What does Covid-19 mean for my contract?

Monday, 6 April 2020

The most important questions and answers regarding the impact of Covid-19 on contracts.


Questions and answers:

Whose fault is it that a contract is not (or not properly) fulfilled?

The key question, which is probably currently preoccupying many entrepreneurs around the world, is: Who is to blame if a contract cannot (or not properly) be fulfilled because of the outbreak of Covid-19? The short answer for Austrian law is: Nobody is to blame for Covid-19 – but this does not mean that the same is necessarily true for the defective performance of a contract.

In detail:

The performance of contracts can be made difficult or impossible after the contract has been concluded for a variety of reasons. Such contracts are also referred to as contracts with defective performance. In the individual case, the way the performance is "defective" depends on the respective contract: For example, sales contracts cannot be properly fulfilled if the sold object is destroyed prior to delivery and therefore cannot be handed over; a mobile phone contract cannot be properly fulfilled if the mobile phone network is not accessible (for a longer period of time) and therefore cannot be used for making phone calls via the network.

If the contract itself does not provide a rule for this case, the legal system tries to create a balance of interests. To this end, it usually focuses on the contractual partner to whom the default is attributable, ie, in whose "sphere" the default falls. The basic rule is: Just because something has gone wrong in the sphere of one contractual partner, the other contractual partner should not have to suffer as a result.

However, there are also deficiencies in performance which do not fall within the sphere of anyone. Such defaults could not have been prevented even with the utmost reasonable care. They are simply a case of force majeure. Classical cases of force majeure are wars or terrorist attacks. Since a famous decision of the Austrian Supreme Court in 2005 (case no 4 Ob 103/05h), it is also clear that the outbreak of SARS is considered a case of force majeure under Austrian law.

Based on this "SARS decision", it will therefore also be possible to claim that the outbreak of Covid-19 is a case of force majeure. As a first intermediate result, it can therefore be stated that if the outbreak of Covid-19 is a case of force majeure, it legally is not anyone's fault.

But this does not necessarily mean that nobody is to blame if a contract cannot be fulfilled (or cannot properly be fulfilled, i.e. late or otherwise incorrectly) due to the outbreak of Covid-19:

  • There will certainly be cases where the contract cannot be fulfilled because of Covid-19 in and of itself. Constellations of both direct and indirect effects of the pandemic are possible.

The immediate effect of Covid-19 could be, for example, that the debtor has to stop his production operations because all of his employees have fallen ill with Covid-19. Indirectly – and this will be the more frequent case – the default could be caused by the legal measures taken as a result of Covid-19: Although the debtor's employees are healthy, the company must nevertheless cease production because of statutory law which forces them to effectively shut down the plant.

In all these constellations, it is important to note that a case of force majeure regularly occurs only when the debtor is so badly affected by Covid-19 (or its legal consequences) that he was no longer able to "prevent" the default. If this is the case, as a rule the debtor does not face damage claims.

  • The situation is different in cases where debtors are also affected by Covid-19 (either directly or indirectly, as described above), but the breach of contract would not have been an unavoidable consequence of that.

Let us stay with the example from above: If the company is not affected by statutory shutdown and not all employees fall ill, but only one of several, it may well be reasonable for the debtor to still perform his obligations properly. It could be argued that a diligent entrepreneur must always be prepared for a certain percentage of his employees to be absent due to illness (pandemic or no pandemic) and must therefore always take precautions. If he does not do so and therefore cannot perform properly, it is "his fault" – and not the fault of Covid-19.

The debtor should therefore not be able to excuse himself on grounds of an extraordinary event (such as a pandemic) when he would not have been able to perform the promised service under normal circumstances anyway (employees become ill "just like that" according to general life experience).

Although the outbreak of Covid-19 is therefore force majeure, something else may apply to the specific breach of contract that occurs during the outbreak of Covid-19. Depending on the individual contract, a creditor can, after legal examination, come to the conclusion that the debtor is liable for damages even in the case of breaches of performance in the period of Covid-19. Conversely, as a debtor you need to know all the more at present what you have to pay attention to and how this can be properly documented, so that later – after the pandemic is over the contractual partner may have had a quiet minute to think again – you can defend yourself against unjustified accusations in a legally clean way.

