Hardship clauses in international contracts during the Covid-19 pandemic
The unexpected developments during the Covid-19 pandemic have led to economic hardship for one contracting party in numerous contractual relationships. Supply chains are interrupted, event venues are empty, the purchase of seasonal goods becomes economically unattractive due to a lockdown. This naturally leads to a tension between the principle of contractual compliance (pacta sunt servanda) and the desire of the disadvantaged party to restore the economic balance expected at the time of the conclusion of the contract or to withdraw from the contract. This tension is not new. In German law, it is legally regulated by concepts such as impossibility (the mutual performance obligations cease) and disruption of the basis of the contract (the performance obligation is adjusted up to the possibility of termination) (see the article by our partner Janik Goßler: Impossibility and force majeure - possible legal implications of the coronavirus epidemic).
Force majeure and hardship clauses (collectively referred to here as hardship clauses), have become prevalent in international contracts in this context. The pandemic raises new issues in the application of these clauses, which are increasingly also dealt with by arbitral tribunals.
Is the Covid-19 pandemic covered by force majeure and hardship clauses?
If a case of hardship occurs, the contracting party affected first has to clarify whether the agreed clauses cover the case of the Covid-19 pandemic, i.e. whether the pandemic or related government measures are “trigger” events that allow invocation of the hardship clauses. Insofar as clauses explicitly mention “pandemics”, this question is usually easy to answer. “Natural disasters” and “official orders” can also cover the Covid-19 pandemic.
The scope of application of the clauses is to be determined in each individual case through contractual interpretation – and thus left to the assessment of the arbitrators. The arbitrators’ background and the handling of hardship cases in their respective national law may have an influence on the interpretation. In common and civil law jurisdictions, force majeure and hardship concepts are sometimes very different. Therefore, there is much to be said in favour of arbitral tribunals having to interpret hardship clauses autonomously, i.e. starting from a conclusive provision in the agreed clause, which in principle excludes recourse to statutory dispositive provisions. In this context, when agreeing on hardship clauses in international contractual relationships it is advisable to choose a formulation of the prerequisites of corresponding clauses that is as comprehensive, clear and adapted to the contractual situation as possible.
Are the requirements of force majeure and hardship clauses met in Covid-19 pandemic cases?
So far, there are no published ICC arbitral awards on hardship clauses in the context of the Covid‑19 pandemic. Experience shows that “hardship clauses” in international arbitration are only accepted under strict conditions.
In particular, hardship clauses usually require the developments that have occurred to be unforeseeable. With regard to the unforeseeability of the Covid-19 pandemic, 11 March 2020 will be a relevant date, as on that day the Director-General of the WHO officially classified the Covid-19 outbreak as a pandemic due to the rapid rise in the number of cases outside China in an increasing number of countries.
In addition, the party affected can normally only invoke the hardship clause if it is seriously impaired by the pandemic or the resulting government measures. A mere increase in the costs of implementing the contract is usually not sufficient. There are no fixed limits as to when a “case of hardship” is to be assumed, if only because the markets differ greatly and are constantly evolving. In this respect, the arbitral tribunal has discretion in its assessment. These economic questions usually have to be clarified in arbitration proceedings with the help of experts.
It is important for the party affected to notify the contractual partner of the occurrence of a case of hardship in a timely manner and to take into account the agreed contractual notification procedure. In order to fulfil its own duty to minimise damage, the party affected should also do everything possible to keep the damage to a minimum.
What legal consequences, if any, result from the hardship clauses?
The legal consequences of a force majeure or hardship event depend on the contractual provisions, as do the prerequisites. Contracting parties from civil law jurisdictions more often agree in their contracts on an adjustment of the contract. In common law jurisdictions, on the other hand, the relevant contractual clauses usually provide for the option of terminating the contract. Recently, adjustment clauses have also been seen in some cases. A renegotiation obligation is also conceivable. It is naturally difficult for an arbitral tribunal to adjust a contract, as this always involves economic assessments. The contractual distribution of risks between the parties must also be taken into account. In any case, an adjustment must never lead to a better result for one party than the original contract.
The circumstances described should be taken into consideration when assessing claims in the current situation and, as far as possible, when negotiating hardship clauses. We will be happy to advise you in this respect.
Any questions? Please contact: Meike von Levetzow or Dr Morris Besch
Practice Group: Arbitration