Covid-19: Impact on commercial contracts – Germany
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 the 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.
Consequently, German courts will generally recognise and apply choice-of-law clauses in commercial contracts, subject to the following limitations and exceptions:
- 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 Germany, 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.
- Overriding mandatory provisions: The court seized will further apply the overriding mandatory provisions of the law of the forum, i.e. provisions “the respect for which is regarded as crucial by a country for safeguarding its public interests”, and those of the law of the country where the obligations arising out of the contract are performed, which the court may apply if those provisions render the performance of the contract unlawful.
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. For example, contracts for the sale of goods will be governed by the law of the country where the seller has his/her habitual residence. If the contract at issue does not fall within any of the categories listed in Article 4(1), the contract will be governed by the law of the country where the party required to effect the characteristic performance of the contract has his/her habitual residence, Article 4(2).
In addition, certain categories of contracts are dealt with under separate, specific Articles of the Rome I Regulation. This is the case with respect to contracts of carriage (Article 5), consumer contracts (Article 6), insurance contracts (Article 7) and individual employment contracts (Article 8).
Are there any statutory provisions relating to force majeure?
The explicit term force majeure (“höhere Gewalt”) is only rarely used in German statutory law. The most important effects of force majeure events on rights and obligations are determined by general principles of German law, such as impossibility, significant change in the circumstances forming the basis of a contract and fault.
The most relevant provision directly addressing force majeure is Section 206 German Civil Code. Under this provision, the limitation period is suspended as long as a party is prevented from asserting its claims by force majeure within the last six months of the limitation period. Force majeure under this provision means events that could not have been prevented even by the utmost care that could reasonably be expected. In consequence, the threshold is high and any negligence by a party will exclude its application. The suspension of limitation periods due to force majeure is generally accepted if the administration of justice comes to a standstill, be it because of war, natural disasters or pandemics.
Some contracts may also be governed by the 1980 United Nations Convention on Contracts for the International Sale of Goods (“CISG”), which expressly addresses force majeure (see separate CISG chapter).
How are force majeure clauses in commercial contracts applied and interpreted in practice?
Force majeure clauses are common in international commercial contracts, including contracts governed by German law, and are generally recognised by German courts.
The individual design of force majeure clauses varies significantly. They may only refer broadly to force majeure, incorporate examples or an exhaustive list of force majeure events, or exclude certain types of force majeure events. Under general principles of contract interpretation, German courts will seek to determine the intention of the parties at the time of drafting the force majeure clause, even if such intention contradicts its clear wording.
German courts have generally understood force majeure to refer to (i) external events (“von außen kommende Ereignisse ohne betrieblichen Zusammenhang”), which (ii) are unavoidable even with the utmost care to be reasonably expected (“äußerste, vernünftigerweise zu erwartende Sorgfalt”). Courts have recognised epidemics as cases of force majeure in the context of travel law; this understanding may also inform uses of the term in the context of commercial contracts. Legal scholars generally recognise large epidemics as a possible form of force majeure.
Typically, force majeure clauses suspend the obligations of the parties for the duration of the impediment. However, many clauses require a party’s reasonable effort to overcome impediments resulting from force majeure events. To determine which precise efforts are required of a party in a particular scenario, such clauses need to be interpreted on a case-by-case basis, taking into account, among others, the exact wording of the clause, the general contractual risk allocation between the parties and the overall circumstances.
Force majeure clauses also commonly incorporate certain notice requirements. The burden of proof that performance of an obligation is hindered or impeded by a force majeure event lies with the party wanting to rely on a right to refuse performance.
In the absence of statutory provisions and / or contractual arrangements on force majeure, which instruments are available to avoid the performance of contractual obligations?
German law offers several instruments to address the effect of force majeure events on contractual performance. However, there is no case law explicitly applying these general principles of contract law to epidemics.
The most important instruments to cover force majeure events are impossibility, significant change in the circumstances forming the basis of a contract and the general principle of fault:
Impossibility (Section 275 German Civil Code)
This provision applies not only where it is technically or legally impossible to fulfill the obligation, but also in cases where performance is technically still possible, but would require expenses and efforts which, considering the subject matter of the obligation and the requirements of good faith, would be grossly disproportionate to the interest of the other party in the performance of the obligation. For example, if a party was banned from performing its duties under a government ban, as in quarantine situations, this could constitute a case of so-called absolute impossibility, (temporarily) relieving the party from its obligations. In contrast, where parties carry the risk of procuring goods, especially in overseas trading and in wholesale trading contracts, they can be required to make significant efforts, e.g. to ensure alternative sourcing of material, components or goods. This can even mean that they must incur losses to perform the contract. Notably, impossibility does not usually cover situations where general market prices have gone up, making delivery more expensive. The main issue will be to determine the limits of what can still be expected of a party to overcome an impediment. As this depends on the specific circumstances of the individual case and the contractual risk allocation, there are no general guidelines.
