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Contract law:
Effects of the COVID-19 Pandemic on the performance of Supply and Service Agreements

Issues in delivery or performance due to prohibitions or bottlenecks
The COVID-19 pandemic has led to extensive quarantine measures, bans on events and disruptions in the supply chain. In all these cases, the question arises whether the supplier will be temporarily or permanently released from its obligation to perform, whether it can nevertheless demand immediate payment from the customer or, conversely, whether the customer can even demand compensation for loss of profit due to non-delivery. In order to answer these questions, it is, first of all, decisive what the parties have agreed upon in the contract. Where German law is applicable to the contractual relationship, the provisions of the German Civil Code (BGB) and - in the case of international delivery relationships - the UN Convention on Contracts for the International Sale of Goods are relevant.

What rights exist in the event of a delay in performance of the primary obligation?
Not every bottleneck due to the corona virus immediately leads to delay and thus to liability of the supplier towards its customer. The supplier is only in default with its primary contractual obligation in accordance with § 286 para 4 BGB if its performance fails due to a circumstance for which it is responsible. It must therefore be examined in each individual case which contractual obligations the supplier has assumed towards the customer, in the case of delivery relationships in particular whether it has assumed the procurement risk. It is often the case that the supplier suffers from delays in performance by its own suppliers as a result of the COVID 19 pandemic. In such cases, the supplier is not responsible for its own delay in performance, unless it has assumed a special performance guarantee.

Although this does not usually mean that the supplier directly risks an obligation to pay damages in the event of a supply bottleneck as a result of the corona virus, it is urgently recommended that each supplier inform its customers as early as possible about the reason and extent of its own supply bottleneck. Information should also be provided in case a performance could fail to materialise completely. Otherwise, there could be a risk that a court would consider the failure to provide information as an independent breach of duty on the part of the supplier, who could therefore be liable to pay damages to the customer if the customer, trusting in a timely or later scheduled performance, had made further arrangements which he would not have made if he had been given adequate information.

The prerequisite for a delay in performance without fault is, however, that it is still possible to render performance at a later date. In the event of disruptions to the supply relationship as a result of the COVID 19 pandemic, in numerous constellations it is no longer possible for the supplier to render performance.

When is impossibility of performance assumed?
Possibly, the supplier may be completely exempted from the primary obligation to perform due to impossibility of performance (§ 275 BGB). In the absence of any other contractual agreement, this would have the consequence that the supplier would lose its claim to the consideration (§ 326, para 1, s 1 BGB) and, without fault, no compensation for loss of profit could be claimed.

In cases of disruption of performance as a result of the COVID-19 pandemic, the claim for performance can be excluded in three situations: (1) According to § 275 para 1 BGB the claim is excluded if performance is impossible for the debtor or anybody else. (2) According to § 275 para 2 BGB the debtor may refuse performance if it requires an effort that is disproportionate to the obligee's interest in performance. (3) Finally, the debtor may refuse to render a performance for which he is personally responsible if, after weighing up the obstacles to performance and the interest in performance, it cannot reasonably be expected of him, § 275 para. 3 BGB.

Objektive Unmöglichkeit bei behördlichen Verfügungen
A case of § 275 par 1 BGB always exists if an authority or a state has prohibited the contractual performance by sovereign authority and the performance cannot be provided at a later date. This is always the case with so-called just-in-time transactions or precisely scheduled events, where the contract stands and falls with the adherence to the time of performance. In this case, the supplier is also no longer able to perform at a later date, but the customer is consequently also released from his obligation to perform in return (§ 326 para. 1 s. 1 BGB).

The customer may, according to § 326 para. 4 BGB in connection with §§ 346 et seq. BGB reclaim any performance already rendered. Therefore, for example, in the case of an officially ordered ban on an event, the performance is legally impossible, which is why payment does not have to be made or is to be refunded.

If such an absolute fixed transaction is not present, but it is only temporarily impossible to perform, then the claim to performance and consideration is generally retained. However, there is a risk that the customer may withdraw from the contract after a reasonable grace period (§ 323 para. 1 BGB).

Economic unreasonableness due to COVID-19 pandemic
A case of § 275 par 2 BGB can always occur as a result of the COVID 19 pandemic if the supplier is able to render performance but, as a result of the COVID 19 pandemic, requires such expenditure that the service is no longer economically reasonable for the supplier. Case-law determines such cases according to the so-called "victim limit" on the basis of the structure and content of the contractual agreements. Only if the "victim limit" is exceeded, the supplier may refuse performance. This is ultimately always a matter for individual consideration and must be examined in each case.

