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Impact of COVID-19 spread on contract fulfilments

By Martín Carlevaro & Vivian Maldonado, BKM | Berkemeyer - 17/04/2020
Impact of COVID-19 spread on contract fulfilments

The Government of Paraguay has taken a number of actions over the risk of the COVID-19 spread on the national territory, by issuing resolutions and decrees with direct impact in social, legal and financial fields. On March 26, 2020, Law No. 6524 was enacted, "declares Emergency throughout the entire territory of the Republic of Paraguay over the pandemic declared by the World Health Organization due to COVID-19 or coronavirus and administrative, fiscal and financial measures are established''

As a result of the health phenomenon and the restrictions imposed at national level, the terms, inter alia, “acts of God”, “force majeure”, “theory of unforeseen contingencies”, “sovereign act”, gained prominence. Parties of contracts are beginning to question whether such legal expressions could be invoked for exculpatory purposes.

In order to define the subject matter in short manner, related provisions on Paraguayan laws are focused.

ACTS OF GOD AND FORCE MAJEURE

If any impediment to fulfill a contract is faced, we should carefully analyze first the contractual clauses and check whether they regulate the legal consequences of failing to fulfill obligations due to pandemics or similar situations, respecting what is expressly agreed, as long as it is not contrary to imperative laws, morality or public order.

In the absence of contractual stipulation, the second step is to analyze the specific concurrent circumstances and assess whether there are certain situations in which Law considers that one of the parties may be exceptionally exempted, in temporary or definitive manner, entirely or partially, from complying any liability arising from a contract.

These grounds for exemption from contractual liability are provided under the form of force majeure, regulated inter alia through Articles 426, 628 and 721 of the Civil Code [1]-

Both, doctrine and jurisprudence, agree that in order to meet the conditions required under the act of God or force majeure concepts, the event must be: (i) irrelevant or unrelated to the debtor, (ii) unpredictable and supervening on the constitution of the contractual obligation, (iii) subsisting at the time in which it must be fulfilled (the fact or event affecting fulfillment of the obligation must be present and not a simple threat), (iv) the fact or event must turn compliance with the obligation impossible, (v) the debtor must not be in default at the time the act of God or force majeure event is configured (except that it has also occurred due to force majeure), and (vi) the party intending to invoke this exemption from liability must act in good faith, and adopt the necessary measures to mitigate the harmful effects derived from the event.

It is important to point out that, once a temporary impossibility has ceased, the obligation must be fulfilled. A clear example on the application of this legal provision is provided by Law No. 6524 regarding payment of rents, enabling tenants to pay at least 40% of the monthly rental price until June of this year, which prevent landlords from setting evictions against their tenants. Said provision does not establish a reduction or decrease on the rental price, as the remaining amounts (namely, the unpaid portion of the amount) must be paid pro rata along with the total rental price starting on July, within the following six months. Therefore, the obligation should be fully met after the emergency period is over. Regarding the pandemic, it seems clear that a fact of nature (COVID-19 spread) is combined with sovereign acts (resolutions, decrees and laws issued to fight the spread)- which may impact compliance of contracts fulfilled in installments, showing that not all will be affected to the same extent, even it is possible that some contracts are not harmed at all. [2]

Consequence of the application of act of God or force majeure to a particular case will consist in noncompliance by the party invoking the same in regard to any unfulfillment incurred during the event that causes such application. This exclusion as well as the scope of the remaining contractual obligations must be evaluated on a case-by-case basis, analyzing the impact and terms of each contract, which may or may not contain force majeure clauses that define the limits and consequences of any cause for noncompliance; since a guarantee security agreement could have been included (a supposition in which the debtor is responsible for the consequences of an act of God or force majeure event, valid by application of the principle of freedom of choice of each party) or an agreed system to be followed upon a force majeure event occurs, for instance an extension of the contractual relationship beyond the duration to allow full compliance of the respective obligations.

It is essential that the party with the intention to apply this legal concept proves in a reliable way how the pandemic and/or Government's measures affected compliance (causal connection), acted with due diligence and took all measures within his/her reach to prevent or mitigate damages. To this end, it is essential the exchange of written communications between the parties informing in due course and proper form the occurrence of circumstances unforeseen at the moment the contract was signed, as well as keeping on file all sent and received notes for any eventual future claim. Whether or not the activity, in which the party subject to fulfill an obligation is engaged, is listed as exempted from quarantine and isolation should be also analyzed

THEORY OF UNFORESEEN CONTINGENCIES

In cases where certain unforeseen situations cannot be taken as a cause for applying the force majeure concept because it does not prevent from fulfilling contractual obligations, but said fulfillment becomes more expensive, theory of unforeseen contingencies may be applied, as expressly regulated through Article 672 of the Civil Code [3].