What happens if a contract cannot be fulfilled?

The outbreak of Covid-19 itself is, as written above, a case of force majeure – although the same does not necessarily apply to the specific breach of contract. The legal consequences that follow from this finding depend on a multitude of factors:

  • On the one hand, legal consequences depend on the applicable law and on the type of contract. Certain legal systems provide special legal rules for certain types of contracts (eg Austria for rental contracts). Details of such specific rules in Austrian law can be found in the contributions of the respective experts on our Covid-19 information page.
  • On the other hand, legal consequences depend on the individual contract. Some contracts contain explicit provisions in so-called force majeure clauses. However, whether such clauses really hold up seems to be highly questionable (see the question below).

If neither law nor contract provides for an explicit rule, general civil law applies. The basic principle of general civil law in Austria is the fair reconciliation of interests and the restoration of the equivalence which the parties originally intended to agree in the contract. In short, a completely fortuitous event should not lead to the economic ruin of one contracting party and to the other contracting party becoming rich.

Austrian civil law provides for a number of instruments to achieve this balance of interests. Depending on the specific situation, these can either be applied individually or all together:

  • There are innumerable assumptions that contracting parties base their contracts on. However, most of these assumptions are never put in writing because it is simply not possible to regulate all eventualities. This is where the doctrine of the elimination of the business foundation of the contract (in German: Wegfall der Geschäftsgrundlage, in other legal systems also sometimes called frustration of contract) comes in:

If typical and tacitly presumed circumstances of the contract (the so-called "business foundation") change after the conclusion of the contract without any action on the part of the contracting party and if this change of the business foundation was not foreseeable at the time of the conclusion of the contract, then each contracting party can have the contract adjusted or cancelled due to the loss of the business foundation.

In the "SARS decisionSARS ruling" cited above, the Austrian Supreme Court affirmed the application of the elimination of the business foundation of the contract for a trip that could not take place as planned due to the SARS outbreak at the time. It is therefore reasonable that contracts that cannot be fulfilled as planned due to the outbreak of Covid-19 will also be potentially by the elimination of the business foundation of the contract.

However, the exact legal consequence depends on the individual case. The "SARS decision", which has been frequently quoted in recent weeks, provides little information in this regard. It only says states that in such a case a contract can either be adjusted or cancelled altogether. In the specific case, the result was that the customer could not withdraw from a contract regarding a trip to China because the tour operator replaced Hong Kong – which was particularly affected by SARS – as the last stop on the trip, from which the return flight also departed, with Beijing. In the opinion of the Supreme Court, this contractual adjustment was reasonable due to force majeure. What exactly applies in other cases, however, depends very much on the individual contract.

  • If the continuation of a contract is intolerable, it can also be terminated extraordinarily immediately for good cause. The right of extraordinary termination for good cause does not have to be agreed separately (it does not matter if it is not expressly included in the contract and the causes can also be extended contractually) and is usually mandatory for contracts with continuing obligations (if it is expressly excluded in the contract, it is therefore usually not effective).

Whether such termination is possible and reasonable due to the outbreak of Covid-19 must also be examined on a case-by-case basis. In this context, it will be particularly important to consider how to argue that the continuation of the contract is intolerable. Quick action is also required here: The longer the contract is continued after good cause to extraordinarily terminate has transpired, the more difficult it is to argue that it is intolerable to keep up with the contract.

  • In the case of certain contracts, it will also be possible to withdraw from the contract arguing default because of delay of the other contracting party (fault is not necessarily required) or sheer impossibility of performance (see next question).

The other side does not fulfil the contract and I want to withdraw. Do I have to grant a grace period, even if I know that there will be no performance?

Whoever does not perform at the agreed time at the agreed place is in default, regardless of whether he "can do something about it" or not (see the question above, who is to blame for defective performance due to Covid-19).