Impossibility with personal obligation to perform
The third case of impossibility is the impossibility of performance to be provided personally by the supplier. This is particularly the case with service and employment contracts. The questions arising in this context are answered in our special newsletter on employment law issues. However, the authorities do not always issue strict bans, but can, for example, issue conditional permits or simply make recommendations. Especially in the latter case, the supplier affected by the recommendation must decide for himself how to proceed. In such a case, an impossibility should be ruled out. Ultimately, therefore, the actions of the authority in the specific case must also be included in the assessment of an impossibility.

What are force majeure clauses?
In some contracts, the distribution of risk is modified at the expense of the customer by so-called force majeure clauses. Such clauses often provide that the customer, in the event of temporary impossibility, must adhere to the contract for a longer period of time, must tolerate a postponement of performance or that the obligation to pay consideration be upheld despite the supplier’s release. In the past, courts have classified the outbreak of pathogens as force majeure, for example in the case of the outbreak of the SARS virus or the spread of cholera. Another question is whether such force majeure clauses are subject to an examination by the law on general terms and conditions and whether they stand up to the law on general terms and conditions. The extent to which clauses are invalid, for example because of unreasonable discrimination against the contractual partner, cannot be answered in a general way, but depends on the wording and content of the respective clause. In principle, a force majeure clause is only valid if it is in line with the basic ideas of §§ 323 et seq. BGB as set out above.

What applies if the customer no longer has any use for the performance?
For companies affected by the COVID 19 pandemic, the question arises whether the customer has a right of withdrawal or termination due to "force majeure" if the performance is possible but no longer of interest. The organizer, who is no longer allowed to host an event due to an official prohibition, will try to cancel contracts with the landlord for the event location or other service providers. Exhibitors will attempt to cancel goods or services ordered for a cancelled event. If necessary, however, orders placed in completely different areas will also be cancelled, for example because demand has fallen drastically, the range of services offered in a bar, for example, can no longer be maintained and the service can no longer be used to the extent ordered.

Termination of the contract only possible under the doctrine of frustration of contract
There is no statutory exemption from the obligation to accept performance as an equivalent to exemption from the obligation to perform in the event of frustration of contract. Contracts will not normally contain any provisions in this regard. However, the customer may have the right to terminate or withdraw from the contract or to adjust the contract (if necessary postponement) via the legal instrument of the frustration of contract (§ 313 BGB) or termination due to unreasonableness (§ 314 BGB). This is the case if the customer cannot reasonably be expected to be bound to the unchanged contract due to a change in the circumstances or unreasonableness. Whether such a right exists will be decided on the basis of a weighing up of interests and a review of the allocation of risk in each individual case and will be determined according to the relevant type of contract.

Balancing of interests in individual cases
In principle, the customer bears the risk that he cannot use the ordered service due to unforeseeable events. However, exceptions have been permitted in the past. For example, the organiser of a carnival celebration was allowed to cancel the ordered band free of charge because of a frustration of contract, according to a judgement of the Higher Regional Court of Karlsruhe. In this case, the event was cancelled due to a local ban on events in connection with the first Gulf War. However, the music band participated in the proceeds to such an extent that it was more or less to be regarded as a co-organiser and was burdened with the risk of the population's willingness to participate in such events. It is therefore also not possible to give a general answer to the question of how the risk is distributed in the event of a frustration of contract based on the unsuitability of performances due to the corona crisis. On the basis of the legal instrument of frustration of contract, however, there may be a possibility in individual cases that performance need not be accepted if there is no longer any interest due to the corona crisis.

Timely setting of the course is decisive
All different types of contracts have one thing in common: the course for a successful assertion of one's own rights must be set in the right way at an early stage in order to avoid legal disadvantages. Mistakes in this early phase can easily lead to avoidable legal disadvantages later on. In particular, responsible managers should prepare their company for a potentially emerging crisis situation and take measures to minimise losses at an early stage. We would be happy to provide you with our expertise.

Your contact Persons:
Attorney
Dr. Hans-Georg Kauffeld
Tel.: +49 (0)711/22744-16
hk@haver-mailaender.de

Attorney, specialist attorney for international business law
Dr. Christian Aufdermauer
Tel.: +49 (0)711/22744-13
ca@haver-mailaender.de

Attorney, Attorney-at-Law (New York)
Kai Graf v. der Recke LL.M. (Boston)
Tel.: +49 (0)711/22744-41
kr@haver-mailaender.de

www.haver-mailaender.de