Covid-19: Impact on commercial contracts – Portugal
How is the applicable law determined by the courts in case of commercial contracts?
In international cases, the governing law is determined in accordance with EU Regulation No 593/2008 on the law applicable to contractual obligations (“Rome I”). Under Rome I, the general rule for B2B international contracts is that parties can choose the governing law even if it has no connection with the contract. The validity of choice-of-law clauses is governed by Articles 10, 11 and 13 Rome I, which set out the form requirements for choice-of-law clauses.
The choice of law is limited in the following cases:
- Domestic contracts: If the parties choose a foreign law as applicable to the contract, whilst all of them and all other elements pertaining to the contract are located in Portugal, Article 3 Rome I specifies that their choice shall not prejudice the application of those provisions of the domestic law which cannot be derogated from by agreement.
- Intra-EU contracts: Similarly, in contracts where all elements other than the choice of law are related to one or more EU Member States, the parties’ choice of law will not prejudice the application of provisions of EU law which cannot be derogated from by agreement.
Further restrictions apply in case of consumer, insurance, and employment contracts.
In the absence of an express choice-of-law clause, Article 4 Rome I provides default rules which aim at designating the law which bears the closest connection to the contract at issue.
Are there any statutory provisions relating to force majeure?
How are force majeure clauses in commercial contracts applied and interpreted in practice?
Force majeure clauses are valid under Portuguese law in accordance with the principle of party autonomy (cf. Article 405 of the Portuguese Civil Code), pursuant to which parties are free to determine the content of their contracts. They are very common and the objections that may rise in relation to these provisions only relate to cases where excessively broad coverage is sought, in particular if the clause aims at excluding liability in circumstances which do not meet the standard of an extraordinary, unpredictable, unavoidable, and non-faulty event.
As there is no legal definition of force majeure in the context of contracts that are subject to Portuguese law, force majeure clauses usually include a general definition of force majeure and clarify which events amount to force majeure by way of specific examples. When assessing whether an event falls within the scope of a force majeure clause, both examples which are specifically listed (if any) and the agreed general definition are relevant. Accordingly, even if the force majeure clause does not mention pandemics, Portuguese courts may still consider the event covered by the clause as long as the general requirements defined by the parties are met. Given that pandemics should usually be regarded as an extraordinary, unpredictable, unavoidable, and non-faulty event, they should meet the requirements for force majeure, as long as, in the contract under analysis, the event has a significant impact on the performance of any particular obligation and to the extent that such impact does occur. In any case, the relevance of pandemics as a force majeure event may also, to some extent, be grounded in the principle of good faith, which is a general rule of conduct that must be observed by the parties when performing the contract (cf. Article 762(2) of the Portuguese Civil Code).
Force majeure clauses usually also regulate the consequences of a force majeure event. The aggrieved party may typically invoke force majeure (i) to get recognition that the non-performance of a particular contractual obligation has no immediate consequence and is justified by such event or (ii) just to flag that the fulfilment of a contractual obligation is significantly more expensive for the purpose of the agreement. Consequently, if a force majeure event occurs pursuant to the contractual regime, the aggrieved party may be exempted from timely performance of the obligations that are impacted by such event for as long as that event and its effects last.The burden of proof generally rests with the party that invokes the force majeure clause (cf. Article 342(1) of the Portuguese Civil Code). This is the most common legal rule, but parties can agree differently in the contract, setting out a separate regime for the allocation of the burden of proof in specific cases.
In the absence of statutory provisions and / or contractual arrangements on force majeure, which instruments are available to avoid the performance of contractual obligations?
If the contract does not include a force majeure provision, parties can still rely, depending on the nature of the event and its impact, on two alternative legal frameworks: the doctrine of impossibility of performance or the doctrine of hardship (as outlined in detail below). The rights granted to the aggrieved party thereunder depend on the circumstances at hand, and generally include (i) the termination of the respective obligation that should be performed under the contract and that is affected by the event, (ii) the exclusion of liability of the aggrieved party for late performance or non-performance of the obligation, (iii) the modification of the contract, or (iv) the termination of the contract. The burden of proof of the relevant facts rests on the party invoking the regime (cf. Article 343(1) of the Portuguese Civil code). In symmetrical terms, the burden of proof of the facts which prevent the enforceability of any of such institutes or the impossibility of it being invoked by the debtor rests with the creditor (cf. Article 342(2) of the Portuguese Civil Code).
