Coronavirus (COVID-19): Legal Impacts on Business Agreements

Coronavirus (COVID-19) Legal Impacts on Business Agreements

What would be the effect of the coronavirus pandemic on business agreements governed by Brazilian law? The Brazilian Civil Code contains some provisions that could be in theory invoked in the current context. But for such purpose we must ask: Would the pandemic be an “act of God” or “force majeure” event? Would it be an “unforeseen reason” capable of causing a “manifest disproportion” between the obligation that had been agreed upon by the parties at the time the agreement was executed and the obligation to be discharged at the time of its performance? Would it be an “extraordinary and unpredictable event” capable of rendering the performance of one party’s obligations “excessively burdensome” while affording to the other party an “extreme advantage”?

Articles 317, 393 and 478 of the Civil Code aim to relieve contracting parties or allow them to review or even seek to terminate their agreements. You will find below a brief discussion and analysis of each of these articles.

Article 393 – Act of God or Force Majeure: It provides that a “debtor is not liable for damages resulting from act of God or force majeure, unless it has expressly agreed to be so”, defining act of God and force majeure as a “necessary fact”, the effects of which “were not possible to avoid or prevent.”
Article 393 does not give the contracting party the right to seek the revision or termination of the agreement. Its goal is to exempt the contracting party from losses arising from the non-compliance with an obligation.

Generally speaking, act of God or force majeure is a “necessary fact”, that is, a supervening fact, which occurred despite the will of the contracting party and without its participation or involvement, affecting the obligation to be discharged by such party, and the effects of which were not possible to avoid or prevent. It is important to emphasize that the fact that characterizes the act of God or force majeure need not be unpredictable. It suffices that the fact occurs without fault of the contracting party and is supervenient, inevitable or irresistible.

The pandemic caused by the coronavirus and its effects could be considered “act of God” or “force majeure” for purposes of article 393. This is because they are not attributable to any of the contracting parties and, due to their characteristics and implications, would be inevitable and irresistible. After all, it would be difficult to imagine that a party would be able to take measures that could prevent or avoid the harmful effects of the pandemic on its contractual obligations.

However, in order for article 393 to apply, it is necessary to prove that the pandemic and its effects strike or impact a contractual obligation to the point of preventing its discharge. This can be seen in many contexts, such as the supply of goods or the provision of services. Nonetheless, it is questionable and should be viewed with caution in the context of monetary obligations.

Even if the pandemic caused by the coronavirus may negatively impact an agreement (or the transaction regulated by it), it does not necessarily affect or prevent compliance with a payment obligation provided for therein. The pandemic may adversely impact a business activity, but the lack of liquidity to make a payment (even if it occurs as a result of or may be attributed to the pandemic and its effects) cannot be confused with a “necessary fact”, unavoidable and irresistible that affects the “act of paying” to the point of making it impossible (as it would be the case, for example, of a collapse of the banking system or another problem of similar gravity that could jeopardize the availability or access to means of payment).

It should be noted that business agreements often have specific provisions regarding acts of God and force majeure events, (a) defining and exemplifying these concepts, (b) imposing certain obligations on the parties when they occur (such as, for example, obligations to notify and adopt actions to mitigate the impacts of an act of God or force majeure event), and (c) establishing their consequences on the agreement (suspension or even termination when the act of God or force majeure lasts for a long period of time). These specific provisions cannot be overlooked in the analysis of the specific cases.

Article 317 – Review of the Agreement due to Disproportion: It establishes that, “when, for unforeseen reasons, there is a manifest disproportion between the amount of the obligation to be discharged and the amount of such obligation at the time it was assumed, the judge may correct it, at the request of the party, so as to ensure, as much as possible, the real value of the obligation.”

The pandemic caused by the coronavirus and its effects could be considered “unforeseen reasons” for purposes of article 317. It would be difficult to argue that the fast spreading of the disease, its global dimension and the serious economic impacts of the containment measures adopted (many of them, suddenly) do not constitute “unforeseen reasons”, mainly when that expression has been interpreted to include not only unforeseeable events, but also events that, although foreseeable, have unpredictable results.

However, it is important to note that article 317 may only be invoked in courts and provided that the contracting party is able to demonstrate that its obligation has become manifestly disproportionate, that is, much more burdensome than anticipated. Thus, in addition to the occurrence of unforeseen reasons, two additional requirements must be met: (a) the evident disproportion between the amount or burden represented by the obligation that would be or was being discharged immediately before the pandemic and the amount or burden represented by the obligation to be discharged in the current circumstances; and (b) the causal link between the pandemic and the aforementioned disproportion.