Usually, the defaulting party has to be granted a grace period before one can withdraw from the contract. The law requires a grace period of "reasonable" length. What this means in exact terms will depend on the exact nature of the contract. The length of the grace period can be particularly decisive where the creditor wants to withdraw quickly from the contract in order to conclude an equivalent replacement transaction (a cover transaction) with another party currently still being able to perform.

However, it is not necessary to grant a grace period in the case of so-called fixed transactions or in case of impossibility to perform at all:

  • A transaction for delivery by a fixed date (in German: Fixgeschäft) is a transaction for which performance at a certain time is so important to the creditor that he no longer has to accept it afterwards, of which the debtor was fully aware when the contract was concluded.

For example: On 25 December nobody needs the Christmas cards ordered by the printer anymore. But there are also cases that are not so obvious, for example when the B needs the goods from the A so that he can process them himself and sell them to the C in time. Even if fixed deals are not necessarily the case in production chain scenarios, they are possible and depend on what became part of the contract between the individual parties. Whether or not a specific case qualifies as transaction for delivery by a fixed date must therefore be examined on the basis of the individual contract. In any case, it is not a prerequisite that the parties have expressly designated the transaction as such – it is only a matter of the content of the contract, not how it is labelled.

  • Subsequent impossibility to perform the contract is defined as an obstacle which arises after the conclusion of the contract and which permanently prevents the fulfilment of the contract.

For example: The antique is destroyed after the purchase contract has been concluded but before it has been handed over to the buyer. Since it was a unique item, the sale can no longer be fulfilled. Cases of subsequent impossibility are, at first glance, diverse, especially in times when the majority of public life has been paused because of Covid-19. However, details pose difficult legal questions. In particular, one will often be able to argue about whether the fulfilment of the contract is actually "permanently" impossible or not.

Both in the case of a delay of a transaction for delivery by a fixed date and in the case of an accidental subsequent impossibility to perform a contract, the legal system sets forth that no grace period is to be set and the contract immediately "falls away". Strictly speaking, in certain cases one would practically not even need a formal declaration of rescission and the contract would dissolve of its own accord. For documentation reasons alone, however, a declaration of rescission is also recommended in any case. This is particularly important in the case of transactions for delivery by a fixed date, because there the creditor could alternatively insist that he wants to receive the good or service (although he will no longer receive it at the agreed date).

From the moment the contract is cancelled, both parties are free. Neither party is obliged to perform, nor does the other party have to pay for it. If the fee has already been paid, it must be refunded. The same applies if the service has already been partially performed. If the lapse of the contract is due to the debtor's fault (which may also be the case in times of Covid-19, see the question above), the other party is entitled to compensation. This may, for example, involve reimbursing the creditor for the costs of a cover transaction.

What about contracts that provide for certain legal consequences in the event of force majeure (force majeure clause)?

Some contracts contain explicit provisions for the case of force majeure (which, as explained above, probably includes the outbreak of Covid-19). For example, they stipulate that if one party is unable to perform due to force majeure, the other party must still pay.

In principle, the parties have to stick to what they have agreed upon (pacta sunt servanda). However, there may also be situations in which the agreement puts one party at such a disadvantage compared to the other party that it is a violation of moral principles which the Austrian legal system cannot tolerate (this is particularly the case in transactions between entrepreneurs and consumers). Or there may be situations in which the agreement is not in itself a violation of moral principles, but suddenly becomes one due to certain circumstances that nobody could have considered when the contract was concluded.

A global pandemic on an unprecedented scale could be such a situation. Thus, even if a contract contains explicit rules for dealing with cases of force majeure, it may be worthwhile to take a closer look at the specific effects on a contracting party. If the effects are ruinous – which they may well be in the case of an event of the magnitude of Covid-19 – then it may be possible to conclude that in such an exceptional case the force majeure clause must also be adjusted. In the event of a dispute, however, this would then have to be argued with enough factual and legal evidence.

I am an Austrian entrepreneur, but the contract is not subject to Austrian law. Which law applies?

Entrepreneurs are free as contracting parties to choose the applicable law. However, if foreign law is agreed upon when the contract is concluded, foreign law must also apply in the event of a dispute. Just as is currently the case in Austria, many countries have special laws because of Covid-19 one must therefore pay very close attention to the specific situation in the country whose law has been agreed.

