The impact of Coronavirus (COVID-19) on the real estate sector - force majeure, hardship and other related topics
In the context of the World Health Organization declaring COVID-19 as a pandemic, the legal ramifications of this outbreak and the consequences on contractual relationships have become the most common issue faced by our clients in the real estate sector.
Notwithstanding that the parties may restrict, or even exclude, the application of the force majeure or the hardship provisions, we have set out below some of the most frequently asked questions by our clients in the current climate.
1. What is Force Majeure?
Force majeure is an event that transcends the control of a party entering into an agreement, which can lead to an exemption from liability to perform a contractual obligation, under certain circumstances.
Most contracts contain provisions that regulate the force majeure by identifying those events that can be construed as force majeure, together with the related consequences, such as: limitation of liability following the occurrence of a force majeure event, remedy obligation, obligation to notify or the right to terminate the agreement after the elapse of a specific time period.
If the agreement does not contain specific provisions, the parties will refer to the provisions of the Romanian Civil Code, more precisely Article 1351, which defines the force majeure as "any external, unforeseeable, absolutely unavoidable and inevitable event".
1.1. Is the Coronavirus pandemic (COVID-19) a force majeure event?
Although COVID-19 is not the first pandemic flu, it is certainly unprecedented due to its rapid spread and the measures that have been adopted by the governmental/local authorities to enforce certain restrictions, such as cancelling or prohibiting those events that exceed a specific number of people, shutting down public places, as well as the impact on economic and social life.
When the agreement contains a force majeure clause, in order to answer this question, reviewing the wording of such a clause is a priority before going further into the topic.
If there is no explicit force majeure clause, then Article 1351 of the Romanian Civil Code is applicable and, therefore, the conclusions set out below must be taken into account.
Is COVID-19 an external, unforeseeable, absolutely unavoidable and inevitable event?
The pandemic is, indeed, an external event and beyond the parties’ control.
As regards its foreseeability by the parties at the signing date of an agreement which precedes the occurrence of the force majeure event, a more complex review is required. In theory, such outbreaks might be seen as a foreseeable event, given their occurrence during the last decade (e.g. SARS, avian flu). Nevertheless, considering the magnitude of COVID-19, the fact that its spread could not have been foreseen, as well as its "pandemic" rating and the force majeure treatment applied by the Chambers of Commerce in China and Italy, we believe that there are solid grounds for COVID-19 to be described as a force majeure event in Romania as well.
The avoidability of this pandemic raises the question of whether the impact of this event could have been avoided if the parties had taken certain measures. The mere existence of a precarious economic and social situation caused by COVID-19 that would cause the performance of the contractual obligations to be more onerous, does not suffice for such situation to be described as an event of force majeure. The affected party should prove that it had no alternative means to fulfill its contractual obligations due to the outbreak of COVID-19 and that it had used all reasonable endeavors to mitigate the effects of this pandemic, to prove that this event is, indeed, an event of force majeure.
Invoking the force majeure without a prior rigorous review will expose the party to significant risks, such as triggering penalties or even termination of the agreement.
Last, but not least, apart from a legal dispute which leads to a court decision, the force majeure can also be proven through a certificate of force majeure issued by the Chambers of Commerce and Industry of Romania (for more details you can access the following link.
1.2. The legal implications when invoking the force majeure in a lease agreement
Successfully invoking the force majeure allows the lessor/lessee, who is unable to perform its obligations, to be temporarily or permanently released from liability due to the non-observance of its contractual obligations.
Thus, the lessors may invoke the force majeure in order to be discharged from liability when, due to COVID-19, they have insufficient staff to ensure the provision of all the services under a lease agreement (eg. the situation of a commercial centre).
In turn, lessees despite what one may think at the first sight, may not invoke force majeure in order to be exempted from paying rent, as the Romanian Civil Code precludes, in principle, the right of a party to invoke force majeure in relation to obligation having as object gender goods (res certa), such as money.
Nevertheless, retail lessees could invoke the force majeure event, for instance, in order to be released of any liability for not keeping the premises open to the public (due to a decision of the authorities to suspend the activities of the retailers, as measure for preventing the spread of Corona virus), pursuant to the lease agreement terms.
With respect to the built-to-suit type of lease agreements, the lessors (acting also as entrepreneurs) can rely on the force majeure when, due to the COVID-19 outbreak, they do not have sufficient staff to perform the construction works, causing possible delays (non-culpable) in their performance and, by implication, delays in handing over the premises to the lessees.
Moreover, we note that the impossibility of fulfilling the contractual obligations may lead either to the termination of the agreement (should the impossibility of performance be final and total or should the creditor decide such due to a temporary impossibility of performance by the debtor), or to the suspension of the agreement for a reasonable term (should the creditor decide to suspend the performance of its own obligations following the temporary impossibility of performance by the debtor).
The Romanian legislation, more precisely Article 1271 of the Civil Code, allows in cases of exceptional changes of the circumstances that led to the execution of the agreement and which result in an excessively onerous performance by one party (who had not assumed such risk) to initiate renegotiation discussions with its counterpart or even require, under certain conditions, the intervention of the court to adapt the contract in order to distribute equitably between the parties the losses and benefits caused by the hardship situation.
Thus, in the event the conditions of the force majeure are not met in their entirety, the interested party is still entitled to request renegotiation/adjustment of the agreement, unless they have expressly assumed the risk of hardship.