Article 478 – Termination of the Agreement for Excessive Burden: Article 478 et seq. provide that, “in the agreements of continuous or deferred performance, if one of the parties’ obligations becomes excessively burdensome, with extreme advantage to the other, due to extraordinary and unpredictable events, the debtor may request the termination of the agreement.” This termination may be avoided if the other party offers to “modify equitably the conditions of the agreement” or when the agreement imposes obligations on “only one of the parties, if such party requests that its obligations be reduced, or the way of performance of such obligations be changed, in order to avoid [termination by] excessive burden.”

Article 478 is similar to article 317 because it also refers to unpredictable events, requires a causal link between those events and a change in the circumstances of the agreement that results in disproportion or excessive burden, and forces the interested party to seek the relief provided for under article 478 in courts. However, it differs from article 317 in many respects. First, because in addition to being “unpredictable”, the event referred to in article 478 must be “extraordinary”, and such circumstances – the unpredictability and extraordinary nature – must be related to both the event itself and its effects.

Furthermore, the unpredictable and extraordinary events must cause, not a “manifest disproportion” between the amount of the contracting party’s obligation before and after their occurrence (as in the case of article 317), but an “excessive burden” to such contracting party that affords the other party an “extreme advantage”. Although the extreme advantage has often been interpreted as an “accidental element” in the application of article 478, being taken for granted whenever the excessive burden is verified, article 478 refers to it as a necessary element. Therefore, in order for article 478 to be invoked, there must be an evident and significant contractual imbalance, caused by an extraordinary and unpredictable event, which impacts both parties, one negatively and the other positively (although not necessarily in the same proportion).

It is clear, thus, that invoking article 478 in the context of the pandemic caused by the coronavirus may be more difficult than relying on article 317. This is because the party interested in the application of article 478 should not only demonstrate that the pandemic and its effects constitute an “extraordinary and unpredictable” event (something that would not, in the current circumstances, be a problem), but also prove that this event causes an “excessive burden” for the discharge of its obligation while affording to the other party an “extreme advantage” (which proof, in many circumstances, may not be easy to make).

It should be mentioned that, whereas article 317 allows the affected party to seek a review of its obligation, article 478 aims to, at first, end the contractual relationship (although the court should, whenever possible, seek ways to keep the agreement in force, correcting the imbalance). Accordingly, article 478, unlike article 317, should not, as a rule, be relied upon for the renegotiation of an agreement, but in the most extreme cases where it is necessary to terminate the agreement.

Some Conclusions: The fact that the pandemic caused by the coronavirus and its effects constitute an act of God or force majeure event (article 393), an “unforeseen reason” (article 317) or an “extraordinary and unpredictable event” (article 478) does not automatically authorizes, without the analysis of the facts and circumstances of each case, the release of a contracting party or the review/termination of the agreement. The application of articles 317, 393 and 478 require, as demonstrated, the fulfillment of several specific conditions, which will not always be possible in certain circumstances, since some of such conditions are difficult to meet.

In addition, for a party to obtain the relief provided for in articles 317 and 478, it will need to file a lawsuit. Therefore, such reliefs cannot be unilaterally applied, but are subject to a court decision. Regarding the release resulting from the allegation of act of God or force majeure, it does not require the filing of a lawsuit, but claims based on such allegations may also result in disputes that would have to be ruled by courts.

Another aspect to be kept in mind is the fact that the changes recently introduced to the Civil Code by the Economic Freedom Act attempted to hinder judicial intervention in the context of business agreements. The principles of “minimal intervention” and “exceptionality of contractual review” and the presumption of “parity” and “symmetry” in business agreements, with the acknowledgment that the judicial review will only occur “in an exceptional and limited manner”, may create additional obstacles for the application of articles 317 and 478.

Finally, one cannot ignore that the pandemic and the crisis created by it may indistinctly affect both contracting parties. And if the event impacts all parties generally, claims made by one party based on articles 317, 393 and 478 may not be that welcome by courts as the party making such claims would hope. After all, why should a party be released of its obligations if the act of God or force majeure event affects both parties? How could a party seek the review of its agreement upon the occurrence of unforeseeable reasons if such reasons cause disproportion in the obligations of both parties? How could a party seek the termination of the agreement for excessive burden if the loss of such party does not imply an advantage to the other, which has been equally affected by the extraordinary and unpredictable event? In such cases, a negotiated solution, with a view towards rebalancing the agreement and allowing it to be fulfilled by both parties, may be the best way forward.

CGM Advogados
April 8, 2020