Conversely, Austrian law is only applicable if Austrian law has also been agreed (or if no law has been agreed at all and Austrian law applies under rules of international private law). Here too, however, there are exceptions: For example, insolvency proceedings are generally governed by the law in which the debtor has its registered office – irrespective of the contractually agreed law (other laws may apply to branches abroad or if the registered office and place of actual administration are different). The same applies to the provisions on the enforcement of judgments. Rights of lien are also realised according to the law where the lien is located.

Moreover, under international private law, so-called overriding mandatory provisions (Art 9 Rome I Regulation) can never be superseded. These are provisions considered so important for the protection of the public interest of a state, in particular its political, social and economic organisation, that they apply irrespective of which law has been agreed, as long as there is a connection to the legal system of such state. Such a connection could be made, for example, if one of the parties has his habitual residence or business seat in that state. What exactly qualifies as overriding mandatory provision has always been highly controversial. In the past, however, for Austrian law for example certain provisions of tenancy law also qualified, which is why the scope of application should not be too narrow. It is therefore quite possible that Austrian special legislation regarding Covid 19 could also be qualified as overriding mandatory provision and apply in any case, even if foreign law was agreed upon. It should be noted that Art 9 Rome I Regulation applies in (almost) all other EU Member States (in addition to Austria): Even if Austrian law and Austrian jurisdiction have been agreed with a foreign debtor, the debtor could then invoke his "own" overriding mandatory provisions under the law of his home state before Austrian courts.

The legal situation is particularly challenging if foreign law has been agreed but no corresponding foreign jurisdiction or at least no exclusive corresponding foreign jurisdiction (which practically happens quite often). In this case, the situation may arise that the applicable law and the place of jurisdiction are different and the courts of one country have to decide according to the law of a completely different country. This is possible, but in practice it causes delays. In addition, the courts usually have the possibility to disregard certain foreign laws that are in blatant contradiction with their own legal system (this is also called: violation of ordre publicr). Particularly if each country has different laws with rules on what applies in a pandemic, it is quite possible that courts will take a narrower view and give preference to "their own" rules over foreign ones. If the applicable law and place of jurisdiction are not the same, it may thus happen also in this scenario that the originally agreed foreign law is not fully applicable.

In short: The agreed applicable law generally sticks. However, if you are not satisfied with it, you should take a close look at the contract to see whether this also applies to your specific situation.

What should be taken into account when concluding new contracts?

A different assessment will have to be made if the contract is newly concluded now or was concluded at a point in time when the effects of the current crisis on the possibility of providing services were already foreseeable.

For example, if someone agrees to supply breathing masks, the customer can assume that he is also capable of supplying them. If the supplier does not make it clear that the provision of the goods is not assured, he will generally not be able to invoke force majeure. For new events, such as confiscation of medical goods by the state, the above-mentioned applies again.

In newly concluded contracts, therefore, particular attention will have to be paid to the cases in which the obligation to provide services can be waived and also to how long it can be postponed. For example, the customer will no longer be interested in the supply of respiratory masks if this is only provided after the current danger posed by Covid-19 has been eliminated or at least massively contained.

Is there a limit to how much scarce goords (e.g. disinfectants and respirators) may cost?

Entrepreneurs are basically free to set the price of their product independently. However, the law also – and especially – sets limits on pricing in times of crisis. If the price deviates too much from the actual "value" (see below) of the product, this can lead to the invalidity of the transaction:

  • In any case, this should apply if the product is worth not even half of what the seller asked for it.
  • But even if the value of the product is otherwise "noticeable disproportionate" to the price for it and the seller at the same time takes advantage of the buyer's predicament or emotional upset (which is quite conceivable during a pandemic), this can lead to the invalidity of the contract due to violation of the usury ban. In quite blatant cases, such behaviour can also be criminally prosecuted (Sec 154 of the Austrian Criminal Code).

In both such cases, the buyer has the choice of either nullifying (contesting) the contract or holding on to it. Thus, the buyer must take action.