This rule requires the concurrence of the following requirements: (i) contracts of deferred execution, (ii) provision becomes excessively expensive, (iii) application does not proceed when the situation is within the normal scope of the contract, (iv) debtor is not related to the occurrence of the situation, (v) debtor is not in default regarding fulfillment of such obligation.

Unlike acts of God or force majeure events, here we do not face inability to fulfill an obligation, but a disproportionate burden to one of the parties, which may also result in improper profit for the other party. The concept named "suitability of the contract" comes into action as a negotiated and recommended solution, called "shared effort" by doctrine. In any case, suitability of the contract (namely, renegotiation of prices, extension of terms, changes in the scope) would be the result of equal efforts to distribute liabilities and rights in order to restore contract conditions (which includes economic equation) taken into account when originally concluding the contract. This case also requires proof of hardship, good faith and proactive behavior by the affected party.

PRACTICAL RECOMMENDATIONS

In view of the foregoing, we offer the following recommendations:

(i) Analyze the specific contract and do not establish a definitive position a priori.

(ii) Define governing laws since some contracts may be executed locally but regulated by foreign legislation.

(iii) Analyze the specific force majeure clauses, if any, in order to determine the specific formalities for communicating the events.

(iv) Consider the effects that force majeure or the theory of unforeseen contingencies may have on the future performance of the contract and/or the reasonable contractual balance between the parties.

(v) Identify the exact nature of the problems and their causal connection in the noncompliance and/or significant price increase, since updated knowledge of the facts is essential for making appropriate management decisions and capacity to prove these is a key fact for success in any subsequent legal proceeding. For example, if a supplier is unable to deliver supplies or a subcontractor cannot perform certain work, a declaration of force majeure due to COVID-19 should not be accepted immediately, but details on how exactly the provision or rendering is affected must be required, namely, specifically in which sense the decrease in production is due to the closure of factories, quarantines ordered by the Government, diseases of personnel, etc. The precise nature of the problem should be identified and evidence regarding cause of the problem must be obtained.

(vi) Send notices to the other party about the different circumstances arising from the force majeure event in order to inform about all impacts that may affect the contract, under due advice so that good faith is not tainted by a wrong course.

(vii) Verify that no waiver clauses against the legal concepts described herein were included

(viii) Evaluate the impact on costs and terms, to remedy the contract situation and pending obligations of the parties, keeping an eye on equity in the analysis.

(ix) Evaluate a mitigation plan during the occurrence of the act of God or force majeure event or duration of the conditions set by the entities, and feasibility of implementation.

(x) Prove fulfillment of obligations, prior to the occurrence of the force majeure event.

(xi) Adopt all the health security measures recommended by the National Government.

This release, due to the generality of its contents, should not be considered as a legal opinion, but is limited to briefly expose the possibility of applying certain legal concepts and theories to a situation such as the current pandemic, Therefore, in order to assess the real impact of COVID-19 or the national government actions on a particular contract and potential impact thereof on other agreements, such as inter alia finance instruments, insurance coverage, an analysis is required on the specific facts and applicable law. Should any questions arises and/or legal advice is required, do not hesitate to contact us at the following emails: vivian.maldonado@berke.com.py or martin.carlevaro@berke.com.py, or visit our website www.berke .com.py for more contacts.

[1] Art. 426. Debtor will not be responsible for damages and interests caused to the creditor for noncompliance of an obligation when the same is caused by an act of God or force majeure event, unless the debtor has taken responsibility for the consequences of such event, occurred due to his fault, or is in default for a cause different from the act of God or force majeure event.

Art. 628. Obligation is extinguished when, due to causation in fact or causation in law, not attributable to the debtor and prior to being in default, provision becomes impossible. If the impossibility is only temporary, the debtor is not responsible for the delay in fulfilling while it exists. However, the obligation is extinguished if the impossibility lasts until the debtor cannot be forced to execute the service due to capacity or nature, or the creditor no longer has an interest in obtaining it.

[2] Regarding the restrictive measures issued by the Government, which should be verified before invoking force majeure, there is Decree 3478 of 03/20 that extended the quarantine for people, established which industrial and commercial activities are exempt from complying with said quarantine. Some of these activities are, for example, those related to the provision of public services, production, distribution and marketing of goods from agriculture and livestock fields, poultry and fisheries, telecommunications activities, digital services, call centers, among other considered as urgent.

[3] Art. 672.- In contracts with deferred execution, if unforeseeable and extraordinary circumstances occur that would render the provision excessively expensive, the debtor may request the resolution of the effects of the contract pending of compliance. The resolution will not proceed when the expensive nature is within the normal scope of the contract, or if caused by the debtor. The defendant may avoid termination of the contract by offering a fair modification. If the contract is unilateral, the debtor may claim reduction of the obligation or reasonable modification so execution would be possible.

By Martín Carlevaro & Vivian Maldonado, BKM | Berkemeyer - 17/04/2020
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