30 March 2020
Impact COVID-19 on contract performance under Dutch law
Suspend now and worry about the (legal) consequences later? As the COVID-19 crisis is more and more unfolding, newspapers report about retailers simply suspending their (rental) payments or cancel existing contracts in order to preserve cash liquidity. As the present circumstances are unprecedented, companies seem to be less worried about the question whether they even have a (contractual) right to suspend, having cash preservation as their number one priority.
Although it is certainly understandable that companies change into survival mode, automatically relying on contractual or statutory force majeure clauses is not without risks. If (with hindsight) it appears that a contractual or statutory provision or force majeure is wrongfully invoked, a suspension or other refusal agreement to perform under the agreement can turn into a breach of contract, leading to liability for the damages suffered as a result. With the Netherlands being a creditor-friendly country, there is a risk that the receiving contractual counterparty is less understanding and will execute its contractual and/or legal rights.
This note deals on a high-level basis with the legal framework under Dutch law regarding the possibility to 'use' COVID-19 to seek the suspension, variation or rescission of commercial agreements.
Starting point: the agreement itself
Starting point in a commercial relationship is the freedom of contract. Dutch contract law is largely of a non-mandatory nature, with the exception of certain more regulated contracts such as lease and employment agreements. When assessing whether a contract party can rely on the concept of force majeure or whether a certain performance may be suspended, one must first look to the agreement itself.
The Dutch way of interpreting agreements
When interpreting clauses of an agreement, it is important to note that under Dutch law it is not sufficient to merely look at the linguistic meaning of the wording of such clause. It should also be assessed what meaning the parties could have reasonably attached to the provisions of the contract in the particular circumstances at hand and what they could reasonably have expected (known as the Haviltex standard).
With this in mind when interpreting force majeur clauses or hardship / material adverse change clauses, it should be assessed whether such clause encompasses the current COVID-19 crisis and if so, what the legal consequences subsequently are. In practice, force majeur clauses often do not mention situations as a pandemic, viral outbreak of disease. More common are clauses that include catch-all language that broadly excuses performance based on significant events or circumstances outside the parties’ control or clauses that speak of an 'Act of God'.
The principle of reasonableness and fairness under Dutch law
Furthermore it is relevant to note that contractual relationships are governed by the Dutch principle of reasonableness and fairness, which principle is meant to determine the existence and the content of the relationship between the parties by explaining, supplementing and correcting the contract that exists between parties.
The principle of reasonableness and fairness has three functions in Dutch contract law:
- All contracts must be interpreted according to good faith.
- The 'supplementing' function: supplementary rights and duties, not expressly provided for in the contract, may arise between the parties. The requirements of reasonableness and fairness can complement what the parties have not properly arranged or agreed with each other.
- The 'derogating' or 'restrictive' function: anything that applies between the parties because they have agreed it, does not apply if this, in the actual circumstances, would be unacceptable as a matter of reasonableness and fairness.
Safety net: Dutch Civil Code ("DCC")
If the agreement itself does not cover the situation, the DCC provides a safety net.
Force majeure – Article 6:75 DCC
In the event of force majeure, a debtor may invoke that a failure in the performance of the agreement (breach of contract) cannot be attributed to him. In order to invoke force majeure, it is necessary that the failure is not due to the debtor's fault, nor should it remain at the debtor's expense or risk. It must be an impossibility to perform; not every impediment constitutes force majeure. Nor does force majeure arise from a situation in which the performance can still be provided but - in view of the COVID-19 crisis - must be considered very difficult (e.g. costly) or would lead to a disturbed contractual balance.
An important question is, of course, whether the COVID-19 crisis constitutes force majeure in a particular case. This could be the case if the debtor is unable to perform (in time) due to statutory COVID-19 measures, for example due to import or export bans, the closure by government of certain companies, buildings or roads, etc.
A successful invocation of force majeure has the following legal consequences:
- the debtor cannot be obliged to perform (performance is impossible);
- the creditor cannot claim damages;
- where performance is permanently impossible, the creditor lacks the power to suspend performance;
- a debtor may require rescission or modification of the contract, in whole or in part, if unforeseeable circumstances exist.
Duty to renegotiate?
As explained above, an agreement and the relationship between the parties are also governed by the principle of reasonableness and fairness. The requirements of reasonableness and fairness may require the parties to renegotiate if unforeseen circumstances arise that make performance (partly or temporarily) practically impossible. However, this 'duty' does not follow directly from the law, but may result from the requirements of reasonableness and fairness.
If the parties cannot agree on a (temporary) adjustment of the agreement, the parties may request the court to do so.
Amendment or termination due to unforeseen circumstances - art. 6:258 DCC
Any contracting party may request the court to amend or rescind the agreement (in whole or in part) in view of unforeseen circumstances (Article 6:258 DCC). The court will then have to consider whether, in view of the seriousness of the circumstances, the unaltered performance of the contract may not be expected according to standards of reasonableness and fairness. This is a high threshold; the starting point is that a contract party must perform.
There are 'unforeseen circumstances' if, after the conclusion of an agreement, circumstances arise that weren't taken into account at the time the agreement was concluded. Whether or not the risk was actually unforeseeable is not decisive. It can be assumed that contracting parties generally did not take the outbreak of the COVID-19 virus and its consequences into account.
Unforeseen circumstances cannot be invoked if, according to the nature of the contract or the currently prevailing opinion, the circumstances remain for the account of the debtor (Article 6:258 paragraph 2 DCC).
When amending or rescinding the agreement, the court has a great deal of freedom. The judge will consider what is reasonable and equitable in view of all the circumstances of the case. The amendment or dissolution may be pronounced in whole or in part, and also temporarily. It may also be stipulated that both parties may temporarily suspend the agreement. The court may also grant retroactive effect to the amendment or dissolution.
The court may also attach conditions to the amendment or dissolution, such as, for example, awarding damages if the agreement will be (partially) dissolved (Article 6:260 of the DCC). The objective for the court will be to restore the contractual balance disturbed by the unforeseen circumstance, taking into account the changed situation. In case of continuing performance agreement (e.g. entered for an indefinite period of time) a temporary suspension of performance could be the most suitable amendment. After all, the current COVID-19 virus and its consequences seem to be (for now) of a temporary nature.
An important question is then how the disadvantages of the situation are to be distributed among the contracting parties. After all, none of the parties is to blame for the COVID-19 crisis. The starting point will be that the contractual sharing of risk should be maintained; a party should not benefit. Potential benefits that a party will enjoy as a result of unforeseen circumstances (for example any governmental financial support) should also be taken into account.
Suspension – art. 6:262 DCC
Pursuant to Article 6:262 of the DCC a contracting party may suspend performance of its obligation if the other party also fails to perform. The requirements are: (i) there must be a due and payable claim; (ii) the other party fails to perform its due and payable obligation under the reciprocal contract; and (iii) there must be sufficient connotation. Suspension is a temporary defense against performance and leads to postponement, not adjustment.
It may result from the requirements of reasonableness and fairness that a party may only suspend after the other party has been notified of this (and the ground for suspension).
A general opinion on the impact of the COVID-19 crisis on agreements is difficult to give. On a case-by-case basis, the specific provisions of the agreement and the specific circumstances of the case will have to be taken into account in order to determine whether a party should perform fully. As this requires a careful analysis, companies should be careful with simply nonperforming, in view of the potential risks involved.
Do not hesitate to contact Manon Cordewener or Sanne Bouwers should you wish to obtain further information or would like to exchange thoughts.