Impossibility to perform
The coronavirus pandemic is likely to be framed under this legal regime if, because of such event, it becomes impossible for any party to the contract to perform its obligations. If that is the case, performance of the obligation is released on the grounds that an impediment beyond the debtor’s control makes the fulfilment of the obligation impossible
In this scenario, it is important to assess whether the impediment beyond the debtor’s control is permanent or temporary:
- If the impediment is permanent, the obligation will extinguish and no longer be due (cf. Article 790 of the Portuguese Civil Code). In this case, the reciprocal obligations that are connected also extinguish.
- If the impediment is only temporary, the liability for non-performance of the obligation is excluded for the time of the impediment (cf. Article 792 of the Portuguese Civil Code).
As the event is not attributable to any of the contracting parties, non-performance of the obligation is not to be qualified as a case of faulty non-performance and the creditor will not be entitled to compensation for damages. Provisions on late performance will not be applicable as well. However, even in this circumstance, the creditor is entitled to unilaterally set an additional deadline for the performance of the obligation by the debtor and if within such deadline it is not yet possible for the debtor to perform such obligation, the creditor may request the termination of the contract. It is required by the debtor to duly inform the creditor, within a reasonable time and on the grounds of good faith, that such an event occurred (cf. Article 762/2 of the Portuguese Civil Code).
It should be noted that cases where performance of contractual obligations just becomes more onerous, more difficult or more expensive, notably if the cost of performance has increased or the value of what is to be received in return has diminished, are not covered by this legal framework. In this event, most likely, the debtor will bear the additional costs involved.
In the context of the Covid-19 outbreak, the following events, for instance, may trigger the application of these provisions: (i) the Government and State authorities prohibit, by a regulatory act, the import of products from areas particularly affected by the novel coronavirus, or (ii) the Government and State authorities request the destruction of all goods from those territories in storage which were intended to be delivered to third-parties, namely, customers.
The aggrieved party may also have the right to terminate the contract or to request its adaptation/adjustment in case of an unexpected and abnormal change of circumstances. More precisely, a party to a contract has the right to terminate the contract or to claim adjustment of the contract according to Articles 437-439 of the Portuguese Civil Code, if (i) an unforeseen event occurs that causes a substantial change to the circumstances that have been taken into account by both parties or by one of the parties when the contract was concluded, (ii) the performance of the contract is affected in such a way that its execution is contrary to the principle of good faith, and (iii) the substantial and unforeseen change in circumstances is not considered as a contractual risk accepted under the contract. For further details on this doctrine, see our cross-border guide on hardship, which also includes a Portuguese chapter.
In the context of the Covid-19 outbreak, the doctrine of hardship may, for instance, apply when one of the parties is due to supply goods that cannot be produced or delivered as a consequence of (i) the closure of manufacturing facilities for public-health reasons, (ii) a sharp increase in the costs of raw materials, (iii) a lack of raw materials that are needed to produce the contracted goods, (iv) the debtor’s hospitalisation because of Covid-19 or in case of a self-imposed quarantine, (v) a decrease in labour force due to the fact that the workers of the manufacturing facility have been infected with Covid-19, (vi) a lack of stock by the company that should produce or perform the obligation, for reasons relating to Covid-19, or (vii) serious difficulties in dispatching the contracted goods due to temporary closure of borders by virtue of conditions determined by Governments as to the import of goods from areas particularly affected by the Covid-19 epidemic.
What else needs to be considered by clients that are party to a contract which is affected by Covid-19?
When faced with the adverse effects of Covid-19, the parties must assess whether their contracts include force majeure clauses, and, if so, which events are covered and what the impact on the performance of the contract is. However, as outlined above, they may try to resort to other legal instruments should their contracts not include any force majeure clause.
There is no specific legal provision setting a procedure to be followed, nor time limits to be respected, in the event of an extraordinary circumstance with impact on the contract, such as Covid-19. However, the principle of good faith and the general duty for collaboration may require the aggrieved party to notify the other party. Force majeure provisions may also set out specific notification deadlines, which should be duly assessed. The creditor may be entitled to damages for losses caused by the breach of the duty of timely notification.
Where a contractual provision is not available, no specific statutory duty to mitigate damages caused to the counterparty applies. However, as such a duty may, to some extent, result from the general principle of good faith (cf. Article 762(2) of the Portuguese Civil Code), parties should avoid any conduct that is likely to cause or increase damages to the other party.