The covid-19 pandemic affects, more or less severely, the most varied sectors of the economy, preventing or generating difficulties for companies and individuals in fulfilling their contracts. In this situation, what are the applicable legal solutions?

 

Although a pandemic like this one is an unusual experience for Brazilians, the law, in the course of its very long historical evolution, has developed, as a response to crises and troubled periods, institutes to regulate problems of this nature. These institutes deal with the problem of supervening changes in contractual circumstances and their effects on contractual relations as a means of softening the harshness of the traditional principle pacta sunt servanda ("contracts must be performed").

 

In current Brazilian civil law, the following institutes are more commonly employed: theory of unpredictability, excessive burdensomeness, acts of God, and force majeure.

 

We explain each of them below, indicating their legal basis and the practical consequences of their application:

 Theory of unpredictability

Requirements

Consequences

Law: provided for in the first part of article 317 of the Civil Code ("Where, for unforeseeable reasons, there is a manifest disproportion between the value of the benefit due and that at the time of its performance [...]").

Law: provided for in the second part of article 317 of the Civil Code ("[...] the judge may correct it, at the request of the party, in order to ensure, as far as possible, the real value of the consideration").

Legal Scholarship:

·       Long-term agreement:

·       Unpredictability of the supervening event: it cannot be part of the ordinary risks of the contract (an epidemic is considered to be an unpredictable event by much of the legal scholarship).

·       Absence of delay by the party requesting application of the theory.

·       Breaking the contractual balance in such a way as to cause manifest disproportion between the value of the service due and that at the time of its performance.

·       There is legal scholarship that argues that article 317 of the Civil Code functions only to allow correction of the value of the obligations in a period in which the Judiciary did not recognize the legality of adjustment for inflation, a function that lost its meaning after the inclusion of various provisions that make adjustment for inflation mandatory.

Legal Scholarship:

·       In view of the extreme difficulty in fulfilling the contract, the value of the contractual consideration may be revised.

Case Law:

·       Case law does not usually distinguish between the theory of unpredictability and excessive burdensomeness.

·       The same as in the legal scholarship, sometimes also demanding the requirements of excessive burdensomeness.

·       Relevant case: faced with the common scenario of macroeconomic crises in Brazil, case law has already recognized change in currency, inflation, foreign exchange rate variation, rapid devaluation, economic crisis, increase in public deficit, and increase in rates may not be considered unpredictable facts.

Case Law:

·       Review of the value of contractual consideration or application of the consequences of excessive burdensomeness.

·       Relevant case: maintenance of the obligation, without revision or termination of the contract.

Excessive burdensomeness

Requirements

Consequences

Law: provided for in the first part of article 478 of the Civil Code ("In contracts of continuous or deferred performance, if the performance of one of the parties becomes excessively burdensome, to the extreme advantage of the other, as a result of extraordinary and unforeseeable events [...]").

Law: provided for in the Civil Code, in the second part of article 478 ("[...] the debtor may request termination of the contract. The effects of the judgment which decrees it shall be retroactive to the date of the summons"), in article 479 (“Termination may be avoided by offering the defendant an equitable modification of the conditions of the contract.”) and in article 480 (If the obligations in the contract are assigned to only one of the parties, it may petition to have its consideration reduced, or change the means of performing it, in order to avoid excessive burdensomeness.).

Legal Scholarship: The same as the theory of unpredictability, with the addition of the following requirements:

·       Extreme advantage for one party arising from an unpredictable and extraordinary event; and

·       Excessive burdensomeness for the counterparty, arising from the same unpredictable and extraordinary event.

In the case of consumer relations, the unpredictability of the supervening fact is not necessary, and the excessive burdensomeness for the consumer is sufficient (also called the theory of the objective basis of the deal).

Legal Scholarship:

·       Faced with extreme difficulty in fulfilling the contract, first of all, an attempt is made to revise the contract (with the possibility for the defendant to change the conditions of the contract equitably) and, if revision is not possible, the contract is terminated.

Case Law:

·       The same as the legal scholarship.

·       There are no concrete cases of application of the theory because of an epidemic (due to factual absence, not necessarily because case law does not consider an epidemic to be an unpredictable event).

·       Relevant case I: leasing contracts affected by sudden devaluation of the Brazilian Real in January of 1999 and significant appreciation of the U.S. dollar, impairing the consumers' ability to meet their obligations (theory of objective basis of the deal).

·       Relevant case II: contracts for the purchase and sale of future soybean crops affected by "Asian rust" - variations in the project price are foreseeable facts.

Case Law:

·       Same as provided for by the legal scholarship.

·       Relevant case I: excessive burdensomeness equally shared between the parties.

·       Relevant case II: the sale of a future crop, at the right price, in a short period of time, had to be fulfilled by the parties, without revision or termination of the contract.

Acts of God and force majeure 

Requirements

Consequences

Law: provided for in the sole paragraph of article 393 of the Civil Code (“Acts of God or force majeure occur in necessary facts, the effects of which could not be avoided or prevented.”).

Law: provided for in the head paragraph of article 393 of the Civil Code ("The debtor shall not be liable for damages resulting from acts of God or force majeure, if he has not expressly assumed liability for them").

Legal Scholarship:

·       Supervening and necessary fact, not attributable to the party.

·       With inevitable effects.

·       Legal scholarship diverges on whether or not unpredictability is a requirement.

·       Distinction between internal unforeseeable circumstances/acts of God (related to the risks of the party's activity) and external unforeseeable circumstances/acts of God (independent of the risks of the party's activity).

Legal Scholarship:

·       Faced with the impossibility of fulfilling the obligation, the prejudiced party is not liable for the breach.

