielded against supervening events in these legal systems?

Two reasons lead me to take a careful approach to those questions. Firstly, parties must be aware that the wording of the law in these cases is considerably vague and that the factual situations that are to be covered can hardly be predicted. This also applies to the relevant provisions of harmonisation and unification projects, such as the Principles of European Contract Law, which also make reference to the change of circumstances without entering into any details regarding the factual situations to be covered. Secondly, the majority of these mechanisms drive the parties through a renegotiation path that could be deemed non-productive, not least due to an increase in transaction costs.

Once again, the weight and importance of force majeure clauses (that is, their scope and awareness of their interpretation by courts), play an essential role in times of crisis. Reliance on reasonable and cautious party autonomy might outweigh the apparent benefits of legislating on change of circumstances in contract law.

Back to Young Lawyers' Committee publications