It should be highlighted that hardship, unlike force majeure, does not exempt the debtor from fulfilling its obligation, but balances the contractual relationship in the event the respective obligation has become excessively onerous.
3. What are the implications of the suspension of traders’ activity?
In the context that the authorities of the countries affected by the COVID-19 outbreak have taken measures to suspend the activities of traders in order to counter and prevent the spread of the virus, and that the President of Romania has announced a state of emergency as of Monday 16 March, this represents another common issue raised especially by our clients carrying out activities within commercial centres in Romania.
If, until this moment, the applicability of the force majeure due to COVID-19 is uncertain, and if the Romanian authorities take action to suspend commercial activities, closing the shopping centres, restaurants or other similar units, then it can be reasonably determined that we are in the presence of a force majeure event, in which case the above advice becomes applicable.
With reference to the lease agreements entered into by the traders in the course of their business, one issue which arises is the impossibility of using the asset, the very object of the agreement, and the consequences of this, as per Article 1818 of the Civil Code.
When reviewing the relevant Romanian case law, we can see that most of the cases involving the impossibility of using the asset covers those situations when the asset was destroyed, requisitioned, expropriated or confiscated. However, we do not exclude the application of these provisions in situations where the impossibility of using the asset is due to measures taken by the Romanian government or local authorities in suspending the activity of the shopping centres, the very object of such lease agreements, in which case it would lead to an impossibility.
Thus, as per the provisions of Article 1818 of the Civil Code, the impossibility of using the asset can lead to:
rightful termination of the lease agreement if the asset can no longer be used as intended by the lease agreement ; or
a pro-rata decrease of the rent or the unilateral termination of the agreement, but without the right to claim any damages (this choice being at the lessee’s discretion), in cases where the impossibility of using the asset is partial. Such a scenario could be, for instance, the reduction of the operating schedule in a shopping centre, in which case the lessee would have these two remedies available.
4. What do you need to check in the agreements before proceeding to the above?
the definition of force majeure considering that it can often be exhaustive and different to the legal provisions;
whether the parties have determined they will remain responsible despite a force majeure or hardship event;
the conditions that must be met for the force majeure to be applicable (it is often applicable, for example, only after the elapse of a certain time period);
whether the obligation to notify the other party within a certain time period of the occurrence of the force majeure event is specified, subject to losing the right to benefit from the force majeure effects;
the evidence to be provided in case of an event of force majeure (for example, by a certificate issued by the Chambers of Commerce and Industry).
Therefore, the party's right to invoke the force majeure or the hardship provisions in the context of the confusing social-economic situation caused by the COVID-19 pandemic, must be considered on a case by case basis.
Traders should assess the economic implications this pandemic may have with a long-term perspective, by identifying relevant protective measures.
5. The possibility of including a business interruption insurance policy
A potential option to mitigate the risks caused by the interruption of business by unforeseen events, and one which is often considered by businesses, is taking out business interruption insurance. Generally, these insurance policies are obtained in order to compensate for any potential loss of income, or decrease in turnover, caused by a temporary interruption of business, including where the interruption is due to orders/measures taken by the authorities, or for the purpose of maintaining workforce stability or in the event that employers are forced to apply specific corporate and human resources policies.
Such insurance policies are not at all foreign to the real estate sector, being obtained by businesses either voluntarily or for fulfilling contractual obligations (for example, in many cases, landlords impose contractual obligations on tenants to obtain such insurance policies and to maintain them throughout the entire term of the lease agreement).
Many would think that such insurance policies would cover potential losses caused by the COVID-19 pandemic. However, whilst such an event is not excluded, most insurance policies on the current market generally exclude diseases or epidemics from the risks that are covered. Also, usually, the policies that do cover such events expressly state that, in order for the insurance to be effective, the covered disease or epidemic must actually be happening, as opposed to just imminent or speculative.
Therefore, when evaluating the economic impact of the COVID-19 pandemic, traders should assess, on a case-by-case basis, the express provisions of the insurance policies and, in cases where the risks related to diseases or epidemics are excluded, to consider renegotiating the contractual terms of their existing policies or obtaining new policies, covering, for example, the following risks:
- the costs incurred in relation to cleaning and disinfecting a contaminated property (e.g, contaminated premises within a shopping centre); and
- business interruption arising from decisions taken, and orders given, by the Romanian local or government authorities in order to prevent the spread of the virus.
Such an approach should be considered especially given that, in the current context of the spread of COVID-19, the Insurance Services Office (ISO) has recently drafted two communicable disease coverage insurance policies which. when issued, will cover the risks resulting from the interruption of the traders’ business at the insured location, as a result of any imposed quarantine or as a result of any preventative measures taken by the authorities in order to limit the spread of the virus.
6. Final considerations
Consequently, in the current COVID-19 situation, whether businesses can invoke, or not, the rights arising from force majeure or hardship provisions, should be considered on a case-by-case basis, after a thorough assessment of the facts and of the applicable contractual provisions. Furthermore, those traders whose businesses have been affected should verify, through their specialised consultants, whether any interruptions in sales, provision of services or personnel limitations can, in any way, impact upon other obligations or rights, such as financing facilities, purchases, sales in progress or potential insurance policies.
For further information, please contact:
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