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7 April 2020

Test your contract for COVID-19. Legal implications of coronavirus COVID-19’s pandemic for contracts execution

Due to the spread of coronavirus COVID-19, the Ukrainian government introduces restrictions, the number of which varies depending on the situation. As a result, a significant number of companies have a problem of how to perform their contractual obligations and how to respond to the problems with the fulfilment of contractual obligations by their counterparties.

To address this issue, we analysed whether the introduction of a quarantine regime and other similar regimes for contracts is important, what are the main legal instruments offered by Ukrainian and foreign legislation in such cases, and what needs be done right now to use them. Separately, we examined the features of the application of such legal instruments in various industries.

Below, the terms “quarantine”, “emergency” or “state of emergency” can vary but have a general meaning for the execution of contracts.

The introduction of any of the above regimes does not automatically relieve the contracting party from the need to properly perform any contractual obligations and does not directly affect the enforceability of the contract itself. Both the state of emergency and quarantine provide for certain restrictive measures. Thus, each business must analyse how a particular restrictive measure makes it difficult to fulfil a particular contract, regardless of whether such a measure is imposed during quarantine or in a state of emergency.

Not only force majeure. What else is relevant?

The main legal instrument which applies to most contractual obligations in extreme circumstance is force majeure. There are also other legal concepts such as termination of contractual obligations due to the impossibility of their fulfillment, as well as modification or termination of the contract due to  substantial change in circumstances. Below we look at some of their main consequences.

  • Substantial change of circumstances (hardship) implies that the contract can be terminated, or, in some cases, modified as part of a contractual or judicial/arbitration procedure, if the fulfillment of the obligation becomes financially disadvantageous. In Ukraine, this legal instrument is quite effective, but in some other countries (including in accordance with English law) it applies only in exceptional cases.
  • Force majeure means that if it is temporarily impossible to fulfil the obligation, it remains “frozen”. The debtor is not responsible for such obligation during the force majeure period. As soon as the force majeure event disappears, the obligation is “unfrozen” and the debtor must fulfil it, otherwise it will be liable for non-fulfillment. According to English law, force majeure circumstances can be relied upon only if it is expressly provided for by the contract, but in most other countries it can be applied by law.
  • Termination of an obligation due to the impossibility of its fulfillment (frustration of purpose) may occur if the obligation is non-monetary and cannot be performed in the absence of fault of both parties. The other party must be notified immediately so that it can take the necessary measures to minimise damage. In this case, both parties return to each other what was received from the other party in connection with perfomance of the obligation. Even in accordance with English law, this legal instrument can theoretically be applied without reference to it in the contract, but in practice its successful application is very limited.

Due to the fact that although the legal instruments described above have different legal effect and purpose, all of them can, under certain conditions, apply to obligations that are unprofitable or impossible to fulfil due to the spread of the coronavirus COVID-19 and the introduction of the relevant government measures. Moreover, it is entirely possible that companies will first have to rely on force majeure circumstances, thereby “freezing” their obligations, then try to change the contract due to a fundamental change of circumstances, and then terminate it due to frustration of purpose.

It is important, therefore, to carefully document all circumstances related to the fulfillment of the contractual obligations in order to be prepared for any situation. In particular:

  • to record any problem arising out of the performance of the contractual obligations at the company level (e.g., by internal company documents)
  • to establish effective communication with your counterparties and secure evidence thereof
  • to obtain a certificate of the force majeure circumstances (if necessary)
  • to collect testimony from the employees, other counterparties, as well as documents from the governmental agencies
  • to collect media reports
  • to perform other actions stipulated by the contract

Review your contracts and take into account the current situation when concluding new contracts

You can find our detailed analysis here (in Ukrainian). It contain specifics for the following groups of contracts:

  • rent and real estate
  • construction and subcontracting
  • delivery and distribution

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