Force majeure and impossibility - legal effects of the corona (COVID-19) pandemic on contracts

The COVID-19 pandemic is presenting businesses around the world with new challenges. This is especially true in a globalized economy where supply chains span the globe.

A. COVID-19 as the starting point

Initially, only cities and regions in China were locked down, delivery traffic was restricted or no longer possible, and factories were closed; as a result, the question of whether force majeure applied—and what this meant legally—arose only in the context of supply contracts involving China. Now, however, the question has become nearly universal, even for supply contracts with no international component: supply chains are disrupted, and factories have come to a standstill. Many companies are now receiving “force majeure notices” from their suppliers, resulting in the suspension of deliveries. The question of whether the COVID-19 pandemic truly constitutes force majeure and what this actually means for supply contracts is addressed below. In individual cases, the question always arises as to whether force majeure events have been (exhaustively) regulated in the contract (see B.I.). Under the UN Convention on Contracts for the International Sale of Goods (CISG), these cases are resolved in accordance with the rules on exemption (Art. 79 CISG). (B.II). Otherwise, German law does not recognize the term “force majeure” as such, but instead governs these situations according to the rules on impossibility (§ 275 BGB) or the lapse of the basis of the transaction (§ 313 BGB) (see B.III.).

B. Legal Framework

I. What is force majeure? Are there any explicit contractual provisions (“force majeure clauses”)?

To avoid disputes or risks of misinterpretation, many contracts include a so-called “force majeure clause” in the event of extreme, unforeseen events. This clause grants one or all contracting parties the right, in the event of force majeure, to withdraw from the otherwise binding contract or to temporarily suspend performance. The clause is capable of superseding applicable positive (statutory) law. While the first part of the clause typically addresses the definition of what constitutes force majeure and thus determines the conditions for exemption from liability, its second part deals with the intended legal consequences. These can vary in scope and may, for example, provide for a right of withdrawal or termination, a right to temporarily suspend delivery, an exemption from liability for damages, the granting of a grace period, etc.

Force majeure is generally understood to mean an event external to the business, caused by external natural forces or by the actions of third parties, which is unforeseeable according to human judgment and experience, and which cannot be prevented or rendered harmless even by the utmost reasonable care expected under the circumstances, and which the business operator is not required to accept due to its frequency. Essential elements of force majeure are thus unpredictability, inevitability, and exceptionality. Examples of this include (civil) wars, threats of war (to the extent they are unforeseeable), and natural disasters.

Unless a contract precisely defines or even exhaustively lists what constitutes force majeure—and if pandemics are excluded from such a list—the current COVID-19 situation would likely meet the three criteria of unforeseeability, inevitability, and exceptionality. However, this must be continuously assessed, as what is unavoidable today may look very different tomorrow. The decisive factor here is the point in time at which a party invokes force majeure. If the contract contains a force majeure clause, the legal consequences provided for therein apply first. It should be noted that such clauses may not only be included in the contract text itself but are also usually found in the general terms and conditions. In such cases, it must be examined on a case-by-case basis whether these were validly agreed upon (i.e., “incorporated” into the contract) and whether they are valid.

II. UN Convention on Contracts for the International Sale of Goods

The UN Convention on Contracts for the International Sale of Goods (CISG) applies whenever an international sale of goods is governed by the law of a contracting state or the parties have agreed to its applicability. Since the UN Convention on Contracts for the International Sale of Goods is an integral part of German law, it is deemed to have been agreed upon whenever, for example, “German law” is agreed upon in an international sale of goods without explicitly excluding the UN Convention on Contracts for the International Sale of Goods.

Under Article 79 of the CISG, the supplier is not liable for an impediment to performance resulting from force majeure. Article 79 CISG initially governs only the exemption from liability for damages and generally leaves other claims unaffected. If performance is objectively impossible even in the long term, it is recognized that the claim for performance lapses. The burden of proof that the non-performance is due to an impediment beyond the party’s control and that the party could not reasonably have been expected to foresee the impediment at the time of contract formation or to avoid or overcome the impediment or its consequences lies with the debtor. However, a decisive factor in determining whether a contracting party may invoke Art. 79 CISG is that the non-performing party must notify the other party of the impediment and its effect on its ability to perform. If the other party does not receive such notice within a reasonable time after the non-performing party knew or ought to have known of the impediment, liability remains (Art. 79(4) CISG). In such cases, prompt legal review and response are required.

Under Article 79 of the UN Convention on Contracts for the International Sale of Goods (CISG), epidemics, blockades, and the closure of transport routes are generally recognized as force majeure events. In the current situation, it can be assumed that a case of force majeure within the meaning of the CISG may exist. However, the decisive factor is the extent to which a contracting party is affected in each individual case. This may change over time. It should also be noted that, to avert the impediment to performance, the supplier is generally expected to incur additional financial expenses; for example, choosing alternative means of transport may be reasonable, even if this entails high additional costs and losses for the supplier. To the extent that a replacement delivery is possible under the relevant supply relationship, the supplier may be required to deliver replacement goods within the bounds of reasonableness. This, too, is a matter to be determined on a case-by-case basis.

III. German Law

Unless a (valid) force majeure clause has been agreed upon in the contract or in the general terms and conditions, and unless the UN Convention on Contracts for the International Sale of Goods applies, the general statutory provisions apply: Section 275 of the German Civil Code (BGB) provides that a claim for performance is excluded to the extent that such performance is impossible for the debtor or for anyone. The debtor may also refuse performance if it would entail unreasonable effort. Whether the current pandemic renders performance impossible is a matter of case-by-case assessment and depends on the specific circumstances.
If the obligation to perform is waived, the corresponding obligation to provide consideration may also be waived. However, this is not necessarily the case: If the debtor has, for example, committed a culpable breach of duty by failing to take reasonable measures to avoid the impossibility, they are liable for damages. The key question is therefore whether the debtor caused the impossibility of performance either through negligence or intentionally. The burden of proof lies with the debtor.

It is also possible that Section 313 of the German Civil Code (BGB) (cessation of the basis of the contract) applies. This provision stipulates that, in the event of a significant change in the circumstances that formed the basis of the contract, an adjustment to the contract may be demanded. A prerequisite for this is that the obligated party cannot reasonably be expected to continue to adhere to the contract. Only if an adjustment of the contract is not possible or not reasonable can the contract be terminated. Under German law, epidemics and pandemics have already been regarded as force majeure in the past (for example, in connection with the outbreak of the SARS virus). In assessing individual cases, the statements of the Federal Foreign Office and the recommendations of the WHO are likely to serve as particularly significant indicators. Governmental measures (e.g., production restrictions or embargoes) may also be classified as force majeure.

C. Recommendation

If a supplier invokes a force majeure clause, or if a party wishes (or is required) to invoke such a clause itself, it must be determined in each specific case whether a genuine force majeure event has occurred. Unless a contractual provision has been expressly agreed upon in this regard, it must be determined whether the UN Convention on Contracts for the International Sale of Goods or general German law applies. In doing so, the question of what is reasonable for the supplier to do to maintain the supply chain must always be addressed. This may be assessed differently over time. What may have constituted force majeure yesterday may already be a situation that can be managed today: If, for example, a company invokes force majeure even though it was foreseeable that it could not deliver, or there are reasonable solutions available to enable delivery, a force majeure declaration will no longer be of any help.