·       Internal unforeseeable circumstances/acts of God: there is no exoneration from liability; external unforeseeable circumstances/acts of God: there is exoneration from liability.

 

Case Law:

·       If the risk of an epidemic is part of the party's activity, there are no acts of God or force majeure (e.g. hospital activities).

·       However, there is no precedent for a pandemic like the coronavirus, which affects all economic sectors.

·       Relevant case: truckers' strike (May/2018) qualified as a situation of force majeure/external unforeseeable circumstances/acts of God, when the causal link between the strike and the impossibility of fulfilling the obligation is proven.

Case Law:

·       There is no automatic right to revise or terminate the contract. The duration and impact of acts of God or force majeure, as well as the contract's provisions on the issues, must be ascertained.

·       Relevant case: exoneration from liability of the party due to breach of an obligation (in relation to the most varied of consequences. E.g. exemption from payment of a penalty and payment of damages).

 

 

This is a very simplified overview of the institutes, just to provide a first explanation. The problem of change in circumstances, due to their exceptional nature, obviously always depends on a circumstantial analysis. In a more analytical manner, the problem depends on several factors, such as:

  • Nature of the contract: long or short term; type of contract; nature of the obligations agreed upon (of means, outcome, or guarantee); whether the contract is arm’s length or random.
  • Existence of terms and conditions on the subject.
  • The branch of law applicable to the contract: whether subject to civil law, consumer law, labor law, administrative law, etc.
  • Branch of activity of the party to the contract affected by the change in circumstances.
  • Determination of the real impact of the new circumstances on the ability of the party to the contract to fulfil its obligations.
  • Whether or not alternatives exist so that, despite the new circumstances, the party to the contract will continue to fulfil its obligations.
  • Determination in the light of the law, especially objective good faith, to verify whether the measures taken by the party to the contract may be considered reasonable, either to continue to fulfill its obligations to the extent possible, or to protect other interests (for example, the health of its employees).

The implementation of each institute leads to different effects. In the case of the unpredictability theory, the result that can be achieved is, in principle, revision of the contract values, with the objective of re-establishing the economic balanced damaged by the event. For excessive burdensomeness, the request made by the affected party is for termination of the contract (or, in the case of contracts that generate obligations only for one of the parties, revision of the contract), with the other party being able to offer adjustments to the contract in order to maintain the obligation, but on new bases. Finally, for force majeure, the result is, first, release from liability for breach of contract and, second, suspension of performance of the obligation or termination of contract, depending on whether the impediment is temporary (i.e. it lasts for a period that, after exceeding its effects, the parties still have an interest in performance of the obligation) or definitive (the effects last for a period that makes the contract engagement impossible).

 

Another area in which the institutes described above will have various effects is that of administrative contracts. There are many species in this genus governed by different laws and, therefore, they should be treated on a case-by-case basis. In any case, the general rule of Brazilian administrative law (embodied in article 37, subsection XXI, of the Federal Constitution and article 65 of Law No. 8,666/93) points to the fact that, in the case of an unforeseeable event or, even, a foreseeable event but with incalculable consequences, the Government will be responsible for the economic and financial rebalancing of the contracts. That is, even if the event could be classified as pertaining to the institutes of the theory of unpredictability, excessive burdensomeness, or force majeure, the consequence will be the assumption of damages by the Government and not sharing between the parties, as happens in contracts governed by private law.

 

The different treatment of administrative contracts, which may seem more favorable to private parties, is based precisely on the fact that, when participating in a bidding process, the private party prices its contract within conditions of risk, but not of total uncertainty caused by events of an unpredictable or foreseeable nature, but of incalculable consequences. Thus, the pricing of contracts depends on the assumption of uncertainties by the Government, since, otherwise, it would not be possible to choose a winning bid. In addition, private entities that contract with the Government are also subject to contractual amendments and assumption of burdens, due to the power of unilateral amendment of contracts and continuity in the provision of services even under adverse financial conditions, to which private entities are not subject in their relations with each other. Consequently, rebalancing is the protection of private parties who contract with the Government.

 

This general rule has been given its own treatment in public service concession contracts, governed by Law No. 8,987/95 (common concessions) or by Law No. 11,079/04 (PPPs). Because they are long-term contracts, they provide for their own risk allocation. However, even in this type of administrative contract, force majeure events, especially those not insurable, tend to be allocated to the Government, following the rule that total unpredictability should be allocated to the Government. Public services in general will therefore suffer a sensitive and, in all likelihood, unprecedented impact due to the pandemic. It is easy to note some sectors that will be even more affected, such as public passenger or cargo transportation service providers, logistics infrastructure operators (highways, airports, railways, and ports) and health service providers, among others.

 

Thus, if due to measures of loss of demand or increased obligations, with the adoption of new protocols and work shifts to attend to the state of emergency decreed by the Federal Government, by many states, and by some municipalities, it is a fact that the unpredictable pandemic will generate consequences that cannot be addressed without rebalancing of agreements with the Government. The form and intensity of each rebalancing will depend on the identification of the impact and nature of the service.

 

Therefore, at the present time, depending on the circumstances of each contract, all the above institutes may be applicable for contracts whose performance has been substantially impaired by covid-19.

 

In relation to new contracts signed with knowledge of the effects of covid-19, it is very important that the parties explicitly address, and, if possible, in detail, the allocation of the risks of the pandemic. For them, the possibility of contractual revision based on the above-mentioned institutes, especially the theory of unpredictability and excessive burdensomeness, will be reduced due to the predictability of the economic and social effects of the crisis.

 

This article serves as initial guidance regarding the problem, and does not avoid the need to analyze the concrete circumstances of each situation under consultation.