The key question, however, is what actually is the "value" of certain products in exceptional times as these. The news in recent weeks has been full of reports of disinfectants and respirators being sold for several times their price at the beginning of the year. However, the world was a very different place at the beginning of the year and both products were available in virtually unlimited quantities. This is no longer the case and demand far exceeds supply. As a result, not only the cost to the end user has risen, but also the purchase costs in the supply chain - right down to the materials needed to produce disinfectants and respirators. This will probably have to be taken into account when assessing the actual value of a product and, following from this, whether the transaction can be void or not.

Does default interest accrue if I cannot pay my debts because of the Covid-19 outbreak?

Contracts must be honoured even in times of disaster and a pandemic is no reason not to pay your debts. Even if you are blameless, for example because your own business is affected by a temporary forced closure, and you do not have sufficient liquidity, a monetary debt is due on the agreed date. For each day on which a money debt is due but not paid, default interest accrues.

However, in order to mitigate this legal consequence to some extent, Sec 3 2. COVID-19-JuBG (published as Art 37 of the 4. COVID-19 Act, Federal Law Gazette I 2020/24) provides for a cap on default interest at 4 % (per annum). This cap is linked to the following conditions:

  • The contract must have been concluded before 1 April 2020.
  • The payment must have been or become due between 1 April 2020 and 30 June 2020.
  • The debt has not been paid or not been paid in full because the debtor's economic capacity is significantly impaired as a result of the Covid-19 pandemic.

The cap applies to both consumer contracts and business contracts. It is limited to 30 June 2022 (Sec 17 para 2 2. COVID-19-JuBG). From the following day onwards, the agreed or other statutory interest rates apply again as usual (§ 1000 ABGB, § 459 UGB).

If the above-mentioned prerequisites are met, the debtor does not have to reimburse the creditor for any costs for extrajudicial debt enforcement or recovery measures. However, since the law only provides for a cap on interest on arrears, but does not prevent debts from falling due on the agreed date, the creditor can continue to sue from day 1 of the due date and, if he wins, he can also demand reimbursement of costs under the Austrian Civil Procedure Act. Simply not paying one's own debts can therefore be expensive even in Corona times and it is absolutely recommended to come to an agreement with the creditor in otherwise undisputed cases.

My contract provides for a contractual penalty. Does this also apply in case of non-performance due to Covid-19?

For both fault-based and no-fault contractual penalties, Sec 4 2. Covid-19-JuBG (published as Art 37 of the 4. Covid-19 Act, Federal Law Gazette I 2020/24) provides for a special rule. The obligation to impose a contractual penalty is thus not applicable – even between entrepreneurs – under the following conditions:

  • The contract must have been concluded before 1 April 2020.
  • The debtor was not able to deliver in time because either his economic capacity is considerably impaired or he is unable to perform due to restrictions on his working life.

In contrast to the relief in the case of default interest (see the question immediately before), the relief in the case of contractual penalties is not limited to the maturity of the debt in the second quarter of 2020. However, contractual penalties may also be incurred again from 30 June 2022 at the latest, when the special provision expires again (§ 17 para 2 2. Covid-19-JuBG).

In addition, the individual requirements are more far-reaching in contrast to the provision on default interest: it is either based on the impairment of economic performance or on restrictions on working life. According to the legislator comments, the legislator is thinking either of legal restrictions (eg, quarantine measures in the place where the construction site is located) or factual restrictions (eg, due to the requirement of "social distancing").

If the failure to comply is only partly due to the Covid-19 pandemic, the special law also only waives the contractual penalty in exactly that part. The remaining part must be paid. Even if the contract fulfils the above-mentioned conditions, this does not mean that the debtor is actually released from the full penalty. Instead, it will have to be examined in each individual case how much the pandemic actually contributed to his defaulting – and to what extent he would never have been able to fulfil the contract in time even without the pandemic and therefore has to pay the agreed penalty at least proportionately. After all, no one should benefit from the pandemic.

Your contact persons:

Herbert Pimmer
Expert for Contract Law
T +43-1-533 4795-42

Christian Schöller
Expert for Contract Law
T +43-1-533 4795-42