If a party has caused the impediment, it can either not rely on the impossibility or will be subject to claims for damages.
If Section 275 German Civil Code applies, a party does not have to perform its obligations. German courts also apply Section 275 German Civil Code to temporary impediments, meaning that a party temporarily does not have to perform while the impediment exists.
Once a party is not required to perform its obligations under Section 275 German Civil Code, the other party is generally relieved from having to perform its corresponding obligations (i.e. typically from paying for the goods or services), unless the circumstances of the case warrant a different assessment, Section 326 paras. 1, 2 German Civil Code.
There is no clear guidance for cases where a seller needs to fulfill several competing obligations to deliver goods but is unable to fulfill all of them because of a force majeure event. While courts tend to require the seller to deliver the goods to all customers on a pro rata basis, some courts have held that it is for the seller to decide who should receive the goods. In consequence, the first buyers enforcing delivery would have an advantage.
It is upon the party relying on the impossibility to perform to prove the prerequisites of Section 275 German Civil Code.
Significant change in the circumstances forming the basis of a contract
Section 313 German Civil Code will apply where the balance between performance and counter-performance is significantly disturbed in a way that was not foreseeable to the parties when concluding the contract (“Störung des Äquivalenzverhältnisses”).
As a general rule, courts will apply this provision only cautiously and in extreme cases. The principle of binding contracts requires that the provision only be applied if holding the party to the contract would plainly be irreconcilable with law and justice. Yet, despite the lack of supporting case law, a major pandemic could reasonably be argued to be sufficient to apply Section 313 German Civil Code.
As Section 313 German Civil Code primarily leads to a modification of the contract and only as a last resort gives a party the right to avoid the contract (Section 313 para. 3), it can provide flexible solutions.
As with impossibility, the party relying on Section 313 German Civil Code needs to prove its prerequisites. Contractual force majeure clauses will take precedence over Section 313 German Civil Code.
General principle of fault
If damages are claimed due to a disruption of performance, a party is in principle not liable for damages if it can show that it did not act negligently, Section 280 et seq. German Civil Code, which is conceivable in case of a force majeure event. The same applies in case of delayed performance. However, this general standard can and often is modified by contract, be it explicitly or implicitly.
New law to mitigate the consequences of the Covid-19 pandemic
A new law to mitigate the consequences of the Covid-19 pandemic in civil, insolvency and criminal procedural law intends to lessen the consequences of the pandemic for the affected citizens, the real economy as well as courts and public prosecutors offices. With regard to certain contracts and, more specifically, certain continuing obligations, the new Article 240 of the Introductory Act to the Civil Code provides for a temporary right for consumers and micro-entrepreneurs to refuse to fulfil a contract if certain conditions are met. Special regulations apply to rental and lease contracts and consumer loans. More information can be found in our newsletter of 25 March 2020 (p. 11 et seqq.).
Further arrangements were made for cultural events. In case of a cancellation due to Covid-19, the organisers of such events may issue ticket holders with vouchers in the amount of the original admission price instead of reimbursing the purchase price.
What else needs to be considered by clients that are party to a contract which is affected by Covid-19?
Parties should carefully review their contracts which might be affected by the novel coronavirus. In particular, parties should look for notification and mitigation duties as well as possibilities to modify, suspend or avoid their obligations where their own performance can be affected, and possibilities to enforce their rights against parties in breach. This is particularly relevant for parties in the middle of a supply chain, which may at the same time have claims against their suppliers and be subject to claims of their buyers.
If in the middle of a supply chain, parties are advised not to admit a force majeure event towards own suppliers and service providers, while at the same time reserving their rights in this respect towards their own customers. They should also assess the interplay between choice of law and jurisdiction/arbitration clauses in the relevant downstream and upstream contracts of their supply chain to prevent being caught in a trap with potentially differing rulings on both ends.
Once parties become aware of potential supply chain disruptions or delays, they should consider taking a proactive approach, e.g., by enforcing their rights for delivery towards suppliers having to fulfill several competing obligations to deliver goods but unable to fulfill all of them because of a force majeure event.
Parties should review their insurance coverage to identify potential claims against insurers. However, many standard insurance products do not provide cover for damages arising under commercial contracts as a result of pandemics.
Wherever the contractual relationship might be affected by the novel coronavirus, parties should communicate with business partners and negotiate joint solutions. If necessary, parties should look for possibilities to perform cover purchases or sales.
Parties should prevent and mitigate damages resulting from other parties’ breaches. Otherwise, their own claim for damages may be reduced, Section 254 German Civil Code. In certain circumstances, parties can even be required to make a cover transaction.